Fiduciary duty and self-interest
Lifted from comments from Linda Beale’s post Graphs Show It Clearly–the richest are much richer and most of us are poorer discussing the main points and data from David Cay Johnston’s Reuters article The richest get richer is Bruce Webb’s thinking on how the American market system was designed over time:
Defenders of Goldman who base that defense on “greed is good” reductionist understanding of capitalism are simply ignoring the legal and I would say moral structure in which banking and management were embedded: that of fiduciary responsibilities and principal/agent law.
Before Glass-Steagal repeal (and similar legal and business culture changes dating back to the fifties) there was an understanding that commercial bankers had a fiduciary responsibility to their customers,that the relation in question was one of agent to principal. And the same for management, managers were agents of the owners whether directly in a private firm, or indirectly via the Directors of either a joint-stock company or as in insurance of a mutual structure where policy holders were ‘owners’. On the other hand investment banks ad law firms and reinsurance companies like Lloyd’s and it’s ‘Names’ we’re generally set up on a partnership basis where the agents were principals, at least at top levels.
But that distinction broke down, maybe as early as the rise of the Conglomerate and the Multinational where the link between the manager/agent and the principal/owner the principal/mutual holder became attenuated to the point of near nonexistence with the result that what had been agents, say a plant superintendent, now reported to an executive suite at ‘Corporate’ where one-time agents were de facto principals. As exemplified by the bastard blend of President and Chairman of the Boardand Chief Executive Officer into a single person whose theoretical agency relation to ownership was at best mediated through a board of Directors often largely serving under his direction.
And this attenuation of Agent-Principal relations broke down entirely when Glass-Steagal and other actions simply smushed together the partnership and joint-stock/mutual models where the formal and legal structure remained the latter even as the decision making went with the former.
Thus Goldman-Sachs Corporate culture. Instead of maximizing profits for the partners on one hand or for the shareholders on the other and all while maintaining a fiduciary responsibility to the customer/depositor, the executives and traders, who in law are simple hired help, i.e agents promoted themselves in their own minds to principals. Something complicated by the fact that various forms of stock based compensation made certain top executives both de facto and de jure principals quite beyond their selected/elected Chairman/CEO/President blended position.
This obviously needs some polish, it is a blog comment after all, but I think I am on to something, something I have been bouncing around in my mind since I first took a course on Post WWII American History back in the early eighties, that is post multi-national conglomerate but prior to the barrier break represented by Glass-Steagal repeal. That is we are seeing a confluence of several streams that have mostly reduced all notions of fiduciary responsibilities and/or principal-agent law into a fetishizing of maximizing individual self-interest as if every trader at G-S was in the same legal and moral position as a medieval chapman selling goods from his pack purchased with his own money from the producer.
So yes capitalism is organized around the principle of principals maximizing their self-interest. But not everyone is, or should be considered,a principal. And no “Well duh, capitalism equals maximizing return” does not in itself wipe out the entire legal and moral structure that grew up around it. Agency and fiduciary responsibilities still are or should be operative. That is you don’t get to operate Wall Street on the principle “We eat what we kill” no matter what some hot-shot MBA trader might think.
(Dan here…Title added, introduction edited for clarity)
Recall that during the discussion of Dodd Frank there was discussion on making brokers fiduciaries, and Wall Street stopped it. This should tell folks that brokers are only interested in their own profits. The only advisor to be trusted is one you pay and does not get commissions on the side, because that creates a fiduciary duty. However its clear that market making and fiduciary duty create a conflict of interest. While it will never happen I do think that the pre big bang structure of the UK market had some points you could be a broker or a dealer but not both.
All I’ll say is 1983:
Mortimer Duke: Tell him the good part.
Randolph Duke: The good part, William, is that, no matter whether our clients make money or lose money, Duke & Duke get the commissions.
The short version of Bruce and Linda’s response to him is simply: The CEOs and directors now think they own the company. They no longer acknowledge that they too are employees. They don’t acknowledge it because that concept is dead do to lack of real oversite but mostly because there are no strikes. Have a good strike and the real owners might just start getting involved.
