A Report On Deviations In Ethics And Finance

A Report On Deviations In Ethics And Finance

Prepared by, Nemil Shah & Group

What is ethics all about?

Ethics is about answering Socrates' question ―What ought one to do?‖ This is a practical question ... what do I do here and now? ... What should anyone do in my situation? It is a question that it is almost impossible to avoid. The ethical dimension is an area of ‗greys‘ rather than ‗blacks and whites‖: One always encounters the genuine ethical dilemma It is sometimes a matter of choosing the least bad alternative Ethics is about relationships. The ultimate test of our ethics arises in circumstances when we have to weigh the interests of ourselves and others.

It is more often between what is right and less right - in other words between shades of grey. This increases the need for organizations to adhere to a strong set of values to steer them through the minefield of ethical choices with which they are faced as they make business decisions. It is also necessary to ensure that the behavior of the organization is in practice aligned with these values and that employees buy into them, so that the organization actually practices what it preaches. Following are the points where finance deviates with ethics.

Mergers and Takeovers

The merger mania of 1980s put top management on the defensive as predators sought takeover targets. Hostile takeover activity has dissipated in recent years, for a variety of reasons, but the ethical issues surrounding acquisitions and mergers and the ethically questionable conduct that is often involved remain as relevant as ever. The ethical conduct of Target Company‘s top management is often overlooked.

The shareholders of a modern publicly held corporation buy and sell their shares freely, though ordinarily in small quantities and without major consequence for the corporation itself. Occasionally, a new owner – typically another firm will acquire a large fraction of a corporation‘s shares, elect a new board of directors, replace or absorb its top management, and alter its methods of doing business. Consequently, when a substantial fraction of shares does change hands – through a negotiated acquisition, market purchase or tender offer – the new owner expects to gain.

Mergers, acquisitions and takeovers often imply dramatic changes for employees, competitors, customers and suppliers. Not surprisingly, the market for corporate control has generated controversy and is frequently regulated by law or business custom. During most of the twentieth century, critics of mergers and acquisitions in the US pointed to the danger of monopoly and increased concentration. Partly in response to the emergence of the new control transactions such as the hostile takeover and leveraged buyout, more recent criticism has focused on the consequences of corporate productivity, profitability, and employee welfare. Subject to qualifications, the market for corporate control reallocated productive

assets – in the form of going concerns – to the highest bidder. In cases where bidder uses his own money or acts on behalf of the bidding firm‘s shareholders, the market for corporate control pays a paradoxical role. It simultaneously provides (1) a means by which managers may acquire companies using other people‘s money and (2) a means by which they may themselves be disciplined or displaced.

When you buy another company you are making an investment and the basic principles of capital investment decisions apply. You should go ahead with the purchase that makes a net contribution to shareholders wealth. However many factors other than simply the direct financial costs and benefits of the transaction will have to be considered.

Ethical issues in mergers and acquisitions.

With the recent rash in mergers and friendly and unfriendly takeovers, two important issues have not received sufficient attention as questionable ethical practices. One has to do with the rights affected in mergers and acquisitions and the second concerns the responsibilities of shareholders during these activities. Although employees are drastically affected by a merger or an acquisition because in almost every case a number of jobs are shifted or even eliminated, employed at all levels are usually the last to find out about a merger transaction and have no part in the takeover decision. Second, if shareholders are the fiduciary beneficiaries of mergers and acquisitions, then it would appear that they have some

responsibilities or obligations attached to these benefits, but little is said about such responsibilities.

With the recent rash of mergers and friendly and unfriendly takeovers, questions have been raised concerning the ethical propriety of these actions. Some of these have to do with the tactics companies engage in when trying to acquire a company or when trying to avoid being acquired. These include so called ―poison pill‖ tactics and the institution of golden parachuets by the corporations that are threatened with acquisitions and the usual anti-trust problems. Such tactics include the following: 

The target adds to its charter a provision which gives the current shareholders the right to sell their shares to the acquirer at an increased price (usually 100% above recent average share price), if the acquirer's share of the company reaches a critical limit (usually one third). This kind of poison pill cannot stop a determined acquirer, but ensures a high price for the company.

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The target takes on large debts in an effort to make the debt load too high to be attractive—the acquirer would eventually have to pay the debts.

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The company buys a number of smaller companies using a stock swap, diluting the value of the target's stock.

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The target grants its employees stock options that immediately vest if the company is taken over. This is intended to give employees an incentive to continue working for the target company at least until a merger is completed instead of looking for a new job as soon as takeover discussions begin. However, with the release of the ―golden handcuffs‖, many discontented

employees may quit immediately after they've cashed in their stock options. This poison pill may create an exodus of talented employees. In many hightech businesses, attrition of talented human resources often means an empty shell is left behind for the new owner.

