THE FUTURE OF FINANCE:
INVESTOR RIGHTS AND ETHICAL
DECISION-MAKING
A. Mark Harbour, CFA, CIMA®, CPA
Past President, CFA Society of Los Angeles
Harboal@ca.rr.com
(310) 210-1133
www.cfala.org
AGENDA – SESSION OUTLINE
Why cover ethics? Do we have an issue?
More importantly, what can you do about it?
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Introducing CFA
Do we have an issue?
Cheating, Integrity and Trust
Morals, Values, and Ethics
Practical Solutions - Ethical Behavior
Practical Suggestions - Hiring an Advisor
Questions?
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ABOUT CHARTERED FINANCIAL ANALYSTS (CFA)
CFA Institute is the global, not-for-profit association of investment
professionals that has set the standard for professional excellence
since 1947. The CFA Institute family includes over 100,000 members
and 140 member societies around the world.
CFA Los Angeles is one of the large societies of the CFA
organization with approximately 2,000 members in the Los Angeles
region. We are active in supporting education programs for our
members and collaborating with other organizations to provide value
for our members and our community by serving the mutual interests of
our members and the public good.
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CFA INSTITUTE MISSION
To lead the investment profession globally by
promoting the highest standards of ethics,
education, and professional excellence for the
ultimate benefit of society.
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FIVE ORGANIZATIONAL PILLARS
Ethical
Champion
• Championing ethical behavior in
investment markets.
Global
Community
• Creating a strong community of
investment professionals.
Industry
Knowledge
• Being a respected source of knowledge
in investment markets.
Professional
Excellence
• Raising standards of professional
excellence in the industry.
The Greater
Good
• Build an investment industry that serves
the interests of investors and society.
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DO WE HAVE AN ISSUE?
YOU CAN TRUST ME…
Roundtable Discussion With Bernie Madoff
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DO WE HAVE AN ISSUE? 1
Banks and
Financial
Services are
consistently
at the bottom.
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From The Edelman
Trust Barometer - 2014
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DO WE HAVE AN ISSUE? 1
An earlier Edelman survey also highlighted 7 key attributes to building trust that
reflected gaps between importance of and the actual performance received for each as
shown in the following chart –
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ATTRIBUTE
IMPORTANCE
PERFORMANCE
Listens to customer needs and feedback.
Treats employees well.
Places customers ahead of profits.
Takes responsible actions to address an issue
or a crisis.
Has ethical business practices.
Has transparent and open business practices.
Communicates frequently and honestly the
state of its business.
62%
61%
59%
30%
24%
23%
-32%
-37%
-36%
58%
25%
-33%
58%
57%
28%
24%
-30%
-33%
54%
23%
-31%
From The Edelman Trust Barometer - 2013
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Gap
DO WE HAVE AN ISSUE? 1
How much would you estimate we spend to handle fraud?1
For example, assuming a company with $100 MM revenue
Description
Company Revenue
6% is the cost of fraud detection
(and lack of ethical behavior
Leaving the amount to cover
expenses and fund profits
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Amount
$100,000,000
$6,000,000
$94,000,000
– Moral Intelligence 2.0, Doug Lennick and Fred Kiel, April 2011
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WHAT ABOUT THE FUTURE?
In 1969, more than 80% of high school children agreed that “honesty is
the best policy”. By 1989, the figure was 60%1
Recent estimates are that 1 in 3 students cheat at some point in
elementary school. By high school, 51% admit to cheating on a test in
the past year and 74% copied homework.2
56% of MBA Students and 43% of law students admit they cheat.
93% say cheating is justified and 90% have no moral dilemma about
doing so.3
Key Planning Implications –
 Take active steps to strengthen ethical values and behavior for
junior staff (and future generations).
 Incorporate a statement of values to enhance ethical awareness in
business and family succession plans.
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- Fred Schab, University of Georgia survey
- “How could a Sweet Third-Grader Just Cheat on That School Exam” WSJ Article 5/13/13
3
- Johnson Institute recent study
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CHEATING, INTEGRITY & TRUST1
Question - Who Cheats???
Our sense of our own morality is connected to the amount
of cheating we feel comfortable with.
…as long as we cheat by only a little bit, we can benefit from
it and still view ourselves as marvelous human beings.
Answer - We All Do….
…we should focus on early signs of dishonest behaviors
and do our best to cut them down in their budding
stages before they reach full bloom.
