The number of ethical questions that the banking industry faces is many and multi-faceted, but in broad brush strokes, any financial institution that acts ethically must take into consideration those questions that twenty first century globalisation, social and environmental issues pose.1 With this in mind, one should consider the possible reasons behind the recent rise in unethical corporate behaviour and what, if anything, is being done to clean it up.
In August 1989, Charles F. Green, the Deputy Group Chief Executive of National Westminster Bank plc wrote in the Journal of Business Ethics that: Companies do have ethical responsibility and are not protected by limited liability from the consequences of their actions. A company's record and the perception of its ethics affect its reputation and ensure long-term success or failure.
The financial community has a history of placing moral considerations above legal or opportunistic expedients. But we are often exposed to moral dangers and the dangers of contamination are increasing. Deregulation and the technological revolution are sharpening ethical conflicts.
Bankers' role is one of stewardship, based on trust. We are trusted by those who ask us to look after their money and we have a duty to lend that money responsibly. Banking is about rewards reflecting real risks and ethical considerations form an important part of our risk-taking activities. The welfare of our borrowing customers, in good times and bad, is of major concern in any business proposition. Sometimes commercial considerations can be at odds where ethics and politics combine.
We depend on people to run our business and to reflect our ethical standards. We have to let our people know what is expected of them and help them to avoid pressures and temptations. A bank's responsibility extends to government, customers, shareholders, staff and the community. In the future, as we face increasingly complex and conflicting issues, our resolve and commitment to ethical behaviour will be tested.2
Ethics in business, which includes the banking and financial sector, is simply the application of everyday moral or ethical norms to business.
The term 'business ethics' came into common use in the US since the 1960s. This period marked a changing attitude towards society in the US and towards business in general.
The US Civil Rights Act of 1964 was the first piece of legislation to help jump start the business ethics movement. The Act prohibited discrimination of the basis of race, color, religion or national origin in public establishments connected to interstate commerce, as well as places of public accommodation and entertainment.
Corporations, finding themselves under public attack and criticism, responded by developing the notion of social responsibility. They started social responsibility programs and spent a good deal of money advertising their programs and how they were promoting the social good.
Business ethics, as an academic field, also emerged in the 1970s. Norman E. Bowie dates the birth of business ethics as November 1974, with the first conference in business ethics, which was held at the University of Kansas.3
In 1977, following a series of scandals involving bribery by US firms abroad including the Lockheed $12 million bribery case that led to the fall of the Japanese government at the time, the US government passed the Foreign Corrupt Practices Act (FCPA).4 A number of companies prior to the FCPA had already adopted the policy of refusing to pay bribes as a matter of ethical principle. 5 The FCPA was enacted for the purpose of making it unlawful for certain classes of persons and entities to make payments to foreign government officials to assist in obtaining or retaining business. Specifically, the anti-bribery provisions of the FCPA prohibit the wilful use of the mails or any means of instrumentality of interstate commerce corruptly in furtherance of any offer, payment, promise to pay, or authorisation of the payment of money or anything of value to any person, while knowing that all or a portion of such money or thing of value will be offered, given or promised, directly or indirectly, to a foreign official to influence the foreign official in his or her official capacity, induce the foreign official to do or omit to do an act in violation of his or her lawful duty, or to secure any improper advantage in order to assist in obtaining or retaining business for or with, or directing business to, any person.6
In 1984, the Union Carbide disaster at its plant in Bhopal, India, killed thousands of people and injured several hundred thousand and focused world attention on the chemical industry. This led to the chemical industries adopting a voluntary code of ethical conduct known as Responsible Care Global Charter.7
In early 2009, Sir Allen Stanford became the subject of several fraud investigations, and on 17 February 2009, was charged by the US Securities and Exchange Commission with fraud and multiple violations of US securities laws for alleged 'massive ongoing fraud' involving US $8 billion in certificates of deposit. On 27 February 2009, the SEC amended its complaint to describe the alleged fraud as a 'massive Ponzi scheme'.8
Whether it is ethical for investment bankers to receive continued high levels of remuneration and/or a bonus for their efforts in the recent economic crisis rumble on and continues to be a topic of debate.