One such example is when PeopleSoft guaranteed its customers in June 2003 that if it were acquired within two years, presumably by its rival Oracle Corporation, and product support were reduced within four years, its customers would receive a refund of between two and five times the fees they had paid for their PeopleSoft software licenses. The hypothetical cost to Oracle was valued at as much as US$1.5 billion. The move was opposed by some PeopleSoft shareholders who believed the refund guarantee flagrantly opposed their interests as shareholders. PeopleSoft allowed the guarantee to expire in April 2004

Other issues include the rights of bondholders on both sides of a merger or acquisition, rights that are often considered secondary in light of shareholder interests, and the question of the rights of individual stockholders who are usually neglected in face of institutional shareholder power!

However, two important issues have not surfaced as questionable practices deriving from mergers and takeovers, one having to do with the rights of employees in mergers and second concerning the responsibilities of shareholders

during these activities. Employees in the acquiring and in the acquired company are expected to carry out their job responsibilities both during the process of the merger or takeover and after its completion. They are supposed to carry on as if nothing had happened, despite rumors, threats of their jobs, or upheavals on all levels of management. Although employees are drastically affected by a merger or an acquisition because in almost every case a number of jobs shifted or even eliminated after a merger, in fact except for top management, employees at all levels are usually last to find out about a merger transaction. Yet few commentators have thought this was an issue, and almost nothing has been said about the rights of employees during and after a merger or acquisition. It is as if the question of how employees are affected in these sorts of transactions was unimportant or incidental to the fiduciary benefits or losses of the negotiations. Second, although a merger is said to be for the fiduciary benefit of shareholders of both parties, and indeed, this is allegedly the primary justification for a merger or an acquisition, insufficient attention has been paid to the responsibilities of shareholders in these activities.

Management Buy Outs A management buyout (MBO) is a form of acquisition where a company's existing managers acquire a large part or all of the company. Management buyouts are similar in all major legal aspects to any other acquisition of a company. The particular nature of the MBO lies in the position of the buyers as managers of the company, and the practical consequences that follow from that. In particular, the due diligence process is likely to be limited as the buyers already have full knowledge of the company available to them. The seller is also unlikely

to give any but the most basic warranties to the management, on the basis that the management knows more about the company than the sellers do and therefore the sellers should not have to warrant the state of the company. In many cases the company will already be a private company, but if it is public then the management will take it private. Some concerns about management buyouts are that the asymmetric information possessed by management may offer them unfair advantage relative to current owners. The impending possibility of an MBO may lead to principal-agent problems, moral hazard, and perhaps even the subtle downward manipulation of the stock price prior to sale via adverse information disclosure - including accelerated and aggressive loss recognition, public launching of questionable projects and adverse earning surprises. Naturally, such corporate governance concerns also exist whenever current senior management is able to benefit personally from the sale of their company or its assets. This would include, for example, large parting bonuses for CEOs after a takeover or management buyout. Since corporate valuation is often subject to considerable uncertainty and ambiguity, and since it can be heavily influenced by asymmetric or inside information, some question the validity of MBOs and consider them to potentially represent a form of insider trading. The mere possibility of an MBO or a substantial parting bonus on sale may create perverse incentives that can reduce the efficiency of a wide range of firms - even if they remain as public companies. This represents a substantial potential negative externality. The Purpose of an MBO

The purpose of such a buyout from the managers' point of view may be to save their jobs, either if the business has been scheduled for closure or if an outside purchaser would bring in its own management team. They may also want to maximize the financial benefits they receive from the success they bring to the company by taking the profits for themselves. This is often a way to ward off aggressive buyers.

For example On September 17, 2007, Sir Richard Branson announced that the UK arm of Virgin Megastores was to be sold off as part of a Management buyout, and from 07, will be known by a new name, Zavvi.

Why do MBOS occur?

Another reason management buyouts occur is that management can run its business in the most profitable way. As profit-seeking entrepreneurs, management shops around for the lowest priced goods and services. Any savings are realized as extra cash flow in the form of profits or debt-reducing money. Entrepreneurs are careful about costs. Extra expenses come out of management's pockets. Sheehan notes that "for executives of public companies, it is always so easy to grab a cab-or the corporate jet--at company expense. Once you're a manager-owner, you may walk the seven blocks or take Peoples Express."

Hostile takeovers can be moderately reduced by MBOS. In fact, in 1983 top executives of Signore Corp., a packaging-materials manufacturer repelled a hostile takeover by financier Victor Posner. The stumbling block of Posner's attempt was a $430-million management buyout. Another example of a hostile takeover attempt blocked by a management buyout is the Uniroyal case. At Uniroyal's annual meeting in the spring of 1985, Carl Icahn proposed a takeover. As a result, Uniroyal hastily went private. Later Joseph P. Flannery, chief executive of Uniroyal, commented, "We had talked about private ownership in a general way previously, but frankly I think we were too conservative to have taken the risk of a leveraged buyout on our own initiative."

