Consider the case in which the Securities and Exchange Commission charged and then settled with Goldman Sachs over the sale of a financial product called Abacus.1 Goldman was accused, in essence, of working with Client A to create a financial instrument likely to blow up so that Client A could short it (bet that it would lose value) and then turning around and selling that same instrument to Client B, whose expectation was that it would retain its value. Goldman’s defense was that it owed no duty to Client B that was violated. The inference is that Client B’s losses were its own fault—it failed to discover that its trusted advisor was deliberately rolling up excrement and selling it to them. This is an extreme example of caveat emptor; not only must the buyer beware but also he should be on notice that those who have inside knowledge of the situation are going to use it to take unlimited advantage.
How can one possibly thrive in such a situation? It may remind you of those games where, in the end, the only way to win was not to play. That cannot be the right message, though, since we know that the financial markets offer the best opportunities to deploy your capital effectively. Economists speak with great confidence when they state that, over the very long term, diversified stock investments offer the best risk-reward ratio of any major class of investments.2 Stock investments cannot be avoided, and yet they leave you very vulnerable to the abuses that accompany information asymmetries.
What are you, as an investor-negotiator, to do? The answer, of course, is the same thing you would do in any other negotiation. Investing is by no means unique in its vulnerability to the hazards of information asymmetries. To the contrary, the problem exists whenever you negotiate with experts. You must focus your learning not only on the subject matter of investments but also on the people and companies you work with in pursuing them.
Many solutions to this difficulty can be found in Part I of this book. You will also find direct help in the upcoming chapters on “Whom Can You Trust?” and “Who Is a True Professional?” For now, though, remember that you cannot trust blindly but, rather, must negotiate wisely. As for the very specific challenges of investing in a world of knowledgeable sharks, there is no single answer. The best advice is not a simple prescription but a set of cautions and admonitions. You must stay vigilant. You cannot trust imprudently. You must be keenly aware of the problem of asymmetric information and be constantly on guard to avoid being its victim.
Chapter Summary
The people you are negotiating with know more than you do about the subject at hand.
High levels of complexity make matters worse.
This asymmetry leaves you quite vulnerable.
Learn more to minimize the problem.
Don’t trust blindly, but rather negotiate rigorously.
Stay vigilant, don’t trust blindly, and remain on your guard.
Notes
1. Stephen Grocer, “‘Fabulous Fab,’ Goldman and Abacus—a Timeline,” WallStreetJournal.com, July 15, 2013.
2. Jeremy J. Siegel, Stocks for the Long Run: The Definitive Guide to Financial Market Returns and Long-Term Investment Strategies, 2nd ed. (New York: McGraw-Hill, 1998).
Chapter 16
Whom Can You Trust? And Why?
The combination of conflicting interests and asymmetric information creates a situation in which it is unwise to trust most advisors. They may be decent people with good intentions and a warm heart, but, in reality, they are not likely to put their client’s interests ahead of their own. It would be imprudent even to expect that level of unselfishness, and experience shows us that extreme caution is called for in light of typical practices. The incentives are stacked against an advisor being highly trustworthy and, since advisors are human, most of them act on their own interests. This creates a huge difficulty for the client in need of the best possible advice.
For historical and legal reasons, this dilemma is particularly difficult when dealing with our financial lives. The problems of conflicting interests and asymmetric information, however, are not unique to investment advice. Indeed, they arise whenever we pay someone to give us highly skilled guidance about subjects on which they have much greater knowledge, which could include anyone from an auto mechanic to a hairstylist to a financial advisor. What is to be done about this predicament? How can we get the guidance, care, and help we need in an area outside our own expertise without being preyed upon by someone who has the requisite skills?
Be Extremely Careful about Whom You Trust—and How Much
The first step is to trust carefully and only when appropriate. It is tempting to extend our trust to warm people who seem eager to help us. In this busy and overburdened modern world, it is also very convenient. But, of course, it is a big mistake. You don’t offer unearned trust to the car salesman or the other side’s real estate broker. Neither can you give unguarded trust to the financial salesperson. This is a situation that cries out for caution and skepticism.
It is worth examining, though, why we are often less than appropriately skeptical when dealing with financial advisors. Part of the problem, I believe, is that we have a bias toward trusting members of our own team. We are brought up to think in terms of us and them. Our socialization includes rooting for our side and learning to boo (and even hate) the other.
