Ethical Decision-Making in the Securities Industry PDF

Ethical Decision-Making 2 CHAPTER OVERVIEW In this chapter, we investigate the nature of values, ethics, and the law. We then use case scenarios to illustrate ethical concepts, and we conclude by providing some practical guidance reg...

Ethical Decision-Making 2 CHAPTER OVERVIEW In this chapter, we investigate the nature of values, ethics, and the law. We then use case scenarios to illustrate ethical concepts, and we conclude by providing some practical guidance regarding the fundamentals of ethical decision-making. LEARNING OBJECTIVES CONTENT AREAS 1 | Define ethics and explain the difference Overview of Ethics between ethics and rules. 2 | Explain the relationship between values, The Relationships Between Values, Ethics, ethics, and the law. and the Law 3 | Explain what values are and the importance of Value Awareness value awareness. 4 | Explain what happens when values conflict. Ethical Dilemmas 5 | Apply the ethical decision-making process. An Ethical Decision-Making Process © CANADIAN SECURITIES INSTITUTE 2 2 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 KEY TERMS Key terms are defined in the Glossary and appear in bold text when they first occur in the chapter. end values means values ethical dilemma Mom test ethical relativism morals front page test unified value system legal test values © CANADIAN SECURITIES INSTITUTE  CHAPTER 2      ETHICAL DECISION-MAKING 2 3 INTRODUCTION The securities industry could not exist without the public’s trust and confidence. In the previous chapter, we discussed how important it is for Registered Representatives (RRs) to generate trust and confidence by adhering to high standards of ethics and conduct in all of their dealings with their clients. Ethics play a critical role in the securities industry by providing a foundation for the industry’s comprehensive set of rules and a structure in which to interpret and evaluate incidents of potential wrongdoing. An effective ethics program is a powerful tool for creating a strong corporate culture, where company values and aspirations play a critical role. In this chapter, we investigate the nature of ethics and provide practical guidance regarding the fundamentals of ethical decision-making. OVERVIEW OF ETHICS 1 | Define ethics and explain the difference between ethics and rules. Ethics are generally defined as a set of values and standards that guide individual behaviour. A person’s values can change over time, but the change is always driven by standards of right and wrong, and not by personal need. Commonly agreed-upon ethical values include accountability, fairness, honesty, loyalty, reliability, and trustworthiness. Ethics as a concept can be defined more specifically in three ways: The rules or standards governing the behaviour of a particular group or profession A set of moral principles or values The study of the general nature of morals and the moral choices made by individuals Morals are the rules and habits of a society’s conduct that are established according to perceived standards of right and wrong. Moral principles are based on reason. They are not established, nor can they be changed, by authoritative bodies. However, they may underpin decisions made by those authorities. Because the objective of this chapter is to provide a theoretical basis for ethical decision-making, we treat ethics as a continuous process of examining behaviour and making decisions within the context of moral principles. ETHICS VERSUS RULES A fundamental difference exists between ethical behaviour and compliance with rules. An industry’s rules and regulations set out standards that participants must follow. People follow rules because they must do so, not necessarily because they believe it is the right or moral thing to do. In fact, it is possible to act unethically even when complying strictly with the rules. Furthermore, rules cannot encompass every possible situation that may occur in day-to-day business. In contrast, ethical behaviour requires internally established moral judgments that can be applied in any situation. It goes beyond prescribed behaviour to address situations where rules are not clear or are contradictory. Ethics involve compliance not only with the letter of the law, but also with the spirit of the law. In the securities industry, the basic concepts that constitute ethical behaviour are founded on ethics theory and ethical principles. The regulatory environment in which the securities industry operates consists of the rules and requirements of the provincial securities regulators, the self-regulatory organization (SRO) to whose rules a dealer © CANADIAN SECURITIES INSTITUTE 2 4 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 member and approved persons are subject, and, in some cases, the federal government. These rules, coupled with accepted industry practices, set a basic standard for ethical behaviour in the industry. DID YOU KNOW? Ethics in the Securities Industry Industry rules and regulations can be distilled into standards of ethical conduct. As an RR, you are expected to conduct yourself accordingly, as follows: You must take proper care and use independent professional judgment. You must conduct yourself with trustworthiness, integrity, honesty, and fairness in all your dealings with the public, clients, employers, and colleagues. You must, and should encourage others to, conduct business in a professional manner that reflects positively on you, your firm, and your profession. You should also strive to maintain and improve your professional knowledge and that of others in the profession. You must act in accordance with the securities act of the province or provinces in which you are registered. You must also observe the requirements of all SROs of which your firm is a member. You must hold client information in the strictest confidence. THE RELATIONSHIPS BETWEEN VALUES, ETHICS, AND THE LAW 2 | Explain the relationship between values, ethics, and the law. To develop a set of professional or corporate policies and standards based in ethics, you must first understand the interrelationship between values, ethics, and laws. Values Values are the individual or cultural measures of the