Ethical Lapses on Wall Street

Wall Street is selling an expertise that does not exist.

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The second annual survey of Wall Street ethics (or the lack thereof) from the law firm Labaton Sucharow generated much interest but few surprises for me. Did you really believe Wall Street changed for the better since 2010 when the Dodd-Frank Act was passed by Congress?

Daniel Solin
Daniel Solin
If anything, the data is not as disturbing as I thought. The fact that only about half of the respondents felt their competitors engaged in illegal conduct, or that almost a quarter believed their own companies acted illegally, was less than I would have projected. The online survey of 250 people who work in the financial services industry including traders, portfolio managers, investment bankers, hedge fund professionals, financial analysts, investment advisers, asset managers and stock brokers found that almost a quarter (23 percent) of those responding have observed illegal conduct or had first-hand knowledge of wrongdoing in the workplace.

I actually found some good news for the securities industry in the survey. Only 28 percent of the respondents felt that the industry doesn’t put the interests of their clients first. Wall Street should consider that figure a victory. I would have put that figure closer to 90 percent. Brokerage firms have been lobbying hard to avoid being saddled with a true fiduciary obligation toward their clients (which every registered investment adviser firm has) because they want to continue putting their own interests ahead of those of their clients. How else could you justify selling your clients proprietary funds with poor historical track records, or high-commission products such as limited partnerships, equity-indexed annuities and (my personal favorite) hedge funds?

Here’s what’s missing from the survey. Wall Street has to act unethically because it is selling an expertise that does not exist. It purports to be able to pick stocks, time the markets and select mutual fund managers who will outperform in the future. Investors are wising up to the fact that no one has these skills, once you eliminate luck from the equation. Numerous studies demonstrate this fact.

Investors are getting the message. According to data compiled by the Investment Company Institute, the market share of stock index funds increased from 8.7 percent in 1998 to 17.4 percent in 2012. As information about the lack of expertise of “market-beating” brokers and advisers continues to spread, market penetration of index funds will continue to increase, with devastating potential consequences for the securities industry.

The recent spate of insider trading convictions of hedge fund managers is illustrative of the problem. If these “masters of the universe” had the expertise to “beat the markets,” they would not have to resort to illegal activity to achieve that goal. The balance of the securities industry is simply following their lead. They can’t produce results justifying their fees. They are losing market share. They are desperate.

I can save those who do surveys measuring Wall Street’s ethics a lot of time. The financial services industry will demonstrate an appalling lack of ethics. They have no other options.

Dan Solin is the director of investor advocacy for the BAM Alliance and a wealth adviser with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His latest book, 7 Steps to Save Your Financial Life Now, was published on Dec. 31, 2012.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.