In Conversation with JC de Swaan: Ethics in Finance, Stock Trading Manias, and Financial Systems Across Borders

JC de Swaan is a lecturer in the economics department at Princeton University, where he is affiliated with the Bendheim Center for Finance. He teaches courses on ethics in finance and on Asian capital markets to undergraduate and graduate students. JC de Swaan is also a Partner at Cornwall Capital, an investment fund based in New York. Prior to Cornwall, he worked at a global macro fund on China strategy, an Asia-dedicated hedge fund, and McKinsey & Company. In his recent publication, Seeking Virtue in Finance: Contributing to Society in a Conflicted Industry (Cambridge UP, 2020), he draws from inspiring individuals in the field to propose a framework for pursuing a viable career in finance while benefiting society and upholding humanistic values.

Shirley Ren (BT): Coming from a political science and economic development background in undergrad and at graduate school, how did you become interested in the notion of using finance to do good and eventually decide to pursue a career in the investment space?

Jean-Christophe de Swaan (JC): I studied political science and economic development at a point when finance was not seen as being relevant to economic development in any way. Then eventually, in the latter half of the 1990s, research started coming out linking financial institutions to economic development and various positive trends in the economy. That spurred me to be more interested in understanding finance as a force for good, which steered me to become an investment professional. I was interested in the notion of investing in emerging markets and having the investments become a catalyst for local development. 

My first role in finance was as an investment professional at a long-short equity hedge fund that was dedicated to Asian markets, and it took me about one week to determine that it would literally have zero impact on the economies. It was largely because as a hedge fund investment equities manager, you’re buying and selling in the secondary market with other hedge funds and asset managers, so you don’t have much of a direct impact on the companies themselves and certainly very little on the economies. That spurred me to think deeper about what in the investment industry could be a force for good. Over time, my interest broadened to investment strategies that particularly have a strong impact on companies and eventually the economy. So, I moved away from just investing in developing economies and pursued strategies that seem to have positive externalities outside of generating high returns. Over time, I migrated towards becoming involved in constructive shareholder activism and venture capital. 

BT: That’s really interesting, I also wanted to touch upon the other aspect of your career, which is teaching. I’m curious to hear how your involvement in academia has shaped your perspective on the industry and the ethics of finance.

JC: It’s certainly been very complementary in that the real-world investment experience informs an important part of my teaching. And my teaching, both the interactions with students and exposure to academic literature and debates, has refined my understanding of finance. I’ve been particularly interested in the impact of finance on society, and academic research has prodded me to think harder about the consequences of what I do as an investment professional on a day-to-day basis. The externalities of finance, both the benefits and limitations, and even costs, have been a very dynamic area of academic research. This is a narrative that has not gotten a lot of attention in the industry, except for pressure movements like Occupy Wall Street. Recently, there has been this interesting development in investment management, a transformation towards embedding ESG factors in the investment process, so now the focus in the industry has gone much broader. 

BT: I want to dive a bit deeper into your book on the ethics of finance, since it is a culmination of your industry and teaching experience. First of all, what motivated you to write the book?

JC: As an investment professional, I wanted to develop a better understanding of the impact of finance on society. Separately, my passion was teaching. There are a couple of observations that I made early on when I started teaching ethics in finance at Princeton. One of them is that a large proportion of my students were very interested in working in finance, but concerned about being “corrupted” the minute they walk into a financial institution after graduation. That went crescendo after the Global Financial Crisis, since there was greater awareness about the limitations of finance, conflicts of interest in the industry, and potential ethical challenges. The second observation was when one of my students asked me, “When we talk about ethics of finance, why do we always talk about bad behaviors and characters and not constructive behaviors and inspiring people?” I decided to make it a part of the course. However, I couldn’t find any literature around it, so I made it a research project, which crystallized in the book. 

The idea was to identify ethical role models whom we could learn from and emulate. These are not altruistic individuals, they are self-interested, ambitious, and successful, but they were able to manage and balance their self-interest and collective interests. From studying their behavior, I teased out a framework of virtuous behaviour in an industry that has a lot of conflict of interests. 

BT: Could you briefly share the framework you discuss in the book?

JC: The first and most important pillar of the framework is serving your customers faithfully even when no one is looking. The industry offers very fertile grounds for self-serving, because it is complex, opaque, and there is often an asymmetry of information and knowledge between the finance professional and their customer. There is also great potential for fostering cognitive bias, many of the issues that we see in the industry are frankly driven by good people making bad decisions, because they’re being oblivious to the consequences of their decisions. 

