Ethics and Financial Markets

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INTRODUCTION

Ethics in a finance and a financial markets a has perhaps a never been a as relevant a as it is today. In an industry a where the a conclusion and a enforcement of a contracts is based on trust – trust from the provider of capital that he is fairly rewarded for the risk of potentially losing some of his assets; trust from the borrower that he is charged a fair price for his access a to capital – any breakdown in that confidence can quickly lead to a incorrect pricing and in turn, improper allocation of resources. Lack of confidence in the financial a system in a general typically a means a rising counterparty a risks, and prompts a lenders of a capital to a require a higher risk a premium a in their a investment returns, raising a the overall a cost a of capital in a the a economy. In similar fashion, fears a that some participants in financial transactions a may prove to be ‘rotten apples’ would force all others to pay a higher price a for access a to resources, even a if the a broad a majority behave a in a proper manner. In a developing a country like South Africa, reluctance a to lend, or a demand for a an elevated risk a premium, for fear a of fraudulent a or information-withholding behaviour, can easily limit the ability of the a general public a to access a credit and, in a turn, impede the a path to a more a balanced a and inclusive economic a growth framework.

UNETHICAL PRACTICES IN INDIAN FINANCIAL MARKETS THAT LED TO SCANDALS

· 2G Spectrum Scam

Former Telecom Minister A. Raja is the prime accused who is considered to be the mastermind in this scam by CBI. He stands accused of under-valuing spectrum as the country’s Telecom Minister and selling it to companies he favored, though they were largely ineligible for licenses to run mobile networks. The loss to the national exchequer is pegged by the government auditor at a mind-boggling Rs. 1.76 lakh crore.

· Satyam Case

Mr. Ramalinga Raju, the former Chairman and Chief Executive of Satyam Computer Services admitted a to falsification a in the company a accounts and various a other irregularities. The a estimated fraud a was Rs.700 Crore billion. Coming on the back of global recession, this incident busts a the Indian Outsourcing a Industry and the stock market.

· IPO Scam

A number of key operators, including corporate stock brokers such as Karvy and Indiabulls, were involved in the IPO scam during 2004-05. The modus operandi of the scam was that the operators opened thousands of fake accounts to purchase shares in IPOs in the hope of selling later at huge profits.

ISSUES REFLECTING SUCH SCAMS

Those are the few scams which happened only due to various ethical problems or issue. This study has identified the following five issues influencing such scams.

Self-interest a sometimes morphs a into a greed a and selfishness, a which a is a unchecked self interest a at the a expense of a someone else. This greed a becomes a kind a of accumulation fever. If a you accumulate a for a the sake a of accumulation, accumulation becomes the a end, and if a accumulation is a the end, there’s no a place to stop. The focus shifts from the longterm to the short-term, with a big a emphasis on a profit maximization. For a example, swaps (where two a communication a companies a agree to a exchange the right to a use excess a bandwidth on a their networks) fall into this category. Each a company recognizes the a income generated in the a quarter a earned and a defers a the expenses a through a capitalizing a them as an asset and a logging the a cost as a recognized expense over time, resulting a in an a inflated bottom a line. Companies may make a money out of their a finance a department—not from selling a products, not a from a doing a what the company did, not a from a fulfilling the a company’s mission, but a from a playing a around with its a asset mix.

Some people suffer from stunted moral development: This a happens a in three a areas: the a failure to a be taught, the a failure to look a beyond v one’s own perspective, and the lack of proper mentoring. Business schools too a often reduce everything to an economic entity. They do this by a saying the a fundamental a purpose of a business a is to a make money, maximize a profit, or the really jazzy words „maximize shareholder value,‟ or something like that. And it a never a gets questioned. If the a fundamental purpose a never gets questioned, the ethics never get questioned, because a the fundamental a purpose of something gives you the reason for its existence. It tells you whether you’re doing it well or not.

Some people equate moral behavior with legal behavior, disregarding a the fact a that even though a an action may a not a be illegal, it a still may not a be moral. Everyone a must remember a that the a reason a for all laws is a that the moral a agreement a begins to break down, and the a way a to get other a people in a line is to legislate so that we can stipulate punishments. Yet some people contend that the only a requirement is to a obey the a law. They tend to ignore the spirit of the law in only following a the letter of the law. For example, Companies Act, Contract Laws etc, regulations repeatedly a single out a actions with a “no legitimate business a purpose” (like swaps.) If you are doing a things with no legitimate a business purpose in a order a to avoid a taxation, what a are you doing? You’re violating a the spirit, are you not? You’re staying a within the a letter, but there‟s no purpose there except a to get you a around the law.

Professional duty a can conflict a with company a demands. For example, a faulty a reward system a can induce a unethical behavior. A purely a self-interested a agent would a choose that course a of action a which contains a the highest a returns to him a or herself. For a example, consider a the misguided a practice a of a selling indexed a annuities to a the elderly. If a company is a paying a high a commission for a that product, say a 15 percent, versus a lower commission a for a more appropriate product, say 3 percent, a salesperson may disregard the needs a of the client and/or assume that a the company supports this product and its a applicability by a its willingness to pay fivefold the compensation. Sooner or later, people are going to give a in to that temptation. The purely self-interested agent is just responding to the a reward system a that is in place. “You need to take a look at what you are rewarding.” In general, organizations a get exactly a what they a reward. They just don‟t realize that a their rewards a structures are encouraging dysfunctional or counter-productive behavior or a turn a blind eye to the outcome.

