Lecture #2 Flashcards
What are the indicators of ethical behaviour?
there’s 4
Trust: we willingly increase our vulnerability to another person whose behavior and actions we cannot control
Competence: To possess a specific range of skill, knowledge, or ability to assist, solve or handle the clients needs.
Efficiency: ability to accomplish a job with a minimum expenditure of time and effort.
Fairness: a sense that the service or opinion is free from bias or injustice.
List and define the Ethical issues
(there’s six)
Conflict of Interest: A situation where a person’s obligations clash with personal incentives, creating competing interests between themselves and a client or company
Fiduciary Responsibility: A legal duty to act in someone else’s best interest based on a relationship of trust.
Power Asymmetry: when one party forces its opinion on another party due to position or level of authority
Information Asymmetry: A situation where one party in a transaction has more or better information than the other
Moral hazard: The risk that one party in a transaction acts dishonestly or takes excessive risks because they don’t bear the full consequences
Social Responsbility: The duty of individuals and businesses to act in a way that benefits society, balancing profits with ethical and sustainable practices
Name the ethical issue according to the example
A: lack of objectivity: when the advisor has a financial interest that conflict, or appear to conflict with those of the client
B: material non-public information: the difference between what the client knows and what the adviser knows
C: material non-public information: the ability to affect the outcome of a situation
D: knowledge of the Law: the difference between what the client can do to protect himself or herself and what the advisor can do
E: misconduct or non-professional conduct: a financial Institution has a high responsibility and duty for care of the clients’ affairs.
F: loyalty, fair dealings: a duty to society to do the right thing and act in an ethical manner
A: Conflict of Interest
B: Information Asymmetry
C: Moral Hazard:
D:Power Asymmetry
E: Fiduciary Relationship
F: Social Responsibility
Defien Confidentiality, Privacy and why it it important
Confidentiality: trust relationship between the person supplying the information and those collecting it…assurance that the information will not be disclosed without the person’s permission
Privacy: The right to control access to one’s personal information about oneself.
Why is it important: Choices that individuals and businesses make with respect to privacy influence the way we conduct business
what is the Personal Information Protection and Electronic Documents Act (PIPEDA ACT) and what 3 rules companies have to follow..
PIPEDA (Personal Information Protection and Electronic Documents Act):
- Legislation implemented by the federal government to protect the privacy of Canadians in the private sector
- Sets ground rules for the collection, use and disclosure of personal information in the course of commercial activities
The 3 rules
- Must obtain an individual’s consent before or at the time we collect, use or disclose the individual’s personal information
- Individual has right to access personal information held by an organization and to challenge its accuracy
- Information can only be used for the purposes for which it was collected
What are the Penalities for Non-Compliance of PIPEDA ACT
Penalities can apply if:
- personal information that an individual has requested is destroyed
- a whistleblower is dismissed or harassed
- complaint investigation or audit is obstructed
Fines range up to $10,000 for summary conviction (less serious)
or up to $100,000 for an indictable offence (more serious)
What are the Consequences for Non-Compliance
- Investigation and audit by the Privacy Commissioner
- Hearing in Federal Court
- Possible criminal charges
- Failure to comply with court order:
- fines
- imprisonment
- Loss of reputation, trust, loyalty and in the end, business
FIll in the blank: If an organization is going to use personal information for any other purpose than the original reason collected, consent must be obtained “___”
again
what does Personal Information include and not include?
Personal information includes any factual or subjective information, recorded or not recorded, about an identifiable individual. This includes information in any form.
Personal information does not include the
- name,
- title,
- business address or
- telephone number of an employee of an organization
Does personal information apply to employees to?
Yes, the personal information practices can be challenged by ANYONE
- requests/hearings must be handled within 30 days
What is the Role of the Privacy Commissioner of Canada
- Investigates complaints under the Privacy Act and PIPEDA
- Negotiates and persuades to find solutions
- Makes recommendations based on findings
What’s the best ways to Protect Yourself aganist lawsuits
- Avoid inaccurate, misleading or exaggerated statements
- Avoid representations that cannot be verified
- Review documents carefully for accuracy
- Maintain detailed files and records – more is more
- Document conversations with clients
define Fiduciary Duty, what are some of the challenges
Fiduciary Duty: A fiduciary is someone entrusted to act in another’s interest, such as investment professionals, doctors, and lawyers.
