Level 1 CFA® Exam:
Ethics & Trust
Trust = when you believe – strongly! – that a person or an institution is reliable and trustworthy
Ethics (from Greek ethos, i.e. character) = set of moral principles and rules that guide our conduct
Some More Definitions
Moral/ethical principles = beliefs that juxtapose the good, acceptable, and thus obligatory with the bad, unacceptable, and thus forbidden (these beliefs define our principles and form our values)
Situational influences = external factors, such as environmental or cultural elements, that shape (and may compromise) our thinking, decision making, and behavior
Occupation = doing a job that helps you earn your living
Profession = practicing occupation at the highest level possible, where devotion and true efforts – also to create ethical standards for the profession – are present
Code of ethics = provides general guidance and publicly communicates the established principles and expected behavior
Standards of conduct = more explicit rules that explain the code of ethics in more detail and help to interpret its principles by providing benchmarks for minimally acceptable behavior
Violation = lack of adherence to the code of ethics and standards of conduct established by the organization
Many think that ethical conduct is the equivalent of following relevant laws and rules. However, often there are no established laws or rules to appropriately regulate a situation.
Ethical conduct stems from the ability to identify potential ethical issues and come up with ethical solutions. In the context of ethical conduct, we can talk about the following 3 concepts:
- true ethics,
- good ethical judgment, and
- ethical action in an investment environment.
True ethics is about making good choices even in the absence of appropriate rules or laws.
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To earn investors’ trust:
- transparent business practices should be in place,
- professionals should act responsibly when there’s an issue or a conflict to address.
Organizations should make sure that the code of ethics and standards of conduct (if applied) are clearly displayed and easily available to its members. Members of the organization should obey the applicable code of ethics and standards of conduct.
Let's recall the definition of a violation here:
Violation = lack of adherence to the code of ethics and standards of conduct established by the organization
Violations can be harmful to the organization in many different aspects. They can damage its reputation, both externally and internally. Importantly, committed violations reduce trust!
In the wake of a violation, the organization should:
- investigate the violation
- take corrective actions (also to investigate possible violations),
- make disciplinary regulations and/or take actions against the violator.
There are many different challenges to ethical conduct that may affect our conduct and lead to faulty decision making. As psychological studies explain, we tend to believe in the morality of our own behavior and overlook the impact of various situational influences such as social pressure or challenged behavior in the presence of other people. In the face of self-interest and the lure of profit, we are more likely to shift our brains from long-term to short-term consequences (e.g. individual bonus or promotion). All this may induce unethical behavior even in people who think of themselves as ethical.
Situational influences = external factors, such as environmental or cultural elements, that shape (and may compromise) our thinking, decision making, and behavior
Situational influences may have both positive and negative impacts, e.g. presence of other people may induce loyalty but it may also mean choosing a compromised course of action.
Because of the nature of the client relationship, differences in knowledge and access to information, and the nature of investment products and services, ethical conduct and trust are particularly important in the investment industry.
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The harmful impact of unethical conduct is that it destroys trust!
Investors are less willing to accept risk and demand higher returns, invest elsewhere, or do not invest at all.
Borrowers need to face a higher cost of seeking capital, inability to meet their goals, as well as the reduction in jobs, growth, and innovation.
Types of conduct:
- legal but unethical (in some jurisdictions e.g. trading while in possession of material nonpublic information or whistleblowing)
- ethical but illegal (in some jurisdictions e.g. civil disobedience or peaceful protests)
- both ethical and legal
Generally, the law is not the best way to deal with unethical conduct because it:
- often reflects market practices,
- takes time to react,
- varies across jurisdictions,
- will never be able to account for all possibly problematic situations,
- is rule-based and subject to interpretation.
A good decision-making framework is meant to (i) evaluate a decision from different perspectives, (ii) identify important issues, (iii) help make wise decisions, and (iv) limit unintended consequences. It also exercises good judgment and decision-making skills. There should be a correlation between the company’s ethical code and decision-making framework.
A good decision-making framework should be iterative and it should be possible to approach the process in a different order.
4 Steps of Ethical Decision Making Framework
- Identify: relevant facts, stakeholders, duties owed, ethical principles, conflicts of interest.
- Consider: situational influences, additional guidance, alternative actions.
- Decide and act.
- Reflect: was the outcome as anticipated? why? why not?.
CFA Institute is an organization like many others. Its principles, values, and expectations are stated in the Code of Ethics and Standards of Professional Conduct (Code and Standards). Each year, CFA members and candidates submit their Professional Conduct Statement where they reaffirm their commitment to adhere to the Code and Standards and disclose any conduct that may violate the Code and Standards.
To protect against any possible violations, CFA Institute has its disciplinary process established. Disciplinary actions against the violator include: private reprimand, suspension from the CFA Program, suspension of membership, revocation of the right to use CFA designation, etc.
CFA Institute Code and Standards are principle-based standards. They apply to all CFA members and candidates at all times. As a CFA candidate, you must adhere to the Code and Standards!
You will learn more about the CFA Institute Code and Standards in the following lessons on CFA exam ethics readings.