Leaders and Fiduciaries

Leaders and Fiduciaries
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There is a war of words waging about Goldman Sachs and its role in the larger financial crisis of 2008. The emerging battle lines concern what the bank's leadership did or did not do in betting against mortgage-backed securities - bets that in 2007 alone yielded $4 billion in profit - while at the same time marketing these securities to institutional investors.

On one side of this intensifying conflict, Goldman executives insist they did nothing illegal.

On the other side stands the SEC, Justice Department officials, members of Congress and an increasingly curious American citizenry.

Meanwhile, senators on Capitol Hill have been eager to highlight the yawning chasm between what happened to Wall Street and Main Street in the wake of the financial crisis. And around kitchen tables, American families continue to shake their heads in puzzlement (and, more often than not, anger) as they tally their own losses from the financial crisis. Americans understand quite clearly that their own economic circumstances (and futures) are directly affected by the actions of Goldman's leadership and those of a small number of other large banks. Americans also realize that most of these individuals and their institutions are better off - by some measure - than they were before the financial crisis unfolded. Small wonder that all over the country men and women are scratching their heads and asking the question that David Byrne posed on the Talking Heads' "Stop Making Sense" album: "My God, how did I get here?"

So How Did We Get Here?

The answer is less complicated than most of the conversations now unfolding in the corridors and hearing rooms of power would have us believe. At the root of the financial crisis - and what we learn and build in its wake - is the issue of leaders' responsibility to the people they serve. In the world of investment banking and other kinds of financial decision-making, the term for this responsibility is "fiduciary duty" and it has an important legal pedigree, one that warrants a closer look as we consider the choices a range of powerful people made on the long runway to the financial crisis.

The word "fiduciary" comes from the Latin word for trust. In legal terms, it connotes a person who holds assets in trust for a beneficiary and who is bound to act for the benefit of that person, persons or institution. Since 1929, when a judge named Benjamin Cardozo delivered the precedent-setting opinion, the courts have held fiduciaries - from lawyers to money managers to college trustees - to a very high standard of conduct. Here is Cardozo:

"Many forms of conduct permissible in a workaday world for those acting at arm's length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the "disintegrating erosion" of particular exceptions.... Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. It will not consciously be lowered by any judgment of this court."

If we think for a moment about why Cardozo goes to such lengths to define a standard of behavior grounded in "a punctilio of an honor the most sensitive," we realize that a market economy (or we might add, a viable democracy) depends critically on fiduciaries making decisions - millions everyday - for countless of beneficiaries. Money managers make them as they trade stocks and debt; attorneys make them as they administer estates; and trustees of institutions make them as they help lead such organizations.

Why do modern economies - and indeed the increasingly volatile global financial system - need fiduciaries? Because individuals and institutions cannot on their own make all the choices required to manage their respective assets. So, if capitalism (in all its shapes and sizes) is to function effectively, we need fiduciaries. Those individuals must be held to an unquestioningly high code of conduct. The alternative to such a standard is anarchy and systemic corruption with its corrosive effects on economic, social and political possibility.

At this juncture in history, when so many people in power have played fast and loose with the trust, assets and more, granted to them by millions with less power, it is useful to take the concept of fiduciary responsibility out of the legal drawer and shake it out beyond the courtroom. Everyone in positions of authority - from Lloyd Bankfein, the CEO of Goldman Sachs, to the ratings agency executives who oversaw the evaluation of billions of dollars of mortgage-backed debt to the congressional representatives who refused to regulate derivatives while accepting large campaign contributions from Wall Street - are fiduciaries; that is, they are individuals to whom property or power is entrusted for the benefit of another.

Seen through this lens, it is clear that what lies at the heart of the financial crisis is a widespread, ongoing ignorance -some might say abdication -of the responsibility that must accompany leaders' authority.

This is bigger than lawsuits and bigger than the war of words erupting in congressional hearing rooms this week. This is about the essence of worthy, effective leadership and its centrality to the American economy and polity.

Nancy Koehn is a historian at Harvard Business School and noted authority for providing analysis on the social and economic impact of entrepreneurship and on leadership in turbulent times.

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