This month’s Off The Record focuses on financial scandals and asks whether the succession of Enron-type scandals over the past few years has damaged public confidence in the financial system.
How serious is the damage, and how much trust has been lost? A recent Harris poll found that 90% of US shareholders think that corporate misconduct in the US has weakened investor confidence in the stock market. We wondered what the view was like from Europe.
We found that the view this side of the pond was equally bleak. The pension fund managers and administrators who responded to our survey agree unanimously that investor confidence has been damaged. The only disagreement is about the extent of this damage. A slight majority (56%) think that confidence has been seriously damaged, while a large minority (44%) think it has been damaged ‘somewhat’.
One UK pension fund manager points out that the extent of the loss of confidence will depend on the degree of sophistication or knowledge of the investor: “A professional investor will have more readily understood that there are risks in investing, but nonetheless would have been surprised at the extent of the failures in control procedures.”
The manager of a Swiss pension fund suggests wryly that confidence will return as quickly as memories fade. “In the short term the damage to confidence is serious. But since financial people have no memory there will be no serious damage in the long term.”
We then wanted to know what pension fund managers thought were the main reasons for this damage – corporate misconduct (including fraud), poor investment decisions by asset managers, or any other kinds of misdemeanours or mismanagement.
Again, there is unanimous agreement that corporate misconduct is the main reason. Only one in three managers (37%) blames poor investment decisions. However, one manager has no hesitation in pointing the finger at pension funds – like Enron’s – that invested heavily in their sponsoring companies’ shares. “Certainly for their in-service members this was a very poor diversification measure.”
For many, the combination of mismanagement and misconduct is the main reason for the fall in investor confidence. One manager blames the “apparent failure of auditors to do the job of picking up on dodgy accounts, the apparent ease of hoodwinking investment professionals, and the failure of trust as pension promises have been betrayed.”
Some pension funds see corporate greed as an important contributory factor, blaming “scandalous salaries and bonuses” on the collapse in public confidence.
Turning to the market timing scandal in the US, where mutual fund managers skimmed profits off their own clients, we wondered who precisely had been damaged by this betrayal of clients’ trust. Was it only the US investment management that have been identified by the Securities and Exchange Commission (SEC) and the New York Attorney General, Eliot Spitzer, or all mutual fund managers in the US or managers? Or have ripples of the scandal spread outwards to Europe?
The largest single number of managers who responded to our survey (44%) believe the market timing scandal has damaged only some mutual fund managers in the US. One in five (22%) think that it has hit all US mutual fund managers. However, there is a strong feeling that the damage may have spread beyond the US. One in three managers (36%) say that it has harmed the reputations of fund managers in general.
Bringing matters closer to home, we asked whether pension fund mangers themselves felt that institutional investors like themselves had lost some confidence in asset managers as a result of recent financial scandals.
There seems little doubt from the response that asset managers have some work to do re-building bridges. Two out of three managers who responded to our survey (65%) agree with the suggestion that pension funds have lost confidence in asset managers. A far smaller proportion (30%) disagree and relatively few (5%) offer no comment.
However, even among those who feel that no damage has been done, there is a feeling that necessary lessons have been learned. “It has made institutional investors ask more and more demanding questions of their current and prospective asset managers to ensure that, as far as can be ascertained, their corporate governance and control procedures are up to scratch,” says one UK pension fund manager.
We then asked where you think the solution lies – in tighter regulation and closer supervision of financial services, better corporate governance, or any other remedy. A clear majority (61%) support tighter supervision and regulation, although there are some doubts: “There is little evidence to suggest tighter regulation is effective,” one UK pension fund manager observes.
Some suggest better self-regulation. “External regulation may help but an internal willingness to be firm on corporate governance, segregation of duties, and transparency would help more.” What is needed, he says, is a “culture of doing things right”.
The tyranny of short-termism is blamed by some. Funds should “move back to the long term approach instead of the quarterly mania”, one manager suggests.
Many want a return to an earlier, golden age of “basic ethics and honesty”. Just as many recognise this would not be achievable. One pension fund manager sums up the views of many when he says: “Some integrity would be good, but this seems to be a dying attribute.”
Instead, he suggests that companies should discourage dishonesty by introducing change to the workplace: “Often fraud seems to arise through cosy relationships being built, and agreement to do mutual back scratching, which is more difficult when change becomes more frequent. The jobs of investment managers or those involved in money transactions in vulnerable areas should be rotated on regular but unpredictable timescales and without warning.
“Someone new could sit in the previous incumbent’s desk the next day, or after lunch, looking at what that person had done and checking that it made sense and that there was nothing to ring any alarm bells.”
One casualty of recent scandals has been the company pension plan. A clear majority pf pension fund managers (71%) agree that corporate misconduct or financial mismanagement has reduced employees’ confidence in occupational pensions. A slightly smaller majority (67%) believe that financial scandals have led to a loss of public trust in the providers of pension products. However, there is hope for the industry. “I’d say a reduction rather than a loss of public trust,” one pension fund manager observes. “Most people still prefer pensions for their retirement rather than alternatives such as property investment.”
On a slightly different tack, we wondered whether you thought the investment management community had learned anything from the equities bear market. A large majority (79%) think that a bear market has been a useful corrective for the asset management industry. However, there is scepticism from some: “Evidence suggests that we never learn,” one pension fund manager world-wearily remarks.
One pension fund manager speaks for all, perhaps: “Despite the warnings too few people realised that equities can go down as well as up. Some had a rude awakening – partly through not investing in the most suitable products – and will take some time to be persuaded to re-enter the market to the same extent.”
Finally, we thought we would ask you to choose a New Year’s resolution for asset managers to help them avoid the mistakes of 2003. We suggested: (a) “I will regain/retain my clients’ trust” or (b) “I will put the interests of my clients first” or (c) “I will protect the value of my clients’ capital”. Many voted for all three, but (b) emerges as the clear winner, picked by four out of five (79%) managers followed by (c) picked by almost half (49%) and (a) chosen by two out of five (40%) managers.
All very virtuous. However, one Swedish pension fund manager suggests a resolution which managers are far more likely to choose for themselves. “Most probably a lot of them will wish ‘I hope I will not be found out’ and will repeat this to themselves as a mantra.” Happy New Year.