This week I spoke at a conference where Andy Fastow, ex-CFO of Enron, also spoke. I found his presentation to be one of the most thought-provoking and enlightening discussions on decision-making I have ever heard. I engaged him during the presentation and we got together after and spoke some more. In this post, I share what I learned and a moral gray area that affects the vast majority of advisors. I would have never considered it a moral gray area before this talk, but the reality is that life is full of gray areas and our opinions and decisions are largely influenced unconsciously by incentives, biases, and gray areas.
Before Andy started speaking I wondered what he might say and whether he could even be trusted. I didn’t know the guy other than what you may know about him – he was deceitful with Enron’s accounting and was a major contributor to their downfall. He was refreshingly open and honest, making a joke that the only reason he is in demand as as a speaker today is because he went to prison, for which he is reminded every day and is ashamed and embarrassed of. We all make mistakes – his happened to be quite big and public. But what led to the mistakes, the slippery slope of moral decisions, can affect all of us. And this was largely the purpose of his talk – to help us be aware of these unconscious influences. And for that, I found the talk one of the most enlightening I have heard.
Andy, as he stated, won CFO of the year, was lauded as a financial genius, and went to prison for the same financial shenanigans. Think on that for a second. His creativity in off balance sheet reporting and special financing made him a Wall Street darling and caused him to serve six years in prison. In his own words, through creative accounting, he was able to mislead investors by making what should have been a BB- rated company appear as a BBB+ company.
Can You Follow the Rules and Be Immoral?
One thing Andy often said in his talk is that he, and others at Enron, were rule followers. They weren’t out to break any rules. They were simply looking for loopholes and ways to show their company in the most positive light. Every deal he did was approved by auditors, lawyers, and the board of directors. How could that be? Because their job was simply to make sure Enron was following the rules. When an idea was presented that would creatively solve a problem (or make the company look better than otherwise) the team would see if they could do it. Oftentimes, the answer the would get is, “there is no rule that says you cannot do this.” And so they did it. Sure, they may have been intentionally trying to make their finances look better than they were, but they were following the rules. And that is how it was justified. They were following the letter of the law while making a mockery of the spirit of the law. Just because rules allow something doesn’t mean it is ethical, moral, or right to do.
The Financial Advisor Moral Dilemma
That evening I thought more on what Andy shared about all the gray areas we face in life. And I thought what gray areas might we financial advisors face. There is one, in particular, where the vast majority of advisors follow the rule, but may not be completely forthcoming. And that is with respect to investor cost.
When an investor asks how much this (relationship, portfolio, services…) is going to cost, many advisors will quote their AUM fee schedule. And that is correct. You are giving them the information they are requesting – you are following the rules. But does it go far enough? Are we (unconsciously) misleading investors over the true cost to investors? Let’s face it, what people want to know is what the total cost of any product or service will be…not just how much compensation one party in the transaction will receive.
The True Cost of Investing
Many advisors employ investment strategies that include mutual funds, exchange-traded funds, or other investments have have their own internal expense ratio. Do we include that when we are providing the cost to investors? I would say most advisors do not. Why? Because it will inflate the costs and if their competition isn’t disclosing those costs, will make them seem comparatively higher. And if the client didn’t ask, why should we disclose it. They could read a prospectus after all…in fact they should! All of that is following the rules, but is it right for the client that really wants to know the total cost?
We could improve our transparency and reduce any moral dilemma by stating our AUM and then stating that there are fees of underlying investments we use that range from [an example] 0.03% – 1.20%. For advisors that use mutual funds with higher expense ratios that may be hard to justify to a client, this would be a great opportunity to contemplate whether such expense is really in your client’s best interest or whether there may be lower cost alternatives that you would feel more comfortable disclosing. The slippery slope of decision-making and gray areas exists everywhere. Being aware of it is the first step to improving your decision-making.
Related: When Profit Maximization Fails