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Rich Sternhell on the Evolution of Trust in Business (Trust Quotes #13)

Rich Sternhell was a Managing Principal at Towers Perrin, now Towers Watson, until his retirement last year. He was a Towers Perrin Board member, and chaired Board committees including client relationships, technology and quality; he not only consulted, he managed. He ‘sat in many chairs,’ as he puts it.

His career, post-MBA, covered four decades that saw radical shifts in employee compensation, consulting, and the role of management. Now free to indulge the thoughtful side of what he has seen, he agreed to share some insights with us.

CHG: Rich, thank you for sharing your thoughts with the Trust Matters audience. You’ve got some big-picture perspectives for us, so let’s dive right in. You started work post-MBA at New York Life in 1970. What are the biggest changes in business you’ve seen since then?

RS: Almost all the changes in business can be related to technology and the resultant increase in what I’ll call the velocity of business. Perspectives are shorter. What is often seen as “quarter to quarter” management, I would describe as management of metrics, rather than of the business. Whether it’s stock price, market cap, EBITDA or cash flow, the focus on metrics that are market-visible has monopolized management attention. We have moved from management that is passionate about products to management that is passionate about the numbers they report.

The focus on acquisitions, divestitures, etc., that can increase price multiples has created a loss of shared understanding between employees and management as to the source of value for the organization. This has also created a generation of management that is focused on management of their careers rather than their companies.

There is also a loss of organizational connectedness. Fellows in their 50’s and 60’s who would take the time to coach a young newcomer. They told stories about the past and made people who were long gone part of that newcomer’s memory bank and connection to the organization. I see very little of that today.

That newcomer is planning career moves through moving around rather than moving up. The few old-timers left have lost interest in mentoring young’uns who will be moving on to more fertile fields.

CHG: Let’s take that first one, management by career, not company. Say a little more about that?

RS:Those who have made it to the C Suite often have spent their energies making sure their resume gets them there. It becomes hard to change perspective to become passionate about a business you didn’t grow up in, have limited long-term relationships within and compensation highly leveraged to stock performance that has the potential of creating generational wealth.

CHG: Let me be devil’s advocate a bit here; isn’t it also a good thing that we’ve developed an ethos of mobile, project-oriented work, that fits very well with a fluid, collaborative kind of organization of work for the future?

RS: A mobile workforce is absolutely essential in an economy as technology driven as ours is. At the same time, company cultures have become fragile. But the bond that existed between management and the workforce doesn’t have the strength of shared experiences over long periods of time.

My favorite set of questions on employee engagement surveys has to do with leadership. There are always questions like, “Does leadership care about the associates?” “Does company leadership act in the long-term best interest of the organization?” Inevitably, scores on these questions come in significantly lower than questions that relate to the individual employee’s location or sphere of responsibility.

Managements fret about these results a great deal but then take comfort in the normative data that says that other companies score equally poorly. Almost inevitably a corporate communications campaign begins with messages from leadership about how much they really care.

I think these campaigns are self-defeating. Employees want to know that the management they see has “signed on” and take ownership of the messages. The direct communication from senior leadership has allowed middle management to abdicate their role in communication. When middle managers snicker at senior management messages the result is worse than if no communication had been made at all.

CHG: Many Trust Matters readers have little perspective on another major shift you’ve seen—the decline of the defined benefit plan. It can sound awfully arcane, but I’ve heard you say it was one of the tragedies of our time. Explain?

RS: The defined benefit plan was a bet by the workforce and a commitment by the company to the long-term health of the business. It was an obligation taken on by company ownership in return for the loyalty of the workforce. It provided a degree of security to employees at all levels that allowed them to think about the long term.

While our culture places a high value on individual responsibility we are asking employees to make decisions on matters for which they are woefully unprepared. The 401k has been sold as a replacement for pensions while it is clear that the numbers simply don’t work that way. In my early days as a pension consultant we talked about defined benefit plans as a company tool that enabled employees to be retired from a company with the security that they wouldn’t embarrass the company they worked for by being out on the street.

Companies no longer feel that embarrassment, and employees have been led to believe that somehow the DC plan will provide for their retirement. It can’t provide the same level of income replacement. Management looks to stock options to fund their retirement…employees don’t have the same opportunity.

Employees don’t trust the security of their job, their health insurance or even social security. In the absence of tools to manage for the long-term they act for the short term. It has become all about self-preservation.

CHG: Given those perspectives, what do you have to say about trust as it has evolved in business? Let’s start with headlines: what do the Goldman and BP headlines have to tell us about trust?

RS: Trust in business has many different components, all of which link to each other. There is trust between co-workers, trust between employee and supervisors, trust between salesman and customer, trust between salesman and production. BP is a great example of the disconnect that can grow.

Let’s start from the premise that for a business to survive and thrive it must create value for customers, and a return for its investors. It also must function within the framework of legitimacy established by societal norms. To the extent it enhances the communities within which it operates, goodwill is created which can be turned to competitive advantage.

On the other hand, damage to the community results in a destruction of the trust essential to maintaining not only a customer base, but the relationship with all the constituencies on which a business depends. This isn’t just a business case issue, justified internally by the needs of the business–it is about the underlying linkage of communities in a free market society.

Trust is fundamental to the achievement of all business objectives and its absence is the greatest threat to our business community as well as our broader society. Unfortunately, there are strong forces at work that have the effect of weakening our society’s trust in our business community and its leaders.

The village blacksmith was well aware that each implement he fashioned was critical to future orders. The quality and timeliness of his product determined his position in the community. To the extent he failed to meet his customers’ expectations, he created the opportunity for competition. To the extent he failed to manage his costs, his family starved. He didn’t manage his business for quarterly results, but for the well-being of his family, i.e., "long term selfish". The community he served also knew that their well-being depended on his success.