worth we place on certain ideas and behaviour. Our values inform our life goals and influence the decisions we make to achieve those goals. They reflect the importance we attach to other people, money, work, leisure, and family, and the importance we place on others versus ourselves. As we grow older, our core values may shift, but rarely do they change drastically. Ethics Ethics are a set of moral principles that govern our behaviour. Our personal ethical stance is built on our personal values, and the ethics of a society are built on cultural values. Laws Laws are not synonymous with ethics, but they are commonly contained within and grow out of society’s overall ethical sensibility. Like ethics, laws are based on values held by society. Adherence to common values allows people to live together creatively rather than destructively in an environment where the consequences of their actions are predictable. Rules and laws deal with legally sanctioned behaviour. Ethics are concerned with how we relate to other people, how our actions affect others, and how best to encourage actions that allow us to live together as a society. Makers of laws concern themselves with those actions society deems to be so important that violating them will have serious consequences to society as a whole. Ethics also address these issues, but they are more concerned with how we relate to each other on a day-to-day basis, such that society benefits socially. © CANADIAN SECURITIES INSTITUTE  CHAPTER 2      ETHICAL DECISION-MAKING 2 5 For various reasons, ethical behaviour is not synonymous with legal compliance. Laws attempt to lay out the parameters of appropriate behaviour and apportion responsibility for risk by setting standards of allowable behaviour. The legal system requires proof and evidence and attempts, as much as possible, to define behaviour in black-and- white and right-or-wrong terms. However, laws may be out of date, deficient, or even absent in certain areas. Without a strong code of ethics, deficiencies in the law allow for behaviour that may be strictly legal and yet highly unethical. EXAMPLE A number of laws have been created around accounting procedures, corporate governance, and accountability. Previous laws were either not adequate to deal with fraud on this scale, or were simply not taken seriously. For example, before Enron’s collapse, many accountants and auditing firms regularly circumnavigated laws and rules pertaining to transparent accounting procedures because they fully believed they would not be caught. In other words, the law held little importance for those professionals who were not inclined to behave within ethical boundaries. An old adage holds that you cannot legislate ethical behaviour. Companies that base standards only on compliance with today’s laws could well have a recipe for lower profits, greater environmental liabilities, and less than ideal decisions. The ethical corporation is one that identifies its core values, creates an ethical atmosphere that is grounded in its core values norms, and then grounds those values and behaviours in the culture of the organization. It does so in a manner that is at a minimum in compliance with applicable laws, but in so doing, may achieve a higher level of compliance and legal conduct than that which is expected. DID YOU KNOW? What is narrowly correct in legal terms may not be ethically acceptable in practice. Minority shareholder rights are a good example of this legal-versus-ethical dilemma. Currently, a company’s preferred shareholders can legally hold as little as 10% of the total share offering in question and yet still have voting control over the company’s actions. Meanwhile, the remaining 90%, who are common shareholders, also have a financial stake in the company but have no say in its activities. Many investors are currently challenging this unequal distribution of voting power as unfair and unethical. The set-up also lends itself to conflicts of interest in that preferred shareholders may be concerned with their own best interests over those of the company. VALUE AWARENESS 3 | Explain what values are and the importance of value awareness. Integrity, trust, honesty, and competency are all values that are prized by professionals in the securities industry. The security industry justifies its right to be self-regulating on the basis of a claim to these core values. The reputation of an RR who lacks any one of these values would be compromised, which would in turn put the reputation of the industry itself at stake. In this section, we explore the concept of values so that we can better understand them in the context of the securities industry. THE NATURE OF VALUES Values enter into practically every decision you and your company make. They may be based on knowledge, education, and life experience. © CANADIAN SECURITIES INSTITUTE 2 6 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 It is not easy to define the meaning of a particular value to everyone’s satisfaction. A term such as trust, for example, can mean different things to different people. However, though it may be difficult to get group consensus on their meaning, values provide important guidelines for both individuals and companies. Despite their ambiguous nature, values do have several common characteristics: They are beliefs, not facts. They are long lasting, not fleeting; however, they are not fixed or unchangeable. They guide your goals and behaviour on both a personal and corporate level. Your personal value system guides your ethical stance and behaviour, helps you form your life goals, and influences the actions you take to achieve those goals. It is therefore critically important that you take the time to truly understand what your personal values are. VALUES CLARIFICATION Situations that challenge your values can leave you with the uncomfortable sense that something is wrong. A keen awareness of your value system can help you navigate such predicaments. When you know what your values are and are consciously guided by them, you are more likely to act in accordance with those values, even in unfamiliar situations. Without that awareness, you are more likely to make wrong decisions that can damage your reputation and that