Goldman Sachs, a US bank, was charged with misleading investors. In April 2010, the US watchdog, the Securities and Exchange Commission (SEC) charged Goldman Sachs with failing to disclose vital information that one of its clients, Paulson & Co, helped to choose which securities were packaged into a mortgage portfolio that was then sold to investors in 2007. It was claimed that Goldman Sachs did not disclose that Paulson, one of the world's largest hedge funds, had bet that the value of the securities would fall. The SEC alleged that investors in the mortgage securities, packaged into a vehicle called Abacus, lost more than US $1bn in the US housing market collapse. On 17 July 2010, Goldman Sachs agreed to pay US $550m to settle civil fraud charges of misleading investors. The charges concerned Goldman Sach's marketing of mortgage investments as the US housing market faltered. The SEC said it was the biggest fine for a bank in its history.9
This is not in itself a problem as a sense of willingness in the banking and financial sector to increase standards will, essentially, come from heightened interest to do so on the part of the individuals within the sector. However, when pooled, the efforts of such individuals could represent a significant opportunity to maintain and increase market confidence.10
Reputation is the key to the business case for ethics, and reputation of the sector and the financial institutions within it is important. Good, ethical behaviour can also be a competitive advantage, and, in time, potentially a way to lighter regulation.11
It is interesting to note that the Financial Services Authority (FSA), the UK regulator, does not provide a definition of 'ethics' or 'ethical standards' in its eglossary12 section of its website. However, the FSA has instead described eleven 'Principles for Business' (Principles) that currently apply in whole or in part to every financial institution that it regulates. The Principles are a general statement of the fundamental obligations of financial institutions under the regulatory regime and derive from the FSA's rule-making powers.13
Breaching a Principle makes a financial institution liable to disciplinary sanctions. In determining whether a Principle has been breached, it is necessary to look to the standard of conduct required by the Principle in question. Under each of the Principles, the onus will be on the FSA to show that a financial institution has been at fault in some way. What constitutes 'fault' varies between different Principles. For example, under Principle 1 (Integrity), the FSA would need to demonstrate a lack of integrity in the conduct of a financial institution's business. Under Principle 2 (Skill, care and diligence) a financial institution would be in breach if it was shown to have failed to act with due skill, care and diligence in the conduct of its business. Similarly, under Principle 3 (Management and control), a financial institution would not be in breach simply because it failed to control or prevent unforeseeable risks, but a breach would occur if the financial institution had failed to take reasonable care to organise and control its affairs responsibly or effectively.14
During a speech on 17 June 2010, Hector Sants, Chief Executive, Financial Services Authority stated that when he joined the regulator, he was told by the senior management at the time that 'the FSA does not do ethics'.15 Since being told, the world has collectively experienced the worst financial crisis in modern times.
Sants stated that:
Some of the causes of the crisis were deeply routed in behavioural issues that resulted in actions and decisions that, with the benefit of hindsight, were not the right ones. A firm's culture plays an important role in influencing the actions and decisions taken by individuals within firms and in shaping a firm's attitude towards their customers. Worryingly, even after all the supposed lessons learnt exercises, we are still seeing some decisions by management in major firms that we would judge not to be prudent. Furthermore, we all know that most major institutions have a 'set of values' to which they ascribe - however, in many cases there is clearly a gap between what they claim to believe and do, and what they actually do. These values also tend not to be aligned or 'lived' by the employees meaning the firm does not 'practice what it preaches'. So at the least, I would assert that regulators have an obligation to consider the question of whether they should have a role to play in relation to the ethics and culture of the firms they regulate.16
Financial institutions must have the right culture and society knows that regulatory rules, even when combined with effective supervision, are not sufficient to ensure the probability that future banking failures or unethical behaviour is minimised. It raises the issue of whether this one-dimensional approach has to be questioned.