In a buyout, management becomes an active member on both sides of the table. It acts on behalf of the shareholders to determine whether a sale is in their best interest and seeks the best possible price. It also acts on its own behalf as a profitseeking entrepreneur. The morality of such a transaction has been questioned, but one thing is certain: the stockholders stand to gain a hefty profit. Investment bankers play a key role in defining the premium price that must be offered to persuade stockholders to part with their shares.

Flaws in MBOs

Although previous ethical analyses of management buyouts have presented useful insights, they have been flawed in three major ways.

First, they define the transaction too narrowly, emphasizing the going private aspect and ignoring the leveraged aspect. Leveraging alters the nature of the transaction substantially and warrants additional ethical analysis. Second, these previous analyses ignore the impact of buyouts on non-stockholder constituents of the firm, an omission which renders their implicit utilitarian approach incomplete. Third, these analyses do not include Rawlsian, libertarian, or Kantian perspectives on ethics.

MBOs and ethic

Management buyouts have been a favorite target of corporate governance types for years but the critics may have a new line of attack—criticizing managers for scuttling deals.

The traditional criticism of management buyouts—where a company‘s senior executives cooperate with financiers to buy a company from public shareholders and take it private—has been that management could exploit shareholders by buying the company on the cheap and discouraging other bidders. When the buyout market was firing on all cylinders, objecting to management buyouts on these grounds was a favorite past-time of self-styled shareholder advocates. But now that the buyout market has ground to a crawl—if not a complete halt—the

conflicted role of buying and selling a company same time could be working the other way.

Junk Bonds and Leveraged Financing Bonds Bonds usually generate return by their interest rate, which is paid at certain specified intervals to the bondholder. bonds have the advantage of being a debt instrument; if the issuing company is declared bankrupt, all debt, including debt instruments such as bonds, have much higher priority in being paid from the company‘s liquidation than any instrument reflecting ownership, such as stocks. Bonds are generally classified into two groups - "investment grade" bonds and "junk" bonds. Investment grade bonds include those assigned to the top four quality categories by either Standard & Poor's (AAA, AA, A, BBB) or Moody's (Aaa, Aa, A, Baa). Junk bonds are collateralized debt obligations. (Collateralized Debt Obligations are sophisticated financial tools that repackage individual loans into a product that can be sold on the secondary market. These packages consist of auto loans, credit card debt, or corporate debt. They are called collateralized because they have some type of collateral behind)

Let‘s see how junk bonds function in market:

 A not so good creditworthy client comes to an agency for home loan

 They provide him , with an assumption that real estate prices will always soar up,  And they are just intermediary who charge commission , loan would be financed by bank  Bank collect all the mortgages repack them as CDO  They bifurcate it into various parts depending open risk involved and rates offered  They get it covered under insurance and get good ratings by agencies  Investors interested in high ranked and high yield bonds buy it. Suddenly real estate bubble breaks down and bonds hold no more value Suddenly real estate bubble breaks down and bonds hold no more value

This crash of junk bond market has led to high cash crunch and loss in trust and faith of investors.

Few anecdotes make it far clearer 1. You know you shouldn't. Your CPA wouldn't approve. Your wife would be furious if she found out. The guilt would consume you. Still... you can't help casting a lustful glance at Junk Bonds with their 10-12% rate of return. Just remember... flashy investments usually go up in smoke, and when these babies fall, they fall hard. They're called "junk" for a reason. 2. "I think the Securities and Exchange Commission should set much tougher standards. For instance, when investors lose money, instead of stockbrokers

sending them letters of reassurance, they should have to send them letters saying, 'Here, take some of mine.'"

Ethical Issues Ethical questions associated with junk bonds are to do with the risk to the business, effects of possible failure to repay very high levels of debt on the business and its stakeholders-its employees, suppliers, share holders etc. the risk of failure means the risk of job loss , unpaid bills. Yet if taking this risk is the only way the project can be financed and people associated with the business know this and are prepared to go forward on this basis there is nothing inherently unethical about the

proceedings .if the risk were transferred to employees or banks or suppliers ,however ,while owners continue to take the returns this would be unethical . Leveraged Finance