of your firm. The process of becoming aware of the values that drive your day-to-day decisions and behaviour is called values clarification. If you fail to develop a conscious understanding of your value system, many of your decisions will be influenced by what psychologists call unconscious drives. Our values influence what we perceive life to be, what we want out of life for ourselves, and the actions we take to meet our life goals. There are generally two types of values: end values and means values. The values that help define our personal goals, which may be years away, are our end values. The actions we take today to achieve our goals are directly influenced by our means values. End values include a sense of accomplishment, service to people, security, a world at peace, and social recognition, which can be viewed as goals toward which we strive. Means values include ambition, openness, or competence, which can be viewed as actions we take to achieve our goals. A unified value system is one in which end values and means values mutually reinforce and support each other. Both people and corporations get into trouble when their means values do not align with their end values, which is why values clarification is such a critical process. IMPORTANT NOTE Our goals must be guided by our values, and not the other way around. In clarifying and articulating our values, we must not allow personal or corporate objectives to dictate the process. THE IMPORTANCE OF VALUES TO AN ORGANIZATION Every organization should be guided by a set of values that communicates to all its members what the company stands for. Whether the values are explicit or implied, they constitute the essence of the organization’s spirit and leadership philosophy. Many organizations publish a distilled version of those values in a mission statement, both for public consumption and in internal policy manuals for employees. Such statements set the expectation that the company’s employees will live up to an ideal based in the company’s values. In the financial services industry in particular, the ideal most firms strive for is a climate of ethical behaviour where trust can flourish. The term commonly used to describe this ethical climate is tone at the top. To be effective, tone at © CANADIAN SECURITIES INSTITUTE  CHAPTER 2      ETHICAL DECISION-MAKING 2 7 the top should filter down through the organization. Every employee must communicate the firm’s guiding beliefs to every other member and to anyone who has dealings with the firm. Then, these values must be put into practice on a daily basis. An explicit statement of organizational values helps to harmonize the firm’s values with its day-to-day activities. Through such a statement, the firm’s leaders can give clear direction regarding the standards employees are expected to adhere to when executing their responsibilities. It also allows them to encourage ethical behaviour among colleagues and employees without being physically present. Additionally, an explicit values statement provides the following benefits: A sense of common direction for all members and guidelines for their daily behaviour The social energy that moves an organization into action A framework for ethical decision-making A sense of stability and continuity in a rapidly changing environment IMPORTANCE OF VALUES TO INDIVIDUALS Everyone should have a well-thought-out philosophy to provide direction and give meaning to life. At the heart of such a philosophy is a set of beliefs that require no justification other than they are right and central to one’s life. Your ethical practice rests your awareness of these core values. Knowing what your core values are allows you to hold them consciously in place as you live your life and make your daily decisions. Thus, the first question to ask in the values clarification process is, “What are my core values?”. Clearly defined core values will influence the following aspects of your life: Your ability to interpret situations, make decisions, and solve problems Your perception of other people and your ability to relate well to them Your perception of success Your perception of ethical behaviour Your value system as a self-aware person will also provide you with the moral courage to resist when you are being pressured to do what you believe to be wrong. IMPORTANCE OF VALUES TO SOCIETY We are all products of our society, which means we have absorbed the values that influence society from the time we were infants. Societal values have therefore influenced how we think and act. For example, the Agrarian and Industrial Revolutions were marked by uncertainty and a breakdown in ethical norms as individuals and societies faced new social problems. The old way of understanding the world no longer applied. Our current age is also marked by uncertainty and a shift of focus to the individual, who is seen as more important than the group – the so-called “me generation” phenomenon. This mentality, which was rampant from the 1960s to the 1990s, was supported by a system ethicists refer to as ethical relativism. We are only now beginning to balance that stance with an increased focus on the wellbeing of society in relation to the individual. Ethical relativism states that there is no such thing as a universal moral principle that governs our behaviour. Everything is relative, situational, negotiable, and personal. Each new situation requires us to redefine our values and actions, with each of us having an equal say on what is right or wrong. © CANADIAN SECURITIES INSTITUTE 2 8 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 The ethical relativist understands the individual as the focus of ethical behaviour. Therefore, ethical relativism leads naturally to the placement of individual needs over the needs of the community. The consequences of this stance can be catastrophic. In the securities industry, ethical relativism has led to many cases where people in a position of power have put their own interests before those of their clients. As a result, society is currently trying to curb the excesses of individualism and ethical relativism. Serious violations in the securities industry are sometimes the result of the violator’s morally relativistic, “me