Common approaches to this problem are often mistaken. Accountants tend to quantify risk, giving equal weighting to probability and severity providing a reasonable estimate of quarter to quarter financial impact. Actuaries, on the other hand, give significantly greater weight to severity, recognizing the long term economic impact of the high-severity risk. Not surprisingly, the accounting perspective has gained precedence in recent years.

The re-establishment of trust among all stakeholders at every level is central to rebuilding business legitimacy. The risk of breaking trust, whether through cutting costs on deep water drilling platforms or breaking faith with customers, needs to be seen as a fundamental attack on business legitimacy, not just a cost-benefit analytic.

It’s been said that for an organization to claim a value, it must be non-negotiable….without exceptions. What does this look like? Examples include:

· A firmwide commitment to operate on principles rather than incentives

· A commitment to honor values over strategies, even successful ones

· An instinct to forgive the mistake….but to terminate for the cover-up

· A culture that commitments are sacred, whether to a colleague or a client

· A shared understanding that the long-term success of the organization must override the short-term benefit to an individual or unit

Building a trust-based organization from the bottom up and the top down is a serious commitment, but well worth the investment.

CHG: How about trust between employer and employee?

RS: John Bogle, the founder of Vanguard, has spoken often about the shift from ownership capitalism to management capitalism. My sense is that an employee’s understanding of the interest of a business owner was intuitive. The employee may not have liked the owner but intuitively he/she knew that they had an interest in the preservation of the business.

This is not true about the employee’s relationship to management, particularly when they see a revolving door in the C Suite of people from other businesses and industries who do not share the same long-term interest in the organization’s well-being. The increasing gap in pay between senior management and the average employee has exacerbated that gap in trust.

CHG: You’ve told me before you take a somewhat dark, pessimistic view of people, but it often comes out pretty optimistic. What is it that you think motivates people in business, and what does that mean for management?

RS:I truly believe most people want to find fulfillment in their work. In today’s world, concern about security—job, health, wealth–is an enormous distraction to engagement. It is an enormous challenge for management to overcome and often creates an internal conflict for the employee. Should I take the risk of doing “the right thing” or should I “keep my head down”? The more clearly management articulates “the employment deal”, the greater the opportunity for increased engagement and the creation of long-term value. I have seen values based management at work and have little doubt that there are organizations out there making it work today.

CHG: What does that suggest for management-by-numbers?

RS: The numbers are critical. Management won’t stay in place very long if they can’t deliver results. But management only by the numbers isn’t enough. Values will trump strategy over time.

The real challenge is the friction cost that loss of trust has on a business, our economy and our society. Loss of trust means an increase in a myriad of costs through due diligence requirements, procurement processes, government regulation and litigation. Sales take longer to close. Contracts take longer to negotiate. The legal aspects of operating a business have exploded.

None of these areas have anything to do with increased value of the product or service a business produces but the costs imposed are a direct result of decreased trust. Thus we have an ever-increasing number of workers who don’t contribute to creating value, but are essential elements in today’s business environment.

CHG: What can an individual TrustMatters reader do to enhance his or her ability to trust, their personal trustworthiness, or the level of trust in the business world of today?

RS: The need and desire for trust is universal. The challenge comes when we believe that it is important to act in a trustworthy manner in some situations and not in others. Understanding our interdependence with vendors, customers, employees and other stakeholders is essential. To the extent we employ situational ethics and call a violation of trust a business judgment we weaken the trust framework of an organization. Each individual has the capacity to ask themselves the critical question in every business judgment they make as to whether they are acting in a principled manner.

CHG: What do you think of the MBA Oath movement that began last year?

RS: It is certainly a worthy aspiration…much like any approach to ethical behavior. It is discouraging that such an oath would be perceived as necessary. The implication of the MBA Oath movement is that there is some degree of career sacrifice entailed with living up to the oath. That in itself is demeaning to business people.

CHG: What’s the best business book you ever read? The best advice you ever got? And what’s the one thing you’d recommend to a new MBA today?

RS: I can’t give you just one Charlie, but I’d put your book Trusted Advisor up with the best. It is the first book I recommend to anyone entering sales, consulting or professional services. My daughter is a doctor and my son an attorney. I have made sure that both of them have copies and have read it.

Another is by your co-author, David Maister. David’s writing has been formative in my thinking as a consultant and manager for almost 30 years. I’d pick True Professionalism as my favorite. A recent read has been General Eisenhower’s Report on Operation Torch. I only wish I had read it 30 years ago. Anyone who has to manage a merger or a large project with a multidisciplinary team should be required to read it.

Finally, a new book by a professor at Columbia, Sheena Iyengar, The Art of Choosing. The Art of Choosing is a fascinating book from a pure marketing perspective, but even more interesting as probably the most helpful thing I’ve ever read in understanding cultural differences.

For the new MBA I would say that business is an honorable profession as long as you practice it honorably. Every decision is a choice and knowing that the choices you make have earned you the trust of your colleagues and your clients is the greatest reward you can hope to receive.

CHG: I’m blushing, but I know you’re serious, so I’ll leave it in. And many thanks to you for spending time and sharing wisdom with us, we greatly appreciate it.

——–

This is number 13 in the Trust Quotes series.

The entire series can be found in our Trust Quotes section on TrustedAdvisor.com

Recent posts in this series include:

Trust Quotes #12: Martha Rogers and Don Peppers Interview
Trust Quotes #11: Jim Peterson
Trust Quotes #10: David Gebler

Too Big to Trust? Or Too Untrustworthy to Scale?

