[Xantar]

The problem is that most of these CEO's compensations are derived exactly as you said: They come from the bottom-line, and thats how the books get cooked so that they can get their bonuses while the company slowly slides into bankruptcy so the CEO can keep their job and walk away with a ton of cash.

Right, but the thing about financial malfeasance is it's always discovered, and investigators are pretty good about figuring out who's at fault in the end. My proposal (which does not necessarily conflict with yours, but we'll get to that) is that stock options issued to company employees should be able to have negative value. We'd also probably have to mandate that people hold their stock for a year after leaving the company. Anyway, I'm just throwing it out as an idea.

Force the financial industry, specifically securities, credit and banking, to form a national self-regulating association with ethics standards, like in Real Estate, Medical and Law. Right now financial ethics are determined by the institution and there is no reprocussion for their violation.

I think it's important to think through all the implications of what you're saying here, so I'm going to lay them out as I understand them. You tell me if you disagree with any of it.

What you are proposing is that financial professionals be licensed by some voluntary, non-profit group just like like the medical board for doctors or the bar association for lawyers or the board of accountants for CPAs. People working in those professions are required to possess and maintain a license to practice for two reasons:

1. Their work is so complicated that only people who have been competently trained can do it, and

2. Their job is considered an essential service to the public.

Point #2 is especially important because that's why the profession has mandatory regulation for itself. A computer programmer can be certified to a certain level, but it's not actually illegal for him to work without certification. The idea is that if he screws up, his work can be fixed easily and in any case, the computer programming profession isn't about saving the world (most of the time). But a doctor or a lawyer or many other kinds of professionals have such great responsibility on their hands that they must be restrained by a code of ethics to prevent them from doing great harm to the public interest.

I certainly agree that financial professionals wield a great deal of power and should probably have some voluntary industry standards at the very least. But as I see it, for ethical standards to be set and enforced, there has to be licensure by a professional association, and for such an association to exist, there must be some mandate that this profession exists to serve the public which is why there are those ethical standards.

I'm not saying I think that's a bad idea. I just think it's kind of an interesting way to look at investors. They usually think of themselves as serving their own interests and it just so happens that the byproduct of their collective action benefits the public.

Now maybe you didn't mean for this association to set ethical standards so much as professional standards. In other words, the Association of Financial Professionals wouldn't set rules like "You must withdraw in cases of conflict of interest" and would set rules more like, "You must adequately investigate your investments" or "You shall not mix mortgages with other types of investments." This makes financial professionals into something more like a computer programmer who is supposed to adhere to published guidelines but can't be banned from working if he fails to do so. The problem with that is, as I said before, if there's no ethics mandate, then you can't justifiably ban someone from the profession.

Anyway, however we decide to structure it, the main concern I have about your proposal is the part about using the courts. I think courts have a role to play, but I would be much more careful for a few reasons. Firstly, a court case is long, costly, and almost never leaves anyone satisfied with the result. I worked for the Superior Court of Delaware for two years, so believe me when I say that's the reality.

The second problem is that a case of financial wrongdoing could be pretty complicated — way too complicated for a jury to understand. I saw eight medical malpractice cases brought to trial in my time, and I honestly don't believe a single one of them was decided justly. Some of them had results I agreed with, but it was clear to me that the jury was basing their decision on the likability of the doctor rather than the facts. I have no faith in a jury's ability to do any better when deciding a "financial malpractice" case. Yes, you could just have the case decided by a judge or an arbitrator, but the Constitution says that if a defendant wants a case brought to trial before a jury of 12 people, we have to let him do it.

The compromise in Delaware was that cases worth less than $100,000 are required to go through an arbitration hearing first before they can be allowed to go to jury trial. That sort of has its own problems, though. Arbitrators are lawyers themselves, and they all feel a certain solidarity with fellow lawyers. It's just human nature. The result is any case that makes it to arbitration is almost always awarded at least a little money. Likewise, my instinct is that if a case is brought up before a panel of investment bankers, stock traders and other such financial professionals, they will not be able to avoid being influenced by their common backgrounds. One way or another, the interest of the public will not be totally served.

A set of ethical rules set by a professional association seems like a good idea to me, but I think we have to also somehow change the balance of incentives. If we don't do that by altering stock options, then maybe we should mandate that certain clauses be written into executive employment contracts. Or maybe we should require that 25% of a company's voting stock should be owned by the public (boy, good luck getting that one passed). Or maybe something else. I think you and I agree that market-based incentives are the most efficient ways to alter human behavior, and I think there must be some way of changing the incentives around in the financial markets.