Unconscious (Ethical) Incompetence: The Curious Case of SAC Capital Advisors
Noel Burch is credited with formulating the Four Stages of Competence model. It describes the psychological states involved in a progression of competence, as in:
1. Unconscious Incompetence
2. Conscious Incompetence
3. Conscious Competence
4. Unconscious Competence
The model has always struck me as one of those so-obvious ideas (like spreadsheets) that the miracle is no one ever thought of it before. It just makes sense.
It is usually applied to the mastery of skills, expertise, or knowledge. It is equally interesting, however, to apply it to the concept of moral development in people and in organizations. Which brings us to the curious case of SAC Capital Advisors.
SAC Capital: The Contradiction
Last week, SAC Capital Advisors was indicted by a Federal Grand Jury in New York for insider trading. The firm pleaded not guilty, and of course nothing I say here should be construed as an opinion on the merits (and my legal credentials are zip-squat anyway).
In reporting on the story, New York Times financial reporter James B. Stewart highlights an interesting question:
According to SAC Capital Advisors, the wildly successful hedge fund now accused of systematic crime, the firm not only has “a strong culture of compliance” intended to “deter insider trading,” as the firm put it recently, but may also have one of the most rigorous and “cutting edge” hedge fund compliance programs in the country.
The firm said it spends “tens of millions of dollars,” on compliance, “deploys some of the most aggressive communications and trading surveillance in the hedge fund industry,” has hired big-name lawyers like Peter Nussbaum and Steven Kessler to oversee compliance, and has a staff of “no fewer than 38 full-time compliance personnel.
Which sets up the question: What were they doing?
Two Scenarios for Going Bad
Let me suggest a continuum of answers to that question, with the two extremes reflected in the following two purely hypothetical internal conversations at SAC following the indictment:
Version A: “Can you believe our bad luck? Just when everything was going so great, some flunky up and blows the whistle on the greatest inside deal since Teapot Dome. It was perfect! I guess it was too good to be true, something had to go wrong some day and we’d get found out. Well, let’s fight the hell out of it and see what we can still walk away with.”
Version B: “Can you believe our bad luck? We take compliance seriously around here, nobody spends on compliance like we do, we’ve got the best systems in the business, the best programs, the best communications and the best lawyers to make sure we’re squeaky clean, and – a couple of lousy bad apples come in and ruin it. Not only for us, but for our clients as well. If they only knew the opportunities we pass up… For crying out loud, when is enough; blood from a stone. We are over-regulated to a T already, how much more compliant can you get?”
I don’t know about you, but I’d put money on the B end of the continuum. What looks like clear malfeasance from the outside all too often looks like business as nearly usual on the inside, with shrill grenades of misunderstanding being lobbed in from the outside. Whether it’s SAC, Enron, WorldComm, or the generals in charge of preventing rape in the military, most frogs sitting in the water don’t notice the temperature rising to a boil.
Which raises the ethics conundrum – Scenario B is a form of Unconscious Ethical Incompetence. The doers of badness do not recognize that it is badness they are doing. Indeed, they often see it as goodness.
In the Four Stages model, unconscious incompetence is the first step in the process. That heightens the contradiction, because the evil-doers in such cases think they are actually at the opposite end of the scale – having already internalized the right behaviors so that they are unconsciously competent. Nothing could be more wrongheaded and insulting, they think, than to suggest they are actually at the bottom of the scale!
Hence the reaction – not guilt, or even remorse, but pained indignation. Moi? Nous? Surely you jest.
You Can’t Depersonalize Trust and Ethics
Cases of this sort highlight a vicious circle in managing for trust. Violations of trust are met with new processes or procedures for preventing it in future. Since so much of business is about processes and metrics, this is seen as a perfectly normal response.
However, by turning trust and ethical issues into issues of process, they are robbed of their context in a relationship, and therefore stripped of their human quality. The predictable result of this is to lower the internal standards of conscience and social behavior, which then leads to more violations. And on, and on.
This is the substitution of quantitative, transactional, impersonal focus for qualitative, relationship-based, human phenomena. Unless checked, it only gets worse. Financial services is only one of the most obvious industries in which this happens. You can see it in pharma, in many sales organizations, even in academia.