Sants went on to say that:
The goal of all financial institutions regulated by the FSA should be to understand their own culture and the potential risks posed by the wrong culture. This culture should facilitate 'the right behaviours' and thus the 'right judgements' being made within a strong set of prudential and consumer protection rules. Behaviour is influenced by leadership, strategy, decisions, incentives, controls and the threat of sanctions: deterrence. The first question which then stems from this statement is what are the 'right behaviours': how do we judge the judgements? Normally at this point the word 'ethics' enters the debate. There is a view that the right behaviour stems from the individuals making them having the right ethical framework. I think this word - 'ethics' - is not precise enough and carries too much baggage for regulators. The better focus for regulators would be culture, which no doubt reflects the ethical framework of the organization.17
It was his view that it was right that the FSA 'does not do ethics', or as Sir Howard Davies, former Executive Chairman of the FSA between 1997 and 2003 once put it "it is not for the FSA to seek to act as the conscience of the square mile' in the financial city in London. However it is Sants' view that a regulator's role is "to police behaviour and ensure financial institutions have the right culture, which facilitates the delivery of the outcomes we expect".18
Ethical banks are part of a larger societal movement toward more social and environmental responsibility in the financial sector. This movement includes ethical investment, socially responsible investment, corporate social responsibility and is also related to such movements as the fair trade movement, ethical consumerism and boycotting. Ethical banking is a juvenile sector within this movement. Other areas, such as fair trade, have comprehensive codes and regulations that all industries that wish to be certified, as fair trade, must adhere to. Ethical banking has not developed to this point; because of this it is difficult to create a concrete definition distinguishing exactly what it is that sets an ethical bank apart from conventional banks. Ethical banks are regulated by the same authorities as traditional banks and have to abide by the same rules. While there are differences between ethical banks, they do share a common set of principles, the most prominent being transparency and social and/or environmental aim of the projects they finance. Ethical banks sometimes work with narrower profit margins than traditional ones, and therefore they may have fewer offices and operate mostly by phone, internet, or mail.19
Historically banks have been viewed solely as financial institutions, which should concern themselves with all things financial. Morality has not entered the equation. This public view has allowed banks significant leeway with concern to ethical standards. This is because they have not been associated with the actions taken by the businesses they lend to. Banks have also stated that a reason for not mounting the new challenges that sustainability presents is that such inspection would require interference in the activities of clients.20 However, with changing social demands, and as more is known about the effects that banks can have through their lending policies, banks have begun to feel pressure from the general public, non-governmental organisations, government's, and the like to go beyond conventional business management.21
In 2008-2009, an Integrity Survey was conducted by KPMG Forensic at a time when public trust and confidence in the capital market had been shaken. During this turbulent environment, the relevance of the survey was greater than ever as financial institutions, regulators and investors sought better understanding of factors that may have contributed to the economic challenges.
A summary of the key findings from the survey is as follows:
-- The prevalence of misconduct remained high. Nearly three out of four employees (74%) reported that they had personally observed or had firsthand knowledge of wrongdoing within their organisations during the previous 12 months. Employees surveyed who worked in the public sector and the automotive industry reported the highest rates of misconduct. However, employees in highly regulated industries, such as banking and finance, reported lower rates of misconduct relative to other industries. The prevalence of serious misconduct varies more widely across industries.
Employees working in the banking and finance industry reported the highest instances of misconduct (60%) that could cause a significant loss of public trust. This contrasts with employees in other sectors such as diversified industries and chemicals, where the prevalence of serious misconduct was 26% lower.
-- The nature of observed misconduct remained serious. Nearly half of the employees (46%) reported what they observed could cause a 'significant loss of public trust if disclosed'. This figure not only remained on par with previous years at the national level, it peaked at 60% for employees working in the banking and finance industry.
-- Pressures, incentives, inadequate resources and job uncertainty continued to be major drivers of fraud and misconduct. Respondents reported that managers and employees felt pressures to do whatever it took to meet business targets (59%); they believed they would be rewarded for results, not the means used to achieve them (52%); they lacked resources to get their jobs done without cutting corners (50%) and they feared losing their jobs if they did not meet targets (49%).
-- While whistleblower mechanisms were gaining traction, there remained a risk that boards of directors and senior management may not hear from employees about fraud and misconduct risks until it was too late. More than half (57%) of the respondents reported that they would feel comfortable using a hotline to report misconduct, which was up from 40% when KPMG first began surveying. However, only approximately one half (53%) believed they would be protected from retaliation, and even fewer (39%) believed that they would be satisfied with the outcome if they reported misconduct to management.
-- Ethics and compliance programs continue to have a favourable impact on employee perceptions and behaviours across the board. For example, the percentage of respondents who reported working in an environment in which people feel motivated and empowered to do the right thing doubles (from 43% to 90%) among employees who work in companies with comprehensive ethics and compliance programs versus those who did not.22
KPMG Forensic asked the employees what factors might cause employers and managers to engage in misconduct. Excessive pressures, incentives, uncertainty over the rules, inadequate resources and job anxiety were among the major drivers cited.
-- 59% of employees felt pressure to do 'whatever it takes' to meet business targets.
-- 53% believed that they would be rewarded for results, not the means used to achieve them.
-- 51% believed the Code of Conduct is not taken seriously.
-- 51% lacked familiarity with the standards that apply to their jobs.