- For Investment Professionals, they must prioritize clients’ interests above their own or their employer’s
Challenges:
* Profit Motive: Investment professionals aim to earn profits, which can conflict with fiduciary obligations.
* Complexity of Finance: Complex investment strategies can hide unethical practices, like overcharging fees or recommending unsuitable securities.
* Time Horizon Differences: Professionals may prioritize short-term profits over long-term client goals.
- Accountability Issues: The “IBG YBG” mentality (“I’ll be gone; you’ll be gone”) reflects a lack of accountability for poor decisions with long-term impacts.
define Agency Theory, Agent, Principal
Agency Theory: Explains incentives and contractual solutions when a principal hires an agent to act on their behalf.
- Highlights that agent’s incentives often differ from the principal’s.
Agent: The party hired to work on behalf of the principal.
- Examples: Money managers, financial advisors, etc.
Principal: The party who hires another to act on their behalf.
What ethical issue does this tackle? A manager might avoid extra effort for a small incremental client gain due to low personal compensation for the additional work.
Conflict of Interest
define Residual Loss
Residual Loss: The inefficiency or loss due to incomplete incentive alignment in contracts.
- The loss caused by misaligned incentives in a contract.
- Ex. A company hires a manager to maximize profits, but the manager prioritizes personal convenience, such as avoiding cost-cutting efforts, hiring friends over qualified candidates, or lax supervision. These misaligned incentives reduce efficiency, creating residual loss
what is Rule 204A-1 of the Investment Advisers Act of 1940?
Rule 204A-1 of the Investment Advisers Act of 1940: Requires registered advisors to maintain a code of ethics.
what is the Financial Industry Regulatory Authority (FINRA) and what do they do
Financial Industry Regulatory Authority (FINRA):
○ A nonprofit organization with legal authority to enforce securities rules and regulations among brokers and traders.
○ Promotes ethical standards and investor education.
what is the Securities and Exchange Commission (SEC):
Enforces securities laws in the U.S. aganist market manipulation
Which of the following statements about client confidentiality are true? (Select all that apply.)
A) Investment professionals must keep client identities private.
B) They can disclose investment amounts if requested by colleagues.
C) They should avoid revealing specific investment choices (e.g., stocks vs. bonds).
D) Identifying clients to others is acceptable if they are public figures.
✅ A) True
❌ B) False – Client investment details must remain confidential.
✅ C) True
❌ D) False – Confidentiality applies to all clients, regardless of status.
- Mentioning a client’s association with a hedge fund implies their financial status due to investment minimums.
is an example of:
Breaches of Confidentiality
Define Ongoing Duty
Ongoing Duty: The duty of confidentiality persists even after the client relationship ends.
* Disclosing that a person was a former client still reveals private financial information.
* Similar to the medical profession, where doctors cannot discuss former patients’ health details.
Ethical Breaches
Ethical Breaches: Disclosure of any client-related details without permission is a violation of trust.
define the 4 Ethical Investment Principles
- Ethical Understanding – Investors must fully understand the investments they engage in, including risks, returns, and fees, to avoid making uninformed decisions.
- Ethical Use of Information – Investment decisions should be based on accurate and accessible information, ensuring that data is not misused or manipulated.
- Responsible Investing – Investors should avoid supporting businesses or activities that cause harm, ensuring their financial decisions align with ethical standards.
- Trust and Fairness– Managing others’ money requires fairness, honesty, and avoiding any abuse of trust, whether explicitly or implicitly given.
define the Risk Assessment and Investment Policy Statement (IPS)
-
Risk Assessment
○ Professionals must determine a client’s risk tolerance using indirect questions rather than complex financial jargon (e.g., beta or portfolio standard deviation).
○ Risk tolerance includes the client’s comfort level with short-term fluctuations in investment value. -
Investment Policy Statement (IPS):
§ Written agreement outlining the client’s investment goals and the compensation structure.
Helps maintain trust, prevent misunderstandings, and establish legal grounds for contract violations.
Define Churning
Churning: Excessively buying and selling securities in a client’s account to generate commissions for the broker.
○ Criteria: Depends on the client’s Investment Policy Statement (IPS) or agreement.
§ Example: Trading blue-chip stocks monthly for a long-term investor would be churning.
what are the max gifts and incentives an analyst can receive?
Gifts and Incentives: Gifts or payments (e.g., tickets, resort conferences) to influence trade routing.
- SEC regulation prohibits gifts exceeding $100/year.
what are Soft Dollars what are the accepted uses and prohibitations?