People in sales never had a fiduciary duty. A GS person selling some product to a customer doesn’t have a fiduciary duty to the buyer, pre-Glass Steagall or post. Your argument – that the duty is changed by the governing regulatory regime – is utterly detached from reality.
I’m missing the point of referencing the Trading Places quote. I was under the impression that you, and many other commenters here, supported the Volcker Rule, prohibiting proprietary trading. In a world with the rule in place, the merchant banks are reduced to a position of match maker. Now you may think this is a feature, but then it’s difficult at the same time to complain that they don’t care about their client outcomes. A good bookie doesn’t care about the outcome of the game either, because s/he’s balanced the book such that it’s matched and they’re only collecting the vig.
jpe
Few people working in the stock brokerage business or investment banking industry present themselves as sales people. Certainly in the case of someone who has specifically represented themself as an “investment advisor” and charges a fee for that service is acting in the role of an agent. When the broker or the banker presents to the buyer a recommendation regarding the equities being sold then that broker or banker has also taken on the role of the advisor and, therefore, accepts a fiduciary responsibility to the client. That is a far cry from taking a call from an investor who has made their own choice and simply asks that a product be purchased for them. That is a straight forward sale.
And before the repeal of Glass-Steagal the roles were more clearly delineated, commercial bankers being pretty clearly fiduciaries, investment bankers less so. Instead we have the ethos of one sector operating within the other with the result that one-time commercial bank clients being served by hired agents are now dubbed ‘muppets’ by the ‘eat what we kill’ folk.
Dan didn’t ask me before promoting my comment to a post, if I had known I would have thrown a few more ‘IMHO’s and ‘BTW I am neither a finance guy or a securities lawyer’ in the mix.
But I will say that the layman’s idea of a typical stock- broker handling a client’s account with a certain autonomy implicitly includes a fiduciary agent serving a principal and not some guy maximizing sales in his employer’s products. Now I could not tell you for sure which side of the divide traditional stock brokerages fell on prior to repeal of Glass-Steagal, but clearly old line firms like Merrill-Lynch were selling trust and not ‘client beware’.
For that matter the very concept of mutual funds and promotion of 401ks builds in the idea that professionals are acting on your behalf and achieving better results than you could on your own. How exactly does any of that align with ‘caveat emptor’?
jpe
there are salesmen and there are salesmen
you sound like one of the criminal kind. a good salesman earns his customers’ trust.
what is wrong with America today is that we have created a ruling class of the criminal kind of salesman.
It is worth noting that whatever the underlying legalities major consumer oriented stock brokerages deliberately market reliability and trust: Prudential’s Rock is an example and even the very name Fidelity as in Fidelity Investments means ‘loyalty’. Nor were main street type brokers normally selling company products beyond managed funds, themselves clearly in the “leave the driving to us” realm.
It is not like these firms are naming themselves ‘Dewey, Cheatem, and Howe’ or ‘Muppet Pluckers’. Nor is the claim that sellers have no inherent requirement to supply goods in working order particularly convincing. Being a car salesman is not carte blanche to see cars with known defects, even when sold ‘As Is’. Now there is a distinction between selling non-defective products and a fiduciary relationship, but equally there is a line between a reasonable claim to ‘caveat emptor’ and fraud. And it would be interesting to examine brokerage licensing law in this regard. Because while traders may not themselves be licensed (I don’t know) they certainly are in an agency relation to some principal who is, which transfers the liability upwards. That the salesman himself has no personal legal responsibility doesn’t insulate the whole sales process from manufacturer/designer to end buyer.
“People in sales never had a fiduciary duty.”
This is flat out, not true –at least not before financial deregulation took over in the 1980s. The term “fiduciary duty” itself would not even have existed if it hadn’t meant something at one time. Sadly, now that we have a SCOTUS that thinks corporations are people deserving of more rights than actual people and a thoroughly corrupt Congress and Executive branch both working for the .1%, fiduciary duty is truly all but dead.
And then there is the additional concept of “professional” and the expected responsibilities when one forms a relationship with a “professional”.
I have not heard Wall Street referring to it’s self as just a bunch of Joes and Janes.
One needs to be careful in thinking about who the client is in these instances. It seems implicit in many of the comments that concern is that Goldman’s corporate culture is leading to a fleecing of granny, and while fleecing may be taking place, it’s certainly not of granny.