Individual responsibility can wither under the demands of the client. Sometimes the push to act a unethically comes a from a the a client. It is a quite a natural and a acceptable a that people a who do a business are, for a the most part, highly ethical people trying to do the right thing most of the time. Most a of them a are trying to help their clients achieve their financial objectives.

INSIDER TRADING

Insider trading refers to the practice of “insiders” trading on shares of a company for which they have privileged “material” information not available to the “public”, and for which they seek to gain pecuniary or other benefits. “Insiders” refer to any person or group that is able to gain such privileged information about a company. Insiders can include directors, managers or employees of a company. Or they can refer to persons who gain privileged information indirectly from such managers or directors in a more intimate capacity, such as friends, family members, or close but external business associates. Or they can refer to persons who have a contractual or supply linkage to such a company, such as those who print annual reports or stockbrokers who may inadvertently gain an information advantage. Thus “inside” information can be gained from a multitude of sources from which such private information can be exploited for financial or other gain.

The Ethics Involved in Insider Trading

Insider trading has managed to earn itself a dreadful name in the recent years. People who engage in insider trading are thought to be completely devoid of ethical values. However, not all individuals who engage in insiders trading are unethical; studies have shown that some insider trading is useful to the investment society. Some researchers in philosophy, law and economics have not decided whether insider trading should be penalized at all while others state that it should be illegal in all situations. The best thing to do is to detach those who are illegally harmed by insider trading. If such people exist, then obviously worded legislation could be passed to stop any scheme from being faithful against these people and groups, while allowing non- fraudulent transactions to be completed without dread of action. Until it can obviously be shown that an insider trading fraudulently harms an individual, there should be no law or regulation limiting the practice, since such limitations breach individual rights, it will also destroy the competition between the people and the company, and will most likely have a negative market response.

People often confuse the marketplace with a game in which rules of play are set and put into action so that everyone involved gets an even chance. The market is more similar to life itself in the sense that diverse people come with special assets, talents, looks, genetic makeup, economic and climactic conditions; and the people have to do their best with what they have. In reality, however, the theory of “insider trading“ used in business ethics has a wider meaning, which includes anyone’s capability to make agreements based on not yet publicized information of the company’s opportunities. Insider trading per se, apart from its association with fraud or violation of fiduciary duty, involves engaging in financial investments based on information others do not know about. It is apparent that such actions should be considered to be ethically immoral since they affect others unfairly.

LIMITS FOR THE REGULATORS

With the ambitious efforts on the part of regulators to up their game as well, specialist skills have also been recruited from the markets into official institutions. Yet the extent to which regulators can enforce more ethical standards in the industry, and avoid a repeat of the excesses that contributed to the global financial crisis or the other major crisis, may have its limitations.

The first problem resides with the ability of regulations to envisage all possible infringements. In a world where financial innovation has been moving fast, and new and more sophisticated products continue to be developed, there is always the risk that unethical market participants remain one step ahead of regulatory authorities, in the same way as unethical athletes and sport physicians attempt to be one step ahead of anti-doping agencies. And indeed, new transgressions in the recent past have been committed after the promulgation of legislation aimed at curbing improper practices – providing evidence that legislation will not completely prevent the occurrence of improper or fraudulent behavior.

The second issue is one of finding the optimal degree of regulation. While the events of the past decade have clearly demonstrated the limits of ‘light touch’ regulation and reliance on the market’s ability to self-regulate, there may equally be a risk that too much regulation will stifle financial innovation, result in elevated compliance costs that will be passed through to the end-customer, and limit the willingness of institutions to provide funding to all but the most creditworthy borrowers.

Furthermore, ‘top-down’ regulation brought about by international bodies like, for example, the G-20, may not be appropriately tailored to all jurisdictions in which they would apply. It would be undesirable, for instance, for regulations initiated in response to developments witnessed in the world’s largest economies to end up stifling financial development in an emerging country like India. A push for elevated regulation may also easily break the fragile consensus achieved by most countries after the global financial crisis.

CONCLUSION

In conclusion, while a lot of work remains to be done, it is nonetheless very encouraging to note that key steps have been taken by regulators and financial institutions alike to tighten behavioural standards in the industry. It is equally encouraging that South Africa, while largely sheltered from the global financial crisis, is embarking on measures to limit the risk of such crises occurring locally in the future, including strengthening market conduct regulations as part of the move to a twin peaks system of regulation. Nonetheless, the future evolution of the financial industry will bring new challenges for regulators and professional bodies alike. I will only mention a few potential examples here. Much has been written, for instance, about the growing role of non-bank institutions in financial intermediation, and indeed, one potential consequence of stricter regulation of banks may be to shift a greater share of transactions towards the non-bank sector. Extending codes of good behaviour and governance to a broader swathe of financial market players will be a continuing task for regulators and professional bodies.

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