Fairness Outside the Cocoon

Investment bankers, security analysts, traders, and other finance professionals often behave as if they lived in a cocoon. They need to recognize that they live under the community's rules of fairness as well as the market's rules. Through anecdotes, quotations, and survey reports, this article discusses how internal and external obstacles keep finance professionals from perceiving the community's rules of fairness—rules that often make their way into the law. Ultimately, those who fail to understand and follow the community rules of fairness are taking risks they would be wise to avoid. Investment bankers, security analysts, traders, and other finance professionals often behave as if they lived in a cocoon, insulated from the fairness norms of the community. Finance professionals can take pride in the contributions they make to society by analyzing the value of companies and stocks, linking entrepreneurs with investors, and operating markets that provide liquidity and optimal sharing of risk. In their profession, however, although they favor regulations that promote fairness, they often hold the naive belief that their own perceptions of fairness are shared by all. They are not.Social norms, including rules of fairness, are rules of behavior enforced by the community. They often make their way into the law. People who violate rules of fairness that are enshrined in the law are punished according to the law, but people who violate rules of fairness that are not enshrined in the law do not escape punishment. Their punishment ranges from injury to their reputation to loss of career and social shunning. I discuss community rules of fairness and the perils of violating them through examples, including examples of those engaged in “spinning” (allocating lucrative shares in initial public offerings to executives one is courting) and market timing (in-and-out trading) and the Enron traders who crossed the line between arbitrage and theft.Sometimes, people violate rules of fairness—even those they understand—when the benefits they expect to derive from the violations exceed the expected costs. The benefits can be substantial profits; the potential costs are fines, loss of career, and jail time. For example, the tax partners of KPMG concluded that the profit from each tax shelter they sold would be $360,000 whereas the fine, if the shelter was discovered by the U.S. IRS, would be only $31,000. What about loss of career and/or jail time?At other times, people violate community rules of fairness because they fail to understand them. For example, one investment banker apparently did not understand that spinning shares worth hundreds of thousands of dollars to executives whose business she courted was perceived as different from paying for clients' golf games or dinners.Finance professionals often ask that society make the legal line clear and keep it constant. But such requests are naive. Society has often changed the rules of business after the fact and enforced the law unpredictably. Finance professionals must manage the risks of changing rules of fairness as they manage the risks of volatile markets. They must begin by knowing the risks.The kinds of surveys that have been used to elicit community views on subjects as diverse as the fair punishment for murder and the fair price of snow shovels are useful also in eliciting community rules of fairness in financial markets. Such surveys show, for example, that people judge well-off executives who trade on inside information more harshly than they judge summer interns who trade on the same information.Some might feel distaste for following rules of fairness uncovered by surveys of the entire community. Shouldn't we follow rules of fairness that are based on fundamental rights? Unfortunately, some rights conflict with other rights, and not all agree on which rights are fundamental. Moreover, following rules of fairness that are based on our own notions of fundamental rights is fine if these rules are stricter than the rules set by the community. But rights-based rules of fairness are of no help when, for example, they permit spinning just because the individual thinks it is fair or permit accounting fictions because the individual believes the effects are modest.Finance professionals who misperceive community rules of fairness put themselves at risk, just as they do if they misperceive the risks of bonds. A finance professional must know the community rules of fairness to judge the risk of violating them.Finance professionals who fail to understand and follow community rules of fairness are taking unnecessary risks they would be wise to avoid.