If you think back, this training started at the beginning of your schooling. Most of us went to elementary school and competed against the kids from the other elementary schools in the city. When we got to junior high, our teammates were those kids who had been adversaries at the other elementary schools. In my town, the new enemy was the other junior high. Those two junior high schools dumped into a single high school, and now the adversaries were high schools in surrounding towns. Most of my peers went off to the state university, where their teammates were from all the other high schools. The new enemies were the surrounding state universities. Of course, when bowl games came around, we rooted for our division champion—the very neighboring state U that we hated two months earlier.
So who is really your teammate, and who is your adversary? In light of the constant shifting and rearranging, there is plenty of room for confusion. Somehow, though, we have automatic good feelings about whoever is currently declared to be our teammate. Those good feelings and the blind trust that can grow from them leave us vulnerable to being taken advantage of.
Sophisticated financial firms, aided by top behavioral scientists, make every effort to win your confidence, allay your suspicions, and sit at your table as a trusted member of your negotiating team. I am reminded of the television commercial featuring an older man in a tux making a toast at a young woman’s wedding. “We worked and strived 24 years for this moment. Seeing our beautiful girl walk down that aisle makes all the effort worthwhile.” And then the punch line: “But hey, I’m only the financial advisor, let’s hear from the Dad.”
The effort to win his way onto your team is easy to understand. Whether he intends to serve you or cheat you (or doesn’t know the difference), sitting on your side of the table will bring the advisor great advantage. It is incumbent upon you to see the situation clearly. He is not really on your team in that his interests are not well aligned with yours. The incentives driving his behavior are likely to steer him away from the very best solutions for you. By the very nature of the system he works in, he has remarkably strong motivations to sell you things and ideas for his own advantage. His company wants to use your capital for its own benefit. To all this must be added the lopsided division of applicable knowledge; he knows all about the subject at hand, and you know far less. You are at a sharp disadvantage in dealing with this advisor. That disadvantage will be many times greater if you are mistakenly lulled into complacency by warm assurances of a team effort.
You Can Work Well with People without Trusting Them
As a skilled and confident investor-negotiator, though, you need not fear working with such an adversary. It is not even necessary to think of him as an opponent. You can work fruitfully with such people to create win-win
solutions where everyone comes out ahead. What you cannot do, however, is stop being vigilant about who is fully on your side and whom you should fix with your sharpest negotiator’s eye. These folks may be part of your team, but you must use all your negotiating skills to deal with them carefully, negotiate with them actively, and afford them only the amount of trust that prudence will allow.
To put it bluntly, these are not people you should trust.
You Can Trust Those Whose Best Interests Make Them Trustworthy
Whom can you trust, then, to do what is best for you and put your interests first? Skilled negotiators know that the way to get someone to do what you want is to make it be in their best interest to do so. The folks you can trust are those whose interests will be best served by acting for your well-being and keeping your trust.
In light of the human tendency to act in one’s own best interest, the actions of others can be influenced by changing their incentives. In other words, if you can make it be in your partner’s best interest to do the thing you want him to, he probably will. Even people with greater knowledge, power, authority, and strength can be influenced through a change in their incentives. You can get others to be trustworthy by making it clearly in their best interest to do so.
We trust people all the time because we are confident that their best interests will keep them from betraying that trust. For example, we never worry that drivers will seek advantage by traveling on the wrong side of the road. The negative consequences of the likely crash are simply too great for them to risk it. So, too, we put our lives in the hands of airline pilots without a worry. It is in their best interest to use all their skills to bring the plane in for a safe landing. We trust the tellers at the local bank not to take our money and run off to the casino. It would little profit them to lose their job and end up in jail. The local restaurateur will not deliberately serve us rancid food because word would get around town and his enterprise would be ruined.
I play a game with many of my students in which I ask them to give me a hundred-dollar bill. After they hand it to me, I suggest that I might keep it. They have little worry, though, because they realize my authority and influence as a professor would be deeply harmed if I were to keep the money. Since they know I treasure the teacher-student relationship above most things, there is little doubt that I will jeopardize it for a hundred dollars. (I usually caution them, though, that the result might not be the same for a million dollars.)
In short, we can trust people whose best interests require that they remain trustworthy. By the same token, those whose interests do not require keeping faith are probably poor candidates for our unmitigated trust. Be extremely careful, though, in the educated guesses you make about their underlying interests. If you guess wrong, you may place too much reliance on someone unworthy of it. As a result, you will want to do a whole lot of checking.
Placing trust only in those whose interests and incentives point strongly toward their trustworthiness in a given situation is only a partial solution. It does not solve the problem posed at the beginning of this chapter. How can you get the guidance, care, and help you need in areas requiring expertise you do not have? What are you to do about the danger of being victimized by those who possess the necessary skills? The next chapter offers answers to those very big questions.
Chapter Summary
Be careful with trust, and do not have undue confidence in people because they are nice.
