What Is an Ethical Wall?

What Is an Ethical Wall?

Let me tell you directly: what was once called a Chinese wall—and that's an offensive term we shouldn't use anymore—is now properly known as an ethical wall. It's a virtual barrier set up inside a company to stop sensitive information from moving between departments. This prevents conflicts of interest and keeps things confidential.

In the US, companies like corporations, brokerage firms, investment banks, and retail banks use these ethical walls to handle situations where confidentiality is key to avoiding conflicts. Over time, big financial institutions have put in place ethical wall policies to self-regulate, creating boundaries between departments. But these haven't always worked perfectly, so the Securities and Exchange Commission (SEC) stepped in with regulations on how information is shared, including fines, penalties, and legal actions for violations.

Key Takeaways

Here's what you need to grasp: an ethical wall is a business term for a virtual barrier that blocks information exchange between departments in a company. It's not physical, but it's meant to stop the sharing of info that could lead to ethical or legal problems. In finance, these barriers became more necessary after the Gramm-Leach-Bliley Act of 1999, which got rid of old laws banning companies from mixing banking, investing, and insurance services.

How Does an Ethical Wall Work?

You'll see ethical walls in action a lot in investment banking. Investment bankers often get non-public, important info about publicly traded companies or those going public via an IPO. They're in charge of setting up barriers to control how that confidential info flows—or doesn't flow—to other parts of the bank.

The push for these walls got stronger after the Gramm-Leach-Bliley Act (GLBA) in 1999. That law scrapped rules from the Great Depression era that kept banking, investing, and insurance separate. It led to huge firms like Citigroup and JPMorgan Chase. But critics say the GLBA hurt consumers by weakening protections, reducing choices, and creating 'too big to fail' institutions that worsened crises like 2008-2009.

These walls really came into focus during the dotcom bubble, when the GLBA aimed to stop banks, insurance, and financial firms from merging to protect customer info—though that's not entirely accurate in how it played out.

What Is an Example of an Ethical Wall?

Consider this scenario: a financial firm has a corporate investment arm working on a secret takeover of one company by another. That info is confidential to avoid insider trading. But another division has advisers telling clients to buy or sell stocks in those same companies. An ethical wall ensures the takeover details don't reach those advisers.

This need was reinforced by the Sarbanes-Oxley Act in 2002, which required stricter protections against insider trading. You'll find ethical walls in other fields too, like law. They can be temporary or permanent—for instance, if a law firm represents both sides in a dispute, a temporary wall keeps teams separate to avoid collusion or bias.

Why the Term Is Culturally Insensitive

The old term 'Chinese wall' came from the Great Wall of China, built to keep out enemies. It started being used in the US after the 1929 stock market crash, when Congress discussed barriers between brokers and investment bankers.

But in recent years, it's been called out as culturally insensitive. In a 1988 case, Peat, Marwick, Mitchell & Co. vs. the Superior Court, Judge Low pointed out how offensive it is, with negative connotations toward Chinese culture. Plus, the metaphor doesn't even fit— the Great Wall is a one-way barrier, but an ethical wall is two-way to block communication both ways. The judge suggested 'ethics wall' instead.

How Do You Create an Ethical Wall?

In a business, you create an ethical wall when someone or a department must keep information from another part of the company. These barriers are standard in finance and law.

What Is Involved in an Ethical Wall Process?

To set one up, you notify upper management about conflicts of interest and any involved parties. Then, the wall ensures info stays confidential to the right people or departments, not shared where it could cause problems. This protects customers and prevents gains from conflicts.

What Is the Gramm-Leach-Bliley Act?

The Gramm-Leach-Bliley Act, passed in 1999, was meant to protect customer data from being shared by financial firms. It repealed parts of the 1933 Glass-Steagall Act, which had banned banks from mixing investment, commercial banking, and insurance. The GLBA modernized things by letting these institutions merge under one holding company.

The Bottom Line

Ethical walls are standard in business, finance, and law to shield customer info from other departments and avoid conflicts. They gained prominence during the dotcom boom with regulations pushing firms to specialize rather than combine services. Though the term has evolved from its offensive origins, it's still vital for business ethics, ensuring data privacy and better info-sharing practices, especially in finance.