Page III of III        [Bottom of Page] [Previous Page] Ethos in Praxis : The Missing Elements in Ethical Investing - III 5. Problems with Ethical Investing in Practice The moral principles and their correlative criteria, as seen even in this report, eventually become a laundry list of do's and don'ts. As with any list of rules, they ossify and become inflexible. This defect is especially pronounced when the lists are incorporated into stock screens that eliminate companies from portfolios (negative screens) and to highlight companies to consider buying (positive screens.) The power of principles is not in their absoluteness but in their interpretation under different circumstances. Even the Ten Commandments must be interpreted and applied. Once criteria are part of the screening process, they become part of a thoughtless procedure - an empty shell that once contained vibrant ideas. 5.1 Moral Ambiguities Consequently, screens cannot adapt to ambiguities that are always a part of moral evaluation. One ambiguity is that a corporation can be engaged in moral and immoral behavior at the same moment. A part of the organization may be giving generous health benefits to its employees, while another part is lying breezily to its customers about its services. A screen may be able to assign quantitative numbers to each act and net the results. This procedure may be effective for a one ambiguity but a great number of ambiguities may arise within the same organization. Another ambiguity problem is that immoral acts occur in gradations. A corporation may commit many small acts of immorality. For instance, an airline overbooks a flight and bumps passengers off that flight, and then treats these people very shoddily (not in line with their human dignity). How many times must it do this act before it is morally unacceptable and the company's stock subsequently sold out of or avoided in the portfolio? If a screen must take into account all ambiguities, and assuming it can, the screen will be an unwieldy instrument to use for evaluating the ethics of hundreds of companies listed just on the Morgan Stanley Far East (ex-Japan) Index. In reality, there are thousands of stocks to screen, if one wants the scope to invest in the universe of stocks in the region. One route ethical funds can take to alleviate the problems associated with the difficulties screens have with moral ambiguities is to set up a committee or a team of analysts to interpret and apply the stated moral principles that drive an ethical fund's investments. This ethics committee works alongside the screens to make necessary adjustments. For the example given above of the uncaring airline, the ethics committee will get information (if it is possible to obtain) about how customers are treated when flights are delayed or cancelled, how often oxygen is recycled in the cabins so customers will not emerge with splitting headaches after long flights, the concentration of e-coli in the onboard drinking water, the frequency of lost luggage, and other data that reveal how people are treated. This information must be obtained for all airlines and given due consideration. We repeat the iteration for other industries because each has its own peculiar ethical problems. The task begins to sound Herculean but it is necessary if an ethical fund is to be thorough in its research. In practice however, this work cannot be done without hiring an army of well qualified and therefore, expensive analysts who are committed to thoughtful ethical research on a full-time basis. If the research is shoddy, then the ethical fund violates its mandate. Nor is the committee system immune from the same problems inherent in screens i.e. the ossification of rules. After some time, the ethics committee may be inclined to take a more structured or bureaucratic approach. The introduction of codes, particularly when they contain many detailed rules, represents a shift towards bureaucratic formalization. Rules do not address a full range of likely ethical problems. Where both formalization and adherence to the rules are high, decision-making by the ethics committee may be strictly rule-bound. This limits the ability to respond to ethical challenges and dilemmas that lie beyond the scope of the rules. 5.2 Faulty and Incomplete Information Even if one can account for moral ambiguities, it is extraordinarily difficult to get accurate information that one needs to assess the moral behavior of corporations. Proponents of ethical investing may argue that it is worth trying to get this information in order to assess the moral quality of a corporation. Mutual funds can then assure ethically conscious investors that their money is not going to bad companies. Surely, the assurance is a false one for how can we get all the relevant information to evaluate a corporation's ethical standing? Could an ethical fund company have known that Enron was setting up subsidiaries so that it could commit accounting fraud or a massive scale? When would fund managers of ethical funds have know that WorldCom (considered by many as an ethical company) was inflating its profits by astounding amounts? They would have found out this information when the news became public but they would have had the stock in their portfolios before that, believing the company to be ethical. Most recently, Elliot Spitzer, the New York attorney general, is investigating AIG, a respected insurance company, for potential accounting irregularities. At the heart of