3 Steps to Avoid Making Ethical Mistakes That Could Hinder or End Your Career

This post covers this element(s) of GAMMA PI: #7. Individual Characteristics
Avoid Making Ethical Mistakes

Let’s say a co-worker wants you to go out with the team after work but you don’t find it appealing and so you mention you’re not feeling well. Later that evening you run into them at a bar. How would you feel in the moment when your “little white lie” is discovered? I suspect, the same as me…very small.

Some might consider this example as a relatively minor ethical challenge. But what if it were more severe, such as making a bad ethical decision on the job? Now the scenario puts you in your bosses’ office with your firm’s compliance officer asking about questionable actions you recently took. Before you say “that would never happen to me,” review the “Notices of Disciplinary Action” at the back of every CFA Magazine where you’ll find analysts at the wrong end of bad ethical decisions, who also probably thought it would never happen to them.

Many other professions are plagued with ethical challenges, but it’s especially prevalent in equity research because we’re often responsible for the stewardship of other people’s assets (or making recommendations to those who manage those assets). There is a basic rule pertaining to risk taking that says the more at risk, the more likely an individual will make an unethical decision. Given that analyst and PM compensation is often based on stock picking performance, there is a temptation to make unethical choices, especially when the impact on compensation is significant.

Given the high degree of ethical challenges analysts face, they need a framework to ensure they’re navigating the right path

With the understanding that we operate in an environment that’s regularly testing ethical boundaries, I created the 3-step process below to help equity research analysts avoid the most common ethical dilemmas they face:

Step 1: Spot Ethical Dilemmas

In order to make the right ethical decision, it’s imperative to first spot when a dilemma is emerging (sometimes, less-experienced analysts don’t realize they’re walking right into an ethical dilemma until it’s too late). Most of these dilemmas occur as:

  • Misconduct by the analyst for personal or professional gain, such as:
    • Seeking material, nonpublic information
    • Omitting risks or relevant facts
    • Relying solely on company management to provide an assessment of risks for an investment
    • Misrepresenting the thoroughness of research conducted
    • Not clearly identifying an opinion, which could be interpreted by others as a fact
    • Modifying a financial forecast or valuation multiple solely to justify a predetermined price target
    • Covering up a mistake that could lead others to make an impaired investment conclusion
    • Plagiarizing others’ work
    • Misrepresenting past performance or qualifications
    • For the sell-side, sharing material, non-published information about a stock or recommendation with a client before it has been published or widely disseminated to all of the firm’s clients
  • Conflicts of interest between two or more parties that rely on the analyst for an objective investment recommendation such as the following situations:
    • Being asked or influenced by a client or portfolio manager to make a recommendation change solely to help the person’s position
    • Being asked by a trader or client for an objective analysis of a stock when the analyst is in possession of information that can’t be disclosed to the party (e.g., an impending ratings change or proprietary information that hasn’t been disseminated)
    • Specific to sell-side analysts:
      • Being less than objective with a stock recommendation because the analyst has received information, either directly or indirectly, that the firm could lose an investment banking transaction if he doesn’t have a positive rating
      • Being biased to write favorably about a company’s stock because the company has provided the analyst special access to management, superior information, or gifts such as tickets to a sporting event

Step 2: Review Your Intended Action

Ensure your action or response to the potential dilemma will be:

  • Legal
  • Transparent (not hiding your action or response from your manager or compliance officer)
  • Prudent
  • Protective of others’ legitimate interests
  • Consistent with your firm’s rules
  • Consistent with the CFA Institute guidelines

Step 3: Test Yourself

If you’re struggling with a decision because it could result in unethical behavior, run it through these tests:

  • The TV Test: Before you act, imagine how you would feel if all of detailed elements of your actions were reported on national TV (or posted on LinkedIn or YouTube)
  • Discipline Committee Test: Imagine being called upon to explain your decision before the senior management of your department or the CFA Institute’s Disciplinary Review Committee. If you are uncomfortable with the idea of presenting your actions to your peers, make a more ethical choice
  • The 10-Year Test: Try to envision how your actions might affect your circumstances 10 years from now if fully understood by others
  • The Exemplar Test: You may have heard the expression, “What would Jesus do?” This test is particularly useful to depersonalize an ethical dilemma, and while it certainly can be faith-based, it doesn’t necessarily need to be. Think of someone whose integrity you greatly admire. It can be a religious leader, an historical figure, a professional mentor, a family member, or anyone else you respect. Try to imagine that person in your situation, and ask yourself whether he or she would follow the course of action you have chosen. If you can’t imagine that person doing what you have in mind, come up with a different solution.

Once you’ve decided on the ethical path it’s important to move forward with that course of action as soon as possible to avoid the temptation to back away from your ethical decision (immediately email or tell a colleague the ethical path you intend to take so you have a public commitment).

If you’ve determined that a conflict of interest will potentially bias your investment advice, disclose it to all parties involved, and if the conflict prevents you from rendering an objective view, exit the situation gracefully. Most firms are required to have at least one compliance officer, which is a role that can help navigating to the right decision.

This Best Practice Bulletin™ targets #7. Individual Characteristics of GAMMA PI™, within our Pathway to Success Framework

Improve you or your team’s stock picking and communication skills with our equity research analyst training tools, which includes workshops such as the one above, as well as our GAMMA PI™ assessment and one-on-one coaching.  Also, consider ordering the book that inspired the founding of AnalystSolutions and the Best Practices Bulletin: Best Practices for Equity Research Analysts.

©AnalystSolutions LLP All rights reserved. James J. Valentine, CFA is author of Best Practices for Equity Research Analysts, founder of AnalystSolutions and was a top-ranked equity research analyst for ten consecutive years

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