Skip to main content
Log in

Conflicts of Interest Arising from the Prudent Investor Rule: Ethical Implications for Over-the-Counter Derivative Securities

  • Published:
Journal of Business Ethics Aims and scope Submit manuscript

Abstract

The Prudent Investor Rule creates a potential ethical dilemma for investment advisors selling over-the-counter financial products issued by their firms. The "opportunity" to defraud investors using complex, over-the-counter derivative securities designed for client-specific risk management is much higher than for exchange traded securities. This paper emphasizes the ethical responsibility held by trustees and their organizations to eliminate potential conflict of interests through internal control and monitoring. Independent evaluations of the performance of investment advisors and independent appraisals of complex over-the-counter securities are important in reducing the risks of conflicts of interest. Recent lessons learned from the corporate ethics crisis and requirements of the 2002 Sarbanes Oxley Act would suggest that conflict of interest must be eliminated with third party validation of derivative pricing. By performing due diligence and validation, the trustee is able to satisfy the requirements under the Prudent Investor Rule.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

References

  • —: 2002, 'Former Merrill Executives Face SEC Fraud Charges', Wall Street Journal (March 17), p. A1.

  • —: 2002, 'ISDA To Testify Before U.S. Senate Agriculture Committee: Additional Regulation of OTC Derivatives Unwarranted', Business Wire (July 9), www.findarticles.com/cf_0/m0EIN/ 2002_July_9/88621873/print.jhtml (accessed: March 24, 2003).

  • Bovin, Jean Michel and Paul H. Dembinski: 2002, 'Ethical Issues in Financial Activities', Journal of Business Ethics 37, 187-192.

    Google Scholar 

  • Buffet, Warren: 2003, 'What Worries Warren', Fortune (March 3), www.fortune.com.

  • D'Aquila, Jill M.: 2001, 'Financial Accountants' Perceptions of Management's Ethical Standards', Journal of Business Ethics 31, 233-244.

    Google Scholar 

  • Duronio, Carolyn L.: 1996, 'Fiduciary Concerns Under the Prudent Investor Standard', Trusts & Estates 135(13), 33-41.

    Google Scholar 

  • Ferrell, O. C., John Fraedrich and Linda Ferrell: 2002, Business Ethics: Ethical Decision Making and Cases (Houghton Mifflin Company, Boston, MA), pp. 30-31.

    Google Scholar 

  • Gasparino, Charles: 2002, 'In Grubman Inquiry Preschool is Pressed on Tracing Admission', Wall Street Journal (November 18), C13.

  • Goodwin, Iris J. and Pierce McDowell: 1999, 'Delegating Responsibility: Trustees Explore the Once Taboo', Trusts & Estates 138(4), 8-14.

    Google Scholar 

  • Jennings, Marianne M.: 2000, 'Professional Responsibilities, Ethics, and the Law', AIMR Conference Proceedings: Ethical Issues for Today's Firm 2, 4-11.

    Google Scholar 

  • Kettel, Brian: 1999, 'Derivatives: Valuable Tool or Wild Beast?' by Global Treasury News (www.gtnews.com) as reported in Ed McCarthy (2000) 'Derivatives Revisited', Journal of Accountancy, May (www.findarticles.com/cf_0/ m6280/5_189/62259880/print.jhtml-accessed March 21, 2003).

  • Knox, Noelle: 2002, 'House Expands Wall Street Inquiry', USA Today (September), B-10.

  • MacKenzie, Michael and Christine Richard: 2002, 'Derivatives Are a Boon to Lenders', The Wall Street Journal (November), C15.

  • McCall, John J.: 2002, 'Leadership and Ethics: Corporate Accountability to Whom, for What and by What Means?', Journal of Business Ethics 38, 133-139.

    Google Scholar 

  • McCarthy, Ed: 2000, 'Derivatives Revisited', Journal of Accountancy (May) (www.findarticles.com/cf_0/ m6280/5_189/62259880/print.jhtml-accessed March 21, 2003).

  • Mittleman, Alan J.: May 2000, 'The Total Return Trust Revolution: The Opportunity and the Challenge', Journal of Financial Service Professionals 54(3), 66-77.

    Google Scholar 

  • Murphy, Diana E.: 2002, 'The Federal Sentencing Guidelines for Organizations: A Decade of Promotion Compliance and Ethics, Iowa Law Review', http://www.ussc.gov/orgguide.htm, accessed 11/16/2001.

  • Simes Ronald and Johannes Brinkman: 2002, 'Leaders as Moral Role Models', Journal of Business Ethics 35, 327-339.

    Google Scholar 

  • Smith, Randall and Jesse Drucker: 2002, 'Securities Firms Agree to Pay $8.3 million in Message Dispute', The Wall Street Journal (November 18), C13.

  • Spurgin, Earl: 2001, 'Do Shareholders Have Obligations to Stakeholders?” Journal of Business Ethics 33, 287-297.

    Google Scholar 

  • Thompson, Duane R.: 1996, 'Uniform Prudent Investor Act: An Interview with Don Trone', Journal of Financial Planning 9(6), 50-58.

    Google Scholar 

  • U.S. Code: Title 18, Section 1001.

  • Valdmanis, Thor: 2002, 'Reform for Analysts Outlined', USA Today (October 25), B-1.

  • Walczak, Lee, Richard S. Dunham, and Paula Dwyer: 2002, 'Let the Reforms Begin', Business Week ( July 22), p. 26.

Download references

Author information

Authors and Affiliations

Authors

Rights and permissions

Reprints and permissions

About this article

Cite this article

Clark, J.M., Ferrell, L. & Ferrell, O.C. Conflicts of Interest Arising from the Prudent Investor Rule: Ethical Implications for Over-the-Counter Derivative Securities. Journal of Business Ethics 47, 165–173 (2003). https://doi.org/10.1023/A:1026049803679

Download citation

  • Issue Date:

  • DOI: https://doi.org/10.1023/A:1026049803679

Keywords

Navigation