first” stance. At its worst, in the context of the securities industry, ethical relativism can lead to the following thought patterns: Relative I know how the market works. Situational My client is unsophisticated and will follow any advice I give to him. Negotiable Now that I know my client will follow whatever advice I give to him, what am I going to do? Personal I will make this decision based on my personal value of greed. It’s okay if I personally benefit from this transaction as long as I don’t get caught. Ethical relativism is based on a serious flaw in stating that there is no such thing as a universal moral principle. In fact, much research supports the idea that all cultures accept certain universal principles of right and wrong. Hans Küng, a noted Swiss theologian, found that all major world religions teach the same moral principles, as follows: Do not lie, steal, or kill. Do not practice immorality. Respect parents and love children. Likewise, Rushworth Kidder, an American writer, teacher, and ethicist, interviewed world leaders and found that the following principles are commonly held worldwide: Love Truth Fairness Freedom Unity Tolerance Responsibility Respect for life Thus, contrary to ethical relativism’s stance, there do appear to be universal moral principles by which we must all abide. In fact, our legal system, as well as the industry’s standards of conduct, are based on these principles. Unfortunately, in terms of values education, there is much work to be done. The individual’s right to do what he or she wants to do, regardless of the consequences to other people’s wellbeing, must be constantly challenged. In order for moral principles to prevail, it is critical that securities professionals not only understand that clients’ interests are more important than their own, but that every professional must act in such a manner that the clients’ interests come first. One of the securities industry’s answers to ethical relativism is the concept of professional duty of care under which the client’s interests come before those of the RR’s. Fiduciary duty is also applicable in certain situations. © CANADIAN SECURITIES INSTITUTE  CHAPTER 2      ETHICAL DECISION-MAKING 2 9 MOTIVES AND BEHAVIOUR Ethical managers stress that their organization’s goal is to create client and firm profit through ethical actions. A firm and its employees must comply with society’s norms when these exceed legal standards. They must also comply with society’s expectations of fair competition; highly qualified staff and service; and respect for life, property, and the environment. In effect, responsible behaviour requires that both compliance- and integrity-based requirements be satisfied. Narrow adherence to only the letter of the law, but not to its spirit, can quickly erode a firm’s reputation on which RRs and the firm heavily depend. Ethically tuned employees may do the right thing for right or wrong reasons. Enlightened managers, in respecting their employees, may pay less attention to the reasons behind actions, and more attention to actual ethical behaviour. Whether the employee’s motive is fear of punishment, respect for authority, or concern with society’s human rights, the result is the same. Likewise, as long as employees provide exemplary service, it may not matter to the client or the regulator what motivates them. A high level of duty of care may be the result of self-gratification, need for approval, or personal commitment to service. Whatever their motivations or reasons, what is important to all parties concerned is that they make the ethical choice. This is not to say that employee motives are unimportant to an organization. Rather, what matters is good behaviour, not the reasons behind the behaviour. As investors become more active in demanding a say in how the companies they invest in are run, new governance models are emerging. At issue are new definitions of shareholder and employee rights, director and executive liability, and corporate governance. The implications here go beyond mere legal compliance to touch on ethical issues. It may be that new sets of ethically tuned standards regarding acceptable business practices must be articulated and made the corporate norm. Existing laws may not yet legally reflect current challenges. However, the gap does not mean that a proactive business can afford to ignore them, whether on business, legal, or ethical grounds. Case Study | Garret Garret is a portfolio manager at York Investments, an advisory firm specializing in managing assets for high-net- worth clients. Garret often directs a large number of his trades to Block Inc., a small securities dealer run by Mark, his old school classmate. Block is not very competitive on order execution pricing compared with other large dealers. However, the company does supply free research as part of its arrangements with its clients. Three of York’s equity analysts have questioned the usefulness of Block’s research, demanding to know why Garret continues to use Block for order execution. The truth is that, in return for Garret’s business, Mark recommends Garret’s advisory services to Block’s wealthiest clients. Garret has not disclosed this arrangement to York or to the clients Mark refers to him. As part of his working relationship with Garret, Mark charges all of his clients a slightly higher fee for access to research. About 80% of Block’s clients make use of this research. The remaining 20% do not use it but still pay the higher fee as part of Block’s overall fee structure to its clients. Garret wonders if it is right to charge the fee to those Block clients who do not use his research. Mark, for his part, sees no problem with the arrangement. Analysis Industry and professional codes of ethics do not permit the withholding of information about personal interests that are materially relevant to client services or recommendations. Garret is also faced with the issue of whether his and Mark’s interests are conflicting with the interests of the clients who are paying a research fee, but who are not using the research. Conflicts of interest will be discussed in greater detail further on in this course. However, it is important to note here that under industry