Ethics and Regulation in the Professional Asset Management Industry

Ethics and Regulation in the Professional Asset Management Industry 11 December, 2011 Whenever a person is hired to perform a service or look after the interest of another, the question of rules for interactions and transactions behavior arises. This is particularly important for the financial industry were portfolio managers may be entrusted with portfolio value of trillions of dollars , the inherent risks associated with financial investments and the fact that portfolio managers are often exposed to ethical conflicts.

Hence, it is no surprise that the financial industry is highly regulated to ensure that there is a minimum level of acceptable practice. Guidelines are built on two legs – formal legally enforceable regulations and ethical standards. Both follow the overall principle that “portfolio managers will always act in the best interest of their investors”. Legal regulations are complex often with an interaction between state and federal laws. At the very basic level they establish adequate disclosure of information related to the investment process and provide anti-fraud protections.

These cover aspects like documentation, reporting, fairness, timeliness and accuracy of information. At a more complex level, regulations cover specific investments types like for example retirement / pension assets that have different risk management requirements. Following are the principal Securities Laws for the Asset management industry and their primary target user: * Securities Act of 1933 for security issuers * Securities Exchange Act of 1934 for security brokers * Investment Company Act of 1940 for mutual funds Investment Adviser Act of 1940 for advisors and private managers * Employee Retirement Income Security Act (ERISA) for retirement asset managers and fiduciaries * Pension Protection Act of 2006 for pension fund sponsors and managers Several agencies / institutions are responsible to ensure these industry regulations are managed and followed: * SEC – U. S. Securities and Exchange Commission (the main federal agency) * U. S. Department of Labor (pension plans including 401 (k) plans) * NASDR – National Association of Securities Dealer rules * U.

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S. Commodity and Futures Trading Commission * U. S Internal Revenue Services (tax policies) These financial regulations are the “1st leg” of regulating investor/agent relationships and they provide the legally binding and enforceable framework of conduct. The “2nd leg” comprises voluntary ethical behavior standards. They follow the same overall principle of “investors come first” but describe in much more detail how the clients/investors interest must always take precedence over the interests of investment professionals and their employers.

Ethical guidelines are the indispensable as they fill a void space. Policies and regulations may punish illegal behavior but cannot prevent such abuses from happening in the first place. Also while some financial transactions may not have violated any laws but could still be to the disadvantage of investors because of unethical behavior. Thus, Ethical guidelines aim to establish a self-regulating, voluntary behavior to prevent abuses before happening and to provide guidance for aspects of financial transactions not covered by formal policies.

Leading institute is the CFA, the Chartered Financial Analysts Institute https://www. cfainstitute. org/Pages/index. aspx, previously AIMR – (Association for Investment Management and Research), which established a code of ethics for its members. Key elements are: * act with integrity, competence, diligence, respect and in an ethical manner. * place integrity of the investment profession and interests of clients above own personal interests. * use reasonable care and exercise independent professional judgment when conducting investment analysis, recommendations and taking investment actions.

This ethics code is complemented with precisely defined conduct and actions that are acceptable (or unacceptable). The Centre of Financial Markets Integrity founded by the CFA has created a comprehensive “Asset Manager Code of Professional Conduct” providing more detailed minimum standards for providing asset management services to clients. These standards extend the rules for individuals to those of entire investments firms. Of note, agents and companies strictly adhering to ethical standards may achieve higher trust and preference ratings from investors as well as employees.

Therefore, it is in the own interests of financial institutes and agents to be a CFA member and follow their ethics code. However and despite these wide-ranging regulations in place investors’ interests are not always followed. Two reason fall mostly in two categories 1) Ethical dilemmas: these are situations where the “investor interest” evaluation is not straight forward, therefore posing an ethical dilemma for the agent. Examples include where an agent may occur expenses for costly company research or other expenses which may not be clearly to the benefit of the client. ) Guidelines must be put into daily practice. A policy by itself is not sufficient to achieve compliance. The responsibility is with the leadership of financial companies by creating a corporate culture that reinforces ethical behavior, by always leading with best example and by establishing a regulatory compliance framework with capability trainings, frequent internal communication, and by strict enforcement. Closing remarks Much progress has been made in updating and raising the standards of legislation to be more comprehensive and to avoid a repetition of historical financial crisis.

However, no matter how detailed regulations may be “the question really boils down to staying true both the spirit and the letter of the law. ” (Carlo V. di Florio) This is the reason why ethical codes such as provided by CPA are a critical complement to legal regulations as they provide behavioral guidelines. In fact, efforts are being made to make the ethical behavior standards legally mandatory. 913 study submitted in 2011 for the Dodd-Frank act as well as FINRA and the code framework itself is in a constant process of updates and expansion (e. . the Shingle theory). This is encouraging and will provide further guidance “how to put the investors’ interests first”. The investor is playing an important role in the process as well: Being very specific about individual investment priorities, by selecting only CPA proven financial partners and, last not least, by staying in close contact with the agent to ensure the steady flow of information. After all – asset ownership also carries the owner responsibilities. References Brown,C. , & Reilly, F. K. (2009).

Investment Analysis and Portfolio Management. (9 ed. ). Mason, OH, Cengage Learning. Carlo V. di Florio, director of the U. S. SEC’s Office of Compliance Inspections and Examinations (OCIE). downloaded on 08 December 2011, http://blogs. cfainstitute. org/marketintegrity/2011/11/30/fatally-flawed-compliance-without-ethics-in-the-investment-industry/ Carlo di Florio, Harvard Law School Forum on Corporate Governance and Financial Regulation, Nov 25-2011, downloaded on 08 December, http://blogs. law. harvard. du/corpgov/2011/11/25/compliance-and-ethics-in-risk-management/ “913 Study”: Study on Investment Advisers and Broker-Dealers as Required by Section 913 of the Dodd-Frank Wall Street Reform Act (January 2011), downloaded on 8 December 2011 http://www. sec. gov/news/studies/2011/913studyfinal. pdf Jon Stokes “Fatally Flawed: Compliance without Ethics in the Investment Industry” (30 November 2011) · Enterprise Risk Management- Integrated Framework, Committee of Sponsoring Organizations of the Treadway Commission (September 2004)

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