Code of ethics is more than just a set of rules for traders

While the investigation of Fidelity traders for accepting inappropriate gifts from brokers may be a one-off affair, it underscores the need for an effective ethics program, mutual fund experts say.

“What it did for us was sort of emphasize the importance of people understanding not just the letter of the rules but the spirit of the rules,” Capital Research's Paul Haaga says, “and having the kind of culture that looks for trouble rather than how to stay within the letter of the rule.”

However, cautions Bibb Strench, a partner at Sutherland Asbill & Brennan, industry experience has shown that even with a well-developed ethics program and employee training at every level, “you always have the knucklehead factor” of people who are too aggressive or lack common sense. That's why having a process to fall back on is important, he says.

“Ethics is the heart and soul of the organization,” says Merrill Lynch director James Bodurtha. “Ethics is not just about playing by the rules, but playing by the spirit of the rules and asking the right questions.” For that reason, the CCO cannot be just a cop standing on the corner but has to be an integrated part of the management team – somebody who's involved in helping identify and solve problems.

At Alliance Capital, which got hit with large fines for market timing, a primarily new management team has been at pains to instill an ethical culture, says Larry Cranch, general counsel. “I think that it's really got to come from the most senior management of the investment adviser,” he says. “I don't think that the board is really in an effective position to do it. And I don't even think a CCO – without the support of the CEO of the adviser – is necessarily in a very good position to do it.”

With the right tone at the top, an organization will fall in line pretty quickly, Cranch says. “They want to work in an organization like that – that has that kind of leadership. But they're also scared, and they know they're going to get fired if they don't do it.”