rules, approved persons such as RRs and Investment Representatives are responsible for identifying and addressing conflicts of interest. If they cannot be avoided, material conflicts of interest must be disclosed in all cases where a reasonable client would expect to be informed. © CANADIAN SECURITIES INSTITUTE 2 10 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 ETHICAL DILEMMAS1 4 | Explain what happens when values conflict. An ethical dilemma arises when we are faced with two or more choices and we must make an ethical decision. However, not all ethical decision-making involves an ethical dilemma. Every ethical decision falls into one of two categories: Right-versus-wrong issues Right-versus-right dilemmas When faced with a decision in a right-versus-wrong situation, the ethical choice is obvious because the other choice is clearly wrong. An ethical dilemma occurs when our central beliefs regarding the right way to act are present in two or more of the possible choices—in other words, when our core values are in conflict. In this section, we discuss an ethical decision-making process that will help you make decisions in such situations. Case Study | Murray Murray has been an RR with Catskills Investments for over 25 years, during which time he created a large book of clients. Recently, Catskills was taken over by Wealth Makers Securities Inc. (WMS), a firm that specializes in serving high-net-worth clients. To meet each client’s needs effectively, WMS has implemented a policy that prohibits RRs from servicing more than 100 accounts. As with any securities dealer, WMS has expected productivity levels that must be maintained by all RRs. Any RRs who are unable to meet their targets over a given time will be asked to leave the firm. Murray, who wants to stay with the firm despite the account restriction, finds himself facing a dilemma. A number of his elderly clients have been with him since he started in the business and they rely on him. They are not large revenue producers, but they are loyal clients who would be lost if they were forced to find a new advisor. It is unlikely they could find someone to take care of their accounts the way Murray has. On the other hand, Murray knows that he will have to keep only his top 90 clients if he is to meet WMS’s high productivity requirement. Another concern Murray has is that a few of his major clients have opened up small accounts to allow their teenaged children to dabble in the market. Murray is afraid that if he closes out these accounts, the parents would be offended and would close out their accounts as well. Besides, even though the children’s accounts may be relatively small now, these young people are the future heirs to their parents’ assets. Murray knows that maintaining a relationship with them could be lucrative in the future. Murray also has a handful of accounts that belong to day traders. Their accounts are relatively small, but when the market is active, these clients enter several trades a day, which generates a fair amount of commission. However, when the markets are quiet or down, the accounts are relatively dormant. Ethically, what should Murray do? 1 Much of this discussion is based on Rushworth Kidder’s How Good People Make Tough Choices (New York: Fireside, 1996). © CANADIAN SECURITIES INSTITUTE  CHAPTER 2      ETHICAL DECISION-MAKING 2 11 Case Study | Murray Analysis In this situation, Murray is faced with a complex ethical dilemma. His top 90 accounts are necessary to meet his productivity targets, which means he has only 10 account spaces available for other clients. Several questions arise. Does he have an equal obligation to all his of clients? Which clients should he keep? His elderly clients who really need professional advice? The children of his wealthy clients, whose accounts may someday become lucrative and whose parents he does not wish to offend? The day traders, whose accounts could bring in a significant amount of money in an extended bull market? Murray has a number of possible courses of action. Each choice has some right elements, and no choice is thoroughly wrong. How is he to decide on the right course of action? Murray’s first step in resolving the dilemma is to identify which of the following values are in conflict: Professionalism: Is he conducting his clients’ business in a professional manner? What is the best way to let clients go when he can no longer work with them? Financial wellbeing: How can he generate sufficient revenue to meet his firm’s imposed revenue goals from a reduced client base? Fiduciary responsibility: Does he have a fiduciary duty to put all of his clients’ interests in this situation above his own? Integrity: Are his actions in keeping with how he sees himself as a person and as a professional? In the course of Murray’s ethical decision-making, these are just some of the issues that he must consider and act upon. RIGHT-VERSUS-WRONG ISSUES A right-versus-wrong issue will have one of the following characteristics: One choice is clearly illegal. One choice lacks a basis in truth. The negative consequences of one choice will far outweigh any possible positive results. One choice does not conform to society’s shared code of fundamental values that define right and wrong. With right-versus-wrong issues, there is only one right course of action. Codes of conduct, codes of ethics, and compliance policies are mainly concerned with these types of issues. However, as Murray’s case study shows, not all situations are black and white. In fact, most of the ethical decisions we face day to day do not involve clear-cut, right-or-wrong choices. In Murray’s case, several conflicting “right choices” make the decision-making process difficult, as follows: Loyalty and personal responsibility to his elderly clients versus the business interests of his employer Long-term business goals (in the case of his teenaged clients) versus the short-term need to drop unprofitable clients Self-preservation in terms of his financial wellbeing versus the wellbeing of his clients The right course of action in this situation is not obvious. Murray has entered a grey area where each choice contains right elements, and where his core values are present in each possible decision. In