Ethical Theories and Decision Making

• Four Quizzes: Weeks 4, 6, 9, and 12

Week 1: Ethical Decision Making - Ethical Theories

• An ethical dilemma involves a choice between options where ethical principles conflict.
• In a given case, a junior staff member faces the dilemma of whether to cheat on a test to secure a potential promotion or bonus.

Principles and Concepts for Ethical Dilemmas

• Utilitarianism: The best action maximizes good for the greatest number of people.
  • Applying Utilitarianism involves assessing the consequences of each option, and choosing the one that produces the greatest overall good.
• Kantianism: Emphasizes respect for humans and universal moral laws.
  • Kantianism calls for acting according to principles that could be universally applied, such as honesty and fairness.
• Kohlberg's Theory of Moral Development: A psychological theory describing progression through stages of moral reasoning.

Options in Dilemma Example

• Doing the test honestly.
• Reporting the cheating.
• Moving to a different department to avoid the situation.

Immanuel Kant's Ethical Theory

• Main feature is described as respecting persons.

Cases: Rationalizations for Bad Ethical Decisions

• Manville Corp: Managers suppressed research on the dangers of asbestos.
• Continental Illinois Bank: Increased loan book led to bad loans.
• E.F. Hutton: Bank fraud through excessive interest-free drawdowns.

Negative Right

• This is defined as the right to be left alone, or not to be interfered with by others.
• Property is an example.

Four Dangerous Rationalizations

• Believing the activity is within reasonable ethical and legal limits.
• Believing the activity is in the individual's or corporation's best interest.
• Believing the activity is "safe" because it will never be discovered or publicized.
• Believing the company will condone and protect the person if the activity helps the company.

Challenges to Ethical Decision Making

• Bounded Ethicality: Limited ability to make ethical choices due to internal and external pressures.
  • Everyone is bounded ethically and susceptible to cognitive biases, and organisational or social pressures.
• Biases: Factors that skew decision-making processes.
• Heuristics: Mental shortcuts used in decision-making; initial choice.

Ethics, Morality, and Philosophical Endeavor

• Ethics fosters good decision making.
• Morality is described as a sociological phenomenon which constitutes the basis for mutually beneficial interaction; every society has a morality.
• Ethics as a philosophical endeavor is the study of morality.

Ethics of Extreme

• Tragic dilemmas make people believe ethical quandaries mostly arise in dire circumstances.

Ethical Dilemmas

• These are ubiquitous and faced daily.
• Can arise in everyday, mundane situations.

Ethics

• Ethics is not optional.

Economic Analysis (EA)

• EA has normative flaws, and its consequentialist character can be unacceptable for many philosophers and lawyers.
• The topic will be revisited when discussing cost-benefit analysis (CBA).

Decision-Making Drivers

• Economics: Focuses on shareholder wealth and utility maximization.
• Law: Distinguishes between public and private life but has several problems.
• Morality/Ethics

Ethics and Business

• Businesses have different rules than family, sports, or partnerships.
• Ethics uses central concepts such as trust, justice, and loyalty.
• Decisions in business are taken at many levels, relying on a fragmentation of response.
• Business systems can lead to systematic problems in the industry, resulting in codes of ethics and government regulation.

Prisoner’s Dilemma

• This is a thought experiment and game theory concept that describes a situation where two people have competing incentives.

PwC Tax Scandal

• Consulting firm PwC misused confidential Australian government information to help multinational companies avoid paying taxes.
• The Australian CEO quit, senior partners stood down, and the individual at the scandal's center is under investigation.
• Peter-John Collins, PwC's international tax expert, helped design tax laws but shared secret knowledge within PwC.
• PwC used this inside information to gain clients and make money, a breach of confidentiality agreements.
• PwC put profits before purpose, risking a $180 million loss for the Australian economy.
• Recommended actions: Team/individual review, firing, public apology, and rebuilding trust.

Market Features

• Main features: private ownership, voluntary exchange, and profit motive.
• Promotes economic activity and welfare.
• Adam Smith's invisible hand argument: Pursuing self-interest can promote society's interest more effectively.
• Problems: Private contracts are not flawless, choice failures, and classic market failures.

Roles Evolve out of Markets

• These include principals and agents.
• Agents have a duty of candour, care, and loyalty.

