Ethics in Investment Management

Contributed by : Aneek Saha, CFA

We had an interesting interaction with Shankar Jaganathan, Founder & CEO Cimplyfive and Shriram Subramaniam, Founder InGovern Research Services, on 21st November 2015 in Bengaluru on “Ethics in Investment management”. Shankar brought in the philosophical perspective and started by posing the question: Who is a professional?
A professional according to the general informal definition is a person who is paid for work. A successful professional is one who is paid a lot for work and an amateur is one who may work for pleasure, not really for a pay-check. Further, he observed the difference between restriction and restraint – restriction meaning that someone prevents us from doing something while restraint means that we don’t do something on our own accord.
Sharkar moved onto ethics which comes from the word ethos, meaning something that is inherent. Customs come from what people think one should do, while law is applicable when one is causing damage to others.

Three Types of Contracts:
After a brief introduction to what Ethics means in the modern era, Shankar combined the above concepts of a professional, restraint, ethics and law. He stated that broadly, there are three types of contracts:
1. The first is buyer beware contract where the seller is not saying anything about the product. It is the buyer’s responsibility to take the call. Buyer beware is a contract among equals, each one is for himself and trust is not necessary.
2. The second is contract of good faith which is also a contract of equals but where trust is a prerequisite. Examples are a prospectus or insurance. If there is a mistake, the offending party can be sued.
3. The third is contract of professional ethics, which is a contract among un-equals such as a doctor and patient, a lawyer and client etc. Here the stronger looks out for the weaker and trust is the essential premise.
Under most circumstances, Investment professionals fall in the contract of professional ethics. There are instances when an investment bank is selling derivative contracts to corporations – this may fall under buyer beware contract since the corporation is a sophisticated entity, typically is knowledgeable about the product and has a team to review contracts.

Other professionals such as Doctors also function under a code of professional ethics – they manage the information advantage they possess and help their clients, always prioritizing the client’s interest ahead of theirs. These professionals are deemed to be performing a service to society and rewards typically are commensurate to the role played.
A thought experiment:

In ancient Rhodes there is a famine, and a merchant loads his ship with grain and decides to sail for Rhodes. Should he tell the inhabitants of Rhodes that other ships are also coming? Which would mean that the price of grain would fall. Secondly if one has a house and there are termites in the house due to which one decides to sell it, should one tell the prospective buyers that there are termites in the house? The solution of these problems according to Shankar is doing the right thing, keeping in mind that ones future reputation depends on taking the right step.

Six Principles of Ethical Conduct:
In dealing with a client one should be: dependable, predictable, available, reliable, respect confidentiality and act with integrity. Building trust with the client involves doing things over and above what is just legal. For example, Voluntary disclosures from companies garners more respect from investors. To build trust, A professional should be able, skilled and certified – This would overtime translate into one’s track record. A professional should be add clarity to conversations. A Lay person’s language involves stories and anecdotes instead of presenting raw data – Communicate! A Professional should aim for connectedness that is take the client into a dialogue and treat him as a partner.

Shriram Subramaniam gave the second part of the talk where he highlighted the current state of affairs in the Investment Management world. He was rational and shared dilemmas present in Investment Industry in India. Typically, though everyone sees the need to act ethically, some environments constrain the actor from behaving well. He highlighted that India ranks quite high in the list of corrupt countries.

The ethical tone in organizations are set at the top. Ambition that is the desire to do better than normal, avarice that is greed and apathy are the three reasons for malpractices. Shriram shared the example of LIC which has a large stake in ITC (13.12%). He left us with the question: Is this ethical since the government is doing a lot to curb smoking?

The presentations were followed by a panel discussion moderated by Vivek Pai, CFA, where more examples of ethical dilemmas were discussed and questions as to whether ethics can be taught, how should ethical conduct be enforced in organisations and companies which were the most ethical were discussed.

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