Leveraged finance is funding a company or business unit with more debt than would be considered normal for that company or industry. More-than-normal debt implies that the funding is riskier, and therefore more costly, than normal borrowing. As a result, levered finance is commonly employed to achieve a specific, often temporary, objective: to make an acquisition, to effect a buy-out, to repurchase shares or fund a one-time dividend, or to invest in a self-sustaining cash-generating asset. Although different banks mean different things when they talk about leveraged finance, it generally includes two main products - leveraged loans and high-yield bonds. Leveraged loans, which are often defined as credits priced 150 basis points or more over the London interbank offered rate, are essentially loans with a high rate of interest to reflect a higher risk posed by the borrower. High-yield or junk bonds are those that are rated below "investment grade," i.e. less than triple-B. A key instrument in much of leveraged finance, particularly in leveraged buy-outs, is mezzanine or "in between" debt. Mezzanine debt has long been used by mid-cap companies in Europe and the US as a funding alternative to high yield bonds or bank debt. The product ranks between senior bank debt and equity in a company's capital structure, and mezzanine investors take higher risks than bond buyers but are rewarded with equity-like returns averaging between 10 and 20 per cent.

Companies that are too small to tap the bond market have been the traditional users of mezzanine debt, but it is increasingly being used as part of the financing package for larger leveraged acquisition deals. Although mezzanine has been more expensive for companies to use than junk bonds, the low coupons coupled with high returns often makes some sort of mezzanine or hybrid debt an essential buffer between senior lenders and the equity investors. There are often different layers of finance involved in leveraged financing. These range from a senior secured bank loan or bond to a subordinated loan or bond. A large part of the role of leveraged financiers is to calculate how each type of finance should be raised. If they overestimate the ability of the company to service its debt, they may lend too much at a low margin and be left holding loans or bonds they cannot sell to the market. If the value of the company is underestimated, the deal may be lost. Leveraged Finance Risks 

Credit risks are concerned with the business and its market. Financial risks which lie within the economy as a whole, for instance, interest rates, foreign exchange rates and tax rates.

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Structural risks are risks created by the actual provision of finance including legal, documentation and settlement risks.

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Liquidity risks are those associated with the inability of a leveraged company to refinance itself in tight credit conditions

Contribution of media in leveraged financing: Roughly 25 new income trust offerings have lost more than half their value in the past few years after being sold mostly to retail investors. The common reason

behind the $2.1- billion in losses is clear: pure, unmitigated greed. Greed by investors, greed by underwriters, lawyers, accountants and greed by the media. We should focus on that last cohort first, because without the greed of the media, investors wouldn't have been burned as badly as they were by income trust investments over the past few years It seems investors have forgotten that the media are businesses too. They survive on advertising dollars, and they rely on content to fill their pages and airtime. In the case of income trusts, the two frequently went hand in hand. Both national newspapers ran several insert sections dedicated solely to income trusts The simple reality is that, as the media remained largely silent, underwriters not only promoted high-risk trusts at exaggerated prices, but they stressed non-existent safety, and misleading yield figures. Thus any misrepresentation either by rating agencies, media or banks leads to losses to various stakeholders. Thus it is unethical on the part of bond issuers.

Insider dealing Insider dealing can be understood as illegal share dealings by employees of a company where they have used confidential price-sensitive information for their own gain or the gain of their associates. It is buying or selling of a security by someone who has access to material, nonpublic information about the security. The inside dealer does not have to work for the company for his dealing to be an offence. Corporate executives are termed as ‗insiders‘ but some ‗outsiders‘ can

also be charged with insider trading. Some such outsiders are a printer who has been able to identify the targets of takeovers from legal documents that were being prepared, a financial analyst who uncovered a huge fraud at a high flying firm and advised his clients to sell, a stockbroker who gained some confidential information through family gossip. So a stockbroker, or merchant banker, who knows about an impending takeover deal who buys shares in the target company with the intention of making a profit, is guilty. If he gets a friend to buy the shares, he is still guilty. Market Abuse and Insider Dealing - What's the Difference? Insider dealing is a subset of market abuse, which covers many different types of abuse in public markets. Essentially, 'inside information' is specific confidential information which would have an effect on the price of a publicly traded company's shares, bonds or derivatives if made public. Insider dealing is acting on this information by, for instance, buying or selling shares in the company concerned. An example would be a takeover offer of company X at £1 per share by company Y. Before the offer is made public, the market price of shares in X is, say 80p, and as soon as the takeover is announced the market price will rise to near £1, the level of the offer from Y. If an insider to the transaction is able to buy shares in X at 80p (because the market doesn't know about the impending offer at £1) and can sell them after the public announcement at £1, then the insider stands to make a tidy, low-risk profit in a short period of time. Inside information is not exclusively related to takeovers. Inside information could be, for example, non-public news about a company's product sales or a problem leading to litigation. The pharmaceutical industry is a good example of an area where bad news about products can lead to falls in the price of a company's shares.

