ETHICS IN FINANCE
Finance is the lifeblood of business and with the management of finance, accounting is
invariably associated. Financial management is concerned with many related activities like
investment, financial decision-making and also decisions on dividend payments.
There are, fundamentally, two objectives of FM are:
 First, in the short-run to maximize profits and to plough back some part of this profit.
 Second, to maximize wealth or company assets
Organizations that provide financial services cannot afford to have its employees leave their
morals on the front door when they step inside.
Finance usually depends on a very high level of ethics.
The simplest ethical guide for finance professionals should have three objectives:
 The first is to have higher ethical standards and a more inclusive financial system.
 The second, we should be more conscious of moral choices, but morals should not be imposed
upon people in suffocating ways.
 The third objective is to keep things simple.
Ethical questions arising in finance are in relation to accounting.
Accounts should present true and fair picture of business operations. Accountant can present
either an enlightening or a misleading picture depending on how he chooses to depict it.
Ethical issues in finance relate to the following
1. Insider Trading: - Very notorious form of financial practice. Insider trading refers to
the use of significant facts that have not yet been made public and are likely to affect the
prices of company’s securities in the stock market. It can be done by using one’s official
position in a company for personal gains. It is a concept where a person has privilege to
obtain company’s internal information which he uses for his personal advantage. It may
include information relating to policies, plans and future of the company having financial
implications or stock price sensitive information. Its main motive is to gain more and
more personally. I.e., People having inside information buy most of the shares of a
company when the conditions are very favorable, and the outsiders get less no: of such
shares. It is one of the undesirable situations when company executives pass the
information on to some selected people.
2. Financial Services: Financial Services largely operate through personal selling by tax
advisers, consultants, stock brokers, financial planners etc. It gives them numerous
opportunities for abuse though financial professionals take pride in the level of integrity
in the industry. This gives dissatisfaction to the people and they have objections like
(a) Deception,
(b) Churning,
(c) Suitability.
(a) Deception
Deception means false claims that are capable of being disproved although individual clients
may not have easy access to the evidence but deception is often a matter of interpretation. In
relation to mutual funds promotional material, if it gives emphasis on only strengths of a fund
and not weaknesses, it is misleading. Deception can occur when essential information is
concealed or the past trends are displayed in a misleading manner. In general, a person is
deceived when he is unable to make a rational choice as a result of holding false belief created by
some claim made by someone else. The claim may be incomplete, false or a misleading
statement.
(b) Churning
Churning is defined as exercise or inappropriate trading for a client’s account by a broker who
has control over the account with the intent to generate commissions rather than benefit for the
client. When the control of an account is granted to a broker by the client, and there is breach of
fiduciary duty (trust) not in the interest of the client, the broker is said to be engaged in the act of
Churning.
(c) Suitability
All the intermediaries (brokers, insurance agents and other sales people) should recommend
only the suitable securities and financial products to the investors and not the products which suit
them rather than the client.
3. Financial Markets
In financial markets, there are moral rules, behavior and expectations which prevent investors
against fraud and manipulations. Financial Transactions mainly take place in organized markets
like commodity markets, futures or option markets and currency markets. Ethical issues must be
observed because of unequal information, bargaining power and resources available with
different market players. Many participants in the market enter into long term relations with
investors which involve obligations to act as agents. However, they become subject to unethical
and unhealthy conduct when these agents fail in their duty to safeguard the interests of investors.
Though contracts with investors mention the scope of their duties and remedies available in case
of noncompliance, the problem is that contracts themselves are often vague and incomplete,
resulting in disagreement and uncertainty about ethical and legal contract.
Irregularities in financial markets can take the following forms:
(a) Efficiency: The main objective of financial market regulation is to ensure efficiency which
can be achieved only when people have confidence in their fairness of operations. When people
tend to believe that the financial market operations are not fair and equitable, it affects efficiency
of the market operations. This happens when companies or financial intermediaries do not
observe laws relating to financial disclosures and maintenance of accounts.
