Ethics and Investing

By Larissa Fernand |  05-04-17 | 
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About the Author
Larissa Fernand is Senior Editor at Follow her on Twitter @larissafernand

Michael McMillan knows how to tell a story. And a good story needs conflict, which is right up his alley.

As the director of ethics and professional standards at the CFA Institute, McMillan travels around the globe talking to students and professionals on the conflict that is often inherent in ethical decisions.

He effectively uses illustrations to bring out the ambiguity in making ethical decisions without letting needless details detract from his core message. At the 2016 Morningstar Investment Conference in Mumbai, he presented the audience with two actual life incidents (Situation I and II below). By inviting the audience to be a participant in his narrative, he intuitively increased their engagement and willingness to buy into his message.


You manage a mutual fund. Smith is an equity analyst. Recently, Smith has made a number of timely buy and sell recommendations that have resulted in your fund outperforming its benchmark. Based on his most recent recommendation, you build a large position in a firm called Leed Systems. At a recent social event, you learned that Smith's girlfriend is an engineer at that very firm.

This morning, Smith rushes into your office and tells you to sell all of the company’s stock because he thinks that their quarterly earnings, which will be reported tomorrow, will be far below consensus estimates. The resulting significant decline in their share price is not something you would like.

What would you do?

  • Sell immediately
  • Sell, but first ask Smith to update his research report
  • Don’t sell
  • Purchase put options in Leed Systems

The ethical dilemma

By not selling you could be hurting your portfolio and your clients.

By trading or selling your shares you could be acting on material non-public information that is perhaps gleaned from his girlfriend.

You may choose to sell because you do not want to damage your portfolio and your duty is towards your investors. But at the same time you are worried about breaking the law. Or, is Smith the one who is breaking the law?

What the firm did….

Smith was questioned as to how he got this information. He denied getting it from his girlfriend and said it was based on his analysis. The firm then felt comfortable selling the shares but were concerned about their image. If the public found out the connection between the analyst and his girlfriend how would the company be perceived? They also questioned their policies: Going ahead, how must one handle such a situation?


You recently joined as the senior portfolio manager in an investment management fund. The analyst here is very bullish on the Biomed stock and suggests that you invest 4% of your portfolio in it.

The problem is that in your previous job, as an analyst with a private equity firm, you studied Gates, a non-listed company which is a competitor of Biomed. You believe that the vaccine that Gates is developing will have a detrimental impact on Biomed.

What would you do?

  • Say nothing because you signed a non-disclosure agreement at the earlier firm
  • Place Biomed on the firm’s restricted list
  • Discourage the team from investing in Biomed without telling them what you really know
  • Open up about everything you know about Gates

The ethical dilemma

By revealing all that you know, you are disclosing material non-public information, since Gates is a private company. Is that ethical or legal?

If you place Biomed on the firm's restricted list, you are still using your material non-public information to prevent the analysts from acting.

Or, you could do nothing and 3 weeks later, Gates comes out with the vaccine causing the Biomed stock to plunge. There goes the performance of your portfolio, which in turn will impact your clients' money and your bonus.

To whom is your duty? Your prior employer - the private equity firm? Your current employer? The investors of the fund you are managing?

What the individual did….

He approached the compliance department. The compliance department, after conversing with their lawyers, placed Biomed on the firm's restricted list.


The above relate to investment management. Take a look at these.

  • You are meeting with a potential client in a foreign land and they have presented you with an expensive gift in accordance with the local custom. Would you refuse the gift thereby offending their sensibilities and risk losing the business? Would you accept the gift and risk the perception that it influenced your decision and behaviour?
  • You are pulled over for drunken driving on your way home from the company Christmas party. Do you disclose this to your supervisor or wait to see what happens to you in court first?
  • Your mentor was just fired and he asks you to copy his files to help in his job search. You want to help your mentor, but the files belong to the company. Would you help him or refuse?

Ethical dilemmas are grey areas that rarely have a clear right or wrong course of action.

Professionals often face ethical dilemmas that have no satisfactory responses. They have to think about the consequences to their clients, to the organization, to themselves, and also perception of others – be it colleagues or the public. Sometimes, the best option is not perfect but the lesser of the two evils.

Regardless of which course of action you decide to take, it does not mean that you are a bad or unethical person. It just demonstrates the fact that people perceive and react to the same situation or set of circumstances in different ways.

Does that justify unethical behaviour?

NO. McMillan never tires of pointing to the difference between unethical people and unethical behaviour.