It is possible through the use of derivatives to profit from a fall, as well as a rise, in the price of shares or bonds To better understand how and when insider dealing offence may arise let us take the example of a bank which lends money and may get access to price sensitive information. Use of such information may be a criminal liability. For this lets consider an abstract from the paper published by The Financial Law Panel (FLP) outlining the risk to lenders of committing insider dealing offences if they enforce security over listed securities while in possession of price sensitive information and highlighting situations in which such a problem may arise for the banks. Criminal liability Broadly, it is a criminal offence for anyone who has price sensitive information about a company to deal in its listed securities, to arrange or encourage someone else to do so, or to disclose the information unless disclosure is in the proper performance of the office of the individual concerned (Part V, Criminal Justice Act 1993 "the Act"). The offences can only be committed by individuals - not the institutions which hold charges over listed securities. It is not necessary that the decision takers should know the inside information, merely that they should be aware that other officers of the bank are prohibited from dealing.

When might the problem arise? There is thus a conflict between a bank's need for information about its borrower and its wish to ensure that it can enforce security without running the risk of

committing an offence under the Act. The paper sets out the most common situations in which the problem might arise: * The bank lends to a holding company which has a listed subsidiary. The holding company charges shares in the subsidiary as security for the loan. * The bank makes a personal loan to a director or controlling shareholder of a listed company and as security for his obligations under the loan he charges his shares in the listed company to the bank. The listed company may or may not be a borrower from the bank. * The bank lends to a listed company. The company's holding company guarantees the obligations of the borrower and as security for its guarantee charges to the bank its shares in the listed company. In the course of their dealings, the borrower(s) or guarantor will almost certainly give to the lending bank information relating to the listed company. The bank is likely to encourage this disclosure and will therefore risk being made an insider.

Ethical issues regarding insider trading The two rationales that support the argument against insider trading . One it is based on property rights and holds that those who trade on material, nonpublic information are stealing away the property that belongs to corporations. Some companies may sell this information to favored investors, employees may use it for their benefit, and company may use it to buy back its own shares. This might be an inexpensive way to encourage employees to get more valuable information for the firm but at the same time this may discourage investors to invest in such a company as they are at a disadvantage. It also raises the ethical question about the harm done to the investing public at large.

The second rationale is based on fairness; it holds that traders who have inside information have an unfair advantage over other investors as a result making stock market not a level playing field. Stock market regulation requires that both buyers and sellers of a stock should have sufficient information to make rationale choices. Trade at stock market takes place only if buyers and sellers have different information about the stock that leads them to different conclusions about the stock‘s worth. However using inside information is objectionable as an outsider how much ever diligent he may be is barred from access to such sensitive information. Some economists argue that stock market would be more efficient without the law against insider trading. Argument given in support of this is that information would be registered in the market more quickly and at a less cost than the alternative of leaving the task to research by stock analyst. These arguments look at the cost of registering information only and not at the adverse consequences of legalized insider trading. Legalized insider trading would discourage some investors who view it as an unlevel playing field or will be forced to adopt costly defensive measures. A firm may tailor the release of information to maximize the benefit of insiders. This may undermine the relation of trust that is essential for business organizations. Legalized insider trading will breach the fiduciary duty of every insider to serve the interest of the company and its shareholders. The use of information acquired while serving as a fiduciary for personal gain is a violation of this duty. This would be a breach of professional ethics.

Slippage of confidential information may not be intentional. It may be a matter of indiscretion, of one person or several people saying individually innocent things

which put together may turn out be something of use for already informed person. However there are employees who use this information consciously for their own benefit. As stated by MICHAEL FELTHAM, head of the stock exchange‘s insider dealing investigation group there is a percentage of people who will misuse the information if they are given an opportunity. This raises ethical concerns about the loyalty of individual towards the firm, and questions the assumptions of confidentiality and professionalism. The base or undercurrent of business is shaken if such values are not upheld. Trading on information obtained by virtue of conscientious observation analysis, or assiduous investigation, must be distinguished from trading on information acquired through a breach of confidence or theft. The trader‘s relationship to the source of the information and to the subject of the information is therefore essential to determining the ethical status of any case of insider trading. Information acquired incidentally or accidentally, trading on it may not be unethical. However insider trading is not a victimless crime, the shareholders whose corporate information has been misappropriated are the victims of such crime.

It is difficult to hold someone guilty for insider trading. It requires that the jury be satisfied that the information received was price sensitive, that the information was actually passed to the defendant, that the defendant knew that the information was confidential and price sensitive, that the defendant knew that the information was unpublished ,and that the defendant used the information to profit or to avoid loss. The definition requires such complications and makes it difficult to prosecute. The problem of legal enforcement is compounded by the fact that it is difficult to make distinction between an acceptable and unacceptable ‗insider‘.

