Reading 1 - Ethics and Trust in the investment Profession

Question 1

In a 2013 study on trust, investors indicated that to earn their trust, the top three attributes of an investment manager should be that it:

Answer 1

1) Has transparent and open business practices
2) Takes responsible actions to address an issue or crisis
3) Has ethical business practices.

Question 2

Stakeholders

Answer 2

Individuals or groups of individuals who may be affected either directly or indirectly by a decision and thus have an interest, or stake, in the decision.

Question 3

The word ‘ethics’ comes from:

Answer 3

The Greek word “ethos,” meaning character, used to describe the guiding beliefs or ideals characterizing a society or societal group.

Question 4

Define ‘a principle’

Answer 4

A principle is defined as a belief or fundamental truth that serves as the foundation for a system of belief or behavior or a chain of reasoning.

Question 5

Moral principles or Ethical principles

Answer 5

Beliefs regarding what is good, acceptable, or obligatory behavior and what is bad, unacceptable, or forbidden behavior.

Question 6

Ethics

Answer 6

The study of moral principles or of making good choices. Ethics encompasses a set of moral principles and rules of conduct that provide guidance for our behavior.

Question 7

Ethical conduct

Answer 7

Ethical conduct is behavior that follows moral principles and balances self-interest with both the direct and the indirect consequences of the behavior on others.

Question 8

Ethical actions

Answer 8

Ethical actions are those actions that are perceived as beneficial and conforming to the ethical expectations of society. An action may be considered beneficial if it improves the outcomes or consequences for stakeholders affected by the action.

Question 9

How is telling the truth about the risks or costs associated with a recommended investment an ethical action?

Answer 9

One that conforms to the ethical expectations of society in general and clients in particular

Question 10

How is telling the truth an ethical action?

Answer 10

Telling the truth builds trust with customers and clients and enables them to make more informed decisions, which should lead to better outcomes for them and higher levels of client/customer satisfaction for you and your employer.

Question 11

What are the widely acknowledged ethical principles?

Answer 11

Honesty
Fairness or justice
Diligence
Respect for the rights of others

Question 12

Define ‘Laws and regulations’

Answer 12

Laws and regulations are rules of conduct specified by a governing body, such as a legislature or a regulator, identifying how individuals and entities under its jurisdiction should behave in certain situations.

Question 13

Investment advisers and portfolio managers who are required by law to act in their clients’ best interests must:

Answer 13

1) Always put their clients’ interests ahead of their own or their employers’ interests
2) Must understand the client’s financial objectives and risk tolerance, research and investigate multiple investment opportunities, and recommend the investment or investment portfolio that is most suitable for the client in terms of meeting his or her long-term financial objectives.
3) be expected to monitor the client’s financial situation and investments to ensure that the investments recommended remain the best overall option for meeting the client’s long-term financial objectives.

Question 14

In countries with only a suitability requirement, it is legal for investment professionals to:

Answer 14

It is legal for investment professionals to recommend a suitable investment to a client even if other, similar suitable investments with lower fees are available.

Question 15

Code of ethics

Answer 15

An established guide that communicates an organization’s values and overall expectations regarding member behavior. A code of ethics serves as a general guide for how community members should act.

Question 16

Standards of conduct

Answer 16

Behaviors required by a group; established benchmarks that clarify or enhance a group’s code of ethics.

Question 17

Violations of a community’s established code of ethics and/or standards of conduct can harm the community in a variety of ways:

Answer 17

1) Violations have the potential to damage the community’s reputation among external stakeholders and the general public
2) Violations can also damage the community’s reputation internally and lead to reduced trust among community members and can cause the organization to fracture or splinter from within.

Question 18

To protect the reputation of its membership and limit potential harm to innocent members, the community may:

Answer 18

Take corrective actions to investigate possible violations, repair any damages, and attempt to discipline the violator or, in severe cases, revoke the violator’s membership in the community.