This will be my fourth week on the road; more on that later in the week. At least all that plane time (and waiting in lines time) makes for good reading time—thanks to the iPhone Kindle Reader app.  (and no they don’t pay me for saying it).

I’m re-reading Francis Fukuyama’s 1995 classic Trust: the Social Virtues and the Creation of Prosperity

It’s the perfect companion for Andrew Ross Sorkin’s Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System—and Themselves. 

Here’s why they belong together.

Fukuyama’s View of Trust

Fukuyama makes a compelling case that economic development is strongly affected by the cultural norms of a society—in particular, the propensity to trust. In this, he is up against both neo-classical economists (who argue people are rational utility-maximizers), Marxians (who argue it’s all about the money), and a ton of management theorists (who pretty much believe both).

As Fukuyama puts it:

The Chinese, Korean and Italian preference for family, Japanese attitudes toward adoption of non-kin, the French reluctance to enter into face-to-face relationships, the German emphasis on training, the sectarian temper of American social life: all come about as the result not of rational calculation but from inherited ethical habit.

Who we trust, it turns out, radically determines the nature of business we engage in. He explains why large French companies are state-owned, and why Chinese companies find it hard to hire professional management (think Wang Laboratories). 

Fukuyama describes several cultures in the world–southern Italy, chunks of Russia, some Chinese regions—which contain high-trust pockets of communities within a broader society of low-trust intermediate institutions. 

Those high trust pockets? Think the Mafia, Chinese tongs, and street gangs.

Their values? Fierce loyalty toward each other, coupled with a level of competitiveness bordering on paranoia regarding other competing pockets and the world at large.

See where this is going?

Too Big to Fail?

Andrew Ross Sorkin’s book is riveting reading, a blow-by-blow account of who said and did just what to whom during the extraordinary market meltdown that brought down Lehman Brothers, resulted in the TARP legislation, and nearly brought the world financial system to a full stop.

Part of the charm is sorting out the black hats and the white hats; maybe I should say black and shades of gray.

Paulson and Geithner emerge as the flawed heroes. Jamie Dimon plays to the crowd, but is also the only really good manager of the lot, and the only one to show flashes of true industry leadership and something resembling responsible social behavior.

The rest, frankly, resemble refugees from a failed Sopranos casting call. Jimmy Cayne, John Mack, and Dick Fuld in particular come off as mob leaders, with Goldmans’ Lloyd Blankfein coming off better only because of a better sense of a world beyond New York. 

Wall Street as Low Trust Culture

The majority of suggestions to reform Wall Street focus on four solutions:

1.structural cures (e.g. separate investment and commercial banking functions),

2.regulatory cures (e.g. prescriptions for capital ratios),

3.enforcement (e.g. tougher sanctions, more investigative staff for the SEC),

4.compliance (more procedures).

None of those critiques draw the conclusion that feels obvious if you’ve just read Fukuyama: that the dominant model of leadership on Wall Street has been pretty much like the Mafia—or the Sopranos, anyway. Wall Street has been run by a cabal of low-trust, tribal, familistic gang leaders. 

The inability to work as a group when the industry was threatened; the tendency to circle like cannibalistic sharks when there’s blood in the water; the pathological obsession with ‘enemies’ (the most hated being the short-sellers, who as near as I can tell were never shown by anyone to have done any significant harm and who in fact did a lot of good, but were nonetheless the villain of choice); the celebration of loyalty coupled with the ability to flip allegiances on a dime. All these are traits of low-trust cultures.

A trader once told me how he was recruited. 

“The guy from [Big Wall Street Firm] walked into a room of 25 expectant recruits, and said, ‘Who here is motivated by fear and greed?’ Me and another guy raised our hands timidly. ‘The rest of you can go home,’ he said, ‘I’m only interested in these two.”

So how do these clowns get so much power? Amid all the defeatist models that posit human beings as innately susceptible to money, that assume selfish motives are immutable and can only be beaten by more rules and rewards, I still think there is a valid role to be played by culture and character. 

There are more than a few moments of perspective, responsibility and decency shown in Sorkin’s book by Geithner, Paulson and Dimon. Why aren’t there more players like them?

In Sorkin’s final pages, he warns that we’re already letting the opportunity for genuine reform slip by—and not just regulatory and structural reform either. But, he says:

Perhaps most disturbing of all, ego is still very much a central part of the Wall Street machine. While the financial crisis destroyed careers and reputations, and left many more bruised and battered, it also left he survivors with a genuine sense of invulnerability at having made it back from the brink. Still missing in the current environment is a genuine sense of humility.

Whether an institution—or the entire system—is too big to fail has as much to do with the people that run these firms and those that regulate them as it does any policy or written rules. 

Amen to that, Mr. Sorkin. We cannot afford these low-trust types wandering around with their hands on the financial world’s throat.

 
 
 
 
 
 
 

 

The Power of Shame to Fix Low Trust

Randy Schumann Pay Your BillLongtime friend of TrustMatters Shaula, together with hubby Neil, ran across the photo you see on the right here while on the road in Montana. (Click here to see the web version if you’re reading in text).

It seems that one Randy Schumann may have an account in arrears at the local Gas Mart.  And the retailer in question has resorted to a time-honored tradition to enforce some social justice.

Ouch.

Let me suggest, in all seriousness, that we need more Tiger-Town justice, and less Sarbanes-Oxley types of solutions. 

Shame–for lack of a better word–can be good social policy.

Positive Uses of Shame in Creating Public Trustworthiness

The Tiger Town in Montana is hardly alone. 

* Think about the “perp walk,” used by cops and prosecutors quite consciously.  As Wikipedia puts it, “Perp walks are often done to politicians or businesspeople accused of white-collar crimes (whose reputations may be susceptible to damage by public spectacle).”