questions about AIG's accounting are finite reinsurance products and at what point an entity should consolidate the assets and liabilities on to a group's balance sheet.21 There are questions about Starr International, a Panama based private company, which provides lucrative share-based incentives to senior AIG employees and owns 12% of AIG's shares, and CV Starr, which owns agencies that underwrite business on behalf of AIG. Maurice "Hank" Greenburg, the former chairman and Chief Executive of AIG, who gave up his posts because of the investigations, is a director of both private companies. Each of the companies is majority owned by AIG executives. Investigators are trying to find out if AIG indirectly channeled money through Starr that could have contributed to compensation, and whether its relationship with Starr could have enhanced the consistency of its reported earnings. Even if the company is not judged as doing anything illegal, it is acting unethically because the roles of Starr and CV Starr represent a conflict of interest between AIG executives and the company. Evidence of dubious accounting schemes continues to come out. AIG performed most of the transactions in the 1980s and 1990s when the company enjoyed good standing in many ethical funds. Yet, how would an ethical fund have discovered such information if not for the crusading attorney general? The point is that information about the ethical behavior of corporations is often difficult to discover. Researchers must rely on public information provided by the company itself. A full picture of a corporation's moral behavior requires investigative research that will take time, human resources, and committed sleuthing. To be fair, large mutual fund companies like Calvert Investments, which sells socially responsible investment funds, say they rely on a variety of information sources including interviews with management, policy statements, information on the Lexis-Nexis database, and discussions with advocacy organizations. Calvert assesses corporate compliance with federal, state, and local environmental regulations by reviewing the data from U.S. environmental and social regulatory agencies. The company claims that their analysts can directly link to the Environmental Protection Agency's databases and review a company's environmental performance by factory. The company also looks at the reports that corporations send into the Global Reporting Initiative (GRI). The Coalition for Environmentally Responsible Economies or CERES funds this project. The GRI came out with its 2002 Sustainability Reporting Guidelines that help companies report on their environmental, social, and economic impacts and performance. The GRI is a voluntary reporting framework that hopes to elevate sustainability reporting practices to a level equivalent to that of financial reporting in rigor, comparability, ease of audit, and general acceptance. Investors have been using GRI reports to aid in the social screening process. Since the reporting process is voluntary and no audit is made of the reports, companies may be tempted to be sparing with the truth. No company wants to be ethically suspect and it will not willingly reveal practices thought to be so. [Top of Page]  [Bottom of Page] This situation also applies to companies that have signed up to be a member of the United Nations Global Compact, mentioned in section 3. In theory, Compact members must commit themselves to the nine principles. Participating companies must inform the pubic in annual reports on any progress they have made in implementing the principles. The firms also are encouraged to carry out projects to promote the nine principles in partnership with organizations in the UN family. Companies cannot become signatories of the Compact if they violate human rights, tolerate forced or child labor, manufacture or distribute anti-personnel mines, or violate other relevant commitments of the United Nations. However, the UN does not check company compliance, either continuously or selectively. Thus far, the UN has not removed any company from Compact membership because of guideline violation. Therefore, many NGOs view the Global Compact and its guidelines with considerable skepticism. Thus, while it is laudable that Calvert apparently makes a good effort to get information on the ethical position of a company, it may not find information that the company does not wish known. Multinationals may not even have a true view of the ethical standards of their own subcontractors. A recent investigation revealed that Chinese factories are involved in deceiving their multinational clients about labor standards at their factories. Factory managers in China have become increasingly sophisticated at falsifying worker time cards and payroll documents to disguise irregularities including underpayment, excessive hours, and inadequate health and safety standards. Auditors hired by international companies to check the validity of labor standards estimate that more than half of factories they audit in China are forging some of their records. Many of the international companies that source from China are learning less about the actual working conditions in the factories they use, even as they step up efforts to monitor them. The investigation notes, "The practices also mean that some western groups' assurances that they are abiding by China's labor laws and their own codes of conduct are based on faulty information. The widespread forging of records