Ethical Issues in Finance
BY:- Pankaj Singh Chandel
Ethical issues in Finance
Ethics in finance can be developed around three broad
In financial markets
In financial services industry (including banking and
By financial people in organizations
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”.
• Financial services sector, i.e., credit card fraud, cheque
fraud and other types of identify-related fraud;
• Insurance fraud
• Telecommunication-related fraud
• Securities-related fraud
• Computer-related fraud
Types of bank frauds
• 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 involvement or negligence
of bank employees;
• Pledging of goods belonging to a third party;
• Accepting obsolete and inadequate stocks;
Types of bank frauds (Contd.)
• 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- Duplicate
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
Frauds in insurance sector
We can identify three types of fraud in the insurance industry:
1. Internal fraud against the insurer committed by an
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 seen in the both life and non-life insurance sector
Combating insurance fraud
The following measures can be adopted to combat fraud in the
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
Combating insurance fraud (Contd.)
6.Need for transparency and fairplay
8.Building consumers’ awareness
9.Rewards for whistle-blowers
10.Effective legislation and judicial action
• Accountant should present ‘a true and fair view’ of
the financial statement of business operations.
• The picture the accountant paints can be either
enlightening or misleading , depending on how
accountant chooses to depict it.
• Even within law , various practices can be carried out
by accountants which are often regarded as being in
ethically grey areas. The most common practice of
this kind is known as ‘ creative accounting’.
• It is a term which is popularly associated with ‘
cooking the books’ in a way which is legal although
Creative Accounting definition…
• The use of aggressive and/or questionable accounting
techniques in order to produce a desired result, generally high
earnings per share.
• Creative accounting may include selling assets with a low cost
basis, shipping unusually large quantities of product near the
end of the year, and failure to write down inventories that
have declined in value
• A typical aim of creative accounting will be to inflate profit figures.
• However, Some companies may also reduce reported profits in good years to
smooth results. Assets and liabilities may also be manipulated, either to remain
within limits such as debt covenants, or to hide problems
• The term “window dressing” has similar meaning when applied to
accounts, but is a broader term that can be applied to other areas.
• In the US it is often used to describe the manipulation of investment
portfolio performance numbers. In the context of accounts, “window
dressing” is more likely than “creative accounting” to imply illegal or
fraudulent practices, but it need to do so.
Abusive Tax Shelters
• Shifting of profits from high tax country to lower tax
country in order to take advantage of the loopholes
in the tax laws of the different countries.
• The basic objective is tax evasion.
• The large accounting firms form teams dedicated to
gaming the tax codes for the benefits of their clients.
Major accounting firms are under the attack for tax
advice that violates the spirit of the tax law by
exploiting the letter of the tax laws
• Insider trading refers generally to buying or selling a security ,
in breach of a fiduciary duty or other relationships of trust and
confidence, while in possession of material, nonpublic
information about the security.
Examples of insider trading cases that have been brought by the SEBI are
• Corporate officers, directors, and employees who traded the corporations securities after learning of
significant, confidential corporate developments;
• Friends, business associates, family members, and other tippees of such officers, directors, and
employees, who traded the securities after receiving such information;
• Employees of law, banking, brokerage and printing firms who were given such information to
provide services to the corporation whose securities they traded;
• Government employees who learned of such information because of their employment by the
• Other persons who misappropriated, and took advantage of, confidential information from their
• Because insider trading undermines investor confidence in the fairness
and integrity of the securities markets, the SEBI has treated the detection
and prosecution of insider trading violations as one of its enforcement
• The main argument against insider trading is that it is unfair to those who
do not have the privileged information.
• There is also the argument that it is the unethical misappropriation of
proprietary knowledge ( i.e. Knowledge that only those in the firm should
have, knowledge owned by the firm and not to be used by abusing one’s
fiduciary responsibilities to the firm. Such behaviour also undermines the
trust necessary to the proper functioning of a firm.
• Most important argument against insider trading is that it leads to
inefficiency in the markets.
Role of ethics
• Ethics plays an important role in finance and sources of ethical
behaviour in finance and accounting can be from the following :-
– Code of Conduct for Accountants and Auditors
– Code of Conduct for Merchant Bankers
– Code of Conduct for Insurance Agent
– Code of Conduct for Bankers
– Code of Conduct for Brokers and Members
– Code of Conduct for CFO