Question 19

CFA Institute is an example of a community with an established code of ethics and standards of conduct. Its members and candidates commit to adhere to shared beliefs about acceptable conduct for individuals participating in the investment industry. These beliefs are presented where?

Answer 19

In the Code of Ethics and Standards of Professional Conduct (Code and Standards), which are included in the CFA Institute Standards of Practice Handbook.

Question 20

The CFA Institute’s Code of Ethics and Standards of Professional Conduct communicates what?

Answer 20

The organization’s principles, values, and expectations

Question 21

What does the CFA Institute’s Standards of Professional Conduct outline?

Answer 21

Minimally acceptable behaviors expected of all CFA Institute members and candidates

Question 22

Each year, what do the CFA Institute members and candidates do?

Answer 22

CFA Institute members and candidates re-affirm their commitment to adhere to the Code and Standards each year. In addition, to protect the reputation of the community, members and candidates agree to submit a Professional Conduct Statement each year disclosing conduct that may have violated the Code and Standards.

Question 23

1) Which of the following statements is most accurate? Ethics can be described as:

(A) a commitment to upholding the law.

(B) an individual’s personal opinion about right and wrong.

(C) a set of moral principles that provide guidance for our behavior.

Answer 23

C is correct. Ethics can be described as a set of moral principles that provide guidance for our behavior; these may be moral principles shared by a community or societal group.

Question 24

Which of the following statements is most accurate? Standards of conduct:

(A) are a necessary component of any code of ethics.

(B) serve as a general guide regarding proper conduct by members of a group.

(C) serve as benchmarks for the minimally acceptable behavior required of members of a group.

Answer 24

C is correct. Standards of conduct serve as benchmarks for the minimally acceptable behavior required of members of a group. Some organizations will adopt only a code of ethics, which communicates the organization’s values and overall expectations regarding member behavior. Others may adopt both a code of ethics and standards of conduct. Standards of conduct identify specific behavior required of community members and serve as benchmarks for the minimally acceptable behavior of community members.

Question 25

What is the difference between a job and a vocation?

Answer 25

A job is very simply the work someone does to earn a living. A vocation is a job or occupation to which someone is particularly well suited and is very dedicated.

Question 26

Define Profession

Answer 26

1) based on specialized knowledge and skills.
2) based on service to others.
3) practiced by members who share and agree to adhere to a common code of ethics.

Question 27

What is the difference between clients and customers?

Answer 27

A customer purchases goods or services in a single transaction or series of transactions and pays for each transaction or series of transactions. A client, in contrast, enters into an ongoing relationship with a professional, hiring the professional to use his or her special knowledge for the benefit of the client, usually for a fee.

Question 28

Some codes will be enhanced and clarified by the adoption of standards of conduct or specific benchmarks of behavior required of members. These standards may be:

Answer 28

Principle based or rule based

Question 29

The CFA Institute Code and Standards are an example of:

Answer 29

Principle-based standards; they are based on the shared principles of honesty, integrity, transparency, diligence, and placing client interests first.

Question 30

In regards to ethics, as a CFA Program candidate, you are expected to:

Answer 30

to act in accordance with the ethical and professional competency responsibilities of the investment profession as expressed in the Code and Standards.

Question 31

What is the CFA Institute’s Code of Standards designed to do?

Answer 31

The Code and Standards are designed to foster and reinforce a culture of responsibility and professionalism.

Question 32

The CFA Institute’s Code and Standards apply to:

Answer 32

All your professional activities, including but not limited to trading securities for yourself and/or others, providing investment advice, conducting research, and performing other investment services.

Question 33

Which of the following statements best describes how professionals use their specialized knowledge and skills? Professionals use their specialized knowledge and skills:

(A) in service to others.

(B) to advance their career.

(C) for the exclusive benefit of their employers.

