Practical analysis for investment professionals
20 February 2012

Codes of Ethics: If You Adopt One, Will They Behave?

In 1989, the blockbuster movie Field of Dreams made famous the phrase, “If you build it, he will come.” Though some critics found the film maudlin, audiences adored its celebration of blind faith.

Fast-forward to the year 2001, when regulators and law makers are walking through the destruction brought about by the bursting of the dot-com bubble and the Enron accounting scandal, they hear a voice that whispers, “If companies adopt a code of ethics, their employees will do the right thing.” So they enact a variety of laws (Sarbanes-Oxley) and other regulations that either encourage or require companies to develop and adopt a code of ethics. Nothing happens, and by 2008 the global banking system is facing a financial collapse.

Fast-forward again, to 2011, when individual and institutional investors are walking through the carnage of their portfolios brought about by financial institutions that engaged in subprime lending and packaging, selling, and investing in collateralized debt obligations, and they hear a voice that whispers “What happened? No one came, no one behaved ethically.”

So what gives? After all, what employee wouldn’t be motivated to behave ethically if they worked for a company whose core values are respect, integrity, communication, and excellence? Or, who wouldn’t behave ethically at a company that states in its code of ethics: “An employee shall not conduct himself or herself in a manner which directly or indirectly would be detrimental to the best interests of the Company or in a manner which would bring to the employee financial gain separately derived as direct consequence of his or her employment with the Company. Moral as well as legal obligations will be fulfilled openly, promptly, and in a manner which will reflect pride on the Company’s name.”

As it turns out, Enron was the company that espoused those wonderful core values and made these compelling statements in its 64-page code of ethics booklet—and we now know how “ethically” many of their employees behaved. Unfortunately, I could point to the codes of ethics of many institutions involved in the financial skullduggery that caused the 2008 crisis, and find the same lofty principles and inspirational statements.

So why aren’t codes of ethics effective in deterring unethical behavior? I have read a number of articles which provide some compelling answers to this very question. (Surprisingly, many of these articles were written before the financial crisis.) One in particular, “Corporate Codes of Ethics: Necessary but Not Sufficient” by Simon Webley and Andrea Werner, grabbed my attention.

What was missing from Enron and is currently lacking in many financial institutions is the existence of an ethical culture and a comprehensive ethical program. According to Webley and Werner and numerous other authors, having a code of ethics without creating an ethical culture and a comprehensive ethics program is like having a Ferrari without wheels—i.e., it looks good, but you’re not going anywhere.

An ethical culture is created and fostered by top management (including the board of directors), who manifest their commitment to ethical practice in their attitudes and behavior. You can’t create an ethical culture if employees and other stakeholders perceive the company to be dishonest or unfair in its business dealings, or if they believe the company does not value or safeguard human lives. You can’t have an ethical culture if employees don’t feel comfortable discussing ethical issues or if unethical behavior is not questioned. Therefore the first step in positively influencing employee behavior must come from top management.

A comprehensive ethical program consists of:

  • a well-designed code of ethics,
  • the provision of guidance for employees,
  • a system for obtaining advice and speaking up on ethical issues, and
  • ethics training.

A well-designed ethics code should inspire and promote ethical values, and not just consist of a set of constraints, rules, and violations. It should focus on all stakeholders who are affected by the company’s objectives (employees, customers, suppliers, shareholders, as well as the community in which the organization operates). It should also include short scenarios of common ethical dilemmas that employees may face and/or a list of questions that employees should ask themselves when faced with an ethical dilemma, such as:

  • Is it legal and ethical?
  • Is it consistent with company policy and the company code of conduct?
  • Can I explain it to my family and friends?
  • Would I be comfortable if it appeared in the newspaper?

Employees also need a way to voice their issues and concerns, such as a hotline they can use to seek advice on ethical issues or to raise concerns about questionable behavior. Ethics training should also be an integral part of the program because it helps reinforce and embed the company’s values and norms. In addition, ethics training should not only involve new employees, it should be conducted on a regular basis with all employees in order to raise awareness and sensitivity to ethical issues. The practical application of ethics in the workplace is something that managers can’t afford to take on blind faith.

In summary, an ethics code is like a marriage license: unless the participants make a serious commitment, it is only a piece a paper.

More Resources

Dobson, John. “Why Ethics Codes Don’t Work.” Financial Analysts Journal, November/December 2003.

Dobson, John. “Monkey Business: A Neo-Darwinist Approach to Ethics Codes.” Financial Analysts Journal, May 2005.

Online Training

Ethical Standards for Investment Professionals: An Interactive Case-Based Course. CFA Institute, May 2011.

Ethics Course Module 1: Standard I—Professionalism. CFA Institute, September 2011.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

About the Author(s)
Michael McMillan, CFA

Michael McMillan, CFA, is director of Ethics Education at CFA Institute, where he was responsible for creating, sourcing, and developing educational content for CFA Institute members and investment professionals in the area of ethics and professional standards. Previously, he was a professor of accounting and finance at Johns Hopkins University’s Carey School of Business and George Washington University’s School of Business. Prior to his career in academia, McMillan was a securities analyst and portfolio manager at Bailard, Biehl, and Kaiser and at Merus Capital Management. He is a certified public accountant (CPA) and a chartered investment counselor (CIC). McMillan holds a BA from the University of Pennsylvania, an MBA from Stanford University, and a PhD in accounting and finance from George Washington University. Topical Expertise: Financial Statement Analysis · Standards, Ethics, and Regulations (SER)

4 thoughts on “Codes of Ethics: If You Adopt One, Will They Behave?”

  1. pchepucavage says:

    An easy solution to this is to give the legal,audit and compliance staff guaranteed contracts that protect them against retaliation for enforcing the code including bringing vilolations to the board and regulators if needed.

  2. hq hip hop says:

    Appreciate this unique site! I am hooked and beginning create adjustments

  3. James says:

    What explains behavior that Chief Investment Officers, Directors of Research and Portfolio Managers are in fact marketing people dressed up as investment professionals? The most important skill to succeed is presentation skill. That is how people are promoted at my multi-billion dollar shop and we tell others that we have an ‘investment culture’. Fund Manager changes are disclosed only in SEC filings, never in press releases. The attempt to hide information from clients is deliberate, yet we claim to be acting as fiduciaries. We called a marketing consultant recently. Among the first things they said was to forget about investment performance.

    I don’t think things were done in this manner even 10 years ago but standards have fallen drastically.So long as we don’t break any laws or violate the ethics code, we are pretty much free to do anything. Being a public company, there is a whistle blower program but no employee (or even ex-employee) will say a word as long-term compensation is in management’s hands. Unless CFA Institute is willing to take confidential / anonymous complaints about unethical behavior (not just in word, but also in spirit) by asset managers, this problem will remain pervasive and come to attention only after something egregious happens.

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