Ethics and Investment Management: True Reform

What happened to ethical behavior in the era of the dot-com, the bubble, Enron, and WorldCom? We were not involved in close ethical calls in these cases. The lapses were great, the conflicts many, and the cost, in terms of investor trust, nearly unspeakable. Each time scandals occur, market reforms result, but the pattern is that, despite their extensive nature, the reforms do not bring us an insurance policy against misconduct. True reform lies not in statutory or codified detail. Rather, true reform comes from a strong moral compass that is applied by leaders who demonstrate ethical courage. True reform requires a focus on doing more than the law requires and less than the law allows. As we look to the future, the events of the past and their lessons cannot go unheeded. Focusing on those events and learning from them is the beginning of true reform.The interaction of analysts with the markets in the era of the dot-coms, telecoms, and 1990s bubble contains three lessons. The first lesson is that the missteps were not ethical close calls. The lapses were great, the conflicts many, and the cost, in terms of investor trust, nearly unspeakable. The ethical misdeeds involved, first, conflicts of interest as research gave way to deal making, as analysts and other investment professionals used their positions (and research) for personal gain, and as the use of soft dollars was falsely justified and became a way of life. Second, analysts accepted and used false impressions, falsehoods, and frauds as they transformed into cheerleaders rather than objective examiners. The result of the conflicts was that the role of analysts became muddled.A second lesson comes from the recognition that we have been down the road of market abuses and reforms before. This latest round of scandals is the third since the mid-1980s. The first was the savings and loan disaster, and the second was the insider trading/junk bond debacle. In each case, individuals go down a path of ethical shortcuts and an unwillingness to question, and following each scandal, the result is extensive, expensive, and often ineffective regulation. The Sarbanes–Oxley Act and all the related organizational and professional mandates are only the latest attempt at regulation.In such times, we turn to the law to establish standards and reforms, but statutory and codified reforms are minimum standards for behavior. Despite their extensive nature, the reforms can deal only with the lapses uncovered. They can give us laws and regulations, but they do not bring us an insurance policy against future misconduct. We cannot possibly legislate, regulate, or codify every conflict of interest and every ethical dilemma or question. The result of efforts to do so is oppressive regulation that often finds those affected seeking the very loopholes ethical behavior condemns.True reform comes from three characteristics we need in our leaders and in ourselves. First is a strong, meaningful moral compass in individuals—self-imposed control governing individual action. Second, ethical issues need to be analyzed properly. We must deal with each basic issue—for example, the conflict of interest inherent in an industry—rather than letting it slide and trying to deal with the inevitable moral questions spawned by the initial misstep. Retention of moral absolutes requires constant introspection, discussion of practices, and exploration of those practices from the perspective of clients and the market, not from industry practice. Finally, the moral compass and ethical analysis need to be applied by leaders who demonstrate ethical courage. True reform requires a focus on doing more than the law requires and less than the law allows.