Answer 33

A is correct. Professionals use specialized knowledge and skills in service to others. Their career and employer may benefit, but those results are not the primary focus of a professional’s use of his or her specialized knowledge and skills.

Question 34

Which of the following statements is most accurate? A profession’s code of ethics:

(A) includes standards of conduct or specific benchmarks for behavior.

(B) ensures that all members of a profession will act ethically at all times.

(C) publicly communicates the shared principles and expected behaviors of a profession’s members.

Answer 34

C is correct. A profession’s code of ethics publicly communicates the shared principles and expected behaviors of a profession’s members. The existence of a code of ethics does not ensure that all members will behave in a manner consistent with the code and act ethically at all times. A profession will often establish a disciplinary process to address alleged violations of the code of ethics. A profession may adopt standards of conduct to enhance and clarify the code of ethics.

Question 35

Studies have shown that our beliefs and emotions frequently interfere with what?

Answer 35

Our cognitive reasoning and result in behavioral bias, a tendency to behave in a way that is not strictly rational.

Question 36

The overconfidence bias can result in what?

Answer 36

A failure to consider, explicitly or implicitly, important inputs and variables needed to form the best decision from an ethical perspective.

Question 37

Situational influences

Answer 37

External factors, such as environmental or cultural elements, that shape our behavior.

Question 38

The bystander effect demonstrates what?

Answer 38

Demonstrates that people are less likely to intervene in an emergency when others are present.

Question 39

Define the effects of the situational influence of loyalty.

Answer 39

Loyalty to supervisors or organizations, fellow employees, and other colleagues can tempt individuals to make compromises and take actions that they would reject under different situational influences or judge harshly when taken by others.

Question 40

What are some situational influences that frequently have disproportionate weight in our decision-making?

Answer 40

Bonuses, promotions, prestige, and loyalty

Question 41

Situational influences shift our brain’s focus from:

Answer 41

the long term to the short or immediate term

Question 42

Which of the following will most likely determine whether an individual will behave unethically?

(A) The person’s character

(B) The person’s internal traits and intrinsic motivation

(C) External factors, such as environmental or cultural elements

Answer 42

C is correct. Social psychologists have shown that even good people may behave unethically in difficult situations. Situational influences, which are external factors (e.g., environmental or cultural elements), can shape our thinking, decision making, and behavior and are more likely to lead to unethical behavior than internal traits or character.

Question 43

Which of the following statements is most accurate?

(A) Large financial rewards, such as bonuses, are the most powerful situational influences.

(B) When decision making focuses on short-term factors, the likelihood of ethical conduct increases.

(C) Situational influences can motivate individuals to act in their short-term self-interests without recognizing the long-term risks or consequences for themselves and others.

Answer 43

C is correct. Situational influences can motivate individuals to act in their short-term self-interests without recognizing the long-term risks or consequences for themselves and others. Large financial rewards are powerful situational influences, but in some situations, other situational influences, such as loyalty to colleagues, may be even more powerful.

Question 44

To help evaluate the potential risks and rewards of the investment, investors:

Answer 44

conduct research, reading and evaluating the borrower’s financial statements, management’s business plan, research reports, industry reports, and competitive analyses

Question 45

Which of the following statements is most accurate? Investment professionals have a special responsibility to act ethically because:

(A) the industry is heavily regulated.

(B) they are entrusted to protect clients’ assets.

(C) the profession requires compliance with its code of ethics.

Answer 45

B is correct. Investment professionals have a special responsibility because clients entrust them to protect the clients’ assets.

Question 46

Why is fostering trust extremely important in the investment industry?

Answer 46

Diminished trust in financial markets can reduce growth in the investment industry and tarnish the reputation of firms and individuals in the industry, even if they did not participate in the unethical behavior. Unethical behavior interferes with the ability of markets to channel capital to the borrowers that can create the most value from the capital, contributing to economic growth. Both markets and society suffer when unethical behavior destroys trust in financial markets.