Rat* The use of the giant inflatable rat as a shaming device is a long-time tool of unions.  But it goes further; the rat is protected legally (I’m not kidding, see here) as a form of free speech.

* Let’s not forget about the (used to be, anyway) power of investigative journalism.  The notion of muck-raking in the US http://en.wikipedia.org/wiki/Muckraker ; the power that the Washington Post put behind Watergate, or the New York Times behind the publication of the Pentagon Papers.

* Local TV news shows delight in consumer protection episodes that go by names like the Wall of Shame, our version of the Puritans’ placing people in the stocks in the middle of town. Cops know it’s more effective to post photos of Johns than of prostitutes (so do town governments, which is why that doesn’t often happen). 

Shame Works by Enforcing Social Standards

It may seem obvious, but let’s take a moment to see why shame works.

Most people intuitively agree with Justice Brandeis that “sunlight is the best disinfectant.”  Transparency is a valuable social vehicle for increasing trustworthiness in our institutions.  Disclosure is a bedrock of legislative regulation—in pharmaceuticals, financial services, and environmental policy.  The idea is that organizations will not put out to the public things that they would prefer not be seen by the public. 

The most powerful thing about shame is that it works by enforcing social standards.  If the behavior that is exposed runs strongly counter to public instinct, then the power of shame is large.

If you are ashamed by something, it means you fear the judgment of the public.  To be ashamed, on a very personal level, means to feel the rejection of our peers.  It is a powerful effect, and serious medicine when administered at scale.

Shame Should be Part of the Response to Financial Scandals

The popular press is all over Washington to do something to prevent further abuses in the financial sector.  The pressure is building, because so far very little has been done.

Part of the problem is that “what should be done” has come to rhyme with massive, heavy-handed governmental regulation.  Worse yet, most of that regulation has to do a combination of prohibition (Glass-Steagall)  and massive efforts at compliance and disclosure.

The problem with disclosure alone is it rapidly degenerates into mountains of fine-print, while accomplishing nothing in terms of felt social obligation on the part of those writing it.

The problem with structural change alone (think Sarbanes-Oxley) is that it’s expensive, and the opportunity costs are even higher than the outlays.  Just think of the massive price we pay every day in airports because we haven’t figured out a socially acceptable way to keep terrorists from planes other than forcing granny in Dubuque to dump her over-sized tube of toothpaste when she boards a plane.

I’m far from alone in this.  Read the devastating critique by famed Madoff whistle-blower Harry Markopolis.  He suggests that what we do not need is the routinized, predictable box-checking approach to compliance.  Instead, we need randomized, aggressive sampling, followed by publicity. 

Exactly. Unexpected audits, followed by the application of shame.  Bring on the judgment of the people who own the society, who are the ultimate source of the approval of whatever goes on in our society. 

Enough with laws and regs; up with enforcement and shame.

And Randy—about that account.  The Rat is next.

Trustworthiness? Or the Appearance of Trustworthiness?

I received an email from my friend (and ex-colleague) Martin, who retired to the Caribbean more than ten years ago.  He makes a point I agree with in language more accessible to him than to me (British, that is).  Since he’s brilliant (by which of course I mean he agrees with me), I thought I’d let readers hear another voice.  

Charlie, we’ve emailed a number of times about words like trust (which you pretty much own), trusting (i.e. when a buyer is trusting of the seller), trustworthy (i.e. what a buyer hopes the seller is).  As I read the commentary on Obama’s plan to improve the regulation of the financial services sector I am getting somewhat depressed. Not, I hasten to add, because I do not think Obama’s heart is in the right place.

My concern is that his regulatory approach doesn’t mandate nor does it seek to combat untrustworthiness. Too often this ‘Nation of Laws’ falls back to the common defense that ‘nothing I did was illegal’ even if it broke all sorts of ethical boundaries with the nadir being reached with the apocryphal words ‘it depends on what the meaning of is, is’.

I am reminded (and this was more years ago than I care to remember) of my initial exposure to the English Legal System in the 17th and 18th centuries where, because of the rigidity of the ‘common law’ (i.e. I didn’t do anything illegal), a Court of Chancery grew up where by the Chancellor could grant some type of relief ‘in equity’ which was essentially "a manifestation of the ideas of justice entertained by individual chancellors."

While one could argue that the plaintiffs attorney business is a sort of surrogate for relief against the ‘nothing I did was illegal’ defense, I wonder if the US needs something similar to the Court of Chancery where there is some body where a person aggrieved by financial creativity could ask the question, "OK, I know what they did to me was technically legal, but was it ‘right’?"

I fear that unless the Obama approach to regulation adopts this sort of philosophy I feel sure that the brilliant students coming our of Law Schools and Business Schools will continue to act in an untrustworthy manner by finding ways of disadvantaging the unsuspecting and trusting buyer.

I know many of your clients are in the financial services industry. Is their aim to BE trustworthy or to appear to be trustworthy?

Best,
Martin

Martin, I could not agree with you more.

As a (lawyer) friend of mine points out, there is no concept of “truth” in the law as it exists in the US today – there is only evidence.  For the MBAs’ part, they (OK, we) replaced relationships with outsourced business processes, and management with metrics, effectively removing any sense of “ethics” by depersonalizing the behavior of human beings.  (Maybe it began when we started calling people ‘human capital.’ Note which is the adjective).  

The combination has been devastating, as you point out.   Look at any corporate org chart where you see “ethics,” and the next two words are “and compliance” – as if they were the same thing.  As you point out, they are–or ought to be–very different concepts.   