Ethical Reasoning

• Ethical reasoning requires ethical concepts and principles.
• Can be understood as both intellectual process and a psychological process.
• Intellectual procedure to justify ethical judgements requires willingness to seek out and act on reason and be impartial.
• Frameworks can help to assess ethical dilemmas.
• Develop an ethical mindset.

Human Decision Making

• The cycle ranges from infant to adult shown through Kohlberg's six stages.

Four Pistons of Ethical Decision Making

• Moral awareness: Detect and appreciate ethical dilemmas.
• Moral decision making: Develop defensible solutions.
• Moral intent: Desire to do the right thing.
• Moral action: Act on intent.

Ethical Theories

• Classified as old and dusty but highly relevant.
• Consequentialist moral reasoning "Utilitarianism"
• Categorical moral reasoning "Kantian ethics"
• Virtue ethics

Teleological Theory

• Actions are right or good if they achieve a certain goal or outcome.
• Utilitarianism: decision-making process involving alternatives, consequences, and maximizing benefit, often calculated using CBA.

Deontological Theory

• This Judges actions based on whether they follow a set of rules, rather than the consequences of those actions.
• Categorical moral reasoning includes Kantian ethics.
• Principles involve universalizability and respect for persons.
• Examples: Lying, killing

Virtue Ethics

• Linked to Aristotle.
• Virtues are not feelings.
• Examples include integrity, kindness, compassion, courage, courtesy, honesty, loyalty, and tolerance.

Rights and Justice

• Rights have an important role in business and ethics
• Rights can be natural.
• Justice embodies fairness.
• Taxes and crime are examples

The "Silver Bullet"

• This is a simple framework for moral discussions
• More awareness
• Moral decision making.
• Moral intent.
• Moral action.
• Involves identifying the issue and relevant concepts/principles (welfare, duty, rights, fairness, honesty, dignity, integrity).

Business Ethics in a Nutshell

• Involves seven "simple" questions.
• Welfare includes asking, "Who is affected by any proposed course of action? Is anyone harmed, and if so, can the harm be justified?"
• Duty includes asking, "What is my duty in this situation? In particular, are there any special duties that belong to any role or relationship that I am in?"
• Rights includes asking, "Are anyone’s rights being violated? If so, can the violation be justified?"
• Fairness includes asking, "Is any proposed course of action fair to all affected parties?"
• Honesty includes asking, "Am I being entirely honest in my decision?"
• Dignity includes asking, "Am I showing respect for all persons involved?"
• Integrity includes asking, "Is the decision one that would be made by a person of integrity?"

Week 2: Whistleblowing, Trade Secrets, Conflicts of Interest

• This involves ethics discussions

Whistleblowing Definition (Boatright)

• By member or former member of organisation
• Non-public information
• Illega or immoral conduct by organisation that is opposed to public interest
• To appropriate audience outside normal channels of communication
• Voluntary release, not illegally required
• Moral protest

Conditions for Justified Whistleblowing

• Is the situation of sufficient moral importance?
• Do you have all the facts and have you properly understood their significance
• Have all internal channels and steps of short of whistle blowing been exhausted
• What is the best way to blow the whistle
• What is my responsibility in view of my role within the organisation
• What are the chances for success?

Whistleblowing Cases: Enron

• Enron was a major energy, commodities, and services company.
• Initially, it was widely regarded as one of the most innovative companies in the U.S.
• The company engaged in fraudulent accounting practices to hide its financial losses.
• Sherron Watkins was a Vice President at Enron and one of the key whistleblowers in the case.
• Enron used Special Purpose Entities (SPEs) to hide debt and inflate profits, misleading investors.
• Enron filed for bankruptcy, and the CFO and CEO were convicted of fraud.

Whistleblowing - The Role of Loyalty

• Employees are agents of principle
• Loyal agreement
• Are agents disloyal or too loyal?
• What options do you have when you observe wrong doing
• Is loyalty irrational when wrongdoing is observed

Whistleblowing in the Australian Financial Services Industry

• Governed by specific terms and conditions.
• ASIC Information Sheet 238: whistleblower rights and protections.
• ASIC Information Sheet 239: How ASIC handles whistleblower reports.

Arguments For and Against Whistleblower Protection

• Arguments against protection:
  • Open to abuse.
  • Adds another layer of regulation on business.
  • Requires legal remedy for unjustly dismissed employees.
• Arguments for protection include the contributions whistleblowers make to society and rights of freedom of speech.