Unfortunately, most outside consultative solutions to institutional trust issues tend to focus primarily on traditional change management factors – incentives, structures, communications (or culture, which I tend to see as the result of all the other things). But those traditional change management factors, which work so well when introducing quality or customer focus initiatives, have limited range when it comes to issues of trust and ethics. In fact – they make it worse, by implicitly suggesting the issues are ones of incentives, structure and communication.
What is sorely needed is something that sounds too old-fashioned – personal role-modeling of character-based behavior by leaders. Personal actions at the most minute level – comments, reactions, shading of language, confidence of decisions, personal displays of integrity in the moment. These are the things that employees notice, absorb, and emulate.
Former SEC Chairman Harvey Pitt had done some consulting for SAC. He told reporter Stewart that he “Came away from his visit to the firm unimpressed. ‘My sense was that it was a check-the-box mentality, not a serious commitment,'” he said.
Whether he was right or wrong about SAC, the distinction is powerful. As Mr. Pitt also said, “When it comes to compliance, you have to live, eat, breathe and drink it. It has to be embedded in a firm’s DNA.”
And the route to the firm’s DNA (metaphorically) goes straight through that of the leaders (literally).
Hi Charlie- over the weekend my friend Francine McKenna over at TheAuditors wrote a very interesting piece that provides additional support for your check the box mentality argument, bringing in yet another “player” into the mix. http://bit.ly/13rsl0s
Barbara Kimmel, Executive Director
Trust Across America – Trust Around the World
Thanks for the reference; interesting and informative.
Though I have to say, much of what Ms McKenna is saying fits under my heading of “Violations of trust are met with new processes or procedures for preventing it in future. Since so much of business is about processes and metrics, this is seen as a perfectly normal response.”
She suggests that more enforcement, or more clear guidelines for auditors, are appropriate ways to go. And at the margin, that’s always going to appear to be the case.
But, just like the never-ending war between cryptographers and the people who try and break codes, staying within the boundaries of laws and enforcement and processes is going to ultimately dig you deeper. The way out of that loop requires that we get, yes, out of the loop.
Maybe a more optimistic analogy would be hackers. The trick is not just to get better hack-resistant codes and tougher laws against hackers – it’s also to flip them, turn them, get them to switch sides and work for the white hats.
Leaders who themselves are passionate about trust and ethics will figure out ways to imbue it in the organization.
A good post. But I want to take issue with something you said that is tangential to the main thread. You said
“Unfortunately, most outside consultative solutions to institutional
trust issues tend to focus primarily on traditional change management
factors – incentives, structures, communications (or culture, which I
tend to see as the result of all the other things).”
Yet your recommended solution to corporate ethical disfunction is that leaders model correct behavior. This is every bit as much culture as incentives, structures and communications, if not more so.
I completely agree, and thank you for making the clarification. Role modeling correct behavior is an important and valuable contribution to changing corporate culture in almost all settings. I should have been more clear, so as to state that, in the case of trust and ethics, I consider that particular culture-creating tool to be multiples more important relative to the others. It’s the relative level of emphasis that I’m saying needs to be upped.
My apologies for not having been more clear, and thanks to you for highlighting it.
It occurs to me that the focus in incentives, structure and formal communications is part of consultants culture, as they are things that are relatively easy to analyze, explain and recommend. Hard to get paid for telling CEOs to do the right thing and wait for it to trickle down.
Charlie, I enjoyed the post and generally agree with all your points. But I think you let SAC’s clients off the hook. Their clients want returns that beat the benchmarks and don’t want to know too much about how they achieve that. Clients have to demand ethical behavior in order for it to make it into the DNA. But lets not let the rest of us in the 99% off the hook too easily. We all want competitively priced iPhones. We all now know how Apple is able to do that….cheap Chinese labor in Foxcom’s sweatshops. We don’t demand that Apple clean up its act in a meaningful way, just as we don’t demand of garment manufacturers that they support effective building codes in Bangladesh. Are we any less to blame than the clients and executives at SAC? Rich
Yes, we are less to blame. I don’t buy the “everyone’s doing it” line as equally exculpatory to the doing of it.
But you’re certainly right, there’s hypocrisy in going along with it, and it makes it all very difficult to change, no doubt.
In a similar vein, I note a story today on how students from easy-grading schools are more likely to get admitted to business school than kids from schools that are trying to fight grade inflation. That one, I think, is all about passive acceptance – both on the part of the MBA programs, and of the schools taking the easy way out in grading. A tough issue.