-- 50% lacked resources to get the job done without cutting corners.
-- 49% feared losing their jobs if they did not meet targets.
-- 47% believed policies or procedures were easy to bypass or override.
-- 34% sought to bend the rules or steal for their own personal gain.23
As the current economic crisis has unfolded, there has been widespread condemnation of the excesses that lead to the crisis and a near universal call for new ethical values to underpin the global economic system. In order to develop a deeper understanding of the nuances of public opinion on the topic of values - particularly the opinion of the next generation - the World Economic Forum (WEF), in collaboration with Face book and Georgetown University, carried out a unique opinion poll.
The poll questions were designed to provide insights into the personal values of the respondents, where they derive those values from and how they perceive the role of values in the global economic and governance systems. The opinion poll was conducted through Face book and reached over 130,000 respondents in France, Germany, India, Indonesia, Israel, Mexico, Saudi Arabia, South Africa, Turkey and the United States. The majority of respondents were under 30 year's old.24
More than two thirds of people believe the current economic crisis is also a crisis of ethics and values.25 Only one quarter of respondents believed that large multinational businesses apply a values driven approach to their sectors, while a little over 40% believed that small and medium sized businesses applied such an approach. When asked whether businesses should be primarily responsible to their shareholders, their employees, their clients and customers or all three equally, almost half of the respondents chose the option of 'all three equally'.26
When asked to identify which values were most important for the global political and economic system, almost 40% chose honesty, integrity and transparency, 24% chose others' rights, dignity and views, 20% chose the impact of actions on the well-being of others, and 17% chose the preservation of the environment.27
Almost two thirds of respondents believed that people do not apply the same values in their professional lives as they do in their private lives.
An ethics audit is a new technology which was developed at the European Institute for Business Ethics (EIBE), Nijenrode University, and the Netherlands Business School. Ethics auditing is a process which measures the internal and external consistency of an organisation's values base. The key points are that it is value linked and that it incorporates a stakeholder approach. Its objectives are intended for accountability and transparency towards stakeholders and it is intended for internal control, to meet the ethical objectives of the organisation.28
The value of the ethical audit is that it enables the company to see itself through a variety of lenses. It captures the company's ethical profile. Companies recognise the importance of their financial profile for their investors, of their service profile for their customers, and of their profile as an employer for their current and potential employees. An ethical profile brings together all of the factors which affect a company's reputation, by examining the way in which it does business. By taking a picture of the value system at a given point in time, it can:
-- clarify the actual values to which the company operates;
-- provide a baseline by which to measure future improvement;
-- learn how to meet any societal expectations which are not currently being met;
-- give stakeholders the opportunity to clarify their expectations of the company's behaviour;
-- identify specific problem areas within the company;
-- learn about the issues which motivate employees; and
-- identify general areas of vulnerability, particularly related to lack of openness.29
One of Britain's largest investors, Aviva Investors, has suggested that new rules should be introduced to cover ethics audits that would increase the cost of capital for companies with controversial environmental and human rights records. Steve Waygood, chief of sustainability research and engagement at Aviva Investors, said "If companies were forced to publish long term data on the environmental, human rights and health and safety implications of their projects and investors could vote on these plans at shareholder meetings - it would force businesses to become more responsible".30
Commonly accepted principles of corporate governance include:
-- rights and equitable treatment of shareholders - organisations should respect the rights of shareholders and help shareholders to exercise those rights. They can help shareholders exercise their rights by effectively communicating information that is understandable and accessible and encouraging shareholders to participate in general meetings;
-- interests of other stakeholders - organisations should recognise that they have legal and other obligations to all legitimate stakeholders;
-- role and responsibilities of the Board of Directors - the board needs a range of skills and understanding to be able to deal with various business issues and have the ability to review and challenge management performance.
It needs to be of sufficient size and have an appropriate level of commitment to fulfill its responsibilities and duties. There are issues about the appropriate mix of executive and non-executive directors;
-integrity and ethical behaviour - ethical and responsible decision making is not only important for public relations, but it is also a necessary element in risk management and avoiding lawsuits. Organisations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. It is important to understand, though, that reliance by a company on the integrity and ethics of individuals is bound to eventual failure. Because of this, many organisations establish Compliance and Ethics Programmes to minimise the risk that the firm steps outside of ethical and legal boundaries;
-- disclosure and transparency - organisations should clarify and make publicly known the roles and responsibilities of the Board of Directors and management to provide shareholders with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company's financial reporting. Disclosure of material matters concerning the organisation should be timely and balanced to ensure that all investors have access to clear, factual information.31
Issues involving corporate governance principles include:
-- Internal controls and internal auditors;
-- the independence of the entity's external auditors and the quality of their audits;
-- oversight and management of risk;
-- oversight of the preparation of the entity's financial statements;
-- review of the compensation arrangements for the Chief Executive Officer and other senior executives;
-- the resources made available to directors in carrying out their duties;
-- the way in which individuals are nominated for positions on the Board of Directors; and dividend policy.