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– Taken from The Honest Truth about Dishonesty, by Dan Ariely
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CONTRIBUTING FACTORS1
Ability to Rationalize
Conflicts of Interest
Creativity
One Immoral Act
Being Depleted
Pledge
Others Benefitting From
Our Dishonesty
Signatures
Watching Others Behave
Dishonestly
Amount of Money
to be Gained
Moral Reminders
Culture That Gives
Examples of Dishonesty
Probability of
Being Caught
Supervision
Increase Dishonesty
1
No Effect
Decrease Dishonesty
– Taken from The Honest Truth about
Dishonesty, by Dan Ariely
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INTEGRITY1
For an object or system to have integrity, it must be in a state or condition of being
whole, complete, unbroken, unimpaired, sound, perfect condition.
Workability: the state or condition that
determines the available opportunity for
performance (i.e., the “opportunity set”)
Bicycle Wheel Example: As we remove
spokes from the wheel, integrity is more and
more diminished, and as integrity is more and
more diminished, the wheel becomes less and
less workable.
When we remove enough spokes the wheel
has no integrity and collapses into complete
failure and will not work at all.
To the degree that integrity is diminished, the opportunity for
performance (the opportunity set) is diminished.
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– Taken from Integrity: A Positive Model that Incorporates the Normative Phenomena of Morality, Ethics, and
Legality by Werner H. Erhard, Michael C. Jenson, and Steve Zaffron
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IMPACT OF INTEGRITY
You are whole and complete when your word is whole and complete, and
Your word is whole and complete when you honor your word in one of two ways:
1. By keeping your word, on time as promised; or
2. As soon as you know you won’t keep your word, you inform all parties involved
and clean up any mess caused in their lives.
When you and your people do this, you are honoring your word even despite having not kept
it, and you maintain integrity
What happens when you take specific action to improve TEAM INTEGRITY?
Results (per Michael Jensen for his organization – SSRN1):
1. 300% increase in output;
2. No required increase in input
3. Happier people in the organization
{Jensen’s co-authors/consultants note large gains in their client’s productivity, and reductions in injury
and death rates in the mining industry by implementing actions to improve integrity}
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– SSRN - Social Science Research Network
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WHAT IS TRUST?1
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Trust is an option, a choice
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Trust is dynamic. It involves personal responsibility, commitment,
and change
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Trust is a social practice, not a set of beliefs…an aspect of culture
and the product of cultivation
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Breaches of trust do not mark the end of trust but are part of the
process of trusting
 The core strategy for building trust is the practice of making and
receiving assessments and learning how to negotiate them
 “Trust is something that you ____________.”
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Building Trust: In Business, Politics, Relationships, and Life, by Robert C. Solomon and Fernando Flores
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THE ECONOMICS OF TRUST?1
Trust =
Speed
Cost
Trust =
Speed
Cost
“Transcendent values like trust and integrity literally
translate into revenue, profits and prosperity.”
Quote from Patricia Aburdene, Author of Megatrends 2010
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– Taken from The Speed of Trust, Stephen R. Covey
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VALUES, MORALS & ETHICS
Values –
our fundamental beliefs
Morals –
values we attribute to a system of beliefs
(usually outside ourselves)
Ethics –
Decisions and actions
Being open about our values…
 Provides a sense of your character
 Expresses openness which invites trust
 Encourages others to follow your lead
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PROFESSIONAL CODES
Codes of Conduct are
Rules Based
(think externally enforced)
Codes of Ethics are
Values Based
(think self-imposed)
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WHY ETHICAL CODES?
On the whole, human beings want to
be good, but not too good, and not
quite all the time
George Orwell
Ethics is: Our capacity for obedience
to the unenforceable
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TOUGH CHOICES (FOR ACTION)
Are not right versus wrong
but are right versus right –
Truth versus loyalty
Do I tell the truth or protect my team?
Individual versus community
Should my needs or my community come first?
Short-term versus long-term
Does a sacrifice today bring a longer term benefit?
Justice versus mercy
Should I teach a hard lesson or give another chance?
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WHAT ELSE IS REQUIRED?
Is having a personal moral code sufficient?
– Significant statistical reduction of cheating when
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specific reminders recall codes of conduct
– What gives people meaning?
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 “the ability to realize my full potential as a person”
 “being associated with a good (ethical) organization”
 “translating values into operational behavior”
Some professional organizations articulate shared
values in their codes (NASW)
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2
The Honest Truth About Dishonesty: How We Lie to Everyone---Especially Ourselves by Dan Ariely.
Survey responses & quotes from A Spiritual Audit of Corporate America, Ian Mitroff and Elizabeth Denton
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PRACTICAL SOLUTIONS
Begin by self examination (you & your team):
– Review/take a personal survey
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– Consider ethical awareness and improvement as
a routine element of your practice process
evaluation - upgrade based on survey results
– Solicit client feedback designed to improve your
ethical awareness
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- Moral Intelligence and Moral Intelligence 2.0, Doug Lennick and Fried Kiel. A personal
survey PDF is available at Worksheet for Defining your Code of Ethics
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PRACTICAL SOLUTIONS1
FOR INDIVIDUAL DECISIONS AND ACTIONS
 Be aware that your intuitive “system 1” decision process (i.e., the “want”
self) is more likely to be immoral than the deliberative “system 2”. Thus,
for decisions with moral implications, attempt to engage system 2.