Do not trust anyone simply because they are on your team.
You can negotiate and work well together with people you do not trust.
Place more trust in those whose best interests strongly suggest their trustworthiness.
The problem of trust when investing is never fully solved.
Chapter 17
Professionalism: Who Is a True Professional and Why?
It turns out that society, having long struggled with the problem that people must trust certain experts, has come up with a pretty good answer. Individuals have always needed help, guidance, and care in dealing with their greatest treasures. In particular, our health, wealth, rights, and relationship with the Almighty are areas of great vulnerability. We need assistance but are terribly at risk of being abused by those who would help us. The societal answer is that in these areas our care is entrusted to professionals.
The Traditional Professions’ Struggle with Society’s Need for Trustworthy Help
The traditional professions of medicine, law, and the clergy have unique histories and cultures that developed over very long periods of time. What they have in common, however, is an understanding that service, care, and safeguarding are an intrinsic part of professional work. With this shared knowledge, each of the traditional professions trains and socializes its members (novices and elders alike) in these core attributes that are simultaneously skills and values. To be a member of one of these professions requires mastery of a body of knowledge, some sort of certification or passing of a test or assessment, and an apprenticeship of one kind or another. I propose, however, that what they ask for is far greater than that. The traditional professions seek from their practitioners, not only skill, but also adherence to a code that has at its core an understanding that professionals must not violate the complex trusts placed in them by those they serve. It is this focus on faithfulness that is the essence of what separates professionals from others possessing skill and knowledge.
To be a professional, historically, was to be a member of one of these traditional professions. To gain such a place was not easy; it required long, hard work, intense study, and passing various tests. It also required undergoing a powerful socialization; the professions went to great lengths to get their members to think and act as prescribed. Included in this socialization was some variation of the idea of keeping trust. Furthermore, once a person had attained this status, the profession itself was always looking over her shoulder and seeking to encourage, maintain, and enforce the agreed-upon codes and expectations.
The Traditional Professions Don’t Always Succeed—but They Must Always Try
My purpose here is not to idealize the historical professions. It would be naïve in the extreme to suggest that they have always been effective in training and socializing their members to serve and safeguard with the highest levels of faithfulness. The professional bodies, as well, were often as interested in self-protection and promotion as in loftier goals. Sometimes they function more like guilds than as protectors of the highest societal needs. The point, though, is that when they have failed to uphold their self-articulated highest ideals, they have badly fallen short of their avowed professionalism. The professions, and their members, are far from perfect. In their unattained perfect form, however, they are the answer to the great societal problem of who will fairly and faithfully help people protect that which is most precious and important.
Of course, it is neither practical nor reasonable to suggest that an answer lies in always getting a highly ethical physician, lawyer, or member of the clergy to help us with all our problems. We are a society served by a great many groups, vocations, and practitioners. How can we pull together the highest levels of knowledge, skill, training, certification, and apprenticeship and effectively blend them with the concepts of keeper of trusts and safeguarding agent who will never violate or betray the precious things placed in their care?
Reclaiming Professionalism
The answer proposed here is to reclaim the notion of professional and restore to it a precise meaning and high purpose. Our modern society has allowed it to evolve into a word for anyone who has a strong set of skills. This has led to confusion and a loss of usefulness. We have left out the most important part.
After many years of thought and study, I have concluded that the most useful definition of what makes someone a professional is this:
A true professional uses his or her ability and power solely to advance the best and truest interests of the client. When the professional’s interests diverge from those of the
client, the professional always follows only the client’s interests.
By decoupling professionalism from particular groups and, instead, defining it by its special attributes, we can broaden our understanding of who may legitimately be viewed as a true professional. Such a definition, however, stays faithful to the teaching of the traditional professions found in their codes, training, and socialization. The professional uses her skills, knowledge, experience, and training solely in the service of the client. Indeed, whatever power of any kind she possesses is to be brought to the exclusive task of advancing the client’s interests. Although the professional makes a very good and fair living, she is never permitted, under any circumstances, to enrich herself at the expense of that client.
This notion of what makes for a true professional, with its attendant strengthening of expectations and duties, can guide practitioners and providers to a higher level of service and responsibility. By restoring the concept of professionalism to the level of responsibility and trustworthiness prescribed by the traditional professions, a new set of obligations will be assumed by those who would hold themselves out as professionals. This will lead to greater openness, conscientiousness, and reliability on the part of those who wish to be viewed in a professional light. This, in turn, will drive a commercial imperative; few people will seek guidance from less than a true professional. Thus, the choice to embrace this new understanding of professionalism simultaneously helps the practitioner and the client she serves.
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