And while I too think Obama’s heart is in the right place, this effort was all too predictable.  He is doing precisely what America’s “best and brightest” are taught to do as “best practices,” namely create mechanical solutions to issues of human behavior.  Alter the incentives, redesign the institutions, create more Chinese walls, and–especially–more procedures to comply with.

Commonsense suggests that if you treat ethical violations with procedural solutions, you negate the very conscience that made us call it unethical in the first place.  Do that long enough, and the word "ethical" will become listed as "archaic" in the dictionary.

If you prefer the language of academics and empirical proof to commonsense, try this from Roderick Kramer of Stanford:

Gatekeeping measures may actually have contributed to declines in public trust in business.  These studies have found that “innocent employees” who are subjected to additional compulsory oversight measures often “become less committed to internal standards of honesty and integrity in the workplace.”

To flip Ronald Reagan’s words, the act of constantly verifying destroys trust.  Excessive compliance measures ruin ethics.  Big Brother is death on the human conscience.  The trouble with regulatory answers to misconduct is that they foster more cynicism, more degradation of the real issue into mere gotcha contests.  They trivialize issues that are, or should be, ethical at heart.  As you said.

Martin, I honestly believe that the best answer to the decline in trustworthiness lies not primarily in shifting incentives, or in classical regulation.  It lies in mass shaming of the untrustworthy by the consuming public.

The act of mass shaming galvanizes the public’s conscience.  Whether or not any particular Madoff then “gets it” or not is beside the point: a community itself needs to articulate, for itself, that there are standards that lie well above and beyond the common law of “I did nothing wrong.”  The best Chancery court may be the blunt instrument of public opinion.

Your concluding question should be read by every financial services senior exec, and passed out in the form of a quiz to the general employee base of his or her firm, in the following form:

“Your CXO has said that the aim of your company is not just to appear trustworthy, but to be trustworthy.  Do you believe he means it?” 

Now that’s a scary question.
 

The Trust Week in Review

 

Introducing The Week in Trust: a weekly look at the world through trust-related eyes.

Part news-roundup, part mind-stretching and whimsical, part commentary that didn’t have enough zip to make it into the blog, but which needs saying.

Big Story Department.  

Regulation has got to be the story this week.   Regulation, at least to my schizophrenic view of things, represents the failure of capitalism to regulate itself.  I believe that business is a higher calling, and that it ought to be capable of long-term self-interested thinking.  But you couldn’t prove that by recent history.

According to the Wall Street Journal, Wednesday’s announcement represented “the most sweeping reorganization of financial-market supervision since the 1930s.”

Bruce Carton’s most excellent Securities Docket explains in not-that-complicated language why the WSJ is not being hyperbolic.  Credit cards, exotic derivatives, small banks, private equity, hedge funds, insurance—not to mention more energy behind enforcement.  It’s all coming down the pike.

And it’s not just the finance sector.  Let’s not forget (hey it was way back at the beginning of the week) that the US Food and Drug Administration (FDA to those who can read alphabet soup) will be regulating tobacco.  That was a long time in the making, and a milestone of sorts.

Why such a sudden glut of regulation?  On some level sure, it’s the Democrats. But Democrats can’t just regulate for the heck of it, and not all of them want to anyway.

I contend it is, as I stated above, a failure of self-regulation.  Whether it’s mortgage brokers or CFPs or regional airlines or credit card companies, what precedes regulation is a mountain of self-justifying rhetoric, aimed at short-term benefit of market players against consumers: ironically, thus harming the industry long term.

But enough about regulation, it’s Friday.  Let’s raise our sights.

Who Knew Department. 

What do you do if you’re a government with an endemic social dishonesty problem?  If you’re Indonesia, you open up 7500 ‘honesty cafes,’or food stores where the responsibility of paying the right amount is left to the customer.    I don’t know of any larger-scale attempt at testing the old saw that ‘the fastest way to make a man trust you is to trust him.’  Early returns are it’s working great in schools; in government offices, not quite so much.  

Hey, it’s the principle behind vaccines—expose them to a little bit of trusting, and they’re inoculated against being untrustworthy.  Nothing new to readers of this blog.  But way more fun.

Do guns kill people, or – does lack of trust kill them?  One of those academic studies that makes you scratch your head a bit; you know there’s some truth there even if it’s cleverly hidden behind the English language.

Trust Angles Department.

It’s one thing when a bucketshop broker or a used car dealer gets accused of being untrustworthy—right or wrong, that’s the price of being stigmatized as low-trust. Ho hum.

But what if you’re known for high trust and you get accused?  Ouch.  Big Ouch.  For example, the Canadian Conference Board. Ouch, I say.

What’s it mean to trust your babysitter?  Find out.

You may think trust is down, down, down.  After all, that’s the drumbeat du jour.  But how many of you are happily using cloud computing?  What an act of trust that is.  And sometimes, maybe it lets you down.  But–have you stopped using it?  And what does that say about your level of trust.

Your Opinion Department.

PGA pro Vijay Singh is still wearing his sponsor’s golf hat.  His sponsor, interestingly, is mini-Madoff  Stanford Financial.   Hate it when that happens. 

Is he being loyal?  Or stupid?  You be the judge.  

Please give me some feedback: should The Trust Week in Review be a regular Friday feature of TrustMatters?  Enquiring minds (ours) want to know.
 

Collection Agents: Trusted Advisors, or Creepy Hustlers?

Good salespeople, psychologists and counselors know one basic truth: people are influenced by (and buy from, and take advice from) those who listen empathetically to them before selling, advising, etc.  (This beats approaches like value propositions, for example.)

