Download Reading: Ethics in Finance

Reading: Ethics in Finance
On March 19, 2006, Sarah and Jose Parker were told that they could borrow up to $350,000 to purchase
a home! They had no idea they could or would qualify for that amount and now so many homes—homes
that they thought were out of their price range—were suddenly available to them. As first-time
homeowners, they qualified for the interest-only, no-down payment, no-documentation loan! Their
mortgage broker smiled as he told them the news.
Sarah and Jose were considered subprime borrowers. Their credit score was low and they had a limited
ability to cover their monthly living expenses. Although their mortgage broker knew that the couple most
likely wouldn’t be able to afford their adjustable rate mortgage in two years, he believed that in that time,
Jose would have a better paying job or they would move out of the house anyway. Furthermore, he knew
that if he didn’t lend them the money, another institution would.
Sarah and Jose got their loan, bought their house, and three years later found themselves in foreclosure.
Meanwhile, their mortgage broker sold their loan (bundled together with thousands of other subprime
loans) to various investors, who then bundled those subprime mortgages with others and passed them
on. But as housing prices started to drop, many subprime borrowers could no longer afford their homes.
Sarah and Jose (along with thousands and thousands of others) ultimately defaulted on their loan and
lost their home, resulting in one of the largest financial meltdowns in history.
The subprime mortgage crisis is just one of the many events that have shaped society’s perceptions of
the finance industry. In fact, it has been described as the result of one of the greediest business practices
by financial organizations and their management in history. Predatory lending practices, uneducated
consumers, greedy professionals, light regulations, and loose money have all contributed to this financial
catastrophe. Stories such as Sarah and Jose’s are common and each one seems to undermine the
public’s confidence in financial institutions and the professionals who are employed in the industry.
Considering the level of trust that the public places in these individuals, when you place your money in
the hands of a financial planner, insurance agent, mortgage broker, or banker, you have an absolute right
to expect them to behave ethically.
Profit Maximization, Legality, and Pressure
What prompts this type of behavior? Why would professionals in charge of overseeing other people’s
money behave in unethical ways? To begin, we must understand the nature of any business (including
businesses within the finance industry) is to make a profit. This fact can run counter to an individual’s
and/or a company’s philosophy about behaving ethically. Some of the most common ethical challenges
facing the industry are a result of the following:

Profit maximization is at the heart of the financial services industry and all businesses except
those classified as not for profit. If the fundamental purpose of a business is to make a profit, what
happens when the goal (profit maximization) goes against an individual’s sense of right and
wrong? An individual’s desire to do the right thing can become clouded by the desire to make a
profit.

Sometimes moral and ethical behavior gets confused with lawful behavior. Even though
something may not be illegal, it still may be unethical. For example, let’s say that a company is
offering a reward system (high commission and/or bonuses) for selling a particular financial
product. What will stop the broker from pushing the product to all of his clients even though it may
not be right for everyone? For instance, selling a high-risk security to an elderly single woman isn’t
against the law, but it isn’t the right thing to do.

Pressure from clients and from the company can get in the way of making ethical choices. Client
pressure can affect an employee’s ethical standards. If you are an accountant preparing a client’s
taxes and they ask you to create fictitious business expenses, you may agree to do so in fear of
losing the client. Company demands and performance pressures such as increasing quarterly
sales figure can also get in the way of ethical behavior by professionals.
Although ethical issues are prevalent in any business and range from creative accounting practices to
product testing to discrimination, unethical practices from the finance industry seem to make the
headlines more frequently. From professionals that work in the industry to consumers of the products and
services that it offers, almost everyone is affected in one way or another by the finance industry. Because
of its size and its importance to society, sometimes the media paints a pretty grim picture of the ethical
lapses that evolve from the industry. However, most finance industry professionals are honest people
who are trying to help their clients reach their financial goals.
Codes of Conduct and Regulations
There are many different approaches for dealing with ethical problems in the finance industry. They range
from individual companies establishing their own ethical codes of conduct to nationwide regulatory
agencies such as the SEC (Securities and Exchange Commission), the Federal Reserve System, and the
Federal Deposit Insurance Corporation. Many professional associations have also set up their own rules
of good conduct. For example, the American Institute of Certified Public Accountants and the Association
for Investment Management and Research are both professional associations that have published codes
of ethics. All of these entities help to ensure ethically responsible behavior within the finance industry.
Whether you’re the consumer of a financial product or service or someone who works within the industry,
one of the best ways to protect yourself from ethical lapses is to be informed. If you’re an employee, you
should be familiar with your company’s code of ethics and abide by it. You should also be aware of the
process with which unethical or illegal actions are reported and strive to do what is best for all parties
involved. As a consumer, you should always do your research. Know the product that you’re buying or the
service that you’re requesting, ask the right questions, and above all, be informed!