Soft Dollars: Manager/Customer pays the brokerage commissions to purchase research, services, or equipment.
* will jack up commission
* * chrage an extra cent 1 stock (1 cent regulary), that will be reserach payment
- Originated before 1975 when commissions were fixed, enabling brokers to offer bundled research and services as a concession to attract institutional clients.
Permissible Uses
○ Purchase proprietary research from brokers or third-party research (e.g., Bloomberg, Standard & Poor’s).
○ SEC permits soft dollar use for research if fully disclosed.
Prohibited Uses
○ Using soft dollars to pay for business expenses like salaries, travel, marketing, or entertainment.
This violates fiduciary duty by hiding operating costs within client trading commissions.
what Ethical Principle(s) does this scenario violate? Double Charging Clients:Unethical to charge clients twice: once via management fees and again through inflated trading commissions.
Violates Principle #1 (Ethical Understanding) and Principle 4 (Trust and Fairness), if fees are obsecured
Should you disclose use of Soft Dollars?
○ Full disclosure of soft dollar practices helps build trust and prevent ethical breaches.
○ Advisors must clearly separate costs for research and business expenses.
what is the main issues with soft dollars?
Lack of Transparency for Investors
- Investors might not know that their money is indirectly paying for research or other services.
- Since these costs don’t show up directly in fund expenses, they can be harder to track.
- This makes it difficult to determine if a fund is truly cost-efficient.
Potential for Misuse
- Some brokers offer extravagant perks, like expensive conferences, high-end reports, or even perks that might not directly help investors.
- If fund managers use soft dollars for things that benefit them personally rather than their clients, it’s a misuse of investor money.
Hiding Costs in “Office Rent” or “Technology Expenses”
- Hidden Costs: Brokers provide perks like office space, software, or research in exchange for higher trading commissions.
- Disguised as Expenses: Instead of listing these as soft dollar costs, firms categorize them as rent, tech, or business expenses.
- Investors Pay More: Since these costs are buried in trading fees, investors unknowingly cover them.
What Principle is this scenario linked to? Clients must understand fee schedules, discounts for larger accounts, and additional services tied to larger accounts or higher fees.
○ Relates to Principle 4, Trust and Fairness: Ensure clients are fully informed about fees, services, and allocation practices.
define Initial Public Offering (IPO) and Pro Rata Allocation… Challenges: :
Fair Distribution
○ IPOs must be distributed fairly among clients whose accounts meet investment objectives, not solely to larger or more profitable clients.
○ Pro rata allocation ensures equitable distribution based on account size.
Conflicts of Interest
Clients offering gifts or incentives to advisors for better IPO allocations must be “” to maintain “”.
Initial Public Offering (IPO): The first public sale of a corporation’s stock.
○ Often associated with significant price increases shortly after issuance, making them highly sought-after but limited in supply.
Pro Rata Allocation: Distributing investments (e.g., IPO shares) proportionally based on account size. (in equal amounts)
____
avoided, fairness
OVERALL:
Ethical Considerations
Client Discrimination
○ Favoring larger accounts without disclosure violates ethical standards.
○ Advisors must treat all clients equitably and disclose differences in fees and services transparently.
Beneficiary Protection
○ Advisors must ensure decisions benefit the ultimate beneficiaries, not just trustees.
○ Ignoring beneficiary interests can result in unethical practices and fiduciary breaches.
Conflict Avoidance
Advisors must avoid biases introduced by gifts, incentives, or trustee pressures.
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Define Hidden risks, and whats an example of Unrealized Capital Losses
Hidden Risks: Risks not fully disclosed by managers, which may artificially enhance reported performance.
Unrealized Capital Losses
Example: Managers not reporting unrealized losses, hoping for future recovery, is unethical as it misrepresents performance.
Read:
Comprehensive Reporting:
○ Managers must report a wide range of risk measures to provide a complete risk profile.
○ Focusing on a single metric (e.g., beta) can mislead clients about the true level of risk.
Client Education:
○ Managers should ensure clients understand the meaning and implications of risk measures.
○ Knowledgeable clients can make better decisions aligned with their investment goals.
Risk Transparency:
○ Managers must accurately disclose risk measures for both current clients (to assess ongoing investments) and future clients (to set realistic expectations).
define Window Dressing
Window Dressing: A practice used by mutual funds where they invest in well-performing stocks toward the end of a quarter to create the illusion of superior stock-picking skills.
