FINC2011 Lec 13 Business Ethics

Question 1

Why does ethics matter?

Answer 1

• Increases confidence in global financial markets. Instills public trust in markets and support the development of markets.
• Clients are reassured that investment professionals they hire operate with the client’s best interest in mind.

Question 2

CFA code of ethics

Answer 2

• Act with integrity, competence, diligence. Use reasonable care and exercise independent professional judgement.
• Place interests of client and integrity of investment profession above own personal interests.
• Encourage others to practice in a professional and ethical manner.

Question 3

PRESSURE TO AVOID ISSUING SELL RECOMMENDATIONS.

Sell side analysts (brokerage firms) face significant conflicts of interest in making sell recommendations. What are these?

Answer 3

1. Buy side clients may have significant holdings of securities under review and would be adversely affected by downgrades.
2. May encourage analysts to issue favorable research for current or potential clients of IB arm.
3. Targets of unfavorable reports may deny access to company managers and info.
4. Small companies may HIRE analysts making them biased.

Question 4

IB’s face significant conflicts of interests since they operate in both IB advisory and brokerage divisions.

What is the conflict of interest? and how can insider trading be overcome?

Answer 4

Staff in IB division have access to private info. This info could potentially be passed to clients via brokerage division.

CHINESE WALLS: Strict separation of IB and brokerage divisions to ensure info leakages not occur.

Question 5

What is Front Running / Profiting against the Client?

Answer 5

Illegal practice where stock broker profits off advance knowledge of pending orders from its clients.

(e.g. large market sell order which would push price down, so broker short sells beforehand).

Question 6

What is ROGUE TRADING?

Answer 6

IB employees engage in “unauthorised” trades which result in substantial losses. Traders may seek to conceal the losses by making even larger bets to recover the situation.

Question 7

How can you overcome rogue trading?

Answer 7

Remuneration structures of traders at IB’s can create an incentive to take excessive risk. FIX THIS.

Question 8

What is MARKING THE CLOSE / RAMPING?

Answer 8

Making purchase / sale near close of day’s trading, with objective of affecting published prices / reported closing price.

“Window dressing” to inflate valuation.