Ethics in Finance

Business finance involves: the raising of capital from equity shareholders, borrowings, and creditors; investment in the fixed assets needed to run the business ,e.g. land and buildings, plant and equipment, vehicles, electronic systems and other long term assets; the management of working capital, including debtors and creditors, inventories, and cash and bank balances; and the management of revenue generation and business expenditure that produces profit or loss.

Characteristics of Management Prone to Fraud Improperly aggressive financial targets Domination by person or group without controls Aggressive accounting practice to keep stock prices high Pressure to reduce tax liabilities 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 Covered 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. ENRON

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 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 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.

Hostile Takeovers Are those that elicit opposition from the boards or employees of Target company Reasons for opposition are as follows: Disagreements over price Protecting their own interests

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 (Article of Association –kuruluş sözleşmesi) 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. A South African company has an agreement with a third party to sell parts of its business to them, should a hostile bid emerge, thus making the remainder less attractive to the bidder.

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. Sir Richard Branson, the flamboyant but dominant founder of various companies under the Virgin brand, took his flagship listed company private, thus guaranteeing that he maintain control.

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

Ethics in Financial Management The payment of creditors Credit terms to customers Borrowing limits for subsidiary companies Inventory policies Performance targets Transfer pricing between profit responsible divisions in a corporate group

Ethics in Financial Operations The prohibition of bribery The avoidance of conflict of interest Limits to authority to approve expenditure The control of inventory from theft, fraud and pilferage Expense claim rules, detailing what can be claimed and when, supported by what evidence, and approved by management at which levels The control of cash and bank accounts