(b) Unfairness in market: The aim of financial markets is to ensure fairness that protects the
general public against financial frauds. Individual investor can be treated unfairly by the
operations of financial markets by
(i) Fraud, manipulation,
(ii) Unequal information,
(iii) Unequal bargaining power and
(iv) Efficient pricing.
(i) Fraud and Manipulation:
(a) The company that fails to report proper information may be committing fraud.
(b) Manipulation involves buying and selling of securities in order to create false or misleading
impression about the direction of their price so as to induce other investors to buy or sell the
securities.
(ii) Unequal Information:
With unequal information, competition between parties is regarded as unfair because market
players with superior and extensive information are benefited at the cost of those who do not
have adequate information.
Stoke investors and analysts spend considerable time, effort and money to acquire information
and they can use this information for personal use.
Unequal information is objectionable as they reduce efficiency.
Efficiency along with fairness helps to reduce information asymmetric in financial markets.
(iii) Unequal Bargaining Power:
Unequal bargaining power can result because of factors like access to resources and processing
ability of the privileged few.
(iv) Efficient Pricing:
Fairness in financial markets includes efficient prices that reasonably reflect all available
information.
Volatility and fluctuations also affect the market by reducing investor’s confidence and drives
them away.
4. Creative accounting
For gathering money for investment it is necessary to show that the financial health of the
company is very safe and sound. Hence, the company cooks the financial data and manipulates
them to suit the requirements. The cooking of data is also known as creative accounting.
5. Merger of companies may be a financial stunt.
A good company merges with an old company in order to evade taxes or to reduce competition.
After merger, the joint company becomes strong and it is possible to increase prices and market
share. Sometimes merger is resorted to take advantage of the brand image of one of the
companies.
6. Window dressing
Window dressing is a technique used by companies and financial managers to manipulate
financial statements and reports to show more favorable results for a period. Although window
dressing is illegal or fraudulent, it is slightly dishonest and is usually done to mislead investors
Companies typically window dress their financial statements by selling off assets and either
purchasing new assets or using this money to funds other operations. This way the cash balance
on the balance sheet appears to be at a normal amount. Window dressing is probably most
commonly found in investment brokers and mutual fund houses. Eg: Let's assume Company
XYZ wants to look attractive to potential acquirers. It might do some window dressing by
announcing much higher sales projections, obtaining and holding a lot of cash, or making other
announcements that are likely to raise the stock price, even if only for a short time. The objective
is to make a favorable impression on potential acquirers.
7. Misleading financial analysis
Financial analysis of an organization is misleading when it is used to misrepresent the
organization, its situation or its prospects. This type of deceit is sometimes used to obtain money
by misdirecting people to invest in a stock market bubble, profiting (or assisting others to profit)
from the increase in value, then removing funds before the bubble collapses
8. Other issues are:
Another unethical financial issue is creating unusual delay in making payments to suppliers,
taxes, excise duties and other legal payments. Many companies open accounts in different
banks to avoid taxes and avoid adjustments against loans.
Companies may create many independent subsidiaries and make property transactions to avoid
payments to government and taxes.
Financial irregularities also include cheating employees in the matter of payment of regular
wages, medical bills. Bonus,
Securities Fraud Leading To Manipulation Of Financial Markets
Securities fraud is a type of serious white-collar crime that can be committed in a variety of
forms, but primarily involves misrepresenting information investors use to make decisions. The
perpetrator of the fraud can be an individual, such as a stockbroker, or an organization such as a
brokerage firm, corporation or investment bank. Securities fraud, also known as stock fraud and
investment fraud, is a deceptive practice in the stock or commodities markets that induces
investors to make purchase or sale decisions on the basis of false information, frequently
resulting in losses, in violation of securities laws Manipulation is the act of artificially inflating
or deflating the price of a security or otherwise influencing the behavior of the market for
personal gain. Manipulation is illegal in most cases, but it can be difficult for regulators and
other authorities to detect. Manipulation is also difficult for the manipulator as the size and
number of participants in a market increases. It is much easier to manipulate the share price of
smaller companies, such as penny stocks, because they are not as closely watched by analysts
and other market participants as the medium and large cap firms. Manipulation is variously
called price manipulation, stock manipulation and market manipulation.