Question 47

Although laws frequently codify ethical actions, legal and ethical conduct are not always the same. Expand on this.

Answer 47

Many types of conduct are both legal and ethical, but some conduct may be one and not the other. Some legal behaviors or activities may be considered unethical, and some behaviors or activities considered ethical may be deemed illegal in certain jurisdictions. Acts of civil disobedience, such as peaceful protests, may be in response to laws that individuals consider unethical. The act of civil disobedience may itself be considered ethical, and yet it violates existing local laws.

Question 48

Another area in which ethics and laws may conflict is the area of “whistleblowing.” Define.

Answer 48

Whistleblowing refers to the disclosure by an individual of dishonest, corrupt, or illegal activity by an organization or government.

Question 49

How is “whistleblowing” ethical but also, can be illegal?

Answer 49

Depending on the circumstances, a whistleblower may violate organizational policies and even local laws with the disclosure; thus, a whistleblower’s actions may be deemed illegal and yet considered by some to be ethical.

Question 50

Some people advocate that increased regulation and monitoring of the behavior of participants in the investment industry will increase trust in the financial markets. Although this approach may work in some circumstances, the law is not always the best mechanism to reduce unethical behavior for several reasons. Expand on this.

Answer 50

1) First, laws typically follow market practices; regulators may proactively design laws and regulations to address existing or anticipated practices that may adversely affect the fairness and efficiency of markets or reactively design laws and regulations in response to a crisis or an event that resulted in significant monetary losses and loss of confidence/trust in the financial system.
2) Regulators’ responses typically take significant time, during which the problematic practice may continue or even grow. Once enacted, a new law may be vague, conflicting, and/or too narrow in scope. A new law may reduce or even eliminate the existing activity while simultaneously creating an opportunity for a different, but similarly problematic, activity.
3) Additionally, laws vary across countries or jurisdictions, allowing questionable practices to move to places that lack laws relevant to the questionable practice.
4) Laws are also subject to interpretation and compliance by market participants, who may choose to interpret the law in the most advantageous way possible or delay compliance until a later date.

Question 51

Which of the following statements is most accurate?

(A) All legal behavior is ethical behavior.

(B) Some ethical behavior may be illegal.

(C) Legal standards represent the highest standard.

Answer 51

B is correct. Some ethical behavior may be illegal. Civil disobedience is an example of what may be illegal behavior that some consider to be ethical. Legal and ethical behavior often coincide but not always. Standards of conduct based on ethical principles may represent a higher standard of behavior than the behavior required by law.

Question 52

Which of the following statements is most accurate?

(A) Increased regulations are the most useful means to reduce unethical behavior by market participants.

(B) Regulators quickly design and implement laws and regulations to address practices that adversely affect the fairness and efficiency of markets.

(C) New laws designed to reduce or eliminate conduct that adversely affects the markets can create opportunities for different, but similarly problematic, conduct.

Answer 52

C is correct. New laws designed to reduce or eliminate conduct that adversely affects the markets can create opportunities for different, but similarly problematic, conduct.

Question 53

One strategy to increase trust in the investment industry is to:

Answer 53

Increase the ability and motivation of market participants to act ethically and help them minimize the likelihood of unethical actions.

Question 54

How can firms enhance the ability and the motivation of employees to act ethically?

Answer 54

By integrating ethics into the decision-making activities of employees, firms can enhance the ability and the motivation of employees to act ethically, thereby reducing the likelihood of unethical actions.

Question 55

What may be the single most important factor in promoting ethical behavior among the firm’s employees?

Answer 55

Development, maintenance, and demonstration of a strong culture of integrity within the firm by senior management

Question 56

Using a framework for ethical decision making will help investment professionals to:

Answer 56

1) effectively examine their choices in the context of conflicting interests common to their professional obligations (e.g., researching and gathering information, developing investment recommendations, and managing money for others).
2) allow investment professionals to analyze and choose options in a way that allows them to meet high standards of ethical behavior.
3) provides investment professionals with a tool to help them adhere to a code of ethics.
4) By applying the framework and analyzing the particular circumstances of each available alternative, investment professionals are able to determine the best course of action to fulfill their responsibilities in an ethical manner.