So what happens when these techniques are used by credit card collection agents seeking repayment from people who are seriously underwater with their credit card? See What Does Your Credit Card Company Know About You?

First, it works. Second, it’s hard to avoid feeling creeped out.

My question: how do we reconcile these two observations? Can you use “good” trust-building techniques for “bad” ends? Does it mean these techniques are manipulative? Or does it mean collection agents are getting a bad rap, and actually raising positive karma in the world?

I mean the question more seriously than you might think.  It has implications for how we try to restore trust by regulation in the financial sector. 

Therapist, or Credit Collections Agent?

Consider Donna Tiff, a 49-year-old Missouri woman who owned $40,000 on multiple cards. Tiff became adept at countering aggressive collection agents by threatening suicide.

And then Tracey came along. She worked for a company that today is a subsidiary of Bank of America. Tracey had talked to Tiff several times and noticed that there was a mistake on her account — an automatic payment was going to be deducted twice from her checking account. If that happened, Tiff’s other checks would bounce.

“I told her, thank you so much for catching that,” Tiff recalled. “And then we talked for over an hour about my problems and raising kids. She was amazing. She was so similar to me. She gave me her direct number and said that I should call her directly anytime I had any questions or just needed to talk about what was going on.”

Over the next three years, Tiff paid off the entire $28,000 she owed Bank of America and spoke regularly with Tracey, she said. And the $12,000 she owed on other cards? Well, those companies didn’t have a Tracey. They never got fully repaid.

It’s a heartwarming story. Unless you’ve seen how people like Tracey are schooled in the art of bonding. What are the odds that the random customer assistant who dealt with Tiff would have so much in common with her and manage to strike such a close bond? I tried to call Tracey myself, using the information Tiff provided. But I was told she didn’t work there anymore.

I asked Tiff if she ever asked Tracey to write off the late fees and the interest charges.

“Oh, no,” she told me. “She was so kind to me. How could I ask her for something like that?”

I remember when Bill Clinton was first running for president in New Hampshire, and his nickname “slick Willy” was brought up. He reportedly asked a friend, with all the sincerity he could muster, ‘am I really a slick Willy?’

I took that story to mean that someone as smart and as good at empathy as he was ultimately had to wonder about his own motives, and whether he himself could tell the difference.

Or, take Bernie Madoff. He flawlessly imitated nearly every aspect of the trust equation. Does that mean that being credible, reliable, intimate and other-oriented are bad things?

Take the classic Turing test.  If you communicate, via a computer keyboard and screen, with two closed boxes—one with a real person inside, and one with a computer—just how do you tell the difference?

And if you can’t, does that mean the computer is human? We want to say of course not—but try explaining just why.

Trusted Behaviors Without Intentions are Empty

In this case, most of us would say the difference has to do with motives.  Does Bank of America intend to help raise the psychic health of credit-battered Americans, and get paid in the process? Or is it in the business of extracting wealth from people to whom BofA sold their credit cards in the first place, cynically using Maslow’s hierarchy as a tool to get there?

It isn’t just hypothetically relevant. It goes to how we regulate trust in society. It shows the bankruptcy of ever and ever-greater reliance on purely behavioral and metrics-based approaches to trust.  Trust without motives is the computer in the box.

If legislators and regulators cannot figure out a way to put integrity into regulation instead of dealing solely with procedural “compliance,” there will always be a Madoff who figures out how to mimic acceptable behavior.  (See Harry Markopolis’ congressional testimony for a far more workable approach).

You can’t strip trust down to behaviors alone without squeezing the soul out of it. When it comes to trust, intent is relevant.

Regulatory Policy 2.0 – The Alternative

[Second of a two-part Blog Post]

Yesterday I suggested that our existing 3-legged approach to regulation (separation, compliance, transparency) not only failed to prevent Madoff, but positively enabled him.

Today I’ll talk about an alternative.

Until last weekend, when the world discovered Madoff hadn’t bought stocks for 13 years (TrustMatters readers heard about it 5 weeks earlier here), the consensus was Madoff was so sophisticated no one could follow him.

Turns out sophistication itself was the ultimate scam. Madoff built a Potemkin village. He knew what a trading system and a hedge fund should look like, and gave us the appearance of one.

In fact, it was just another Nigerian Ministry scam.  Give me your bank account numbers. and I’ll make you rich. Trust me.

The SEC, like all regulators, relied largly on three mechanical approaches:

• structural separations
• compliance processes
• disclosure.

All were built around the modern sophisticated financial world. What they entirely missed was the human element of any great scam. Hide stuff in the most obvious of places. Utterly believe your own lies. Get the con to focus on your spiel while you swap the pea out of the walnut.

They missed the “man” in con man.

If past is prologue, as unfortunately it usually is, there will be a firestorm of protest and we will end up, through the best efforts of Congress, Fox News and the tabloids, with More of The Same. The same trio of regulations that Madoff manipulated. And it will cost billions and billions more in regulation and in stifled economic sub-optimization.

So what’s the answer?

Human-based regulation–beyond structure, processes, disclosure. Regulation 2.0.

Human-based regulation recognizes and embraces three human traits:

1. We live up (or down) to expectations
2. People are infinitely creative–regulators must be as well
3. Selective audits plus severe consequences both inform and deter people.

Set clear expectations. We cannot allow confusion between “ethics” and “compliance.” The phrase “but it was legal” cannot be permitted to be the end of conversation. Regulators have to continue dialogue with non-lawyer citizenry, stay in touch with norms and mores. Most important—they must have a visceral sense of the “rightness” that their agencies were built on in the first place, and unflinchingly convey that sense of mission and expectations to their industries.