Types of security fraud
1. Corporate fraud
a. Corporate misconduct Fraud by high level corporate officials. i.e.: company itself
b. Dummy corporations Dummy corporations may be created by fraudsters to create the illusion
of being an existing corporation with a similar name.
2. Internet fraud
3. Insider trading
4. Microcap fraud
5. Mutual Fund fraud -A number of major brokerages and mutual fund firms were accused of
various deceptive acts that disadvantaged customers.
6. Ponzi schemes. A Ponzi scheme is an investment fraud that pays existing investors with
funds collected from new investors. Ponzi scheme organizers often promise to invest your money
and generate high returns with little or no risk. But in many Ponzi schemes, the fraudsters do not
invest the money. Instead, they use it to pay those who invested earlier and may keep some for
themselves.
7. Third Party Misrepresentation. The last type of securities fraud occurs when a third party
gives out false information about the stock market or a particular company or industry. “Pump
and dump” schemes are a prevalent type of third party misrepresentations. In a pump and dump
scheme, a person will find a small, unknown company with cheap stock and buy large amounts
of its shares. The perpetrator will then send out false information about the company to
encourage others to buy the stock, driving up the price. Once the price of the stock is high
enough, the perpetrator sells his or her shares for a profit.
PUMP AND DUMP SCHEMES "Pump and dump" schemes have two parts. In the first,
promoters try to boost the price of a stock with false or misleading statements about the
company.
Bribery
Bribery involves an attempt to influence the decision of someone in a position of authority by
offering them money or some other benefit. It is illegal everywhere on earth, though
unfortunately common in some places. It is unethical because it amounts to an inducement to
disloyalty. Decision-makers (e.g., government officials) are obligated to make the decision that is
best for the people they serve, and a bribe is typically aimed at getting them to make the decision
that is best for you instead. It is typically considered illegal & can be punishable.
Factors That Push Business to Pay Bribe
• Competitors are giving bribes to obtain business (which can cause the misuse of the country’s
resources)
• The pressure for higher levels of performance by top management and shareholders
• Tax laws of the country encourage bribery. It can be written off as a business expense.
• Government control over business activities.
• In economics, the bribe has been described as rent
• Government officials are poorly paid and use bribery to supplement salaries.
• Bureaucratic delays can be costly for business.
• Pressure from politicians to make contributions to political parties or causes.
How to prevent unethical practices in finance
1. Monitoring the cheques: All cheques should be kept under safe custody using lock & key, and
the keys should not be with many people but with specific one. Cheques should be always
cleared in sequence and avoid signing a blank cheque. All disbursements made should be
reviewed on a regular basis.
2. Maintain Employees Manual: The best ways of avoiding unethical practices in business are
by maintaining an employee manual in terms of do and don’ts and setting the clear standards of
behavior for employees. This includes setting the appropriate ethical code and delegation of
authority matrix.
3. Periodical review of financial statements: Periodical Review in the name of audit can serve as
a watch dog to maintain accounting records in a righteous manner and helps present the clear and
true picture of the financial position of the business during the period. Though audit will not
always discover all frauds, but it will certainly give a picture of the financial position.
4. Review of sensitive documents: Business needs to maintain confidentiality about its certain
matters so as to avoid misuse of the same by unscrupulous users for their own vested interests.
Hence, there is a need to specify and notify who will receive especially the sensitive documents
to prevent their misuse by others.
5. Checking the payroll: The hole for unethical financial area is payment made to especially
temporary and contractual staff. Hence, due care should be taken in checking every payroll so
that employees are paid appropriately.
6. Employee References: One way to hire employees with integrity based on referrals.
Therefore, when hiring new employees, checking references and perform background checks
that include employment, credit, licensing and criminal history seem very pertinent to hire right
type of employee.
7. Independent Review: In order to ensure the correctness of records and entries, all account
reconciliations and general ledger balances should be reviewed by a person outside the day-today
transactions.
8. Stringent Law: Another means to control unethical practices in finance is to pass stringent
laws to penalize those who follow unethical practices in finance