other words, he has entered that shaded area where most of our decisions must be made. © CANADIAN SECURITIES INSTITUTE 2 12 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 RIGHT-VERSUS-RIGHT DILEMMAS The first step in resolving a right-versus-right dilemma is recognizing it as a dilemma. Once you are certain that you are not facing a right-versus-wrong issue, the difficulty begins. Indeed, with many of the decisions we must make, each possible choice has an element of “right” in it, and no solution will satisfy all competing demands. This unsettling predicament can leave us confused as to what to do. In this section, we look at a method of breaking down dilemmas into four paradigms. By this means, we can critically evaluate various situations to determine the nature of the dilemma, which thus assists us in our decision- making process. TYPES OF DILEMMAS Most dilemmas can be categorized as one of four types: Truth versus loyalty In a truth-versus-loyalty dilemma, the values of honesty or integrity clash with the values of commitment, personal responsibility, or promise keeping. For example, suppose you recommend an in-house investment product to a client, and the client asks if it is the best of its kind on the market. Strictly based on return on investment, the product is fairly competitive with most similar products. However, some products on the market are currently earning a better return. Truth demands that you tell your client that higher-performing products exist (which does not mean they will continue to perform well over time). However, loyalty to your firm demands you support the in-house product. Individual versus group In an individual-versus-group dilemma, the rights and values of the few clash with the rights and values of the many. This dilemma type can be seen in terms of us versus them, self versus others, or the smaller group versus the larger group. For example, suppose you have been allocated 10,000 shares of a new issue that appears to be an excellent investment. To whom among your clients do you offer these shares? Is it fair to offer them to your best customers only, who represent the smaller group? Or should you select lottery-style from among all your clients, who represent the larger group? Short term versus In a short-term versus long-term dilemma, a conflict arises when immediate needs or long term desires run counter to future goals or prospects. In other words, means values clash with end values. For example, suppose a client wants to invest in a security, but you have doubts about its suitability for that client. However, the client insists that you purchase it for him. Do you go ahead with the transaction, or do you refuse because it does not suit the client’s long-term goals? © CANADIAN SECURITIES INSTITUTE  CHAPTER 2      ETHICAL DECISION-MAKING 2 13 Justice versus mercy In a justice-versus-mercy dilemma, the values of fairness, equity, and righteousness conflict with the values of compassion, empathy, and love. For example, suppose you are supervising an employee who has been working overtime during a very busy period. She was supposed to take a seminar that would fulfill her continuing education requirements but did not have time. She decided to take the web- based course instead. To speed things up, she asks a colleague who had previously taken the course to give her the answers to the accompanying quiz. When you find out from another colleague what happened, you have to make a decision. Do you mete out justice by publicly disciplining the employee for cheating? Or do you grant mercy by taking her aside and telling her to take the seminar as soon as she can and to avoid cheating in the future? AN ETHICAL DECISION-MAKING PROCESS 5 | Apply the ethical decision-making process. Ethical decision-making is an eight-step process, as follows: 1. Recognize that there is a moral issue. 2. Determine whose moral issue it is. 3. Gather the facts. 4. Test for right-versus-wrong issues. 5. Test for right-versus-right paradigms. 6. Apply the resolution principles. 7. Make the decision. 8. Reflect on the process. In applying the steps, we refer back to the case study involving Murray, who must cull his client list. 1. RECOGNIZE THERE IS A MORAL ISSUE This step requires that you look at your actions to identify whether a moral issue exists. In Murray’s case, he must first consider whether he is serving all his clients properly and, second, how he can act with integrity in this difficult situation. 2. DETERMINE WHOSE MORAL ISSUE IT IS In this critical step, you must determine who must take responsibility for making a decision and who must be accountable for the consequences. A critical aspect of ethical decision-making is that the one responsible for making the decision accepts accountability for its consequences. In Murray’s case, he must make the decision and answer for the results. He cannot pass off the decision to anyone else. To do so would be to evade both the responsibility to make the decision and the accountability for the consequences. 3. GATHER THE FACTS The third step in the process is to gather the facts. To complete this step, Murray should ask the following questions: To whom do I owe a duty in this situation? Is there any way I could follow the firm’s policy and still make sure my elderly clients are well looked after? © CANADIAN SECURITIES INSTITUTE 2 14 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 Is it possible that an exception may be granted regarding the number of accounts? Overall, how beneficial to me are the day traders’ accounts? How do my future business goals align with the accounts of my wealthy clients’ children? Am I acting in a professional manner? Is the firm acting in a professional manner? Is there a solution that allows me to keep my clients while still accommodating the firm’s wishes? 