Aggressive efforts are under way across the globe to fix perceived causes of the crisis in the financial markets from too-high leverage and too-soft lending standards to opaque financial markets and inadequate regulation. But these reforms, while helpful if developed wisely and enacted effectively, only treat the symptoms; the root cause runs deeper. Restoring the trust and confidence that are the lifeblood of the global markets requires addressing not just the loss of value across asset classes and markets, but also the loss of values within the financial services industrys own ranks.
This loss of values is all too clear. Firms sold complex financial instruments they themselves did not understand. Others failed to do proper due diligence on funds they were paid to analyze. Companies marketed and securitized loans that depended on a perpetual increase in home prices. Others marketed absolute-return investment strategies as if they would deliver positive returns in any market environment. And some funds that promised liquidity have dropped the gate preventing redemptions, while continuing to charge fees on the assets their clients would like to liquidate, but cant.
Relationships across the industry are now being re-evaluated not just because of poor investment performance, but also because of poor performance by financial professionals.
Rebuilding the financial system will depend, above all, on returning the industry to its core values and restoring fundamental fiduciary principles of conduct. This is not idle sermonizing. The word fiduciary comes from the Latin root for trust and means that one acts unequivocally for another in good faith, with complete honesty to merit that trust. As a practical reality, the industry would benefit from a code of fiduciary conduct, based on four core principles:
• (Re)define our industry as a true profession, not just a business. A profession like medicine holds itself to standards that rise above simple profit and loss. Vanguard founder Jack Bogle summarized the problem well: Once a profession with elements of a business, we have become a business with elements of a profession. Once focused on management and investing, we are now focused on marketing and asset gathering. Once focused on stewardship, we are now focused on salesmanship. As a result, most clients today believe the financial services industry is less a profession than simply a complex compensation scheme.
• Single-mindedly focus on doing the right thing for clients. Full stop. In recent years, many firms focused myopically on attracting new clients, growing deposits, loans or assets under management, or boosting quarterly earnings. This encouraged financial advisers to put clients into inappropriate products or devise new ways to charge clients for the same basic service. Moving forward, the industry must focus first and foremost on delivering strong performance and providing good advice to clients only then will new clients, accounts, assets and profits follow.
• Tie employee compensation to value delivered to clients and shareholders. Pay for performance has long been the mantra in financial services. The real key is how performance is defined and measured. Too often it has been tied to the financial equivalent of widget production: commissions produced, mergers done, new accounts opened or asset management fees generated. These production measures inevitably fail against a more balanced performance scorecard that takes the clients and shareholders best long-term interest into account.
• Hold leaders to the highest standard of behavior and drive those standards throughout the organization. Much has been written about the shadow of a leader how the most senior executives influence the actions of those below them. The shadow cast today by the industrys executive suite isnt helping nurture client confidence and trust. Can todays industry leaders honestly say that they celebrate actions focused on clients best interest, even if it hurts their bottom line? Do we penalize the salesperson who gets a deal done, even at the expense of our clients? Now more than ever, industry executives need to lead by example and restore client first values to everyday business.
The flight to quality in the market now does not just describe the move to safer asset classes and securities. Clients and investors also are demonstrating a flight to quality in the providers and advisers with whom they partner. Clients are searching, yearning even, for professionals who inspire confidence and trust. If it wants to succeed over the long term, the industry needs to deliver.