threatens to undermine the aims of the corporate social responsibility movement, a response by multinationals to the concerns of customers, non-governmental organizations and trades unions about issues including human rights and the environment." Companies such as Wal Mart, Nike and Liz Claiborne admit problems of deception exist at Chinese factories that make their products. Compliance executives say the problem occurs elsewhere, citing cases from India. Yet, these multinationals are partially to blame for the deception because Chinese companies find themselves under increasing stress; they must meet the customer's requirements for social compliance, pricing, and delivery time or lose the business. Multinationals want it all - the goods produced at "sweatshop" rates but in socially responsible style - and they are willing to put the pressure on Chinese factories to give them all. This behavior is ethically questionable since one can argue that it is important to treat one's suppliers fairly and multinationals are not doing so with regards to their Chinese subcontractors. The problem of falsifying records is likely to get worse because of the elimination of global textile quotas. Consequently, international companies will increasingly outsource the production of garments and textiles to Chinese factories. Nike has reported in its corporate responsibility report about the possible falsification of records at its Chinese subcontractors' factories but it is unclear if other multinationals are as forthcoming. If information pertaining to ethical behavior of companies is indeed faulty and difficult to obtain, then investing ethically is a flawed endeavor. Ethical fund companies, if we believe that higher ethical standards apply to them, must declare openly the informational problems they encounter. Instead, we read grand rhetoric about how they do intense research and subscribe to "hundreds of specialty publications, ranging from industry publications to social responsibility reports." Ethical funds do not disclose problems with obtaining information on corporate ethical behavior because they fear investors will perceive ethical fund companies as not investing ethically. Ethical fund companies are caught in a dilemma: be honest, and therefore, ethical and disclose the problems with obtaining information, but lose potential investors and their funds. Otherwise, be dishonest and unethical but attract more funds. Apparently, the myth maintained by both investment companies and investors is that the former has all the necessary information to make ethical investment decisions. Research carried out by Mackenzie and Lewis explains why investors are complicit in this lie - investors are themselves dishonest in their approach to ethical investing. The authors did an empirical psychological study of the relationship between the ethical and financial beliefs and desires of ethical investors. They found that none of the participants in the study was prepared to sacrifice their essential financial requirements to address their ethical concerns. As a result, these ethical investors dealt with the trade-offs in four ways: (1) they divided their money into core and surplus accounts (2) they decided it was enough to be only a partial ethical investor (3) they avoided detailed consideration of the costs of ethical investment (4) they avoided rigorous ethical thinking. These four ways resulted in most of these investors becoming simultaneously ethical and unethical investors. For instance, in their ethical funds these individuals would not be invested in arms manufacturers. At the same time, they would be invested in arms manufacturers in their non-ethical portfolios. Participants in the study gave a variety of reasons for investing in ethical funds, what they believed was ethical in ethical investments and how efficacious it was. However, "overshadowing all these ethical beliefs was a fog of confusion." One may argue that the muddle ethical investors are in is not a problem of ethical funds. In reply, I would say that if ethical investors are confused about their ethics and do not hold their own ethical beliefs above financial returns, then they will be less than demanding on ethical fund companies who invest their money. If investors lack moral rigor, they will not hold their investment companies to high ethical investing standards either. Consequently, ethical funds can be lax in applying principles of morality to investment practice. 5.3 Lack of Ethical Reasoning Inconsistent ethical reasoning for the selection or avoidance of companies is one manifestation of the laxity. Most ethical funds use an exclusionary screen to avoid companies judged unethical. Many exclusionary screens (including the ones used by Calvert) will not include manufacturers of tobacco products, alcoholic beverages, weapons, or firearms. They also exclude companies that operate gambling establishments. The moral principle that supports the exclusion of these types of companies is that their products or services cause harm to people and society. Schwartz argues there is little ethical reasoning that goes into the exclusion of these sorts of companies. For instance, ethical investors will not invest in weapons manufacturers because weapons can kill people. This result goes against the principle of doing no harm to people. This analysis is, however, a superficial one. Weapons used by a military force fighting a genocidal dictator are in the defense of human