FIN3IPM – PORTFOLIO MANAGEMENT

WORKSHOP 11 SOLUTIONS

ETHICS IN INVESTING
Question 1

What is the difference between integrity and ethics? Can you have integrity without being ethical?

Integrity refers to strict adherence to a set of principles or values. Ethics refers to moral principles or
values that dictate how we ought to live, takes into account how our behaviour affects others, and
distinguishes between right and wrong. In theory it is possible for someone of “integrity” to strictly
adhere to a set of immoral or unethical principles or values, but we find that people of integrity possess
a strict moral code and tend to display ethical conduct. They do the right thing.

Question 2

Consider the shipwreck situation. You are one of 11 people on a life raft which is designed to hold 10
people, and it is starting to sink. What do you do?

There is no right or wrong answer. It will depend on each student’s personal code of ethics. Some
approaches to ethics would say that 10 lives saved is worth the cost of one life, and one person should
be thrown overboard (or someone should jump overboard). Others would say that it is unethical to kill
a person, irrespective of the consequences. If you think you are doing the “right” think based on your
moral code, this could be considered ethical.

Question 3

Consider the following scenarios, which raise ethical questions. In each case, identify the level within
the business environment at which ethics is being applied.

Nitram Enterprises Ltd is a manufacturing business. It employs a team of 10 salespeople.

(a) Each of the salespeople is encouraged by management to assure their customers that their
product is safer than other products in the market, in order to charge higher prices, when they
know that it is in fact the product is not safe to use.
Level: Organisational

(b) One of the salespeople, Dan, is an especially gifted at his job and usually manages to charge
higher prices than the recommended retail price, pocketing the difference and only passing on
the recommended price to Nitram.
Level: Individual

(c) Nitram manufactures tobacco products.

Level: Industry
Question 4

Dan (from Question 3) takes a course in ethics and is considering whether aspects of this conduct are
unethical. He asks himself the following questions. In each case, identify the ethical principle that is
being applied.

(a) If I tell my customers that Nitram’s products are safe, and they use it, and it damages their
health, is that the right thing to do?
Level: Refraining from willingly harming others
(b) Would I want a salesperson selling me a product that he knows is not safe to use?
Level: Fairness

(c) Am I making a worthwhile contribution to the society in which I live by selling tobacco products?
Level: Solidarity

Question 5

Following his ethics course, Dan decides he should behave more ethically. He thinks about how Nitram
operates and forms the view that the culture within the organisation does not promote ethical
conduct. He observes actions by managers and employees which cause harm to stakeholders of the
firm. He brings these to the attention of the Chief Financial Officer, who says “Those things are not
important, as long as we maximise profit and shareholder wealth”.

(a) List the stakeholders of the firm, other than shareholders, who might be harmed by unethical
conduct.

Customers, suppliers, debtholders/creditors, employees and their families, the wider community
and society in general.

(b) Give examples of unethical conduct that could harm these stakeholders.

The following are some examples of how a firm can cause harm to stakeholders, but it is not an
exhaustive list and many other examples are possible.
i. Selling an unsafe product, whilst assuring customers that it is safe, or charging a higher
price based on false claims about a product, or using a confusing pricing structure so that
the cost of the product or service, harms those customers.
ii. Not paying suppliers on time, or refusing to pay what is owed, using market power to
unfairly drive down prices, or returning goods without a valid reason, will harm the
suppliers.
iii. Debtholders/creditors could be harmed if a business defaults on debt or doesn’t pay interest
or repay principal when they are due.
iv. Many actions could harm employees, such as paying them less than what they are entitled
to receive, underpaying or not paying superannuation contributions, forcing them to work
unreasonable amounts of overtime, refusing to pay for overtime worked, discriminating
against some employees based on sex, race or religion (in how they are treated or dismissing
them unfairly), or making them work in unsafe conditions.
v. A business can harm the wider community and society in general by having discriminatory
employment practices, polluting the environment, underpaying or refusing to pay tax and
ultimately by manufacturing and selling a product that causes harm to society generally.
(c) Suppose you are Dan. Make the case for ethical conduct. Write a short statement to the Chief
Executive Officer explaining how ethics pays; how the firm and its shareholders will benefit by
reducing harm to stakeholders.

To the CEO:
I believe that Nitram should be truthful to its customers about the safety of its products, and
charge a fair price for those products. It shouldn’t manufacture products that are unsafe and
cause harm to society. It should treat suppliers with fairness, cooperating with them and paying
its bills on time. It should treat employees fairly, by paying them the correct wages (including
overtime), not forcing them to work unreasonable overtime and treating all employees equally.
It shouldn’t make them work in unsafe environments. It should pay all taxes owed and take care
not to pollute the environment. If Nitram does all of these things, it will benefit in the following
ways:
i. If it treats customers ethically, by selling safe products at a fair price, this will enhance
Nitram’s reputation and ultimately lead to increased revenue and profit.
ii. Treating suppliers ethically may mean more suppliers will deal with the firm, giving access to
better and cheaper products.
iii. Talented workers are more likely to work for the firm if it is known to treat workers ethically.
There will be greater employee satisfaction and retention, lower absenteeism and more
ethical conduct by employees.
iv. Defaulting on debt may harm the firm’s credit rating, costing it more to borrow in the
future.
v. The reputational benefits from acting ethically in terms of the wider community may also
attract more customers and talented employees. Other businesses and governments may
give favourable treatment to Nitram if it is known to be a good “corporate citizen”. There
may be financial benefits by avoiding fines and legal action.
Signed: Dan

Question 6

(a) Are there any stocks (in Australia or anywhere in the world) that you would choose not to invest
in on ethical grounds? Why?