An example he often resorts to is the Martha Stewart case. She acted on information provided by her broker to sell her stake in biotech company ImClone without stopping to think about whether it was material and nonpublic. Later, when she realized that she may have traded on inside information, she attempted to cover it up by lying to federal officials. Though her actions were unethical and she paid for them dearly (5 months prison, 5 months home confinement, 2 years probation), he believes that inherently she is not a bad person.

He contrasts her behaviour to a criminal mind like Bernie Madoff who knowingly and ruthlessly stole from his clients. Or even headline-grabbing insider trading cases (such as Steven Cohen’s SAC Capital Advisors) where the participants knowingly, willingly, and purposefully traded on material nonpublic information for either personal gain or their employer’s benefit. He cites such people as unethical.

At the Morningstar conference, he told the audience that under the right conditions, good people can be induced, seduced and initiated to act unethically. The desire to please the boss and be obedient to authority. The bias towards conformity. The need to be accepted as a team player. All could result in an individual suspending his own ethical judgement.

Take the case of Tom Hayes (the trader accused for Libor rigging) and Kweku Adoboli (the UBS trader who lost more than $2 billion in a trading scandal). Both in their early thirties when arrested.

(When the officer arresting Hayes presented the warrant saying he was accused of manipulating the Libor, Hayes retorted saying “You mean LIE-bore?” correcting the officer’s pronunciation of “LEE-bore.”)

While there is no shortage of schadenfreude at the fate of smart, well-respected, young professionals who are paid obscene amounts of money, McMillan ponders on what led them to engage in such ethical missteps. In a very interesting post titled Are young investment professionals especially vulnerable to ethical lapses?, he noted the downward pressure in most organizations where young people are hesitant to stand up to higher-ranking, experienced managers.

According to Hayes, traders were already engaged in inappropriate practices when he joined the Tokyo office and trying to rig Libor seemed common. “Who was I to question what they were doing?”

Adoboli had booked fictitious hedging trades in order to conceal the fact that he was exceeding his risk limits. So the enormity of the positions that he accumulated was not apparent as they were masked with fictitious hedging positions. This exposed the bank to much more chance of loss than it could see.

At his trial, Adoboli stated that they were encouraged to take risks and were told that they “wouldn’t know where the limit of the boundary was until you got a slap on the back of the wrist.” He insisted that he did all this for the bank to make money. In sentencing him, the judge told Adoboli that his “fall from grace as a result of these convictions is spectacular”.

McMillan's advice on how to ensure you are on track. 

McMillan believes that situational influences have more to do with unethical behaviour than a person's character. We often make unethical decisions not because we are bad people but because of psychological biases, social and organizational factors. Situational influences that can often affect our decision-making.

Red flags from superiors

  • “No one will ever know.”
  • “This conversation never happened.”
  • “It doesn’t matter how it gets done, as long as it gets done.”


  • “Everybody else is doing it.”
  • “That is the way they do it at Firm X, so it must be okay.”
  • “If we do not do it, someone else will.”
  • “This is the way it has always been done.”
  • “It doesn’t really hurt anyone.”
  • “I want to be a team player, I want to be loyal.”


Avoid rationalizing even tiny unethical choices, for they lead to a slippery slope.  It may start when we make one small unethical decision, but if you get away with it, you make another. It goes on and on leading to a pattern of unethical behaviour. “Most unethical behavior starts very, very small. And you just have no idea that something will grow, grow, and grow to become something huge,” to put it in his words.


We may feel like we're more confident than others. But when we have that attitude, we don't stop and think about the consequences or the perceptions of what we're doing before we do them.

Seek help

When you are confronted with an ethical dilemma in which you are unsure about how to respond, it is often best to seek the advice or input from your supervisor or compliance department.

Think it through

The CFA Institute uses an 8-step process for resolving ethical dilemmas.

  1. Acknowledge that an ethical issue has presented itself.
  2. Determine who is faced with and owns the problem. Sometimes, someone else’s ethical problem can become yours when you are told something in confidence or observe a wrongdoing.
  3. Distinguish between fact and opinion by gathering the relevant facts.
  4. Test the wrong-versus-right parameter. Ask: Can I do this (is this legal) or not (is this illegal)? This is the compliance parameter. It tells employees what they can and cannot do.
  5. Test the right-versus-right paradigm. Ask: Should I do this (is this ethical) or not do (is this unethical)? Ethics is more aspirational than complaince. It tells employees what they should and should not do.
  6. Apply the resolution principles— Are you putting the client's interests first? Are you maintaining your independence and objectivity? Are you treating all clients fairly?
  7. Investigate third-way options or compromises. For example, a third-way option would be to seek advice and/or guidance from a supervisor or the compliance department.
  8. Make a decision and then reflect on what you have learned from the decision.
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