I've been meaning to write this post for a while, and the timing is pretty good now because Eddie posted this article in last week's Bonus Bananas: Here's why Wall Street has a hard time being ethical. The article discusses something that many of us in the industry already know:
Financial incentives often make it challenging to adhere to ethical standards and people end up choosing to do what is illegal or merely permissible instead of what is right.
Now before anyone calls me out for being judgmental or self-righteous, let me try my best to objectively define these terms, from the bottom up.
Illegal
I think this is pretty straightforward. These are the actions that would get you fined, fired, or arrested if they were exposed to the public or to the financial regulatory authorities.
The most prominent/publicized/sensationalized example of this in our industry is insider trading. However, it also includes more "subtle" illegalities such as recommending unsuitable investments to customers (mentioned in the article) or exercising discretionary authority in customer accounts without proper approval. It's unfortunate that many of the ethical issues in finance revolve around this category, because honestly, these lean more toward "criminal" than merely "unethical" practices, and they should be as black and white as other criminal practices outside of finance.
Permissible
In my opinion, here is where ethics begin to play a role. Permissible is when people try to find loopholes in regulations to squeeze out that extra profit. Permissible is when your actions are as dubious as possible without crossing the line into illegality. No person or regulatory authority will stop you from doing these things; only your conscience can. If this is not clear, hopefully it will make more sense after I explain below what is "right" as well as give an example of something that is permissible but ethically questionable.
Right
This is hard to define and honestly, the definition probably differs for everyone. For me, because of my Christian faith, it's as simple as the Golden Rule: do to others what you would have them do to you. And I'm sure for many of you, regardless of your religious background, this rule probably applies as well.
I don't want to get into an argument about whether or not the finance industry is zero-sum, but let's assume it (mostly) is. Therefore, whenever anyone tries to do anything unethical/permissible/illegal to milk the last drop of profit from his counterparty, he is probably not following the Golden Rule. Would he want his counterparty to do the same to him? Or maybe he expects his counterparty to be equally unethical so he does what he does? In the latter case, is that an ideal situation or is it similar to a prisoner's dilemma? These are all questions we often have to ask ourselves while working in finance.
Example
In algorithmic trading (my industry), you see unethical behavior all the time. Panther's spoofing algo and Optiver's "hammer" are examples of clearly illegal practices and both firms were punished severely for it. But what's more interesting/less publicized are permissible actions that may be legal but could be viewed as unethical. Here's an example.
It is well known in the high-frequency trading world that exchanges often do not have technology that can properly handle high volumes of messages from the many HFT firms that trade on them. As a consequence, many exchanges have rules/fees/fines that prevent firms from sending too many messages. For example, an exchange may state (made up numbers): "If a firm sends more than 50,000 messages in a given trading day, they will be fined $10,000." Let's say that I am a trading firm on this exchange and I have this ethical decision:
- I want to put in a trade to buy 35,000 shares of a somewhat illiquid security, and this will certainly move the market.
- I already have a slight (legal, and normal for every big trade) advantage over my competitors because I have information that they do not: someone (myself) will strongly move the market for this security sharply upward in price and I can position myself favorably for such a move.
- However, if I split up my order into 35,000 one-share orders instead of sending one 35,000-share order, I will not be breaking the exchange's messaging rule, but I know that the exchange will be backed up by this large volume of messages. This will cause market makers on the exchange to received delayed market data and give me even longer of an advantage than before.
Is this ethical? It's certainly legal. Messages to and from the exchange that usually move on the millisecond level may take seconds (a life time in HFT) for firms trying to cancel orders, place new orders, receive market data, etc. after this big trade happens. This gives the initiator of the trade precious time to lock in the value of his information that no one else has. What do you think? Some would respond with "Wow! What a great trade!" Others might say "How can you run a business on something as shady as this?" It's unclear.
Conclusion
I wonder how many of you face ethical dilemmas often enough that you have to think about your moral compass. In these situations, would you actually put your company/group at a disadvantage by doing the right thing? Or are you only putting yourself (i.e. your bonus) at a disadvantage? Do these issues occur more often when dealing with clients? Or are they usually internal and related to office politics? Is this more of an issue in sales and/or trading? Or does it also occur often in other fields of finance (if so, how)? I'm really interested to hear your thoughts and opinions on this topic.
.
Sorry, not following this. Surely you will almost certainly get a better fill if you execute one large-size order as opposed to sending a series of 1-lot orders? I do get that you may cause delays in market data / order execution for everyone else and I can see how you MIGHT be able to use that indirectly to your advantage (for instance, you could lift an offer in a correlated security before it properly responds to the price action you are causing in your initial target security) but I fail to see how there is any direct execution benefit for your initial order? Please enlighten me.
