The Perfect Villain

Philip Lawton, CFA, CIPM
CFA Institute

Thoughtful and experienced practitioners, acting on behalf of CFA Institute and other financial analysts’ associations around the world, have formulated principles-based ethical codes and standards of practice to guide investment professionals in their work. The various standards of professional conduct differ in their details but generally agree on fundamental values: the need to protect both the integrity of the capital markets and the priority of the clients’ interests. They offer useful guidelines for the true (and truly rare) ethical leader and for the many imperfect people of good will, people who want to do right but may not always know how to sort out conflicting demands in complicated situations. These individuals, undoubtedly the vast majority, deserve all the support the investment profession can offer them.

But what to do about the others, those who exempt themselves from the rule of decency? How can we protect the investment profession — and the firm — from perfectly unethical people? Let us start by recognizing them.

We may take as a model the perfectly unjust man sketched in the second book of Plato’s Republic. Socrates is debating Thrasymachus about the merits of justice and injustice as competing ways of life. “But to come now to the decision between our two kinds of life,” he proposes, “if we separate the most completely just and the most completely unjust man, we shall be able to decide rightly, but if not, not.” In other words, to establish the superiority of the just man, Socrates suggests that we consider the opposing ideal, the paradoxical notion of the person who has perfected injustice.

Our immediate concern is more modest. It is neither to discern the nature of justice nor to argue in favor of the ethically good life but to identify the person who can do the greatest damage to our profession and, even more alarmingly, to our investment management firm. Our immediate concern is not with philosophy but rather with practical psychology and sound management. Socrates spoke of the perfectly unjust man; we shall think about the perfectly unethical person.

If perfectly unethical people were readily identifiable, we could simply take action to separate them from the firm and, in the best case, from the profession. They do not, however, publicly declare that industry standards of professional conduct apply only to others. On the contrary, they appear to be irreproachable. “For the height of injustice,” Socrates observes, “is to seem just without being so.” The perfectly unethical person is held in high esteem. He may be a philanthropist; she may be the keynote speaker at an industry conference. There’s the rub. Appearances deceive.

In addition to their reputation for integrity, perfectly unethical people exhibit three other characteristics. They are uncommonly competent, persuasive, and powerful.

“In the first place,” Socrates says, “the unjust man must act as clever craftsmen do. A first-rate pilot or physician, for example, feels the difference between impossibilities and possibilities in his art and attempts the one and lets the others go, and then, too, if he does happen to trip, he is equal to correcting his error.” In the investment profession, perfectly unethical individuals understand how the capital markets function. They know the features, characteristics, and behavior of investment instruments, and they grasp complex strategies in their area of specialization. They know how their firm monitors employees’ trades and how regulators examine their firm’s records. In short, they know what they can get away with and how to get away with it. Socrates remarks, “we must regard the man who is caught as a bungler.” Perfectly unethical people are not bunglers but competent practitioners.

They are also compelling speakers. Socrates states that when the perfectly unjust man does happen to slip, “we must concede to him the power to correct his mistakes by his ability to speak persuasively if any of his misdeeds come to light.” Perfectly unethical people have credible explanations ready, and when challenged they deliver their account with sincerity or disbelief or outrage. (After all, consider their good name.) It was not an unsuitable investment — had the transaction worked out more favorably, the client would have been grateful. It was not insider trading but a perceptive appraisal of the issuer’s near-term prospects. It was not market manipulation but a superior grasp of behavioral finance, not a conflict of interest but a win–win situation, not a failure of independence and objectivity so much as an excess of enthusiasm for a promising idea. It is a misunderstanding. Let it slide. You will hurt the firm.

Finally, perfectly unethical people have the forcefulness and self-assurance that accompany power. As investment professionals ourselves, we prize the qualities of intelligence and decisiveness. We admire successful risk-takers, and we reward them with wealth and influence. When necessary, Socrates says, the perfectly unjust man will “employ force by reason of his manly spirit and vigor and his provision of friends and money.” If you wish to keep your job, look away. If you wish to advance, be realistic. This is the way the world works. Perfectly unethical people may prefer to persuade, but they can be bullies too.

So what can we do?

Focusing first on our own attitudes, we can recommit ourselves to the values promoted by the investment profession and reorient ourselves with regard to the standards of practice. We may never reach an accord on what it means to live well, but we can and likely do agree on constitutive values in the limited domain of our professional activities. The work we do advances two goods greater than our own self interest. The investment profession promotes fair and efficient capital markets and serves the client’s financial wellbeing. On this foundation, we can see the standards of practice not as the rules of the game that we consult when the penalty flag is dropped but as guides to right conduct.

This philosophical approach, however, is most unlikely to turn perfectly unethical people from their ways. Thrasymachus was hard to convince, and Socrates himself proved to be the perfectly just man, put to death for seeming unjust. The practical answers are simpler and surer.

We must be no less skilled, articulate, and self-assured than those who seek only to advance their own interests. In addition, we must apply to our own and our colleagues’ ethical decisions the same critical thinking that we bring to such tasks as conducting a manager search, verifying a claim of compliance with the GIPS standards, or interviewing an issuer’s senior managers.

No less skilled: We are responsible to our clients, our firm, and ourselves to maintain and continuously improve our professional competence. However overextended we may be, it is vitally important to find the time to read a journal article, to master a new analytical technique, or to think about how the capital markets are changing.

No less articulate: We must practice ethical reasoning. That means determining the facts, sorting out conflicting demands, and applying the profession’s ethical principles and standards of practice so as to protect and foster the greater good. It also means bringing to light the flaws in arguments that would justify unethical actions or vindicate unethical individuals. Let us strive to become the ones to whom our colleagues turn for advice on ethical issues.

No less self-assured: Perfectly unethical people take pride in a sort of realism that dismisses ethical ideals as illusions and irrelevancies. In fact, the investment profession is built on trust no less than expertise. Our clients and colleagues legitimately expect us to act with diligence, respect, and independence as well as with competence. It is unrealistic to think that these qualities do not matter. Ethically sound values are essential to the investment profession, the firm, and our own identity. And sometimes in real life they require hard choices.

Finally, we are well advised to adhere to the Russian proverb that U.S. President Ronald Reagan quoted in disarmament negotiations with the former Soviet Union: “Trust, but verify.” Reagan repeated the admonition when he left office: “It’s still trust but verify,” he said. “It’s still play, but cut the cards. It’s still watch closely. And don’t be afraid to see what you see.”

Editor’s Note: This article originally appeared in the March–April 2006 issue of CFA Magazine.