BANKING We can't think of any industry where ethics would be more important than in banking -- partly because financial institutions are such a crucial part of the infrastructure of the entire world economy, and their trustworthiness is bound to have serious implications for countless individuals and institutions. Further, banks (like charities) depend almost entirely on trust to sustain their business -- a bank that shows itself not to be trustworthy will very quickly find itself short of customers. Of course, unlike charities, the trust we place in banks is sustained in part by a pretty significant regulatory system.

What are the main functions of the banks??

The main function of the bank is mainly borrowing and lending of money. Here the real question arises that do banks have responsibilities to borrowers?? Should people be able to take on as much credit as‘ they can raise without the lending institutions being prepared to suggest any limit to what borrowers can afford?

Here there is a dilemma for the bank whether to lend more money for the sake of profitability or be a little conservative in lending money?? The answer is simple the banks should lend appropriate amount of money after properly scrutinizing the repayment capacity of the client. Unfortunately the above thing didn‘t happen in case of most of the Investment Banks or I-Banks of America and the greed to earn more money led to a complete collapse of the economy as loans were granted to people with low credibility and without proper security. The main belief among the banks was that the prices of the houses would always rise but when the bubble bursted it was all ugly & Gloomy as banks were not in a position to recover the money which were lent. The losses are expected to be around U.S. $ 3 trillion As the American crisis has demonstrated, ethical values are still not firmly entrenched and followed in many banks in the region. Bribery and corruption have been one of the root causes of the banking problems. Here's a very interesting anecdote that describes how an 'asset bubble' builds up and what are its consequences

Anecdote

Once there was a little island country. The land of this country was the tiny island itself. The total money in circulation was 2 dollar as there were only two pieces of 1 dollar coins circulating around.

1) There were 3 citizens living on this island country. A owned the land. B and C each owned 1 dollar.

2) B decided to purchase the land from A for 1 dollar. So, A and C now each own 1 dollar while B owned a piece of land that is worth 1 dollar. The net asset of the country = 3 dollar.

3) C thought that since there is only one piece of land in the country and land is non produce able asset, its value must definitely go up. So, he borrowed 1 dollar from A and together with his own 1 dollar, he bought the land from B for 2 dollar.

A has a loan to C of 1 dollar, so his net asset is 1 dollar. B sold his land and got 2 dollar, so his net asset is 2 dollar. C owned the piece of land worth 2 dollar but with his 1 dollar debt to A; his net asset is 1 dollar. The net asset of the country = 4 dollar.

4) A saw that the land he once owned has risen in value. He regretted selling it. Luckily, he has a 1 dollar loan to C. He then borrowed 2 dollar from B and acquired the land back from C for 3 dollar. The payment is by 2 dollar cash (which he borrowed) and cancellation of the 1 dollar loan to C. As a result, A now owned a piece of land that is worth 3 dollar. But since he owed B 2 dollar, his net asset is 1 dollar.

B loaned 2 dollar to A. So his net asset is 2 dollar. C now has the 2 coins. His net asset is also 2 dollar.

The net asset of the country = 5 dollar. A bubble is building up.

(5) B saw that the value of land kept rising. He also wanted to own the land. So he bought the land from A for 4 dollar. The payment is by borrowing 2 dollar from C and cancellation of his 2 dollar loan to A.

As a result, A has got his debt cleared and he got the 2 coins. His net asset is 2 dollar. B owned a piece of land that is worth 4 dollar but since he has a debt of 2 dollar with C, his net Asset is 2 dollar. C loaned 2 dollar to B, so his net asset is 2 dollar. The net asset of the country = 6 dollar. Even though, the country has only one piece of land and 2 Dollar in circulation.

(6) Everybody has made money and everybody felt happy and prosperous.

(7) One day an evil wind blowed. An evil thought came to C's mind. 'Hey, what if the land price stop going up, how could B repay my loan? There is only 2 dollar in circulation, I think after all the land that B owns is worth at most 1 dollar only.' A also thought the same.

(8) Nobody wanted to buy land anymore. In the end, A owns the 2 dollar coins; his net asset is 2 dollar. B owed C 2 dollar and the land he owned which he thought worth 4 dollar is now 1 dollar. His net asset becomes -1 dollar.

C has a loan of 2 dollar to B. But it is a bad debt. Although his net asset is still 2

dollar, his Heart is palpitating.

The net asset of the country = 3 dollar again.

Who has stolen the 3 dollar from the country? Of course, before the bubble burst B thought his land worth 4 dollar. Actually, right before the collapse, the net asset of the country was 6 dollar in paper. His net asset is still 2 dollar, his heart is palpitating. The net asset of the country = 3 dollar again.

