Are you across the ethics of investment management? Here’s how and why to keep your service provider accountable. (Reading time 3:10 mins)

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Throughout the course of history, the investment management industry has been plagued with ethics breaches. For most of these breaches, we were not only involved in close ethical misjudgments, but the lapses in judgment were significant, and the cost to investors was unspeakable.

The reason I say “we” is because ethical issues in investment management ­– and financial services more broadly – affect everyone. Even if you don’t work in the field, you’re a consumer of their services daily.

In this article we explore:

  • How ethics are defined
  • Why the breaches occur in the first place
  • High-profile violations of the past
  • The ethical code of conduct AtlasTrend adheres to in managing our client’s money.


How are ethics defined?

Ethics is a branch of philosophy that involves systemising, defending and recommending concepts of right and wrong conduct.

Ethics seeks to resolve questions of human morality by defining concepts such as good and evil, right and wrong, justice and crime. Not to be confused with Social Responsible Investing (SRI), investment ethics within the investment management industry predominantly covers the principal-agent relationship fund managers have with their clients.

Investment ethics can be defined as a list of moral guidelines, which set the standard for best practices within financial services.


Why do ethical breaches occur?

A common public perception of the financial services sector is that it’s inherently more unethical than other areas of business. The misconception persists for several reasons, some of which include:

  • Industry size: it encompasses securities firms, mutual funds, insurance companies and more. Because of its vast size, the industry garners lots of headlines, many of which focus on ethical lapses.
  • Highly regulated: financial services is highly regulated so it’s likely that a higher percentage of bad transactions are identified and reported, perhaps more so than in other less regulated and/or unregulated industries.

Ronald F. Duska and James A. Mitchell discussed why these misdeeds may happen at the meeting of the Business and Organisational Ethics Partnership in 2006.

  1. Self-interest sometimes morphs into greed and selfishness, which is unchecked self-interest at the expense of someone else.
  2. Some people suffer from stunted moral development, this can happen in three areas: the failure to be taught, the failure to look beyond one’s own perspective, and the lack of proper mentoring.
  3. Some people equate moral behaviour with legal behaviour, disregarding the fact that even though an action may not be illegal, it still may not be moral.
  4. Professional duty can conflict with company demands, take for example, a faulty reward system can induce unethical behaviour.
  5. Individual responsibility can wither under the demands of the client. For example, how many people expect their accountants to pad their expenses where possible, or expect their insurance agents to falsify their claims?


When ethics go out the window

Bernard L. Madoff Investment Securities

In 2009 Bernard Madoff, a well-respected and accomplished investment professional, admitted to running a sophisticated Ponzi scheme at his investment company. In doing so, he defrauded investors of over US$64 billion.

Madoff operated his fund by promising high, consistent results he was not able to achieve. He used money from new investors to pay off the promised returns to prior investors. Madoff pleaded guilty to multiple federal crimes of fraud, money laundering, perjury, and theft. He was sentenced to 150 years in prison, and a restitution of US$170 billion.


SAC Capital

SAC Capital, run by Steven Cohen, was one of the leading hedge funds on Wall Street with US$50 billion in assets under management at its peak.

A number of traders at the fund were charged with insider trading from 2011 to 2014, with former portfolio manager Mathew Martoma convicted of conspiracy and securities fraud. Eight former employees of the company were convicted in total.

SAC Capital agreed to pay a US$1.2 billion fine and stop managing outside money to settle the suit.


The Galleon Group

The Galleon Group, run by Raj Rajaratnam was a large funds management group with over US$7 billion in assets under management in 2009.

Rajaratnam was tipped off to an investment Warren Buffet was making in Goldman Sachs by Rajat Gupta, a former director at the investment firm. Rajaratnam reaped US$900,000 from the inside tip. Investigations revealed a similar pattern of trading with other stocks, uncovering a ring of insiders who supplied him with material information from which he was able to profit.

Rajaratnam was arrested along with five others for insider trading and fraud in 2009, found guilty on 14 charges, and sentenced to 11 years in prison in 2011. Over 50 people have been convicted or pleaded guilty in connection with the insider trading scheme.


A framework to avoid ethical pitfalls

We strongly believe in an ethical framework, which acts as a backbone for both our moral and ethical obligations to our clients. We believe that all asset managers should commit to global standards that outline the ethical and professional responsibilities of firms that manage assets on behalf of clients.

In the wake of high-profile investment scandals as at SAC Capital, the need for asset managers to demonstrate an unwavering commitment to a high standard of ethical and professional conduct is paramount.

We believe that ethical behaviour begins at the highest level of investment management organisations, requiring a consistent, company-wide approach to keeping investor protection and the professional conduct of managers as top priorities.

We have decided to adopt and abide by the CFA Institute Asset Manager Code across our organisation. The code outlines the ethical and professional responsibilities of investment management firms that manage assets on behalf of clients. By adopting and enforcing a code of conduct for our organisation, we demonstrate our commitment to ethical behaviour and the protection of our investor’s interests.

In summary, the CFA Institute Asset Manager code covers the following areas:

  1. Loyalty to clients – placing client interests before our own, preserving confidentiality, remaining independent and objective.
  2. Investment Process and Actions – prudence in managing client assets, not engaging in market manipulative practices, having a reasonable basis for investment decisions and following set mandates.
  3. Trading – not acting on material non-public information, giving priority to investments made on behalf of clients over personal interests and maximising client portfolio value by seeking best execution.
  4. Risk Management, Compliance and Support – accurate client correspondence, appropriate maintenance of records, appropriate risk management programs.
  5. Performance and Valuation – presentation of performance that is fair, accurate, timely and complete.
  6. Disclosures – regular communication with clients and appropriate disclosures of any conflicts of interest, fees and relevant firm operating policies.

While we don’t believe ethical scandals will ever be truly eradicated within financial services, we do believe that greater adoption of ethical standards such as the CFA Asset Manager Code will result in a stronger industry committed to the protection of investors interests.


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About Kevin Hua

Kevin Hua is a Co-Founder of AtlasTrend, an investment platform that makes it easy for anyone to learn and invest in trends impacting our world. Kevin has over 20 years experience in financial markets including as Senior Portfolio Manager at Atrium Investment Management and Stark Investments.