Components of a Whistleblowing Policy

• An effectively communicated statement of responsibility.
• A clearly defined procedure for reporting.
• Trained personnel to receive and investigate reports.
• A commitment to take appropriate action.
• A guarantee against retaliation.
• The question is raised on whether Australia should introduce bounties for whistleblowing.

Case: Whistleblowing - Novartis

• Oswald “Ozzie” Bilotta was a Novartis Sales Rep
• Novartis spent hundreds of millions of $ on speaker fees, dinners and entertainment as bribes to get doctors to prescribe their drugs
• Bilotta secretly recorded himself making cash payments to two doctors and got confirmation from four others of having accepted prior remuneration
• Novartis Pays Over $642 Million to Settle Allegations of Improper Payments to Patients and Physicians
• Bilotta to receive US109.4 million whistleblower award

Case Study: The Sure Thing

• Chris Hill and Lukas Kamay met at a party in 2013.
• Hill shared unreleased data from his employer, the Australian Bureau of Statistics, with Kamay.
• Kamay used the information to trade the Australian dollar on the foreign exchange market.
• Kamay's trades triggered red flags, and the scandal came to light.

Patents

• A patent is a legally enforceable right for a device, substance, method or process thats new, inventive and useful
• Benefits
  • Exclusive commercial rights to your invention
  • Right to take legal action that stops others from manufacturing, using and or selling your invention
  • Freedom to license to someone else to manufacture your invention on agreed terms
• Its your responsibility to monitor the market and ensure that your IP isn't infringed.
• You need to apply for patent protection in each countries where you will sell your product.

Trade Secrets

• A trade secret is confidential information that gives a business a competitive advantage, such as secret formulas, methods or processes
• KFC and Coca-Cola are examples.
• Do not prevent other people from independently inventing and commercialising the same product or process
• Protected by secrecy and confidentiality agreements.
• Protection ends if the information is made public.
• Common law covers infringement of trade secrets and breaches of confidentiality agreements.

Arguments to Justify Trade Secret Protection

• Trade secrets as a kind of property and attempts to apply common law principles of property rights to them
• The right to compete and the principle of fair competition
• Employees who disclose trade secrets to others or who use them for their own gain violate an obligation of confidentiality that is part of the employer - employee relationship

Conflicts of Interest

• A conflict of interest occurs when a personal interest interferes with the person promoting the interest of another when the person has an obligation to act in that other persons interest
• Actual vs potential
• Personal vs impersonal
• Individual vs organisational
• Types of conflicts of interest
  • Biased judgement
  • Direct competition
  • Misuse of position
  • Violation of confidentiality

Week 3 - Ethics in Finance

• Important because Finance is important in big businesses in Australia

Financial Services in Australia

• Australia’s GDP 2023: $1.72 trillion (USD).
• Financial Services employs approx. 517,675 people.

Key Ethical Dilemmas in Finance

• Deception
• Churning (excessive buying/selling)
• Suitability
• Conflicts of interest
• Fairness in markets:
  • Fraud and manipulation (insider trading)
  • Insider Trading
  • Ponzi schemes
  • Hostile takeovers

Cognitive Dissonance

• This is a psychological state of discomfort that occurs when someone holds conflicting beliefs, attitudes, or behaviors.

Churning & Active vs Passive Investments

• Churning occurs when a broker makes money through excessive buying and selling, which is unethical and illegal.
• Warren Buffet: Invest in a no loads (Low Fee) Mutual fund.

Insider Information Explained: The Efficient Market Hypothesis

• Defined as a market where prices adjust rapidly to new information.
• Current prices fully reflect available information.

Insider Trading

• It involves trading on the basis of material, non-public information.
• Rationales against insider trading: property rights, fairness, and breach of fiduciary duty.
• Less restriction might increase efficiency and speed up price discovery.
• However, insider trading leads to unfair advantage.

How Prevalent is Insider Trading?

• USing ETFs to conceal insider trading.
• Vinay Patel (UTS), Talis J. Putnins (UTS). 2020

Case: Insider Trading - Oliver Curtis and John Hartman

• Two friends from high school become involved in shady deals
• Hartman was an equities dealer for Orion and Curtis was in corporate finance.
• Hartman would text info to Curtis who made trades using CFDs on short term share price movements.
• They made $1.4m from 45 transactions over 13 months.
• Cracks in friendship arose between them, , Hartman stopped providing info/
• Hartman confessed all to ASIC, they had been unaware of Curtis’ trades.
• Hartman received a sentence of 3 years; Curtis 2 years.

