2. ®1999 South-Western College Publishing 1 Chapter 4 Regulation And Ethics

3. ®1999 South-Western College Publishing 2 History Of Regulations October 11, 1929October 11, 1929 –Appropriate Environment Need for InformationNeed for Information –Shareholders –Financial institutions –Standard accounting practices –Disclosure requirements

4. ®1999 South-Western College Publishing 3 What Are The Major Securities Laws That Protect Investors? Securities Act of 1933Securities Act of 1933 Glass-Steagall Banking Act of 1933Glass-Steagall Banking Act of 1933 Securities Exchange Act of 1934Securities Exchange Act of 1934 Public Utilities Holding Co. Act of 1935Public Utilities Holding Co. Act of 1935 The Maloney Act of 1938The Maloney Act of 1938

5. ®1999 South-Western College Publishing 4 Securities Law And Financial Innovation RegulatorsRegulators –Concerned about the rights of security holders Financial Innovators a step ahead of regulatorsFinancial Innovators a step ahead of regulators –Design –Sell Complex Securities –Trade

6. ®1999 South-Western College Publishing 5 Corporate Governance SystemSystem of Controlling the Corporation RestsRests with the Board of Directors –Elected –Elected by shareholders –Appoint –Appoint senior management –Determines –Determines CEO’s compensation LegalLegal Compliance EstablishesEstablishes Appropriate Ethical Conduct InstitutionalInstitutional Investors –Priority –Priority of clients interests?

7. ®1999 South-Western College Publishing 6 Ethics And Fraud Three Levels of Applying EthicsThree Levels of Applying Ethics –Corporate mission –Constituency relations –Corporate policies and practices Code of EthicsCode of Ethics –Establish acceptable activities and behaviors

8. ®1999 South-Western College Publishing 7 Ethics IntegrityIntegrity DignityDignity CompetenceCompetence Proper CareProper Care Independent Professional JudgementIndependent Professional Judgement Don’t do anything that you couldn’t live with on the front page of the local newspaper! Don’t do anything that you couldn’t live with on the front page of the local newspaper!

9. ®1999 South-Western College Publishing 8 Exercising Independent Judgement Cornerstone of the AIMR’s Code of EthicsCornerstone of the AIMR’s Code of Ethics Influenced by Outside PressuresInfluenced by Outside Pressures ExerciseExercise –Diligence –Thoroughness Present Their Own opinionPresent Their Own opinion Credible Basis for RecommendationCredible Basis for Recommendation

10. ®1999 South-Western College Publishing 9 Insider Trading Base Investment Decisions onBase Investment Decisions on –Information not publicly available –Inappropriately acquired information Insider Trading Sanctions Act of 1984Insider Trading Sanctions Act of 1984 –Enforced by the SEC Insider Trading and Securities Fraud Enforcement Act of 1988Insider Trading and Securities Fraud Enforcement Act of 1988 –Increases jail terms and fines –Cash bounties

11. ®1999 South-Western College Publishing 10 Commission Brokers And Churning ChurningChurning –Buying and selling excessive amounts –Trading excessively for the primary purpose of generating commissions –Difficult to prove

12. ®1999 South-Western College Publishing 11 How Can You Prove Excessive Trading? CourtsCourts Use 3 Tests for Excessive Trading –Analyze –Analyze turnover ratio HowHow frequently securities are traded –Ratio –Ratio of commissions to invested equity –Compare –Compare commissions in all accounts

13. ®1999 South-Western College Publishing 12 Commission Brokers And IPO’s Firm Issuing Securities Firm Issuing Securities Wants the highest price Wants the highest priceBroker Broker’s Client Broker’s Client Wants the lowest price Wants the lowest price The broker has to sell the securities, whether they are what the client needs or not!

14. ®1999 South-Western College Publishing 13 Financial Planners Advise Investors Advise Investors Financial Planners Compensated From Compensated From Commission Commission The investor is dealing with a salesperson

15. ®1999 South-Western College Publishing 14 CEO’s Compensation Indexed to Firm’s PerformanceIndexed to Firm’s Performance Excessive CompensationExcessive Compensation –Increased compensation as firm loses money UnethicalUnethical –Interlocking board membership CEO’s on other boardsCEO’s on other boards

16. ®1999 South-Western College Publishing 15 Improving Investment Manager’s Conduct Incentive structuresIncentive structures –That foster ethical markets –That are satisfactory to investors –That correspond with clients’ desires –That reward independent judgement –Based on serving the client –Linked to earnings