Lecture 3 - Ethics in Finance

Question 1

What happened in the Enron and ML Case?

Answer 1

• Enron executives proposed purchase of three barges for $29m, three quarters of this amount ($21m) would be loans to ML, so it would only need to put up $7m of the purchase price
• In return - Enron would find a buyer and guarantee a return of 15% for Merril Lynch’s outlay
• Enron was committed to buying back the bargers - was this actually alone? Should be $7m in debt, but $12M of revenue was recorded
• off balance sheet partnership owned by Enron bought back the $7m, Enron recorded $7M in revenues and six months later off balance sheet parntership bought back the barges

Question 2

What is the ethical dilemma in this case =?

Answer 2

Should ML have participated in giving the $7M to Enron when members of the company itself were sceptical about the arrangement

Question 3

What is deception?

What is the argument against deception?

Answer 3

• Withholding of relevant information or giving false and misleading information
• Argument against: it is essentially false promising

Question 4

What is churning?

Answer 4

Excessive and/or inappropriate trading on a clients account without their knowledge, with the intent on generating excess commissions

Question 5

What is fairness in financial markets

Answer 5

• Does not involve eliminating loss, as all markets produce winners and losers,
• Involves presuming certain moral rules and expectations of moral behaviour based on fairness in markets

Presuming moral rules
Development of expectations of moral behaviour

Question 6

What are the four kinds of unfairness in markets?

Answer 6

1) Fraud and manipulation
2) Equal information
3) Equal bargaining power
4) Efficient pricing

Question 7

What is equal information?

Answer 7

The goal of equal information is providing equal ACCESS to information within financial markets
- Unequal information is unfair when it is access by illegitimate means

Question 8

What is equal bargaining power? Where can unequal bargaining power arise from =?

Answer 8

Unequal bargaining power can arise from:

• Resources: Larger investors have creator resources
• Processing ability: Differences in ability to process info and make judgements
• vulnerabilities: for example, impulsive decisions

Question 9

What is the definition of insider trading?

Answer 9

Trading of shares of publicly held companies on the basis of material, non-public information

Question 10

What are the two arguments against insider trading?

Answer 10

1) Theft: (narrow definition): stealing material, non-public information that belongs to the company
2) Unfair: Traders who use inside information have an unfair advantage over other investors - markets would be less efficient due to reluctance to trade

Question 11

What is a hostile takeover. What are the two types of hostile takeovers?

Answer 11

Acquisitions of a company that are opposed by the management of the target company
Two types
- Tender offer: Where the acquiring company will buy the targets shares at at a premium price, above the market value
- Proxy fight: Opposing group of stakeholder persuader shareholders to give them the proxy to vote on their shares. If hostile takeover gets enough proxies, the proxies can be used to accept the offer

Question 12

What are the two tactics that can be used by the target company in the event of a takeover?

Answer 12

1) Golden parachutes: Senior employee compensation packages that will entitle them to compensation severla years after employment terminate- protect the managers who will therefore make the best decisions for the shareholders
2) Greenmail: Repurchase of stock from an outside shareholder, at a premium, made for the purpose of avoiding battle for control of the company

Question 13

What is the current size of the Australia superannuation industry?

Answer 13

$1.5 trillion

Question 14

What happened in the trio case?

Answer 14

$176M of Australian’s superannuation funds is lost or stolen from two fraudulent management scheme, both of which trio was trustee of;

• Astarra Strategic Fund
• ARP growth fund
• The fraud was committed by collecting funds through investment vehicles that were not legitimatise, and were offshore which made it difficult for Australian auditors to verify the existence of such funds

Question 15

Which of the trio capital execs went to jail?

Answer 15

Only Shawn Richard went to jail for dishonest conduct, including receiving $1.3M paid into offshore bank accounts

Question 16

How did the parliament report differ from that for the Department of Treasury?

Answer 16

Department of treasury - concluded that both ASIC and APRA conducted their roles appropriately
Australian parliament - surprised of the little follow up activity, and did not believe APRA acted appropriately given during the reviews, a valuation of certain Trio fund assets was not available, miscommunication between the two regulators could have prevented the fraud sooner

Question 17

Why did John Hempton tell ASIC?

Answer 17

He was concerned about the suspiciously smooth earnings of the Astarra strategic fund

Question 18

what role did auditors, financial advisors and custodians play? what is the proposed new name for custodians?
Can custodians be blamed?

Answer 18

Auditor - did not independently verify the existence of company of value of the contract for investors
Financial advisers - acted unethically given they often advised clients to invest in such funds due to secret, illegal commissions
Custodians - limited role, however NAB did little to protect the funds of investors
New name for custodian: Managers payment agent (cannot be blamed as act on instructions of responsible entity)

Question 19

what policy steps is the Australian government recommending to prevent criminal fraud of this type?

Answer 19

1) Dedicated focus of the AFP
2) More detailed scrutiny by APRA
3) More rigorous criminal investigation, involving ASIC, APRA and the AFP
4) Legalisation to allow assets to be recovered from those personally involved with fraud and theft