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Ethical vs. Legal Standards

A summary of the differences between both, and how they can contradict each
other

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Ethical vs. Legal Standards in Finance: What’s the Difference?

Ethical vs. legal standards: what’s the difference? Making decisions that are both ethical
and respectful of laws is something that investment professionals around the world are
constantly mindful of. Such decisions stem from knowledge of the legal system, having
the interests of all parties at heart and an individual’s own professional judgment.
Nonetheless, there exist situations where possible actions violate either professional
ethics or the law. In this article, we will explore the differences between both and guide
decision making in such scenarios.

 
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Defining Ethical Standards

Ethics refers to the moral course of action that takes into account and strives to benefit
all stakeholders in a given situation. Prior to making an ethical decision, an individual
must be able to identify the possible unethical course of action and label it as such.
Ethical conduct also involves striving to create the best outcomes for the investment
professional, the client and the firm.

For example, an investment fund may explain the risks of investing in different asset
classes prior to creating a portfolio or promising clients a certain expected return. While
such a disclosure may dissuade some potential new clients, it will improve the firm’s long-
term profitability since this action may reduce the chance of dissatisfied clients pursuing
legal action against the firm. An investment firm is not necessarily obligated to make such
a disclosure but may do so in a bid to be perceived as ethical.

Defining Legal Standards

Within the investment industry, defining legal standards is much easier than ethical
standards. Acting legally means respecting the applicable bodies of law in the firm’s
jurisdiction. For example, a company may be required to have accounting practices that
adhere to the GAAP or IFRS standards.
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Such laws have been put into place by regulators after 15% onallan
considering all-access
impacts plan
that new
legislation will have. Laws are usually reactive, meaning that they are implemented after
major scandals and aim to remedy an unhealthy environment; such as the Sarbanes-
Oxley Act. The best laws are proactive and aim to prevent scandals by requiring
preventative, best-practice actions.

Ethical, but Illegal

Going back to ethical vs. legal standards dilemma, a decision can be ethical but violate
certain laws. A common example of this is “whistleblowing,” or an individual’s disclosure
of dishonest, corrupt or illegal activity. While it may be ethical to denounce such activity,
doing so may violate organizational policies and thus be considered illegal.

When faced with a dilemma like this, an investment professional should consider the
repercussions of his actions prior to acting. There may be alternative systems put into
place to remedy such activity such as having internal discussions or using an anonymous
tipping service. Point being, there are no set frameworks in place to guide an individual’s
behavior in such situations. The investment professional will have to resort to his/her
best judgment and follow the course of action that will bring the most benefit to clients,
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family, colleagues, employers, and market participants.

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Unethical, but Legal

Conversely, a decision can adhere to certain bodies of law but be seen as unethical. For
example, some countries do not have laws that prohibit trading while in the possession
of insider knowledge. Thus, while it may be legal to trade under these circumstances, it is
considered by many to be highly unethical.

Here again, an investment professional should consider the full repercussions of his/her
actions. For instance, the professional may ask themselves why they are in possession of
such information in the first place and take actions to avoid being in such situations again
in the future. Alternatively, the professional may choose to ignore this information and
continue trading as per normal.

Conclusion

When investment professional finds themselves in a situation where the only obvious
courses of action violate ethical or legal principles, they must assess the situation and
consider new courses of action that don’t. More importantly, firms and individuals must
constantly take proactive action to mitigate the likelihood of such situations arising.

Additional Resources

CFI now offers the Business Essentials Bundle with courses on Microsoft Excel, Word, and
PowerPoint, business communication, data visualization, and an understanding of
corporate strategy. To keep learning, we suggest these resources:

Professional

Accounting Ethics

GAAP

IFRS Standards

Sarbanes-Oxley Act
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Company

Certifications

Courses

Support

Resources
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