Cases & Projects CP 21-1 Ethics in Action Edward Seymour is a financial consulta
ID: 2586491 • Letter: C
Question
Cases & Projects CP 21-1 Ethics in Action Edward Seymour is a financial consultant to Cornish Inc., a real estate syndicate. Cornish finances and develops commercial real estate (office buildings) projects. The completed projects are then sold as limited partnership interests to individual investors. The syndi cate makes a profit on the sale of these partnership interests. Edward provides financial information for prospective investors in a document called the offering "prospectus." This document discusses the financial and legal details of the limited partnership investment Ethics One of the company's current projects, called JEDI 2, has the partnership borrowing money from a local bank to build a commercial office building. The interest rate on the loan is 6.5% for the first four years. After four years, the interest rate jumps to 15% for the remaining 20 years of the loan. The interest expense is one of the major costs of this project and significantly affects the number of renters needed for the project to break even. In the prospectus, Edward has prominently reported that the break-even occupancy for the first four years is 65%. This is the amount of office space that must be leased to cover the interest and general upkeep costs during the first four years. The 65% break even point is very low compared to similar projects and thus communicates a low risk o potential investors. Edward uses the 65% break-even rate as a major marketing tool in selling the limited partnership interests. Buried in the fine print of the prospectus is additional information that would allow an astute investor to determine that the break even occupancy jumps to 95% after the fourth year when the interest rate on the loan increases to 15%. Edward believes prospective investors are adequately informed of the investment's risk Is Edward behaving ethically? Explain your answer.Explanation / Answer
No, Edward is not behaving ethically. This is because the information being provided in the prospectus does not highlight the real and the prominent risk of the high break even of 95% that will come into picture after the first 4 years. What he has done is to highlight the fact that the breakeven will be at a low quantum of 65% for the first four years. By doing this he is, in a way, misleading the prospective investors by just highlighting the low breakeven initially and thus wrongly portraying a low level of risk with this investment. In reality immediately after the fourth year the level of risk will increase substantially and this fact, instead of being highlighted, has been hidden in the fine prints of the document.
All material information should be mentioned prominently in the prospectus and the key information of increasing risk after the fourth year (due to rising interest rate) has not been mentioned prominently. This is completely unethical and is being done with the sole purpose of misguiding the investors. By compromising on integrity and objectivity Edward is being unethical.