(9) B had no choice but to declare bankruptcy. C as to relinquish his 2 dollar bad debt to B but in return he acquired the land which is worth 1 dollar now.

A owns the 2 coins; his net asset is 2 dollar. B is bankrupt; his net asset is 0 dollar. (B lost everything) C got no choice but end up with a land worth only 1 dollar (C lost one dollar) The net asset of the country = 3 dollar.

There is however a redistribution of wealth. A is the winner, B is the loser, C is lucky that he is spared.

A few points worth noting -

(1) when a bubble is building up, the debt of individual in a country to one another is also building up.

(2) This story of the island is a close system whereby there is no other country and hence no foreign debt. The worth of the asset can only be calculated using the island's own currency. Hence, there is no net loss.

(3) An over damped system is assumed when the bubble burst, meaning the land's value did not go down to below 1 dollar.

(4) When the bubble burst, the fellow with cash is the winner. The fellows having the land or extending loan to others are the loser. The asset could shrink or in worst case, they go bankrupt.

(5) If there is another citizen D either holding a dollar or another piece of land but refrain to take part in the game? At the end of the day, he will neither win nor lose. But he will see the value of his money or land goes up and down like a see saw.

(6) When the bubble was in the growing phase, everybody made money.

(7) If you are smart and know that you are living in a growing bubble, it is worthwhile to borrow money (like A) and take part in the game. But you must know when you should change everything back to cash.

(8) Instead of land, the above applies to stocks as well.

(9) The actual worth of land or stocks depends largely on psychology.

Conclusion Banks need to consider how their actions - anywhere in the world - will affect their customers or be perceived by them. But customers are not the only people the banks have to worry about. They also need to take account of regulators in the various jurisdictions in which they operate, and the fact that regulatory standards may shift over time In the current social environment there are many who would argue that a genuine commitment to ethics is an unrealizable ideal. Many think that sound ethical principles are fine in theory but that they can't really be applied in practice. To try to do so is to be nostalgic. They say that to promote virtue is to be old fashioned, to hark back to ideas only useful in a different era. They ask us to be 'realistic' and to embrace the 'modern' way of doing things. This plea is often nothing more than an ill disguised call to allow for the survival of the fittest. Perhaps such people are right. Perhaps a dog-eat-dog world will be the most efficient. And perhaps efficiency is the only value that we need to embrace in the search for a worthwhile life. Or perhaps efficiency is only one of a number of important values that we must learn to juggle across an unpredictable landscape. Those of us who are serious about the need to make ethical considerations an explicit concern in our daily lives must face up to this challenge. After all, what if our critics in the market place are right? What if the prime (and exclusive) aim in life really is to maximize our satisfaction of wants (and not just needs)? What if the liberty of the individual (important as it is) transcends all other considerations? What if it is through competition alone that we find the ultimate expression of our humanity?

The challenge facing us today is to make a choice about which alternative we want. Do we want a society of citizens in which something like the virtues of justice and benevolence make sense? Or do we want the enterprise association in which each of us is little more than a purveyor or consumer of commodities? The latter consigns us to a place where the exercise of virtue will seem an unattainable luxury, where no person can afford to display moral courage.

Our view is that banks have a great capacity to do well while making a legitimate profit. They hold the keys to a bridge across which so many of us must pass if our dreams and aspirations are to become a reality. But few of us will cross a structure in which trust is wanting. In such circumstances banks and society suffer alike. That is one good reason for taking seriously the need to eschew fancy dressing in favor of the simple habit of trust.

Regulation and Self-Regulation

Recent research has begun exploring the complex process of self-regulation, an important feature in cognitive and somatic behavior therapies. Many interrelating factors appear to govern self-regulation, with no single factor responsible for its success or failure. The ability to self-regulate may have advantages in the course of an individual's mental life, especially within the sporting context. For example, Vealey, Hayashi, Garner-Holman, and Giacobbi (1998) developed a questionnaire over a series of experimental trials that examined sources of sport confidence in 335 college athletes. Nine sources of sport confidence were identified among the

athletes that were split into three broad domains (achievement, self-regulation and climate). The athletes rated, first, achievement (includes self-mastery and demonstration of ability), second, self-regulation (includes physical/mental preparation and physical presentation), and third, climate (includes social support, coaches' leadership, vicarious experience, environmental comfort and situational favorableness) in order of perceived priority as the most important sources of improving sport confidence. The financial role of self- regulating: One of the most controversial issues regarding financial markets is how do they regulate themselves? The financial markets have a unique system of regulation; it is a mixture of law, self regulation and customs. The way the financial markets make money is all based on the disclosure of information and how this affects the supply and demand for shares traded on the stock exchange. Often the stock exchanges around the world are owned by the very stockbrokers who compete against each other. Several instances have led to successive bouts of self regulation. Basic Features of Financial Self-Regulation Spontaneous self-policing arrangements can be found in the history of international trade and commercial law, public security, maintenance of public services, and commercial bank clearinghouses. Self-policing arrangements may develop within financial communities as well (Goodhart 1988). In some cases, they evolve into full-fledged self-regulatory organizations (SROs), with internal statutory rules; dedicated financial resources; formal structures involving shareholders, managers, and employees; codes of conduct; and oversight procedures (Glaessner 1993).

