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The Culture of Compliance: Regulatory Acts Are Not the Solution Leadership Sets The Standards

By George Wilbanks

Over the last several years, the investment management business has seen a series of ethical lapses that drastically diminished the confidence of the market in executives and led to significantly greater regulation and regulatory scrutiny. As one of the most highly regulated and transparent businesses in the world, the vast majority of participants in the investment business have built a reputation of trust with clients for decades. What then could have led to such widespread failures at otherwise highly regarded firms?

One explanation lies in the unrealistic expectations of senior executives after more than 20 years of bull markets, which ended in mid-2000. During the prior two decades, senior executives enjoyed the benefits of rising markets-record growth in investment returns, revenues and profits, compensation plans worth multiples of their original projected values, and the ability to take significant business risks using a relatively inexperienced staff.

In mid-2000, the markets began to turn, accelerated by the devastating events of Sept. 11, 2001. The quick results of this rapid reversal were falling profits and business valuations at most major investment management firms. It was typical to see senior executives witness 50%-plus drops in total cash compensation, and retirement and deferred equity related compensation drop by an even larger amount.

Every senior executive had a friend out of work or fired because of a failing business. Most knew someone who had lost their life savings. The outcome of this dramatic turn of events, failed businesses, missed budgets, downsizings, and falling compensation levels stressed every company and all senior executives.

How has this turn of events cascaded into a widespread failure of ethical conduct by senior executives who, for the most part in the prior 20 years, had virtually untarnished reputations for putting clients' interests first?

Citing the research of Zenger and Folkman on corporate ethical misconduct, it is typical for executives to push the gray zone of regulatory structures. However, when this risk-taking was combined with the overconfidence of a generation of executives and the indecisiveness of less experienced managers, a lethal cocktail was brewed.

For purposes of this examination, we are omitting reference to the illegal acts of those willing and able to break laws and commit fraud. What is more important is the larger number of senior executives who simply "sailed too close to the wind" in an effort to "keep the music playing." In areas of regulatory uncertainty, or where there was the opportunity to take advantage of a client in order to increase profits, the failing expectations of the previous 20 years exposed latent weaknesses in character or ethics among many senior executives. Unchecked by the moral compass of approachable, decisive and experienced organizational leaders, far too many senior executives failed to put the interests of their clients first.

In retrospect, what can be learned to lessen the likelihood of repeating these events?

It is clear that enhanced regulation is a blunt instrument that rarely leads to the finely balanced results of improved market performance. What is much more important is the oversight and constant monitoring the culture of a firm that is established by the actions of the senior management. Again referring to the research of Zenger and Folkman, the key attributes of senior executives that are virtually always present in ethically resilient companies that survive tests like the last four years, or the occasional "bad apple" that enters a firm, are so simple they almost appear as common sense:

* Approachable and open

communication style.

* Act with humility.

* Listen carefully and attentively.

* Make decisions thoughtfully

and carefull.

* Act assertively and decisively.

Every senior executive must recognize the weaknesses in peers, subordinates and superiors and constantly work to reinforce these principles, knowing that periodic stress tests will challenge every professional in the organization. Long before ethical lapses appear, senior executives, and those charged with their oversight (including Shareholders, Boards and Trustees), must take corrective action.

It is particularly important for those in oversight roles to take action when the choice is between faster growth and/or greater profitability, and these essential individual character traits that guide the compliant behaviors of entire organizations. If an organization loses the absolute standard of ethical behavior, then their business model is doomed to failure.

George Wilbanks is chairman of the investment committee and a senior partner and managing director in the investment management practice at Russell Reynolds Associates. He joined the firm in 1985 from Dreyfus, where he had been assistant to the chairman, and has also worked at venture capital firm Agtek International. He is a graduate of Williams College and holds an MBA from New York University.