 Utilize pre-commitment devices to “lock in” a desired course of action. (or
perhaps publicly commit to a decision in advance).
 Consider adding more options to the decision (rather than yes or no,
should I choose A, B, or C). Multiple choices seem to elicit more
deliberative thought methods.
 “Debrief” your decisions periodically with a trusted friend or advisor –
particularly one who can play the role of “devil’s advocate” to your
decisions. This will help ensure you are accurate in your recollections and
more concise in projecting for the future.
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– Taken from Blind Spots, Max Bazerman & Ann Tenbrunsel
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PRACTICAL SOLUTIONS1
FOR GROUP DECISIONS AND ACTIONS
 Look for the informal values of the organization. Who “really” runs the
company – assess motivations from the answers to that question. Notice
what is talked about as an indicator of values of those in positions of power.
 Call unethical behavior by its name. (are you “lying” or just
“misrepresenting the facts”….are you “stealing”, or inappropriately
allocating resources”)
 Look for danger zones or “sink holes” in an organization where unethical
behavior is more likely. Specifically, those areas characterized by
uncertainty, time pressure, short-term horizons, and isolation are good
breeding grounds for unethical actions and decisions). Once identified,
take proactive steps to reduce the likelihood of unethical actions and
decisions.
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– Taken from Blind Spots, Max Bazerman & Ann Tenbrunsel
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PRACTICAL SOLUTIONS1
FOR GROUP DECISIONS AND ACTIONS (CONT’D)
 Change the defaults on decisions (i.e., opt out required rather than opting in
for savings plans, and automatic allocations of pay raises to retirement
plans – save more later).
 Communicate more clearly the issues and relative magnitude of decisions.
 Attempt to override the undue influence of short term costs regarding longer
term benefits. (i.e. gas price increases to reduce consumption - but
propose tax increase that doesn’t take effect until some time in the future).
This method is sometimes referred to as “future lock in”.
Web based reference links can be found at - http://www.blindspots-ethics.com/
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– Taken from Blind Spots, Max Bazerman & Ann Tenbrunsel
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HOW DO WE MEASURE SUCCESS?
Mere obedience to law does not measure
the greatness of a nation...
The true test is the extent to which
individuals can be trusted to obey self
imposed law.
John Fletcher Moulton
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DO IT YOURSELF OR HIRE AN ADVISOR1?
ASSESS YOURSELF FOR KNOWLEDGE/SOPHISTICATION AND THE NEED FOR CONTROL
Add up your
scores for all
questions in both
categories – and
plot them on the
chart on the
following page
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– Taken from Wealth Management Unwrapped by Charlotte Beyer
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DO IT YOURSELF OR HIRE AN ADVISOR1?
ASSESS YOURSELF FOR KNOWLEDGE/SOPHISTICATION AND THE NEED FOR CONTROL
- - - - -K N O W L E D G E - - - -
- - - - -C O N T R O L - - - -
High Level of Sophistication
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People like
us – caution!
Capable
Overconfident
Do-it-yourselfer
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Low
Need for
Control
4
6
8
12 14 16 18 20
6
4
Vulnerable
Irresponsible
2
High
Need for
Control
Naïve
Hopeful
Delusional
Low Level of Sophistication
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– Taken from Wealth Management Unwrapped by Charlotte Beyer
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WHO SHOULD YOU HIRE FOR ADVICE?1
KEY QUESTION – WHAT SERVICES DO YOU VALUE?
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– 2010 Survey of Advisors – published by IMCA first quarter 2011
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WHO SHOULD YOU HIRE FOR ADVICE?1
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– 2010 Survey of Advisors – published by IMCA first quarter 2011
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IDENTIFY YOUR SCREENING PRIORITIES1
WHAT IS MOST IMPORTANT?
Assign a percentage to each according to your perception of what is most important to
you - the total must equal 100%
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People
Philosophy
Process
Performance
“Phees”
___%
___%
___%
___%
___%
Who
they
are
What
they
believe
How
Decisions
are made
How
have they
done
What
they
charge
– Taken from Wealth Management Unwrapped by Charlotte Beyer
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SUGGESTED ADVISOR QUESTIONS…
1. What are your qualifications and certifications? Can you name one or two real life
experiences that were most helpful to enhancing your professional skills?
2. What regulatory body oversees you? SEC? OCC? Other?
3. Do you operate under the fiduciary standard in client relationships?
4. What are the top three activities in your service routine that you believe add the most
value to your clients?
