ITN (a British-based independent news service) recently published a poll finding trust in the financial sector is at an all-time low, with just 10% of respondents believing bankers tell the truth.  This puts bankers even lower than journalists and politicians.

Yet if trust is the bedrock of financial intermediation (it is), how can the system even endure, much less serve the critical social and economic functions it should?

This is the subject of John Kay’s Finance needs stewards, not toll collectors (also published on the FT, but behind an on-again off-again paywall).  If you don’t know who John Kay is, you should—and not just because he’s a prolific and insightful writer on economics born in Edinburgh (cf. the fellow on the masthead).

John distills the workings of “financial intermediation” down to this:

The core purpose of a financial system is to enable savers to have confidence in borrowers whom they do not know: confidence that they will earn the returns they expect and be able to realise their investment when they need funds. […]

In the equity investment chain, asset holders and asset managers need to be trusted stewards of savers’ money. Company directors need to be trusted stewards of the assets and activities of the corporations they manage. In the absence of such trust, intermediaries become no more than toll collectors.

It is hard to see how trust can be sustained in an environment characterised by increasingly hyperactive trading, and it has not been.  Trust is essentially personal and cannot easily be found in a dark pool. Impersonal trust can be established only in a rigidly disciplined organisation – the kind that retail banks were once but are no longer – or by regulation of a ferocity that has not been achieved and is probably not achievable.

The chain of intermediation in the equity market is long [yet] trust in the chain can only be as strong as trust in its weakest link.

I don’t know about you but in reading this I immediately sensed a powerful analogy to how compensation practices in BigLaw have changed over the past few decades.

Let’s review.

Given these premises, and sticking with what John Kay just told us talking about financial services:

• Trust is integral to the functioning of the system;
• The phenomenon of “impersonal trust” was dubious to begin with and has now gone all but extinct; and
• Frequent transactions, rather than long-term relationships, corrode trust.

Now let’s think about how regulation has changed over the past few triumphal decades for the financial services industry. Kay (and I agree) submit that it has gone in precisely the wrong direction.

Most asset managers want to do a good job – earning returns for their clients through strong, constructive relationships with the companies in which they invest. Most corporate executives also want to do a good job, leaving the companies they manage in a stronger competitive position. Both asset managers and company bosses find their capacity to achieve these results diminished [by] a culture in which financial rewards – often of absurd generosity – are linked to measures of short-term performance.

In the 1970s and 1980s, financial market regulation largely abandoned a system structured to limit conflicts of interest, which encouraged businesses to build reputations on their performance of specialist functions. The new approach was based on behavioural regulation, designed to combat inappropriate incentives by detailed prescriptive rules. The outcome is regulation that is at once extensive and intrusive, yet ineffective and largely captured by financial sector interests.

In other words, we have shifted from an environment that rewarded building long-term reputations to one designed to micro-manage incentives—always and everywhere presumed to consist of extremely short-term monetary consequences, and nothing worthier or more aspirational.

If this isn’t beginning to sound familiar to you, it should.  Looking back 10, 20, or more years, far more of partners’ compensation was based on seniority and on cultivating enduring relationships with institutional clients. Today I’d wager the leading set of metrics for most AmLaw firms when the annual comp review committee assembles is a combination of (a) value of new business client development; (b) value of “owned” client relationships; and (c) tonnage of billable hours, pure and simple.

Missing from this equation is anything relating to dedication to the firm as a vibrant, enduring enterprise—one worthy of belonging to for the larger part of a career.  Every single one of these metrics is individualistic, and worse—portable.

The question is: How can we begin to return to the time-tested principles we know used to work so well?

To start, let’s not assume everyone involved is venal and grasping.  Let us not, that is, assume the worst.

Our friend Kay puts it thus in the context of financial services (emphasis mine)

[R]ewards need not be exclusively financial. Discussion of incentives often begins today from the false belief that only cash can influence behaviour. [A] system that depends on attracting people to base activities through base motivation is fundamentally flawed.

I fear our compensation systems have suffered the same error that has brought respect for and trust in bankers and financial services to the sub-basement; we have indulged in an extreme focus on short-term behavior, and we have assumed the worst about what motivates our partners.

We can debate whether this dynamic has exacerbated client pushback on fees; I leave that for another day.

But I urge you to ask yourself:  Do I get up out of bed in the morning to participate in and serve a firm and a vibrant institution I believe in and want to help build for future generations?  Or is it for Brand Me?