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Chapter 11
Ethics in Finance
CHAPTER SUMMARY
Ethical issues in finance are important because they bear on our financial well-being. Ethical
misconduct, whether it be by individuals acting alone or by financial institutions, has the
potential to rob people of their life savings. Because so much money is involved in financial
dealings, there must be well-developed and effective safeguards in place to ensure personal
and organizational ethics. Although the law governs much financial activity, strong emphasis
must be placed on the integrity of finance professionals and on ethical leadership in our
financial institutions. Some of the principles in finance ethics are common to other aspects
of business, especially the duties of fiduciaries and fairness in sales practices and securities
markets. However, such activities as insider trading and hostile takeovers raise unique
issues that require special consideration.
Insider trading is prohibited because it involves trading
of information not publicly available or breaching a fiduciary duty by misappropriating
confidential information. Hostile takeovers are problematic because of the conflicting interests
and fiduciary duties that exist among the various parties involved.
CHAPTER OBJECTIVES
11.1: Explain the three basic forms of ethical misconduct when selling financial
products and services, and the responsibilities brokers have to their clients
11.2: Assess the significance of the three main elements of fairness in financial markets
and the ethical issues introduced by new financial instruments and practices
11.3: Summarize the two main arguments against insider trading and the challenges in
applying these theories to its prevention and prosecution
11.4: Analyze the ethical issues raised by various hostile takeover tactics and what they
suggest about the rights and fiduciary duties of officers and directors
SUGGESTED DISCUSSION PROMPTS
2.
Is it unethical for a financial broker to generate commissions in a way that neither
ASSESSMENT FOR IN-CLASS USE
Multiple Choice Questions
Choose the BEST possible answer for each of the following.
1.
Financial dealings most fundamentally require the value of _.
A.
freedom
B.
time
C.
trust
D.
competence
11.1: Explain the three basic forms of ethical misconduct when selling financial
products and services, and the responsibilities brokers have to their clients
Difficulty Level: Easy
Skill Level: Understanding
2.
Financial service people are most fundamentally in the business of selling
___________.
A.
savings
B.
investments
C.
stocks
D.
bonds
Difficulty Level: Easy
Skill Level: Understanding
3.
Deception is an ever-present danger in financial selling mostly because .
A.
the customer has to rely on the seller for all of the relevant information
B.
financial salespeople often do not know very much about the securities they
sell
C.
there are not many laws that regulate financial services
D.
no one ever has all the information at a given time
Difficulty Level: Easy
Skill Level: Understanding
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4.
A financial broker may be tempted to “churn” because by doing so he can
_
.
A.
sell more shares
B.
artificially inflate yields
C.
get more customers
D.
earn additional commissions
Difficulty Level: Easy
Skill Level: Understanding
5.
Due to the wide variety of financial products available, it is incumbent on the broker
to help the customer select those that are .
A.
suitable
B.
liquid
C.
cheapest
D.
least risky
Difficulty Level: Easy
Skill Level: Understanding
6.
Doing business in the financial markets most fundamentally presupposes that
will be respected.
A.
power
B.
fairness
C.
freedom
D.
ideas
Difficulty Level: Moderate
Skill Level: Analyze
7.
Efficiency in financial markets means that ____
.
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A.
social well-being will be maximized
B.
all investments will keep their value
C.
overall yields will increase
D.
fairness will always be maintained
Difficulty Level: Moderate
Skill Level: Evaluate
8.
If people in financial markets have unequal access to information, __.
A.
it is always unfair
B.
this can happen in spite of their expertise
C.
it should not impact their ability to make good decisions
D.
a law has probably been broken
Difficulty Level: Moderate
Skill Level: Evaluate
9.
Agreements reached in financial trading are generally considered fair as long as
__
.
A.
everyone profits from the exchange
B.
all traders involved are professionals
C.
everyone has the same information
D.
they are reached through good-faith bargaining
Difficulty Level: Easy
Skill Level: Understanding
10.
Takeover offers must now be accompanied by enough time so that .
A.
shareholders have opportunity to consider the offer carefully
B.
consumers can decide whether to buy stock in the company
C.
abusive tender offers can be rescinded by government action
D.
there can be an orderly transition of control
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Difficulty Level: Moderate
Skill Level: Analyze
Essay Questions
1.
Explain why in the context of finance it is so important that customers be
11.1: Explain the three basic forms of ethical misconduct when selling financial
products and services, and the responsibilities brokers have to their clients
Difficulty Level: Easy
Skill Level: Understanding
2.
Describe an example of the kind of transaction that a financial advisor might make