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2020 Curriculum CFA Program Level I Ethical and Professional Standards

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Introduction

As a candidate in the CFA Program, you are both expected and required to meet high ethical standards. This reading introduces ideas and concepts that will help you understand the importance of ethical behavior in the investment industry. You will be introduced to various types of ethical issues within the investment profession and learn about the CFA Institute Code of Ethics. Subsequently, you will be introduced to a framework as a way to approach ethical decision making.

Imagine that you are employed in the research department of a large financial services firm. You and your colleagues spend your days researching, analyzing, and valuing the shares of publicly traded companies and sharing your investment recommendations with clients. You love your work and take great satisfaction in knowing that your recommendations can help the firm’s investing clients make informed investment decisions that will help them meet their financial goals and improve their lives.

Several months after starting at the firm, you learn that an analyst at the firm has been terminated for writing and publishing research reports that misrepresented the fundamental risks of some companies to investors. You learn that the analyst wrote the reports with the goal of pleasing the management of the companies that were the subjects of the research reports. He hoped that these companies would hire your firm’s investment banking division for its services and he would be rewarded with large bonuses for helping the firm increase its investment banking fees. Some clients bought shares based on the analyst’s reports and suffered losses. They posted stories on the internet about their losses and the misleading nature of the reports. When the media investigated and published the story, the firm’s reputation for investment research suffered. Investors began to question the firm’s motives and the objectivity of its research recommendations. The firm’s investment clients started to look elsewhere for investment advice, and company clients begin to transfer their business to firms with untarnished reputations. With business declining, management is forced to trim staff. Along with many other hard-working colleagues, you lose your job—through no fault of your own.

Imagine how you would feel in this situation. Most people would feel upset and resentful that their hard and honest work was derailed by someone else’s unethical behavior. Yet, this type of scenario is not uncommon. Around the world, unsuspecting employees at such companies as SAC Capital, Stanford Financial Group, Everbright Securities, Enron, Satyam Computer Services, Arthur Andersen, and other large companies have experienced such career setbacks when someone else’s actions destroyed trust in their companies and industries.

Businesses and financial markets thrive on trust—defined as a strong belief in the reliability of a person or institution. In a 2013 study on trust, investors indicated that to earn their trust, the top three attributes of an investment manager should be that it (1) has transparent and open business practices, (2) takes responsible actions to address an issue or crisis, and (3) has ethical business practices. Although these attributes are valued by customers and clients in any industry, this reading will explore why they are of particular importance to the investment industry.

People may think that ethical behavior is simply about following laws, regulations, and other rules, but throughout our lives and careers we will encounter situations in which there is no definitive rule that specifies how to act, or the rules that exist may be unclear or even in conflict with each other. Responsible people, including investment professionals, must be willing and able to identify potential ethical issues and create solutions to them even in the absence of clearly stated rules.

Learning Outcomes

The member should be able to:

  • explain ethics;
  • describe the role of a code of ethics in defining a profession;
  • identify challenges to ethical behavior;
  • describe the need for high ethical standards in the investment industry;
  • distinguish between ethical and legal standards;
  • describe and apply a framework for ethical decision making.

Summary

  • Ethics refers to the study of making good choices. Ethics encompasses a set of moral principles and rules of conduct that provide guidance for our behavior.
    Situational influences are external factors that may shape our behavior.
  • Challenges to ethical behavior include being overconfident in our own morality, underestimating the effect of situational influences, and focusing on the immediate rather than long-term outcomes or consequences of a decision.
  • In any given profession, the code of ethics publicly communicates the established principles and expected behavior of its members.
  • Members of a profession use specialized knowledge and skills to serve others; they share and agree to adhere to a common code of ethics to serve others and advance the profession.
  • A code of ethics helps foster public confidence that members of the profession will use their specialized skills and knowledge to serve their clients and others.
  • High ethical standards always matter and are of particular importance in the investment industry, which is based almost entirely on trust. Clients trust investment professionals to use their specialized skills and knowledge to serve clients and protect client assets. All stakeholders gain long-term benefits when investment professionals adhere to high ethical standards.
  • Rules and laws often codify ethical actions that lead to better outcomes for society or specific groups of stakeholders.
  • Organizations and individuals generally adhere to legal standards, but legal standards are often created to address past ethical failings and do not provide guidance for an evolving and increasingly complex world.
  • Legal standards are often rule based. Ethical conduct goes beyond legal standards, balancing self-interest with the direct and indirect consequences of behavior on others.
  • A framework for ethical decision making can help people look at and evaluate a decision from different perspectives, enabling them to identify important issues, make wise decisions, and limit unintended consequences.

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