Harness Creativity. Regulators can find role models in the audit profession, the IRS, and the GAO. They can look farther afield at successful police departments, e.g. New York City’s counter-terrorism operation. The ultimate objective can never be to just ensure compliance—it must be to fulfill mission.

Visiting RIA offices to review papers too easily becomes a bureaucrat’s exercise. We need regulators who think like cops, who are inherently suspicious, who demand proof, who creatively out-think the Madoff du jour. (Harry Markopolis’ testimony in Congress—the second part—gives excellent examples of this, epitomized by the simple, “is something funny going on around here? Here’s my card—call me if you see anything suspicious.”)

Selectively audit, severely penalize. Auditors and the IRS have excellent track records doing selective audits. You don’t need to examine every book—just let every bookkeeper know that their books might be the ones examined next.

Combined with the public announcement of severe consequences, this approach both tells the industry what behavior is expected, and says they are accountable to the public they serve. It’s like a police perp walk—it publicly shames and humiliates.

(From this point of view, the continued absence of a perp walk for Mr. Madoff, together with the absence of any consequences thus far, sends the wrong message. It says “old” regulation still holds sway: he can stay in his comfortable digs until the legal process grinds its way to some determination of whether or not he has committed a violation of a particular law).

Madoff’s scam was old-school, Nigerian-Ministry, thuggish. That doesn’t mean the SEC employs incompetent people. It does mean, however, that they are toiling under an inadequate philosophy of regulation.

We will not regain trust in our institutions until we remember that trust is, at its heart, a human thing—and begin to act that way.

Regulation 2.0 is a good start.

Regulatory Policy 2.0 : The Real Meaning of Madoff

[First of a two-part Blog Post]

Madoff has been a late-night TV comedy staple for some time now. While his victims surely don’t appreciate the humor, most of use have relegated him to cafeteria conversation, alongside Lindsay Lohan and the Oscars.

That would be a big mistake.

L’affaire Madoff will dramatically affect our approach to regulation. And in this case, our first instincts—can you say, ‘Sarbanes-Oxley 2.0’—would be the worst. We need Regulatory Philosophy 2.0. Here’s why, and how.

The Latest on Madoff. The headlines this past weekend screamed one thing: Madoff Bought No Stocks for 13 Years. ‘Look how brazen he was, how could the SEC miss that, no way his sons weren’t in on it all along, etc.’

It was no surprise to readers of this blog.

On January 17, I wrote, in a blogpost titled Madoff—Investment Fund or Virtual Reality Game

It’s beginning to look like Bernie Madoff’s business model had less in common with a hedge fund or investment management firm than it did with an online virtual reality game. Sort of a Sim City for investors. The money sent in was real: everything thereafter was from Oz…
…[It] was bupkus. Virtual reality money. Sim City money. Monopoly Money. In the real world, it didn’t exist except in Bernie’s bank account and a computer program.

This was not a case of sophisticated hedge fund managers in Greenwich or rogue currency traders in Hong Kong. The SEC was not out-gunned, outsmarted, or out-manned. This was not a Danny Ocean operation.

This was as simple as a Nigerian inheritance email spam scam. Gimme your bank account number and I’ll send you money. A garden variety mugging. Like a good magician, Madoff got us to look one way, while he swapped card decks.

Overnight, this recasts the regulatory task facing the SEC. We can no longer rely on traditional regulatory philosophy: we must get personal, human, and trust-based.

Regulatory Philosophy 1.0. Regulation (and not just in the financial industry) has become driven by three models—separation, compliance, and transparency. None of them stopped Madoff—in fact, they enabled him.

Separation. Think building walls—to legally and physically separate potential co-conspirators. Think traditional anti-trust laws. Think separating accountancies and consultancies. It is a heavy-handed, expensive, and sub-optimal way to regulate.

Madoff used this to his benefit—claiming his brokerage and investment management businesses were separate because, ‘after all, they had to be.’ Therefore FINRA could claim “it wasn’t my job.” Madoff knew FINRA would make that claim; in fact, he depended on it.

Compliance. This approach turns legislation into a blizzard of administrative processes, which must be complied with. Think check-boxes, filed copies, no-later-than dates, renewal requirements. All monitored and tracked in the latest systems. This approach is less heavy-handed, but equally oppressive—and mind-numbing to boot.

Madoff used this also to his benefit. You want forms? I’ve got forms. But the data was itself bogus.

Transparency. Lawyers, financiers, mortgage brokers and credit card operators love transparency-as-panacea. Coupled with a convenient belief in efficient market theory, this enables people to blame those who didn’t read the small print (Rick Santelli, are you listening?).

Madoff used this to his benefit too—blitzing investors with day-trader-like “records” of trades (bogus). We have come to measure “transparency” by the pounds of documents “disclosed,” rather than by their truth or import.

If we focus only on outrage at Madoff and at government bureaucrats, our politicians will do what they’ve always done: legislate more structural boundaries, design more and more checkbox procedures, and require publication of more minutiae. And thus we’ll enable Madoff 2.0–even faster this time.

Regulation 2.0.  There is a better way.

It is based on a simple fact–people are human. People are good and bad, trusting and non-trusting, sometimes all at the same time. Systems don’t commit fraud, people do. In this case, one Bernard Madoff.

Yet our existing regulatory processes are entirely non-human. Walls, processes and transparency are mechanical things. Devised by people, they can be broken by people. And being inhuman–we don’t trust them.

Our existing Philosophy of Regulation does not engender trust. To trust our institutions, we have to return to a simple principle: trust is inherently human. We have taken the human part of trust out of regulation, and we’re paying the price.

Tomorrow’s BlogPost: Why we need to build regulatory policy more around personal trust.

