Change rewards culture to fix the integrity minefield

September 29, 2013 8:37 pm

Change rewards culture to fix the integrity minefield

By John Authers

Is the UK’s wealth management industry “open, honest, transparent and fair”? That was the question put to several hundred members of the Chartered Institute of Securities and Investment this week, at its annual debate in the City of London. All worked in the industry. To vote against implied a belief that they were working in a “closed, dishonest, opaque and unfair” industry. And yet almost half did vote against, with the motion carrying only by a wafer-thin majority.Full disclosure: I was leading the case for the opposition. This may have helped. But such an outcome is only possible if those in the industry know that it has serious and unresolved ethical problems.

This debate referred to the UK, whose financial service industry has an excruciating record of rip-offs, whether of consumers – from personal pension mis-selling, endowment mortgages and the Equitable Life debacle through to the current payment protection insurance mis-selling scandal – or of others in the industry. London was the home of the Libor scandal after all.

But the UK’s ethical problem is certainly not unique. So what is the problem and how can it be solved? First, there is a problem with culture. Second, there is a problem with compensation. They interact. Incentives work, and pay arrangements give financial professionals an incentive to behave like unprincipled salesmen.

If the ultimate aim is to maximise profits, then almost any link between performance and pay will lead to ethical problems. This was obvious from the debate, where the proponent of the motion started by pointing out that his employees were paid solely on a salaried basis. It was evident to everyone in the room that this made them more likely to behave ethically.

This is clear from research that former Financial Times journalist Jane Fuller carried out for the Centre for the Study of Financial Innovation. “If you have the wrong targets, people do the wrong things,” commented one of the senior business figures she interviewed. Reducing the importance of performance did little to help. As one executive explained, if staff felt that their bonus was the only part of their pay that they could influence, “they will attach over-riding importance to the metrics used, even if it only adds 5-10 per cent to their salary”.

Combining sales incentives with a business model that emphasises cross-selling creates deeper ethical problems. For example, PPI mis-selling arose from fierce competition in the mortgage market, which made mortgages unprofitable. The way to deal with this was to get staff to sell more profitable PPI policies with every mortgage. This bolstered profits in the short run, but not in the long run, as UK banks are now in the hole for £14bn in compensation for mis-selling. The more complex a product, the greater the potential conflicts of interest. How to fix the problem? Moving to a system of salary-only remuneration would settle these issues, but many are reluctant to go that far. One of the executives interviewed by Ms Fuller suggested creating a “service gateway”. No sales bonus would be paid if staff could not prove they had offered an acceptable level of service. Still another idea, as complexity creates opportunities for mischief, is to produce a “kite mark” for products so simple they can be sold without advice.

Changing compensation, to treat people as professionals whose time and advice are valuable in their own right, would go a long way to solving the cultural problem, as well. Other trappings of professionalism might help. One interesting proposal is a financial equivalent of doctors’ Hippocratic Oath. If everyone in the industry, as part of their qualification, took an oath always to act in the best interests of their clients, maybe they might find it harder to engage in amoral behaviour. Knowingly selling junk to customers, now widely thought acceptable on the basis of caveat emptor, might then grow much harder. Another approach adopted by the CISI is to require a test of integrity as part of their exams. There are dangers in this approach. Pigeon-holing ethics in one separate class or exam runs the risk of implying that ethics can be ignored in the rest of the curriculum.

But the test, like an online role-playing game, is subtle and interesting; candidates are confronted with case studies showing ethical dilemmas, and are offered subtly different responses. There are no questions with an obviously wrong answer. Ethics in finance are difficult and subtle – just as they are in medicine or the law – and the experience of taking the test would help make that clear.

But one unescapable truth remains. Taking tests or swearing oaths will not help much if the industry’s compensation practices continue to encourage its employees to cut ethical corners. Fixing the cultural lack of integrity is impossible without fixing compensation.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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