What Is an Ethical Wall?
An ethical wall describes a virtual barrier intended to block the exchange of information between departments if it might result in business activities that are ethically or legally questionable. The term “ethical wall” is increasingly used to avoid cultural insensitivities and promote linguistic sensitivity.
In the United States, corporations, brokerage firms, investment banks, and retail banks have used ethical walls to maintain confidentiality and prevent conflicts of interest. Over decades, large financial institutions have implemented ethical wall policies as self-regulatory measures to create ethical boundaries between departments, although these measures have not always proved effective. Consequently, the Securities and Exchange Commission (SEC) has enacted regulations, fines, penalties, and legal consequences for companies that violate these information-sharing guidelines.
Key Takeaways
- An ethical wall is a virtual barrier erected to block the exchange of information between departments within an organization.
- The wall is intended to prevent sharing information that might lead to ethical or legal violations.
- The need for ethical walls rose significantly with the enactment of the Gramm-Leach-Bliley Act of 1999 (GLBA), reversing historical restrictions and enabling today’s advanced financial conglomerates.
How Does an Ethical Wall Work?
The policy of maintaining an ethical wall within a company is common in investment banking. Investment bankers often have access to non-public, material information regarding public companies or companies set for an initial public offering (IPO). They are charged with developing information barriers that control the flow of confidential information within and across business units.
Following the enactment of the GLBA, the necessity for ethical walls in the financial sector became more pressing. This act allowed combining banking, investment, and insurance services—repealing long-standing prohibitions against such combinations enforced since the Great Depression.
The GLBA has faced criticism for weakening consumer protections and consolidating financial services, limiting consumer choice, increasing systemic risk, and contributing to economic crises, such as the 2008-2009 recession.
An Example of an Ethical Wall?
Consider a financial services firm with a corporate investment arm acting on behalf of a public company planning a confidential takeover of a rival company. Meanwhile, in another division, investment advisers could be advising clients to buy or sell stock in those companies. An ethical wall in this scenario would prevent any knowledge of the takeover talks from reaching these advisers, thus averting potential insider trading.
Ethical walls’ importance was highlighted with the passage of the Sarbanes-Oxley Act (SOX) in 2002, aimed at enacting strict safeguards against insider trading.
Ethical wall policies extend to other professions as well, such as law. For example, if a legal firm represents both sides in an ongoing dispute, a temporary wall may separate the legal teams to prevent possible bias or collusion.
Why the Term “Chinese Wall” Is Culturally Insensitive
The original term, “Chinese wall,” derived from the Great Wall of China, was used metaphorically to describe regulatory barriers post the 1929 stock market crash. Modern discourse deems the term culturally insensitive. In 1988, Justice Low described its offensiveness and incorrectly aligned connotations in the case of Peat, Marwick, Mitchell & Co. vs. the Superior Court. The judge suggested the term “ethics wall” as a suitable alternative.
How to Create an Ethical Wall
In a business environment, an ethical wall is built when specific departments or individuals are mandated to withhold and refrain from disclosing information to others within the organization. These barriers, widely implemented in financial institutions and legal fields, ensure confidentiality and safeguard against conflicts of interest.
What Is Involved in the Ethical Wall Process?
Creating an ethical wall involves upper management awareness of any conflicts of interest along with identifying related or external parties. Subsequently, the ethical wall ensures information remains confidential and restricted to the appropriate individuals or departments. This method defends customer interests and precludes actions leading to undue personal or corporate benefits.
The Gramm-Leach-Bliley Act (GLBA)
Introduced in 1999, the Gramm-Leach-Bliley Act aimed to protect consumers by forbidding financial institutions from sharing sensitive data recklessly. This act reversed several components of the Glass-Steagall Act of 1933, enabling banks to merge commercial, investment, and insurance services under a single holding company.
The Bottom Line
Ethical walls are essential in business, financial, and legal fields to guard customers’ information and prevent conflicts of interest. Especially in financial services, ethical walls rose to prominence during the dotcom boom, leading to regulatory changes in conglomerate structures. While evolving from culturally insensitive origins, ethical walls remain crucial in promoting information-sharing transparency and consumer data privacy.
Related Terms: data privacy, insider trading, financial regulation, legal ethics, information barriers.
References
- Federal Trade Commission. “Gramm-Leach-Bliley Act”.
- Congress.gov. “H.R.3763 - 107th Congress (2001-2002): Sarbanes-Oxley Act of 2002”.
- Justia US Law. “Peat, Marwick, Mitchell & Co. v. Superior Court (1988)”.
