Ethics in Finance
Financial and management accounting
• Financial Accounting is defined as reporting
of the financial position and performance of a
firm through financial statements issued to
external users on a periodic basis.
• Management or Cost Accounting is the
process of identifying, measuring, analyzing,
interpreting, and communicating information
for the pursuit of an organization's goals.
Financial Management
• Financial management encompasses resource
management and finance operations.
• Resource management is the efficient and effective
deployment of an organization's resources such as
financial resources, inventory, human skills,
production resources, or information technology when
needed.
• Financial operations is providing financial advice and
guidance, support of the procurement process,
providing pay support, and providing disbursing
support
Ethical issues in Finance
• Ethics in finance can be developed around three
broad themes:
▪ In financial markets
▪ In financial services industry (including
banking and insurance)
▪ By financial people in organizations
• Financial Transactions is the process by which
the flow of money through an organization is
handled
• The Accounting Function keeps track of all
financial transactions by documenting the
money coming in and money going out
• The Auditing Function is the certification of an
organization’s financial statements or books
as being accurate by an impartial third-party
professional
GAAP - Generally accepted accounting
principles
• The generally accepted accounting principles that
govern the accounting profession – not a set of
laws and established legal precedents, but rather
a set of standard operating procedures within the
profession
• A set of accurate financial statements that
present an organization as financial stable,
operationally efficient, and positioned for strong
future growth can do a great deal to enhance the
reputation and goodwill of an organization
Frauds in the financial sector
Legal authorities define fraud as a crime that
“involves the use of dishonest or deceitful conduct in
order to obtain some unjust advantage over someone
else”.
Frauds include:
• Financial services sector, i.e., credit card fraud, cheque
fraud and other types
• Insurance fraud
• Telecommunication-related fraud
• Securities-related fraud
• Computer-related fraud
• Unauthorized extension of credit facilities;
• Pledging of spurious goods;
• Hypothecating goods to more than one bank;
• Inflating the value of goods;
• Removing goods with the connivance or
negligence of bank employees;
• Pledging of goods belonging to a third party;
• Accepting obsolete and inadequate stocks;
• Frauds in deposit accounts are opening of
bogus accounts, forging signatures of
introducers, and collecting through such
stolen accounts or forged cheques or bank
drafts.
• Frauds are also committed in the area of
granting overdraft facility in the current
accounts of customers
• Credit card fraud
• Phishing
Frauds in insurance sector
We can identify three types of fraud in the insurance
industry:
1. Internal fraud against the insurer perpetrated by an
employee;
2. Policy holder/claims fraud committed against the
insurer, in the purchase and/or execution of an
insurance product by obtaining wrongful coverage or
payment; and
3. Intermediary fraud committed against the insurer or
policy holders by intermediaries – independent
broker/agent.
Frauds in insurance process
• The possibility of fraud is prevalent during
any one of the three stages in the
insurance process:
a. Policy Proposal stage;
b. Policy Contract stage; and
c. Claim Process stage.
• Frauds are also seen in the non-life
insurance sector
Combating insurance fraud
1. Collection of proper evidence
2. Need for regulation
3. Regulation of allied services
4. Need for judicial co-operation
5. Insurers should aim at conviction
6. Need for transparency and fair play
7. Insurers’ coalition
8. Building consumers’ awareness
9. Rewards for whistle-blowers
10. Effective legislation and judicial action
Measures against bank frauds
• Prevention of Money Laundering Act, 2002
▪ Reporting of Cash and Suspicious Transactions
▪ Types of Reports: Cash Transaction Reports (CTR),
Suspicious Transaction Report (STR), Counterfeit
Currency Report (CCR)
▪ Reporting to RBI
▪ Other guidelines are also given under the Act to curb the
menace of money laundering
▪ Compliance to Anti-Money Laundering Standards
• The Banking Ombudsman Scheme, 2006
Characteristics of Management Prone
to Fraud
• Unduly aggressive financial Targets
• Domination by person or group without controls
• Aggressive accounting practice to keep stock
prices high
• Pressure to reduce tax liabilities
• Major performance related compensation
• Non-Financial personnel involved in accounting
matters
Ethical issues in Finance
• Financial statements
• Hostile Takeovers
• Financial Markets
–Insider Trading
Fraud in Financial Statements
• Fictitious Revenues
• Concealed Liabilities and Expenses
• Fraudulent Asset Valuations
• Improper or Fraudulent Disclosures or
Omissions
➢Creative accounting – form of
fraudulent financial reporting so as
to provide misleading information.