SROs could involve payments and securities settlement systems, interbank deposit markets, securities trading and stock exchanges, securities lending and clearinghouse services, deposit insurance, or credit information-sharing systems. SRO responsibilities could encompass: Regulation of Market Transactions Self-regulation of market transactions ensures that they are executed and completed by each member according to pre-agreed rules and modalities.

Regulation of Market Participants Regulation of market participants ensures that members joining in the SRO have an adequate level of reputational capital and that they maintain it over time. Dispute Resolution and Enforcement Actions The efficiency of dispute resolution and adjudication processes is crucial for the success of the SROs.

Pre-Commitment of Resources Incentives in financial self-regulation—especially for inter-bank payment and settlement systems—can be strengthened by members agreeing to individually precommit resources that would be mobilized in the event of one or more members running into illiquidity or insolvency problems. Self-regulatory organization A self-regulatory organization (SRO) is an organization that exercises some degree of regulatory authority over an industry or profession. The regulatory authority could be applied in addition to some form of government regulation, or it could fill

the vacuum of an absence of government oversight and regulation. The ability of an SRO to exercise regulatory authority does not necessarily derive from a grant of authority from the government. The SEC delegates authority to the National Association of Securities Dealers (the NASD) and to the national stock exchanges (e.g., the NYSE) to enforce certain industry standards and requirements related to securities trading and brokerage Because of the prominence of the SROs in the securities industry, the term SRO is often used too narrowly to describe an organization authorized by statute or government agency to exercise control over a certain aspect of the industry. ETHICAL & QUESTIONABLE PRACTICE Ever since 1811, when stock exchanges were allowed to sell shares in businesses, the stock exchanges across the world have been involved in several ethical issue debates. Some of the major ethical issues have included the vast amounts of money involved in the share transactions themselves. Take the classic case of the Barings Bank stock broker of the mid 1990's, one person was amazingly un-monitored, eventually generated such excessive losses that he actually made the bank become bankrupt!, with the resulting loss of income for several hundred employees and the lost investments for several thousand investors. As the markets are owned by stockbroker firms selling shares for businesses, the use of insider information to communicate business information to allow for greater profits from trading shares, was seen as being a very un-savoury side to the stock exchange. Stockbrokers were renowned for paying for business information during the 1970-1980's although attempts have been made to eradicate it; it will none the less remain within the stock exchange system.

When one stock market losses vast amounts of money in share values, there appears to be a domino effect in other stock exchanges. National governments/central banks through exchange rate transactions invest heavily to maintain the parity between the stock exchanges to prevent a global collapse. The first major global collapse can be traced back as far as the 1920's during the Wall Street Crash, this resulted in a severe depression in America, the collapses of the 1980's and late 1990's have created havoc on the global economy. The most worrying aspect of the stock exchange is the power they now wield on the world at large. Shares are traded solely on the basis of generating larger profits, little regard seems to be given to the lives and families of employees whose business trades on the stock exchange, low share value ratings can cripple and bankrupt companies. The closer integration of stock exchanges on a global computer network will only add to the domino effect only allowing for the possibility of total economic breakdown. Businesses in a capitalist system have become more concerned about how they maintain share values to generate greater capital investment, yet at the same time increase dividend payments. This in recent times has meant trying to slash employee levels whilst maintaining productive output; this is often phrased as business ethics. These issues are always bought into discussions about the ethics and power of stock exchanges. South Sea Bubble

The first major ethical case to affect the London Stock Exchange was known as the 'South Sea Bubble‘. The south sea company offered shares an impractical and fraudulent manner. Shares were sold on a partly paid basis, this meant people were able to buy a lot more shares than they were normally able to. The result was that excessive amounts of shares were sold in the south sea company. People were buying the shares on the premise of gaining initial dividends and selling the shares onto other people who would then have to pay the outstanding balances on the shares. As a result of this there was a big crash in the value of all shares on the stock exchange, lots of people lost money in the crash. Parliament implemented the Bubble Act of 1720 as well as the Fraudulent Act of the South Seas Company. The act was the first major regulation of the stock exchange. The Acts made the stock exchange sell shares for a few selected companies only.