Some Recent Insider Trading Cases

• Andy Bechtolsheim (68), Sun Microsystems co-founder and early Google investor, used confidential M&A news to trade.
  • Net worth $18b, he made $415,000 on insider trading
  • Fined $923,740 and five-year ban from serving as director
• Joe Lewis(87), British Billionaire passed tips about companies to friends, personal assistants, private pilots and romantic partners.
  • Crimes spanned 2013-2021
  • Fined $5m and 3 years’ probation in US
  • 52.09% shareholding in AACo, unlikely FIRB action re character test

Working from Home Complications (Example)

• Tyler Loudon, husband snooped on wife’s BP M&A deals, he made $2m.
  • Wife was innocent but got fired from BP, she filed for divorce
• SEC has brought multiple insider trading cases from WFH eavesdropping!

Hostile Takeovers

• Defence Tactics:
  • Crown Jewel option: Option → Friendly firm
  • Golden Parachute
  • Greenmail: Company repurchases stock at a premium
  • Lock up option: A "lock-up option" in corporate finance is a contract that favors a friendly company in a takeover battle by making the target company less attractive to a hostile acquirer
  • Pac-man defence: Acquirer make a bid for the raider
  • Poison Pill: Increase price of share
  • Shark repellent: General term of takeover defence
  • White Knight: Friendly sutor - Makes offer for a target to avoid unfriendly target

Fraud: Ponzi Schemes

• These are investment scams that pay existing investors with funds collected from new investors. There is no real investment.
• Bernie Madoff ran the largest Ponzi scheme in history.
  • $17.5b invested, fake statements showing value was $65b
  • Gave investors paper statements (no electronic access to their accounts)
• Scheme collapsed in 2008 (GFC), he had been running it for over 17 years
• Madoff died in 2021 in a prison hospital while serving sentence for money laundering and fraud

Harry Markopolos

• Tried to reverse engineer Madoff’s results (no volatility, consistent returns of 1-2% per month,) – concluded it was impossible
• He reported findings to SEC in 2001 and 2005.
• SEC did not take reports seriously.

Big Business: Superannuation in Australia

• Total assets in super = $3.85 Trillion
• SMSF’s = $935 Billion

Self-Managed Super Funds (SMSF)

• A self-managed super fund (SMSF) is a private super fund that you manage yourself. SMSF’s are different to industry and retail super funds
• When you manage your own super, you put the money you would normally put in retail or industry super fund into your own SMSF, you choose the investments and the insurance
• Your SMSF can have no more than six members
• Risks include losing money through theft or fraud without compensation schemes, personal liability for all fund decisions, and potential negative impacts from relationship breakdowns.

SMSF - What if Something Goes Wrong?

This is a topic to discuss.

Fraud Case: Trio Capital

• Trio capital was largest superannuation fraud in Australian History -$176m missing from two fraudulent managed investment schemes: -$123 million from Astarra Strategic Fund and $53 million from ARP Growth Fund
  • Trio capital was responsible entity for both schemes
• Key element : move the funds of Australian investors overseas -Schemes had over 6000 Australian investors: - 5,400 investors in APRA-regulated funds received $55 million compensation -remaining were 415 direct investors and 285 investors in SMSFs (no compensation)

Whistleblower

• John Hempton CEO at Bronte Capital
• He wrote an alert to the ASIC chairman re suspiciously smooth returns of Astarra fund in turbulent financial environment. -ASIC launched an investigation after this tip-off

Financial Advisors and Relevant Products in Australia

• Financial advice is provided by a “relevant provider."
• All Relevant Providers must comply with the FASEA Code and Standards.

Celebrity Financial advisor Sam Henderson (SMSF Case Study)

• Henderson was a former TV show host on Sky Business Channel.
• A client sought his advice in 2016, but he advised her to set up a SMSF despite her express wishes. - Lack of suitability - Excessive fees charged
• Henderson pleads guilty in 2020 to dishonesty and defective disclosure charges, and is fined $10,000.

Evaluating Market Efficiency Forms

• Strong-form efficiency: Prices reflect all public and private (insider) information; insider trading would not be profitable.
• Semi-strong form efficiency: Prices reflect all publicly available information, but not necessarily insider information.
• Weak-form efficiency: Prices reflect only past price and volume data, but not public or private fundamental information.
• Completely inefficient markets: Prices do not reflect even basic available information, leading to frequent mispricing.