4. TEST FOR RIGHT-VERSUS-WRONG ISSUES Three tests can be used to determine whether you are dealing with a right-versus-wrong issue: the legal test, the front page test, and the Mom test. Given a set of choices, you should subject each choice to the three tests before you proceed. Legal test In Murray’s case, is it illegal or against industry rules for him to inform certain clients he can no longer service them? Is WMS’ policy of allowing him to handle only 100 accounts illegal? No, neither practice is illegal. In fact, it is standard industry practice for RRs to inform clients with whom they will no longer work that the working relationship is ending. Front page test The front page test deals with reputation. Would Murray’s reputation suffer if his behaviour in this situation became public knowledge? He should imagine how his actions would be perceived if a major newspaper were to publish an article about the situation. Would his reputation be harmed if the general public learned that he let certain clients go to meet his new employer’s investment mandate? Assuming that Murray will inform his clients in a professional and honest manner, it does not seem that his reputation would suffer if his actions became public knowledge. In fact, the publicity could attract wealthy investors to the firm when they learn that WMS requires its RRs to dedicate all of their energy to their type of client. Mom test Murray must consider how comfortable he would feel revealing his decision to the people whose opinions really matter to him. For example, if he chooses to let his elderly clients go and keep only his wealthy clients, what would his mother say? If he would be ashamed to tell her, then it is probably not the right decision. If, on the other hand, he would be comfortable telling her, then it passes the test. In this case, it seems Murray has no choice but to drop some of his clients. Though he may feel badly about it, he has no reason to be ashamed. He can honestly tell anyone who wants to know why it was necessary and why he chose one set of clients over another. If, at this point, you determine that you are facing an ethical dilemma, and not a right-versus-wrong issue, you can move on to the next step. If, however, you have determined that there is only one right choice, you should stop the process here and take the correct action. In Murray’s case, he had identified an ethical dilemma rather that a right-versus-wrong issue. He should now continue the process and decide the best course of action. © CANADIAN SECURITIES INSTITUTE  CHAPTER 2      ETHICAL DECISION-MAKING 2 15 5. TEST FOR RIGHT-VERSUS-RIGHT PARADIGMS At this stage, you should ask the following questions to determine which core values are in conflict: Is this a truth-versus- Murray’s dilemma has some elements of this paradigm. loyalty dilemma? For example, should he tell his elderly clients the truth that they do not fit the investment mandate imposed on them? Or should he be loyal to them and keep them on his book? He does not have this issue to the same degree with the day traders because they do not rely as heavily on his help. They usually contact him only when the markets are performing well, so he does not have the type of personal relationship that requires loyalty. Is this an individual- Murray’s dilemma has a significant aspect of this paradigm in the form of a small-group- versus-group dilemma? versus-large-group conflict. Out of the various groups of clients—the elderly, the wealthy, the wealthy clients’ children, and the day traders, he must determine which group should take priority. Does he owe the same rights of duty to his less profitable clients as he does to his wealthy clients? Is this a short-term Murray’s dilemma has strong elements of this paradigm. From a professional and versus long-term personal point of view, the sensible short-term choice is to concentrate on his wealthy dilemma? clients. They are the focus of his firm’s new mandate and the source of his compensation. However, he must also consider whether this choice will have long-term repercussions. Will his wealthy clients leave if he drops their children’s accounts? What about the harm to his long-term relationships with those children, who may well be his future top clients? Is this a justice-versus- This paradigm could come into play with Murray’s vulnerable elderly clients. mercy dilemma? A just choice would be for Murray to tell these clients that his firm has a new investment strategy that is legal and fair. Unfortunately, he must let them go because they do not fit the new criteria. A merciful choice would be to keep these clients because they have been with him for so long and they would be lost without him. Another merciful choice would be to make sure they are well looked after if he does let them go. 6. APPLY THE RESOLUTION PRINCIPLES The resolution principles consist of four modes of problem solving, as follows: End-based ethical Which solution brings the greatest good for the greatest number of people? thinking Rule-based ethical Which solution results in a suitable rule for others to follow in similar situations? thinking © CANADIAN SECURITIES INSTITUTE 2 16 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 Social contract-based Which solution results in the most harmonious relationships among the various groups? ethical thinking Personalistic-based Which solution aligns most closely with my authentic self? ethical thinking END-BASED CRITICAL THINKING This resolution principle demands a cost-benefit analysis to determine who will benefit and who will suffer. It asks that we look at our actions from the point of view of their consequences for the various parties involved. In Murray’s case, he cannot carry more than 100 clients under the WMS mandate. He should therefore consider which choice would bring the greatest good to the greatest number of people. Suppose he lets go of his elderly clients, the day traders, and any other less profitable clients. If so, his wealthy clients and their investing children would benefit, as would the firm. Any spots available after his wealthy clients and their children have been looked after would go to his most active day traders. If Murray follows this principle, he could well decide to let go of his elderly clients, the remaining day traders, and any other less profitable clients over the 100-client limit. RULE-BASED ETHICAL THINKING This resolution principle requires the decision maker to act the way they would want others to act in similar circumstances. It demands that any action taken be turned into a universal principle. In Murray’s case, he should consider