According to Kurt Schacht, CFA, former CEO of CFA Institute, few things are as critical for a functioning market as the restoration of confidence.

He considers: “many hedge funds had difficulties in 2008. CFA Institute has been calling attention to a code of conduct for the industry. Since 2004 works to develop appropriate legislation and best practices“.

John Rubino, author of How financial analyst to Profit from the Coming Real Estate Bust and Main Street, Not Wall Street, observes: “the details of Madoff fraud differ from others in the past but something does not change: most who acted are business schools graduates. A more complex and opaque financial market require a general ethics and finance guide. They operate in environments were profit is encouraged. For MBA programs the debate is not but were include ethics in the curriculum”.

“If they are all doing it it is to be correct.”

CFA Institute Centre for Financial Market Integrity believes the historically falls in global markets are the result of several factors, including acts or omissions. In many cases the collapse of the financial crisis recalls errors of past crises, including ignorance of risk and widespread use of leverage. But there is a temptation to reduce the role of individuals and conclude that there were systematic failures in extraordinary circumstances that could not have foreseen. The gregarious instinct has possibly promoted certain professionals to take decisions on the basis of “if they are all doing it it must be correct”.

CFA Institute believes that there has been given less attention to the ethical dimension of the financial crisis. But several principles were ignored completely or partly: integrity, competence, diligence, caution and reasoning, independent judgment or encourage others to act in an ethical manner.

Investment banks, in an environment of low interest rates, designed and sold securities to meet demand for a higher return. The toxicity was manifested with the escalation of leverage and downward spiral of the residential market, which led to lack of liquidity. Remuneration based on volume rather than quality of collateral or of borrowers stimulated structured products that were toxic. Many professional investors failed to understand what they contained, despite 1,000 pages brochures, with many buyers relying too much on ratings of credit agencies without demanding better information or perform its own analysis. Credit agencies showed lack of data and experience to analyze, not realizing that the financial products were being sold to buyers leveraged with mismatch between their assets and liabilities. The credit analysis was limited to replicate third parties models , without checking for robustness in extreme situations. The collapse of the residential real estate market was unprecedented, but the scenario should have been included in the models.

The crisis could have been mitigated if the professional standards had been observed.

External credit ratings are useful but may not be the only deciding factor. Investment professionals should consider the possibility that the environment changes quickly and potential impacts on the clients portfolio taking into account their leverage and liquidity.

In addition, good practice dictates more transparency. The assessment of toxic assets was only called into question when different institutions were required to apply fair value or upgrade to market values. That information should indicate expectations and report potential impacts on the direction of the market.

It is not enough to comply with the financial crisis was a broken-down train

In any case it is not appropriate to consider the financial crisis a broken-down train of which all were victims.

Small responsibility  failures can lead to severe crises and this has clearly shown the need to develop a strong ethical culture. It is vital that all professionals and investment institutions are ethically responsible for protecting the integrity of capital markets and customers. But more than a reactionary legislation, which affects efficiency of markets and by itself does not necessarily protect investors from future crises, a strong ethical culture should be stablished.

We can not eliminate risk but can emphasize the importance of effective legislation and adoption of ethical codes by investment professionals. In fact investors have a reason to look at certified professionals who meet codes and professional standards of conduct. They can point out the bugs and ways to improve the system.

José M. Serrano-Pubul, CFA.