The accounts I have read or heard of the ousting of Daniel Godfrey from his position as Chief Executive of the Investment Association offer numerous and wide-ranging ‘explanations’ of the underlying reasons. The lack of buy-in by fund managers to the Investment Principles are cited by some, the progressive approach to transparency by others, and the research on executive remuneration in the fund management industry by a few – and all of these, and more, figure in yet other accounts. No matter the motivation of any or all of the various actors, the process has been a public relations disaster for the fund management industry; a farcical mismanagement that would lead to calls for the resignation of board members in other industries. In its wake, a veritable industry of tales of bullying, deception and collusion by the industry has emerged. One example of this is the now recited but unsubstantiated line that there are some 300 forms of unreported cost. Anecdote rapidly becomes common and accepted knowledge. This will have done nothing for the public perception of the industry or their trust in it.

If regulatory things weren’t bad enough already, this is a direct challenge to one of the FCA's objectives: We aim to support and empower a healthy and successful financial system, where firms can thrive and consumers can place their trust in transparent and open markets.

In fact, the Principles look anodyne to an outside observer, statements of motherhood and apple pie. The ten Principles are:

  1. always put our clients' interests first and ahead of our own
  2. take care of clients' money as diligently as we would our own
  3. only develop, offer and maintain funds and services designed to add value for clients and help them achieve their financial goals
  4. maintain and apply the investment and operational expertise needed to meet the objectives agreed with clients
  5. make all costs and charges transparent and understandable
  6. disclose to investors the source and value of any other material benefit we receive as a consequence of our role as investment manager
  7. ensure regular, timely and clear lines of communication with clients
  8. set out clearly our approach to the stewardship of client assets and interests
  9. maintain a corporate culture that sustains these principles
  10. work with industry colleagues and stakeholders to develop and maintain guidance on industry best practice

The sub-text to Principle 5, which covers costs and charges, is equally bland: We explain our fee structures as simply as possible and the structure itself must be understandable. We also disclose all other costs that could be expected to affect returns in a simple transparent manner. We use standardised approaches to provide comparability. I look forward to hearing answers to the following question from those who have not signed up: What is it about these principles that is so objectionable that only 25 of the hundreds of Investment Association members have subscribed to them? Surely, it cannot be a matter of inadequate time to consider them as the Principles were released in April 2015.

It is interesting that the review of executive remuneration currently under way, and in which the investment association is participating, is considering only the complexity of arrangements when the widespread and popular concern is with the quantum; sleight of hand worthy of Maskelyne, who also invented the pay toilet. I will offer a straw man for the resolution of this question of excessive executive compensation, which was devised jointly with Chris Golden (See: https://chrisgoldenblog.wordpress.com/2013/07/08/)

There are four constituencies that have a claim on a company's earnings. They are:

  • The shareholders: shareholders do, after all, own the company, and may legitimately feel that they have a right to at least some of the company’s profits.
  • The employees: any given employee may well be replaceable (even the ridiculously overvalued CEO or trader).But the employees as a whole are essential. They should therefore expect to get paid, and to be paid fairly relative to other employees of the same company.
  • The taxman: all companies require the basic infrastructure provided by the society within which they work, whether that infrastructure comes in the form of a framework within which the law of contracts is upheld and enforced; or in more practical ways such as the maintenance of the roads used to transport the company's products. There are a myriad ways in which taxes support the business of all and any company, and they are often ignored. We may wish to argue about whether we get value for money for our taxes, but we undoubtedly could not continue for long without any of what is provided (whatever the more rabid believers in free-markets or in libertarianism may believe in their wildest dreams).
  • The company itself! Yes, the company itself has a legitimate right to expect that some of the earnings it has created should be ploughed back into it, an investment in the company's future.

The straw man suggestion is that: any discretionary remuneration (i.e. bonus over and above basic salary) should be considered unacceptable if it ever totals more in any year than the total that the company in the same year pays:

  1. in dividends to its shareholders,
  2. in total ordinary payroll to its employees,
  3. in total taxes to local and other government, and
  4. what earnings the company retains.

This limits the overall bonus pool while linking employee and executive remuneration; but allows considerable flexibility in the amount awarded to any particular individual. It limits the ability to distribute windfall gains within the workforce. It ensures that the company pays taxes in a socially responsible manner. It encourages the payment of dividends to shareholders, reflecting the fact that long-term investment returns are dominated by income received. It ensures that the company has a future, which in turn offers comfort to creditors and suppliers, and provides incentives for employees to invest in their own skills, capabilities and careers. This approach would add no material overhead cost; all of these figures are already calculated, or should be.

Of course, such a schema would be subject to much nit-picking, such as what to do with growth companies not paying dividends. The answer to that particular question is simple: when the retained earnings are invested, impute a dividend, and the obvious and equitable division of the retained earnings is equal. However, in this situation a further limitation on the nature of bonuses should be applied - they should not take the form of cash, but rather be longer-term debt or options.

The key in such an arrangement becomes one of equitable distribution among shareholders and employees by the remuneration committee, and to perform that function properly it requires representatives of both shareholders and employees as members - indeed, it could even be argued that they should collectively control the remuneration committee, when its role is restricted in this way. Of course, there is no fundamental or other reason why the executives of fund management companies should not be subject to this remuneration structure.

This approach is by no means the only feasible way to control executive excess. The High Pay Centre has now completed its long-term, multi-stranded research programme and will be unveiling all of those findings and proposed remedies at a conference on 25 November - a conference where Daniel Godfrey will be one of a panel reflecting the views of investors.

Frankly, an industry and companies within it that lack the insight to comprehend that a progressive enlightened approach to these challenges is superior to the regulatory cosh, when insights into business practice and strategies are integral to their value-added, do not deserve to survive, let alone thrive.