lives. Sometimes it is necessary to use aggressive force to stop great evil e.g. the Nazis, the Soviets, the Islamists. Schwartz gives a variety of examples such as peacekeeping, assistance during natural disasters and survival of a nation (Israel) to show that companies that provide military weapons and equipment are not acting in an unethical manner. They are providing goods that secure the well-being, safety, and security of the world's nations. Of course, weapons manufacturers may be immoral because they sell their goods to homicidal regimes or they may bribe governments in the procurement process. However, ethical funds cannot know these details because they will probably lack the information (see above). How can ethical funds justify branding weapons manufacturers as unethical simply because of the products they make? Ethical funds screen out weapons manufacturers for two primary reasons. First, careful thinking on the morality of weapons manufacturing does not inform their decision. Second, they are trying to cater to the ethical subjectivism of their investors. An ethical fund that engages in sound ethical reasoning may conclude that it is permissible to purchase shares of weapons manufacturers, nuclear power companies, gambling establishments, makers of alcoholic beverages and even tobacco companies (if they advertise responsibly). Yet, because ethical investors are in an ethical fog (see above) they will most probably be horrified that an ethical fund will allow investment in the so called "sin stocks". Will an ethical fund that practices rigorous moral reasoning have any investors? Ethical investing in practice is caught in another dilemma: invest based on clear, well considered ethical reasons and get less funds or invest based on sloppy ethical thinking but get more funds. 5.4 Moral Subjectivism Perhaps the irony is that in order to get funds, an ethical fund must not only be ethically incoherent but even practice moral subjectivism. Monahan illustrates this problem with socially responsible investing screening techniques. Socially responsible investing (SRI) has broader goals than ethical investing. However, the employment of screens to eliminate and to highlight stocks is the same, albeit the principles that underlie the criteria in the screens may be different. The benchmark social responsibility index in the U.S. is the Domini 400, which is the oldest socially and environmentally screened index in the American marketplace. The screen uses an exclusionary (negative) and positive screening approach. The Domini 400 Social Index (DSI) makes a sharp distinction between its exclusionary screens and its positive screens, calling the latter qualitative screens. The implication is that excluding certain companies is quantitative, while including others is not. Monahan points out that the problem with qualitative screens is that they are weakly relativistic, or at least ethically subjective. An investor is left to choose socially responsible standards, based on highly personal, and thus subjective values. While one investor may think companies involved in the production of military hardware are contributing to violence and are, thus, unethical, another may think promoting a strong military is required for social stability and is thus highly ethical. Domini and Kinder believe that it is unproblematic to be an ethical investor grounded in terms of one's own in "relative" values. "Concerned investors must deal with these conflicts, deciding what to insist on and what to accept in order to foster what they care most about. Similarly, the interpretation of moral principles may be subjective and determined by each individual investor, particularly if investment advisors tailor screens to individual desires. Schwartz disagrees with Domini and Kinder's assessment of subjectivism and writes: If [ethics is in the mind of the beholder] is correct, then labeling ethical investment as it currently exists would be accurate, in that each individual can decide whether certain criteria of a fund are ethical or not. The problem is that ethics, as commonly understood, is not merely the values held by an individual. Nor is ethics merely a desire for achieving certain social objectives. Such definition, if accepted, renders ethics into a subjective realm incapable of thoughtful discussion or analysis. Schwartz is defending an ethical realm that is shrinking with increasing popularization of ethical investing. Even financial journalists recommend ethical investors to choose the funds that have the same ethics as they do. A Financial Times journalist writes, "But everyone's personal [ethics] list will look a little different - for me to force my list on you doesn't seem, well, ethical." This therefore, is the type of ethical thinking with which ethical funds must contend. Conclusion The ostensible goals of ethical investing are praiseworthy. We want to give our investment funds only to companies that act morally because we do not wish to be party to immoral behavior. The belief that we are achieving this goal when we invest in ethical funds is one based more on faith than reality. To claim that ethical funds buy only the financial instruments issued by ethical companies is too strong a claim. In practice the missing elements of ethical investing: correct moral judgment that takes everything relevant into consideration, rigorous ethical reasoning, and complete information prevent attainment of the vaunted goal. [Top of Page] [Previous Page]