Unethical Behavior in the Financial Markets

Investment fraud we hear about this constantly. 99 percent of the investment frauds we witnessed came from the Madoff scandal, Stanford Financial Group and others. We thought we had learned our lesson from Enron and Anderson & Anderson about five years ago but it has happened again. This has not only affected the little guy but also big investors that you would not even consider. Where have we gone wrong since it keeps happening over and over? First we are going to look how we can prevent this fraud. Next we will look how we can reduce the fraud. We also are looking how this all comes together and can affect our economy.

When selecting a financial advisor or firm makes sure a third party custodian is used. The investment advisor does not have custody of your assets which means they never directly handle a client’s checks, deposits or withdrawals.

The advisor would open there account at a reputable well know firm as the custodian. That person would have the authority to make investment decisions on your behalf within the parameters that have been set by you and your advisor, but the custodian would be the person who actually would have possession or custody of your assets.

There are four ways you can prevent investment fraud.

Reduced opportunity
“Since the investment advisor does not have custody of your assets they never handle your checks, deposits and withdrawals directly. When the withdrawals are made they must go to one of your other accounts or sent by check to your address of record. Withdrawals that are to go elsewhere require your signature before approval is granted.” Dolan Media Newswire Copyright 2009

Advanced technology to detect signature fraud

“This type of technology means that if an investment advisor, their staff or anyone else attempts to forge your signature, it is likely to be detected immediately.” Dolan Media Newswire Copyright 2009

Insurance:

“Custodians carry large insurance policies. When or if an unauthorized transaction occurs they are responsible for having allowed it to happen and in most cases their insurance will be required to cover this.” Dolan Media Newswire Copyright 2009

Duplicate Statements

“A custodian will send monthly and quarterly statements to you directly. They are required to report all of your account activity directly to you. Your advisor may send your performance reports or account statements that they generate a duplicate reporting system that makes fraud easy to spot. Investment advisors who take custody of your assets themselves and generate their own account statements can report anything on those statements. There is no third party verifying that you really own the assets the advisors say you own. That is how Bernie Mandoff perpetuated his fraud year after year.” Dolan Media Newswire Copyright 2009

The Wall Street Journal reported the following at wjs.com on March 2nd. “The U.S. Securities and Exchange Commission staff is examing the procedures certain investment advisors and brokerage firm have in place for safeguarding assets”.

Before making a new investment or hiring a financial advisor ask the following questions: 1. Who is the custodian of my assets?
2. Why type of fraud detection technology does the custodian have in place? 3. What type of insurance does the custodian provide if fraud occurs? 4. Who generates my account statements?

“SEC now requires that every advisor registered with the SEC to adopt and enforce a code of ethics applicable to its supervised personnel. This was designed to prevent fraud by reinforcing fiduciary principles that must govern the conduct of advisory firms and their personnel.” (www.sec.gov)

How has the economy affected ethics in the financial world? It seems we have been on a roller coaster ride. Not since the Great Depression has the US or the world wide economy comes so close to falling off the financial pipeline. We are no where near being out of the crisis this helped us learn that we have a lack of ethical philosophy which will come back to haunt us if we do not do something about it. Although we have had many investment firms and banks to name of few to fail if could be a lot more in the future if we do not look at this as a learning lesson.

Who is responsible for this financial crisis? Everyone and no one are responsible for this crisis. You as what do I mean. We currently do not have a financial money management philosophy that everyone knows and can agree upon. You have the Republicans versus the Democrat’s and the Liberal’s versus the Conservative’s. At the end of the day there should be some type of ethical financial policy that everyone should follow that would lead to no questions asked.

For years we did not worry about our investments or the money we had in the bank and as a country we felt we were secure. How big is the investment fraud? There were hundred of cases with losses in the $10 – $50 million range. Who were those mainly affected? They were males about 55-65 in age and they were financially literate, college educated, and higher income level and risk takers. We must do our homework to keep this from happening.

We as individuals have created this that the economy is in now. I am not saying we have done this alone. Let’s look at some situations. We bought a house with a non conforming mortgage so when the interest rate re-adjusted we could not afford this so the house was foreclosed on. This is what flooded the housing market and there were more houses on the market than people wanted to buy. So in turn when the sales went down new home sales went down so this put real estate agents and construction workers out of work because the market slowed down. Everything happens in a cycle and this happens every so many years.

What Is Ethics?
Ethics is rules of behavior based on the beliefs about how things should be that a company sets up for its particular business. This could be a set of moral values and principles that are important to that company. The view point what is right and what is wrong differ from person to person. Many financial institutions have a set of guidelines they must follow by the SEC and other governing agencies. When coming up with a code of ethics, you need to start with the guidelines that you much first follow and build on those guidelines.

In 2006 the SEC received of 20,000 complaints the top ten complaints were as follows.
1. Advance fee fraud
2. Unwanted e-mails or faxes
3. Manipulation of securities, prices or markets
4. Transfer of accounts
5. Errors or omissions in account records
6. Problems with redemption, liquidation or closing of accounts
7. Delivery of funds and proceeds
8. Short selling
9. Difficulties in accessing accounts
10. Problems with deliveries of securities
These issues have been addressed in the Code of Ethics in the Standards of Professional Conduct by the SEC. This is why it is important to know your guideline’s that is set by any government agency than you can start from there in making your code of ethics for your company. You may want to research other companies that are in the same line of work on their ethics to help you get started.

Have we turned a blind eye?
I think we have turned a blind eye because if we had not someone who be reporting what they suspected and the government would be investigating. It is not just the consumers fault but it is the government fault. Burdorff had a contact at the SEC and when there was a complaint a few years ago nothing was done. Why? Probably the person that received the complaint felt that he would not do anything like this and put it aside. The companies that had gotten away for this and bankrupt a lot of individuals they had been reported but nothing were done.

The government need to put laws in affect if someone reports a possible fraud that it must be investigated and if not the person who it was reported to needs to be held accountable. This is just one of the aspects that put the country in a financial melt down. Next we have the housing market where there was an influx of housing available. Some of the brokers were doing anything to get people into some of these houses. There were all kinds of loan even those called the non-conforming loans. They were lending to people who really could not afford the type of home they were buying. They were giving them an adjustable low interest rate loan and when they began to adjust they did not have the credit to refinance and they could not afford the new payment which meant a market of foreclosures. These houses were selling for much more than they were worth and when the housing bubble hit you could hardly give them away because they were not worth what was owed on them.

Conclusion

We have turned a blind eye but it is now time to re think how we do things and try to fix what has went wrong. It is going to take time but we can not keep making the same mistakes. These mistakes have cost everyone. People are losing there jobs, homes, cars and some are even living with other family members or on the streets. We have to protect ourselves and keep our eyes open. We are responsible for our own financial well being. We should educate ourselves and do not depend on others to do it for you. If you do you are taking a chance of being robbed one way or another. Another way people are creating fraud that needs to be looked at carefully is through your insurance companies. There are people now using peoples insurance and going to the doctor. Make sure you check your explanation of benefits when it comes in to make sure you are not being charged for something you did not receive.

REFERENCES

Webley, Simon & More, Elise (April 2003). Does Business Ethics Pay? Website: http://www.ibe.org.uk/DBEPsumm.htm

Oberlechner, Thomas (2007) The Research Foundation of CFA Institute

Vishny, Robert W. (2003). Stock Market Driven Acquisitions, Journal of Financial Economics.

Shleifer, Andrei (May 2004) Does Competition Destroy Ethical Behavior?