Wanted: Executives with Integrity, or At Least a Sense of Shame

I spoke a few days ago with a thoughtful, intelligent ex-management consultant who understands the financial big picture very well. What was his take on the crisis, I asked him?

“The whole thing comes down to a serious misalignment of incentives of all the major players,” he said. “Low interest rates and rising asset prices led banks, lenders, ratings agencies, credit insurance and other markets astray–everyone’s incentives got way out of whack.”

As a description, I buy it. But as a diagnosis, I don’t know whether to be disgusted or depressed. I think I’ll be angry.

“The incentives are out of whack” is the language of behaviorism—appropriate for a Skinnerian stimulus-and-response study of rats and cheese in a maze. Looking at the world through Skinnerian lenses has many virtues—not, however, including the concepts of responsibility or integrity.

In a time of financial faltering and blooming Ponzi schemes, this matters enormously. We have a once in a decade chance to alter the trustworthiness and ethics of the financial industry.

Will our new financial regulators view this as a chance to redraw the maze and manage the cheese distribution? Or will they also focus on restoring integrity?

How bad is it? Another friend told me about a conversation between an investment banker and a regulator—the banker said, with a sly wink, “You know, you folks shouldn’t be letting us get away with this.”

“Letting us get away with this?” Who put the gun in your hand? Who raised the drink to your lips? Who do these people think is responsible for their actions? The chief behavioral scientist at the SEC?

Just 7 years ago, post-Enron, Samuel diPiazza, tCEO of PricewaterhouseCoopers, and Robert G. Eccles, a former HBS professor, wrote, in Building Public Trust:

…even transparency and accountability are not enough to establish public trust. In the end, both depend on people of integrity. Rules, regulations, laws, concepts, structures, processes, best practices, and the most progressive use of technology cannot ensure transparency and accountability. This can only come about when individuals of integrity are trying to “do the right thing,” not what is expedient or even necessarily what is permissible. What matters in the end are the actions of people, not simply their words…without personal integrity as the foundation for reported information, there can be no public trust.”

Exactly.

Trust, integrity, and ethics are essentially about the link between individuals in society. Not between rats and cheese.

It must be tempting for Mary Schapiro, new SEC head, to respond to the political howling with a new Sarbanes-Oxley. Please don’t. As Jim Peterson says, “Any law that passes the US Senate 99 to 1 has got to be seriously flawed.”

What we don’t need more of is behavioralism–more paperwork, detailed regulations, disclosures, and Chinese walls. What we need more of is what diPiazza said—trustworthiness and integrity. On the regulatory side, that means better enforcement and sanctions.

But politics are critical too, and fulminating politicians can be as short-term focused as any banker. The public has a big role to play.

May I suggest shame, humiliation, and public shunning. Maureen Dowd has made a nice beginning  but everyone needs to pile it on.

Consider two contrasting headlines yesterday:

Ford Has Worst Year Ever But Won’t Ask For Aid

and

What Red Ink? Wall Street Paid Hefty Bonuses.

Which one is about mice, and which about men?

Get mad as hell about this.  Go shame a Wall Street banker today–we expect people to feel shame, not rats, so their response should tell us something.

 

 

How Not to Regulate Untrustworthy Industries

I haven’t done an analysis on this, but it feels like the financial sector has had more than its share of responsibility for scandal in the most recent economic “troubles.” Which makes it even more tempting to regulate by compartmentalizing and dictating specific behaviors.

In the broadest terms, that would be a mistake.

Say you have a 17-year old son who wants to take the family car out at night. You’re worried about alcohol abuse and aggressive driving—things occasionally associated with teenagers.

Do you say:

a. Absolutely not, and I don’t care what Louie’s parents are doing, you’re not going out at night with the car until you’re 18 / have your own car / etc. Period.

b. OK, but here are the ground rules, and if you violate them, here are the consequences; they will be severe and immediate, and I’ll check randomly.

I think most of us would prefer b. If not, just add a year to the age. Eventually you’re going to have to let the kid out at night.

More broadly, the question is: do you regulate by dictating behaviors, or combining audits with enforcement and sanctions?

You could answer this with ideology, or with a cost-benefit analysis. But there is one factor that I don’t think gets mentioned enough. And that is trust.

Let’s say an accounting firm is considered to have abused its relationship with its consulting branch. You could:

a. force accounting firms to sell their consulting businesses or build strong “Chinese walls (basically what Sarbanes Oxley did), or

b. increase the budget of the GAO, the Justice Departments’ enforcement branches, and the sanctions for violation of rules.

Others know more than I about the costs of Sarbanes; let’s just say it was high. But the real cost was that accountants won’t get to rub noses with consultants. Firms won’t have to develop their own policies. They have had to become compliance-driven, not outcome-driven.

The real trouble with structural regulation is that it removes the ability to evolve relationships, or trust, between business entities. Therefore it removes all possibilities for future economic improvement from trust.

Structural regulation is like putting up a concrete fence with your neighbor; it ain’t coming down anytime soon. The opportunity cost is bigger than the out of pocket cost.

In a really excellent NYTimes piece—The End of the Financial World as We Know It by Michael Lewis and David Einhorn (I find them the best source these days for understanding what just went down)–they nonetheless plop for structural approaches.

They are probably right in part; revolving doors from government to industry lobbying, for example, is a pretty sure source of corruption. But structural solutions ought to come as last options, not first.

There are tons of laws governing the financial industry that simply get buried in process, language, bureaucracy, small print. They simply do not get enforced, and if enforced, they are toothless, and even then do not get publicized.

Before we build concrete walls, invest some money in creative auditing, enforcement, and sanctions that really bite. It at least leaves the door open for good players to do something really good with relationships. To grow up and drive right.