Question 57

What are the four aspects of a general ethical decision making framework?

Answer 57

Identify: Relevant facts, stakeholders and duties owed, ethical principles, conflicts of interest

Consider: Situational influences, additional guidance, alternative actions

Decide and act

Reflect: Was the outcome as anticipated? Why or why not?

Question 58

For the general ethical decision making framework, expand on the identify stage:

Answer 58

Identify the important facts that you have available to you, as well as information that you may not have but would like to have to give yourself a more complete understanding of the situation.

Identify Stakeholders, relevant ethical principles and/or legal requirements, and any potential conflicts of interest

Question 59

For the general ethical decision making framework, expand on the consider stage:

Answer 59

Consider the situational influences as well as personal behavioral biases that could affect your thinking and thus decision making. These situational influences and biases could include a desire to please your boss, to be seen as successful by your peers and family, to gain acceptance, to earn a large bonus, and so on.

Question 60

For the general ethical decision making framework, expand on the decision/act and reflect stage:

Answer 60

After you have acted on your decision, you should take the time to reflect on and assess your decision and its outcome.

Question 61

Ethics refers to and encompasses what?

Answer 61

Ethics refers to the study of making good choices. Ethics encompasses a set of moral principles and rules of conduct that provide guidance for our behavior.

Question 62

Situational influences are:

Answer 62

Situational influences are external factors that may shape our behavior.

Question 63

Challenges to ethical behavior include

Answer 63

Challenges to ethical behavior include being overconfident in our own morality, underestimating the effect of situational influences, and focusing on the immediate rather than long-term outcomes or consequences of a decision.

Question 64

What does the code of ethics publically communicate?

Answer 64

In any given profession, the code of ethics publicly communicates the established principles and expected behavior of its members.

Question 65

How do members of a profession and ethics relate?

Answer 65

Members of a profession use specialized knowledge and skills to serve others; they share and agree to adhere to a common code of ethics to serve others and advance the profession.

Question 66

How does a code of ethics help relations with the public?

Answer 66

A code of ethics helps foster public confidence that members of the profession will use their specialized skills and knowledge to serve their clients and others.

Question 67

How are ethical standards particularly important in the investment industry?

Answer 67

High ethical standards always matter and are of particular importance in the investment industry, which is based almost entirely on trust. Clients trust investment professionals to use their specialized skills and knowledge to serve clients and protect client assets. All stakeholders gain long-term benefits when investment professionals adhere to high ethical standards.

Question 68

How do rules and laws work with ethical actions?

Answer 68

Rules and laws often codify ethical actions that lead to better outcomes for society or specific groups of stakeholders.

Question 69

How do ethical standards not provide effective guidance?

Answer 69

Organizations and individuals generally adhere to legal standards, but legal standards are often created to address past ethical failings and do not provide guidance for an evolving and increasingly complex world.

Question 70

How does ethical go beyond legal standards?

Answer 70

Legal standards are often rule based. Ethical conduct goes beyond legal standards, balancing self-interest with the direct and indirect consequences of behavior on others.

Question 71

How can a framework for ethical decision making help people?

Answer 71

A framework for ethical decision making can help people look at and evaluate a decision from different perspectives, enabling them to identify important issues, make wise decisions, and limit unintended consequences.

Question 72

Learning objectives for Reading 1.

Answer 72

The candidate should be able to:

(1) explain ethics;
(2) describe the role of a code of ethics in defining a profession;
(3) identify challenges to ethical behavior;
(4) describe the need for high ethical standards in the investment industry;
(5) distinguish between ethical and legal standards;
(6) describe and apply a framework for ethical decision making.