Corporate governance remains an ambiguous and often misunderstood phrase. For quite some time, it was confined only to corporate management.
Ethical behaviour, acting with honesty and integrity and considering what is right and what is wrong are all components of a financial institution's culture and add to a bank's reputation. It is probably one of the most important factors to consider when protecting a financial institution's brand and reputation. It is clear that ethics challenges will evolve as globalisation continues. Globalisation will not only intensify market competition, but it is going to make establishing organisation wide ethical corporate cultures and standards more complex. Hence, ethical behaviour is a component that deserves to be considered as an important tool for financial institutions striving for long-term prospects and growth. After all, ethics in banking is a long term investment.
(The writer is an advocate and is currently working as an associate with Azim-ud-Din Law Associates)
1. What are Banking Ethics?, wise GEEK, http://www.wisegeek.com/what-are-banking-ethics.htm.
2. Charles F. Green, Business Ethics in Banking, Journal of Business Ethics, http://www.springerlink.com/content/n8453q261u1728x1/.
3. Norman E. Bowie, Business Ethics, ed. Joseph P. DeMarco and Richard M. Fox, N.Y: Routledge & Kegan Paul (1986).
4. As amended, 15 U.S.C. §§ 78dd-1, et seq
5. Richard T. De George, A History of Business Ethics, Santa Clara Univ., http://www.scu.edu/ethics/practicing/focusareas/business/conference/presentations/business-ethics-history.html.
6. Foreign Corrupt Practices Act, The US Department of Justice (2010), http://www.justice.gov/criminal/fraud/fcpa/.
7. Responsible Care Global Charter, Responsible Care (2010), http://www.responsiblecare.org/page.asp?p=6341&l=1.
8. http://en.wikipedia.org/wiki/Allen_Stanford.
9. Goldman Sachs agrees record $550m fine, BBC Business News http://www.bbc.co.uk/news/business-10656699.
10. Id.
11. Id.
12. http://www.fsa.gov.uk/pages/ About/What/International/european/glossary/index.shtml#e.
13. Principles of Business Chapter 1 Section 1.1.2, Financial Services Authority, http://fsahandbook.info/FSA/html/handbook/PRIN/1/1.
14. Principles of Business Chapter 1 Section 1.1.7, Financial Services Authority, http://fsahandbook.info/FSA/html/handbook/PRIN/1/1.
15. Hector Sants, Do regulators have a role to play in judging culture and ethics?, Financial Services Authority, http://www.fsa.gov.uk/pages/Library/Communication/Speeches/2010/0617_hs.shtml.
16. Id.
17. Id.
18. Id.
19. Ethical banking, http://www.spiritus-temporis.com/ethical-banking/references.html.
20. Marcel Jeucken, Sustainable Finance and Banking - Slow starters is gaining pace, http://www.sustainability-in-finance.com/ifi.pdf.
21. Ethical banking, http://en.wikipedia.org/wiki/Ethical_banking.
22. Richard H Girenti, KPMG Forensic Integrity Survey 2008-2009, KPMG Forensic (2008), http://us.kpmg.com/RutUS_prod/Documents/8/IntegritySuvey08_09.pdf.
23. Id.
24. Faith and the Global Agenda: Values for the Post-Crisis Economy, World Economic Forum (2010), http://www.weforum.org/pdf/faith/valuesreport.pdf.
25. Milagros Rojas and Saadia Zahidi, Faith and the Global Agenda: Values for the Post-Crisis Economy, World Economic Forum (2010), http://www.weforum.org/ pdf/faith/valuesreport.pdf.
26. Id.
27. Id.
28. Id.
29. Id.
30. Garry White, Aviva Investors demand ethics audits, Daily Telegraph (Jul. 31, 2010, 19:34 PM), http://www.telegraph.co.uk/finance/newsbysector/industry/mining/7920356/Aviva-Investors-demand-ethics-audit.html.
31. Id.