the rules of his profession. From a duty-to-clients point of view, a large group of his mandated investors would benefit if he kept only his wealthiest clients. A universal principle might state as follows: At times, an RR may be faced with a change in account restrictions that has an adverse effect on a group of clients who no longer fit the new criteria. In such cases, the RR is permitted to let that group go in favour of clients who do fit the criteria. If Murray follows this principle, it would support his decision to let go of the elderly clients, the day traders, and other less profitable clients. Unfortunately, not everyone will be well served by every business decision. However, as long as a decision is ethical and legal, it can be carried out. SOCIAL CONTRACT-BASED ETHICAL THINKING This resolution principle aims to create harmonious relationships within a group. The decision maker should ask how his or her actions affect the cohesiveness and the wellbeing of the group. In Murray’s case, he should look at his actions from the point of view of his firm and his industry. In this case, Murray knows he must support his firm’s new investment philosophy. He can only do that if he uses the 10 remaining openings, after his 90 wealthiest clients are accounted for, to develop the potential of his business. He no longer has the luxury of carrying a mix of clients, as he did before. If Murray follows this principle, he is justified in letting go of his elderly clients, the day traders, and his other less profitable clients. PERSONALISTIC-BASED ETHICAL THINKING This resolution principle requires that you act in a way that is authentic to who you are and that follows the dictates of your conscience. © CANADIAN SECURITIES INSTITUTE  CHAPTER 2      ETHICAL DECISION-MAKING 2 17 In Murray’s case, he is faced with his feelings of loyalty and duty of care for his elderly clients. He knows that a letter will be sent to all clients who have been let go. If possible, he can supply them with a referral to another RR who he knows is trustworthy and professional. However, he has had long relationships with his elderly clients in particular, and he knows they feel they “need” him to advise them. However, if he decides to let these clients go, he can call each one individually and explain the situation to them. He can personally recommend a replacement RR whom he trusts will look after their interests. If Murray follows this principle, he can act in a way that is true to his authentic self: a competent, honest financial services professional. 7. MAKE THE DECISION Before making an ethical decision, you should review the previous steps of the resolution process. In Murray’s case, his review helped him form the following conclusions: In testing for a right-versus-wrong issue, he found that none of the choices he faced was unethical or illegal. In applying the four tests of the right-versus-right paradigms, he found that his dilemma contained elements of all four paradigms and that all his core values were in conflict to some degree. In applying the resolution principles, Murray found that he came to the similar conclusions no matter which principle he applied. Murray’s choices allow him to do the greatest good for the most people, create a suitable rule for others to follow, maintain harmonious relationships, and stay true to his authentic self. In light of his conclusions, Murray makes the following decisions: Keep the accounts of his wealthy clients to meet his productivity targets. Reserve the remaining accounts for the children of his wealthy clients to ensure future growth. If any accounts are left over, give them to his most successful day traders. Talk to his elderly clients individually and recommend an RR whom he trusts will look after their investments and provide the services they need. Provide support to his elderly clients as they transition to a new RR. Thus, Murray’s choices have three results: They support his duties to the clients he can no longer service. They allow him to grow his assets under management over time. They support his firm in its new business plan. 8. REFLECT ON THE PROCESS The reflection stage is not a momentary step; it is one you should apply over time, especially when similar situations arise. You should observe the consequences of your decisions as they reveal themselves and consider whether you could have made better choices. In Murray’s case, he might consider the following points: Did he provide the best support he could to the clients he had to let go for business reasons? Is there a better way to approach a similar dilemma in the future? © CANADIAN SECURITIES INSTITUTE 2 18 CONDUCT AND PRACTICES HANDBOOK COURSE      SECTION 1 By using the ethical dilemma resolution process, you can determine which of your values are in conflict, what the consequences of your actions will be, and what the most ethical course of action is. The process is summarized in Figure 2.1 below. Figure 2.1 | The Ethical Decision-Making Process Identify the ethical issue. Identify right-versus-right conflict: 1. Honesty versus loyalty 2. Individual rights versus group Identify the decision-maker. rights 3. Short-term goals versus long-term goals 4. Fairness versus compassion Gather the facts. Test for right-versus-wrong issue: 1. Legal test 2. Front page test Apply resolution principles: 3. Mom test 1. Ends-based 2. Rule-based 3. Social contract-based 4. Personalistic If right-versus-right dilemma If right-versus-wrong issue Make the decision. Reflect on the process. © CANADIAN SECURITIES INSTITUTE  CHAPTER 2      ETHICAL DECISION-MAKING 2 19 SUMMARY In this chapter, we discussed the nature of values and ways in which they influence goals. We explored what happens when values conflict and provided some guidance for resolving such conflicts and a general process for making ethical decisions. We also discussed the relationship between values, ethics, and laws. As we saw, laws are based upon values held by society that allow people to live together creatively rather than destructively, in an environment where the consequences of their actions are predictable. In the next chapter, we will explore the Canadian regulatory landscape. © CANADIAN SECURITIES INSTITUTE