To your question, I think this whole industry will put profits before ethics almost all the time, and it's not going to stop before regulations are made more water-tight (eliminating the "permissible" grey area you mention). That's just the culture, and as some others have mentioned, there's a prisoner's dilemma aspect to it as well that puts people who would put ethics before profits at a disadvantage.
Say you're buying 35,000 and there's 5,000 on the offer. Yes you could clear it and you'll get the 5,000 at this level and whatever on the next level, etc. However, if you shoot out those one-lots fast enough, it'd be the same thing. Market making algos would see the one lots and attempt to pull their offers, but the exchange would be too backed up to ack their cancel orders. In the end, both scenarios yield pretty much the same execution but the one-lot method also puts others at a disadvantage for longer.
Great post. Interested to see where the discussion leads.
Unethical or illegal --- what does it matter if the SEC only goes after rogue traders and the buy side? Break the rules and you profit, get caught and pay a settlement where you do not have to admit guilt, rinse and repeat.
It's not just misaligned incentives or a personal choice, it's very clear that the regulators are being told to look the other way.
Also, why even make companies pay the huge SarbOx compliance costs when guys like John Corzine are free?
Seems like finance is one of those industries where the threshold between malum in se and malum prohibitum is pretty thin.
Just a hint, if someone said two Latin phrases like that outside the context of law to me, I would think they were a pretentious douchenozzle. Especially when you know that your audience is mostly people working in finance and not law.. This is not effective communication.
And chances are you had to use Google and/or Wikipedia to keep up !!
Ethical behavior on the street is certainly a prisoner's dilemma. As long as there is one person out there who will put profits before ethics, everyone must be unethical or risk being at a disadvantage. This is the culture, and it will continue to be this way until regulators make it more profitable to be ethical than unethical, which is unlikely for the foreseeable future. What is "right" is debatable, what is more profitable is not.
This doesn't make sense. If you are concerned with being at a disadvantage because ethics, you are also putting profits over ethics.
For me, "it depends". We already know that doing anything illegal is unethical (in this context, although civil disobedience, etc. we are not covering). Understanding the context of laws is critical in understanding if something is "ethical".
Take the tax law, for example. Tax laws were written by and for cronies and by politicians looking to mollify certain constituencies. The tax code SHOULD be a method for maximizing revenue while minimizing economic harm. However, the tax code is not primarily for revenue raising but for social engineering—it’s for picking winners and losers. Since the 1980s, for example, it has been disallowed to write-off credit card interest and auto loan interest but it is very much allowed to write-off home interest. Understanding that the tax code is not for raising revenue but is an unintelligible amalgamation of special interests, I think it’s ethical to do everything LEGAL to avoid paying taxes since legal tax avoidance doesn’t even violate the spirit of the tax code—if anything, it affirms the spirit of the tax code.
A counter example would be insider trading. Insider trading laws were meant to prevent certain people from benefiting from insider knowledge, often at the expense of others. Congressmen and Senators, however, have exempted themselves from these rules. The fact that the nation’s top insiders are exempted from insider trading rules is an affront to the law itself and a violation of the spirit of the law. To me it is unethical—even though it is legal—for a Congressman or Senator to benefit from insider knowledge. If a Congressman or Senator were ethical he or she would put his or her investments into a blind trust while serving in office.
So for me “ethics” comes down to the spirit of the law. If the law itself is nefarious (segregation, for example), legally violated by elected representatives (insider trading), is consciously unenforced (see Colorado and marijuana), or is drawn up in a contradictory spirit (the tax code), then you can get some very interesting ethical conundrums.
So there are only two questions: is it profitable now and is it profitable in the long term.
Many universities don't require an ethics course for finance, econ, business, etc. majors.
You get your ethics training either at the frat house or by a lack of positive reviews/promotions.
Why am I quoted? I didn't say anything.
Sorry, this is weird. I meant to quote the OP. Apologies.
I believe the question is based on the wrong context. Can you explain to me what means "doing the right thing"? What seems wrong to you may be perfectly fine for someone else. What is right today was wrong yesterday and so on and so forth. Really. People forget that ethics are relative and subjective. What I'd agree to is the Financial industry adopting a formal sector-wide code of conduct or principles. Much like doctors, lawyers and accountants have to take an oath in order to become professionals et cetera.
I operated with impeccable ethics and look where it got me.
Doloribus tempore in aut quisquam. Officiis harum consectetur unde vitae. Id eum non adipisci consectetur. Nesciunt rerum ex natus enim nostrum aliquam. Laudantium debitis vitae id nisi dicta. Eos mollitia saepe magni voluptates nihil.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...