Goldman has minimal retail presence. To the extent that they face customers who are individuals (as opposed to customers who are representing a firm, or other investors), it’s through their “Private Client”, i.e, High Net Worth division. Along similar lines, Merrill just increased the minimum account sie from $100k to $250k.
Greg Smith worked in Equity Derivatives, not exactly the area mom & pop are trafficking in.
As such, Goldman’s clients generally consider themselves and would be considered by most lay people, to be “sophisticated investors”. They may not be as sophisticated as Goldman traders, they may be more but at an information disadvantage, but keep in mind, when it comes to most financial assets, for each asset sold the same asset needs to be bought – and the buyer generally believes the asset will appreciate, while the seller believes the asset will depreciate. Not in all cases, certainly, but generally speaking.
The crisis showed that because advisers to sophisticated investors did not want to appear stupid they put their clients money in stupid things. It is clear from the crisis that most financial advisers are incompetent at best even those advising institutions. (Or they are on the take from those who put the toxic waste together). I think the states should rule that their subdivisions are not sophisticated investors after the Orange Co Ca and Jefferson Co Al issues. Require they invest only in plain vanilla investments and take the lower returns to avoid losses.
It’s not a matter of who is being fleeced. It is a matter that there is fleecing happening. Which gets us to the latest deregulation and all those talking against the bill known as the JOBS act. HR 3606.
“but keep in mind, when it comes to most financial assets, for each asset sold the same asset needs to be bought – and the buyer generally believes the asset will appreciate, while the seller believes the asset will depreciate.
And thus is the appropriateness of The Dukes’ exchange: The good part, William, is that, no matter whether our clients make money or lose money, Duke & Duke get the commissions.
Oh yeah, the Dukes tried to “fleece” the OJ market with their “asymetrical” info.
The problem is that since the days of Daniel Drew (and before in the UK (south sea bubble) and France (mississippi company among others) people have been fleeced. So they will always be this is why let the buyer beware is stated. If you don’t understand something just say no. If everyone recoginizes that the broker takes the attittude of the Dukes, then they will not trust them any further than you can throw them.
Today the small investor should not participate in the IPO game as it is rigged as is much of the market, but then it always has been and always will be.
For those companies affected by the Jobs act, the answer is to just say no to their securities as they are going to be out and out gambles just like the early days of the railroads. Assume they are out to fleece you and act accordingly!
There’s no way to know ex ante if any party is being fleeced. Roubini or Krugman will tell you they were calling the top of the housing bubble circa 2002/2003. But if they put their clients into a position that were short housing, and those clients were subject to margin calls, those clients would have been squeezed out of their positions at huge losses well before 2008.
If one investment advisor tells you to sell Apple tomorrow because it’s market cap is egregious, and another advisor tells you to buy Apple tomorrow because it’s comparatively inexpensive given its growth prospects – both can be right at the same time – and the rationale that both are using is not mutually exclusive.
m. jed
You’re describing reasonable uncertainty which every investment firm makes clear to its clients. Nothing is guaranteed, but selling securities that the firm well knows to be below the value of the asking price is dishonest and certainly a failure to excercise due diligence for one’s client. Worst of all is the situation in which the agent sells the firm’s owned securities at a significant price above their real value as known by that firm and its individual agents.
Jack – the point is there’s no such thing as “real value” for a financial asset. Different parties have different views of discount rates, comparable valuations, peer groups, risk profiles, time horizons.
But generally speaking, sellers are selling because they believe the value is too high, and buyers are buying because they beleive the value is too low. By your definitiion, the agent is nearly always selling either the firm’s or it’s clients inventory of securities at a price above the firm’s/client’s view of “real value”.
The situation is certainly more complex than two parties with different views of the value of a financial instrument. Keep in mind that the debacle of 2008 was brought on by years of selling more arcane financial instruments, bundled debt one might call it and insurance of a sort on the value of those bundled debt obligations, referred to respectively as CDOs and CDS. In most cases the actual credit worthiness of those derivatives was nearly impossible to judge having been inflated by the collusive behavior of the credit rating companies. What the fellow from GS tells us in his parting shot is that the same deceptions are continuing in spite of the damage caused last time around.