(b) Are there any stocks (in Australia or anywhere in the world) that you would prefer to invest in on
ethical grounds? Why?

The answers to Question 6 will depend on the personal ethics of each student.

Question 7

Identify whether there are any potential ethical problems in the following scenarios, and advise what
the personal should do to resolve any such problems.

(a) Jill Jorund is a securities analyst following airline stocks and a rising star at her firm. Her boss has
been carrying a “buy” recommendation on International Airlines and asks Jorund to take over
coverage of that airline. He tells Jorund that under no circumstances should the prevailing buy
recommendation be changed.

Jorund must be independent and objective in her analysis of International Airlines. If she believes
that her boss’s instructions have compromised her, she has two options: She can tell her boss
 that she cannot cover the company under these constraints, or she can take over coverage of the
company, reach her own independent conclusions, and if they conflict with her boss’s opinion,
share the conclusions with her boss or other supervisors in the firm so that they can make
appropriate recommendations. Jorund must issue only recommendations that reflect her
independent and objective opinion.

(b) Fernando Zubia would like to include in his firm’s marketing materials some “plain-language”
descriptions of various concepts, such as the price-to-earnings (P/E) multiple and why standard
deviation is used as a measure of risk. The descriptions come from other sources, but Zubia
wishes to use them without reference to the original authors. Would this use of material be a
violation of Standard I(C)?

Copying verbatim any material without acknowledgement, including plain-language descriptions

of the P/E multiple and standard deviation, violates Standard I(C) (and by the way, is grounds for
a charge of academic misconduct if you do no an assignment). Even though these concepts are
general, best practice would be for Zubia to describe them in his own words or cite the sources
from which the descriptions are quoted. Members and candidates would be violating Standard
I(C) if they either were responsible for creating marketing materials without attribution or
knowingly use plagiarized materials.

(c) Frank Barnes, the president and controlling shareholder of the SmartTown clothing chain,
decides to accept a tender offer and sell the family business at a price almost double the market
price of its shares. He describes this decision to his sister (SmartTown’s treasurer), who conveys
it to her daughter (who owns no stock in the family company at present), who tells her husband,
Staple. Staple, however, tells his stockbroker, Alex Halsey, who immediately buys SmartTown
stock for himself.

The information regarding the pending sale is both material and non-public. Staple has violated
Standard II(A) by communicating the inside information to his broker. Halsey also has violated
the standard by buying the shares on the basis of material non-public information.

(d) John Gray is a private investor in Belgium who bought a large position several years ago in Fame
Pharmaceuticals, a German small-cap security with limited average trading volume. He has now
decided to significantly reduce his holdings owing to the poor price performance. Gray is
worried that the low trading volume for the stock may cause the price to decline further as he
attempts to sell his large position. Gray devises a plan to divide his holdings into multiple
accounts in different brokerage firms and private banks in the names of family members, friends
and even a private religious institution. He then creates a rumour campaign on various blogs
and social media outlets promoting the company. Gray begins to buy and sell the stock using
the accounts in hopes of raising the trading volume and the price. He conducts the trades
through multiple brokers, selling slightly larger positions than he bought on a tactical schedule,
and over time, he is able to reduce his holding as desired without negatively affecting the sale
price.

John violated Standard II(B) by fraudulently creating the appearance that there was a greater
investor interest in the stock through the online rumours. Additionally, through his trading
strategy, he created the appearance that there was greater liquidity in the stock than actually
existed. He was able to manipulate the price through both misinformation and trading practices.
(e) Carl Fargmon, a research analyst who follows firms producing office equipment, has been
recommending purchase of Kincaid Printing because of its innovative new line of copiers. After
his initial report on the company, Fargmon’s wife inherits from a distant relative US$3 million of
Kincaid stock. He has been asked to write a follow-up report on Kincaid.
Fargmon must disclose his wife’s ownership of the Kincaid stock to his employer and in his follow-
up report. Best practice would be to avoid the conflict by asking his employer to assign another
analyst to draft the follow-up report.

(f) Erin Toffler, a portfolio manager at Esposito Investments, manages the retirement account
established with the firm by her parents. Whenever IPOs become available, she first allocates
shares to all her other clients for whom the investment is appropriate; only then does she place
any remaining portion in her parents’ account, if the issue is appropriate for them. She has
adopted this procedure so that no one can accuse her of favouring her parents.
Toffler has violated Standard VI(B) by breaching her duty to her parents by treating them
differently from her other accounts simply because of the family relationship. As fee-paying
clients of Esposito Investments, Toffler’s parents are entitled to the same treatment as any other
client of the firm. If Toffler has beneficial ownership in the account, however, and Esposito
Investments has preclearance and reporting requirements for personal transactions, she may
have to preclear the trades and report the transactions to Esposito.