Duties of an Auditor
• To give an accurate statement to the
members about the state of affairs of a
company
• To meet the objectives of the Companies Act
1985 and also the Articles of Association
• To be reasonably skillful and careful in
identifying the true nature of the accounts
Ethical Audit
• An audit that assess a business’s structures,
procedures, systems and policies.
• It measures the extent to which the activities of a
business comply with the standards it has publicly
declared to its external customers
• It measures business conduct against varied moral
standards of the community.
Objectives of Ethical Audit
• To provide a critical assessment of functioning of business
• To investigate into acquisition or restructuring operations
• To determine the type of training necessary for employees
• To establish ethical conduct of business
• To enhance, measure and promote the quality that increases
business performance by assessing them against the ethical
business objective
• To improve the quality of governance by evaluating the
performance and ensuring that financial information is both
available and reliable
Ethical Issues in Financial Markets
• Deception: act of misrepresenting relevant
information
• Churning: Excessive or inappropriate trading
for clients account by a broker who has
control over the account with intent to
generate commissions rather than to benefit
client
• Unsuitability
• Unfairness in Markets
Insider Trading
• Refers to trading on price sensitive
information by company employees or
individuals closely connected with the
firm
• This information has not been disclosed
to other market participants
Ethics & Insider Trading
• It violates equality of opportunity
• Does not give a level playing field
between insiders and outsiders
• Might harm exchange as a whole
because investors might not be willing to
trade on exchange that does not give
shareholders their rights.
Anti-takeover defense measures
• Poison Pills
• Green mail
• Golden Parachute
• People
Pill
Poison Pills
• An anti-takeover device used by company’s
management to make takeover
prohibitively expensive for the bidders
• Company under target changes AOA so that
group of Shareholders have special rights to
buy and sell preferred stock at highly
favorable prices (At times below market
price)
Ethics & Poison Pills
• Poison pills are prohibited in Britain by
takeover code because they prevent
open competition between bidders for
shares
• Use of poison pills are ethical if they are
designed to protect the management
from unwanted takeover bids.
Greenmail
• It occurs where a potential takeover agent purchases
stock in a company
• After the purchases have totaled five percent the
agent must announce his intention to takeover the
company, if that is the intent
• Stock prices go up in anticipation of takeover battle
• Management of target company sends greenmails to
prevent a shareholder from taking over the company
• Takeover agent ends up selling the shares back to
company at an increased or higher negotiated price
Ethics & Greenmail
• Target company may be forced to incur
debts to raise funds to finance the buy
back of shares at premium price
Golden Parachute
• A company gives lucrative benefits to its
top executives such as stock options,
bonuses, etc
• Presence of parachute allows
management to evaluate takeover bid
more objectively
People Pill
• Management threatens that in event
of a takeover the entire management
team will resign
• If managers act in their own interest
rather than company’s long term value
then they are acting unethically
Management Buyout
• It occurs when management decide to
bid for the company
• They convert the company into a private
company and at a later date, bring it
back to market to make substantial
profits.
Ethics & Management Buyout
• Shareholder believe that management may
resort to unethical practices to bring down
share prices and buy out at cheaper rate
• Unethical activities can involve leaking
confidential information by managers for their
benefit during buy out