5. Do you utilize written investment policy statements with your clients? How do you
determine the target return (after inflation) for my overall portfolio?
6. How do you define risk? How would you manage it in my situation?
7. How do you access the best funds or smartest money managers? What criteria do
you use (and frequency) in deciding/monitoring which ones to use?
8. What are your long term career objectives and do you have a succession plan?
9. Are your investment strategies based on a global perspective? How do you view
active vs passive investment strategies?
10. How do you ensure your technology is state of the art?
11. What are your fees? Are there additional indirect fees we pay for specific
investments? How frequently do you review fees with your clients?
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– Some questions taken from Wealth Management Unwrapped by Charlotte Beyer
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QUESTIONS…
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READING RESOURCES 1 OF 2
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The Psychology of Ethics in the Finance and Investment Industry by Thomas Oberlechner (a CFA Institute
Publication)
How Good People Make Tough Choices by Rushworth Kidder
Trust and Honesty in the Real World by Mark Fagan and Tamar Frankel
A Spiritual Audit of Corporate America: A Hard Look at Spirituality, Religion, and Values in the Workplace (J-B
Warren Bennis Series) by Ian Mitroff and Elizabeth A. Denton
Moral Intelligence: Enhancing Business Performance and Leadership Success (Paperback) by Doug Lennick and
Fred Kiel
The SPEED of Trust: The One Thing That Changes Everything by Stephen M.R. Covey, Stephen R. Covey, and
Rebecca R. Merrill
Trust in the Balance: Building Successful Organizations on Results, Integrity, and Concern (Jossey-Bass Business
& Management Series) by Robert Bruce Shaw
A Whole New Mind: Why Right Brainers Will Rule the Future by Daniel H. Pink
Crucial Conversations: Tools for Talking When Stakes are High by Kerry Patterson, Joseph Grenny, Ron McMillan,
and Al Switzler
Emotional Intelligence: 10th Anniversary Edition; Why It Can Matter More Than IQ by Daniel Goleman
Collaboration: How Leaders Avoid the Traps, Create Unity, and Reap Big Results by Morten T. Hansen
Freedom Collaboration: How Leaders Avoid the Traps, Create Unity, and Reap Big Results by Morten T. Hansen
Website – Institute for Wealth Management Standards (Don Trone and Charles Lowenhaupt) http://www.wealthstandards.org/standards.html?cr_i=502
Website – Edelman Trust Survey 2013 - http://www.edelman.com/insights/intellectual-property/trust-2013/
Website – CFA Institute Global Market Sentiment Survey 2013
http://www.cfainstitute.org/about/research/surveys/Pages/global_market_sentiment_survey_2013.aspx
Open Leadership: How Social Technology Can Transform the Way You Lead by Charlene Li
Blind Spots by Max Bazerman and Ann Tensbrunsel
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READING RESOURCES 2 OF 2
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The Honest Truth about Dishonesty: How We Lie to Everyone---Especially Ourselves by Dan Ariely
Switch: How to Change Things When Change Is Hard by Chip Heath and Dan Heath
The Cheating Culture: Why More Americans Are Doing Wrong to Get Ahead by David Callahan
Thinking Fast and Slow by Daniel Kahneman
Integrity: A Positive Model that Incorporates the Normative Phenomena of Morality, Ethics, and Legality by Werner H.
Erhard, Michael C. Jenson, and Steve Zaffron
Strings Attached: Untangling the Ethics of Incentives by Ruth W. Grant
The Righteous Mind: Why Good People Are Divided by Religion and Politics by Jonathan Haidt
The Decision to Trust: How Leaders Create High-Trust Organizations by Robert R. Hurley
Building Trust – an article by Jamie Ziegler with 5 key ideas to build trust
The right and wrong ways to apologize – Link to Bruce Weinstein, Ph.D’s website – look at the blog on ways to
apologize
The Death of Corporate Reputation – Jonathan Macey
Sidetracked: Why Our Decisions Get Derailed, and How We Can Stick to the Plan – Francesca Gino
Trapped: When Acting Ethically is Against the Law – by John Hasnas
IMCA Code of Professional Responsibility (July 1, 2009)
IMCA Standards of Practice (currently under revision)
Building Trust: In Business, Politics, Relationships, and Life – Robert C. Solomon and Fernando Flores
Daring Greatly: How the Courage to Be Vulnerable Transforms the Way We Live, Love, Parent, and Lead – Brene
Brown
Trust Inc. – Nan S. Russell
Practical Wisdom – Barry Schwartz and Kenneth Sharpe
An Ethical Decision-Making Model – website using the Josephson Institute of Ethics material
Resources PDF from the CFA Society of Los Angeles (some duplication of material with this list)
http://www.cfala.org/files/public/AdvocacyandEthicsReadingandResourceList.pdf
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