The second pillar stems from a conundrum, which is that you can serve your customers extremely well and do well for yourself as a result, in a way that extracts value from society. The proverbial example is investing in a firm that pollutes because it hasn’t invested in more energy-efficient machinery. The company is generating excess returns in the short-term, but the cost of pollution is borne by society. As a result, those who invest in the company benefit from this by extracting costs from those who are bearing the costs of pollution. So the second pillar is being mindful of your impact on others, and trying to serving your customers well, ideally, by creating value for society, 

The third pillar delves into the organization itself - treating your colleagues and employees with dignity, enabling them to develop and promoting diversity within the firm and industry. 

The fourth pillar is the most intriguing and interesting to research. It’s citizenship, which stems from the notion that the skillset we develop in finance is very versatile, and we can apply that skillset to pursue social causes outside of primary professional responsibilities, in parallel to your job or after you leave the industry. It is using your skillset, network, and potential financial resources generated from being in the industry to pursue social causes. 

These are the four pillars, and my fundamental belief is that finance is a force for good, and most of finance actually serves the common good. But there’s a part of society that has moved away from the relentless focus on customer service and a singular focus on supporting real economic activities. A lot of financial activities are self-referencing in the financial industry and not serving real economic activities. There are multiple ways of getting to this problem, including regulation, shareholder activism, and greater mindfulness of people in the industry. The book is trying to help well-intentioned finance professionals, particularly younger ones, who are contemplating starting in the industry, to think through how to navigate that world. 

BT: That is really interesting, and some of the potential conflicts of interest are indeed difficult to grapple with. I want to touch upon a recent event in the industry, the Reddit stock trading mania, which is an intriguing case. I’m curious about your thoughts on how this impacts our understanding of ethics in finance as well as implications for the financial industry.

JC: That’s a fascinating situation because it is one full of contradictions. For instance, Robinhood, which is the platform that enabled the movement, is positioned to democratize finance. In a sense, it does do that because it offers a very simple way to trade stocks at zero fees. There’s an element of democratization, making it very simple and easy to use, demystifying the process of investing. The other positive aspect is that it put a lot of downward pressure on trading fees across the industry. 

But now, looking at Robinhood, it’s hard for me to think of it as a force for good, because it’s also gamifying the process of investing. That is problematic because it promotes frequent and momentum trading, investing in stocks solely because they’ve been going up, GameStop as an example. Robinhood is not the only culprit, there is also Reddit, an important source of the dynamic. Going back to the framework of the book, one of the questions is are they serving their customers well with their customers’ interests in mind? On the surface, yes, but one could also make a strong argument that they’re encouraging their customers to do the exact sort of thing that you would discourage your own children, parents, or friends to do. We know that frequent trading by retail investors is a harmful habit – over time, they will likely lose money except for a tiny subset of investors. There is a real conflict and ethical issue. The negatives can be mitigated with certain actions – for instance, moving the platform away from its gamification and encouragement to trade hot stocks, even if it might make them less popular and cause less frequent trading. 

BT: It’s certainly an interesting phenomenon where you have tech and social media firms also participating, complicating the ethics environment. Moving on to your other specialization in Asian capital markets. Could you share a few insights on ethical practices in financial industries in Asia, and how they might be similar or different from North America?

JC: I would say the issues in each country tend to be different and linked to the structure and nature of the financial system, as well as a country’s form of capitalism. Taking the US as a benchmark, we’ve been wedded to shareholder primacy, particularly since the 1970s. The ethical issues in the US tend to revolve around the excessively narrow pursuit of self-interest by senior managers or investment professionals while being oblivious to the consequences on other stakeholders, although we have seen a slight shift take place since the Global Financial Crisis.

Let me give you a radically different example in Asia. In Japan, they have a different approach to capitalism. Since the end of World War II, they’ve had a “community” form of capitalism, where the companies don’t necessarily work for shareholders. Senior managers typically don’t have a lot of ownership in the equity of their firm, and many owners of the equity of a listed company tend to be partners of the firm, who own shares just as a signal of loyalty and symbol of a long-standing business partnership. They’re not going to care whether the share price goes up or down. The byproduct of that is that companies or investment funds are typically not able to buy enough shares to take control. As a result, management is shielded from the influence of minority shareholders. This is changing because Abe (Prime Minister of Japan, 2006-2020) introduced thoughtful and significant corporate governance reforms, but we’re still in that transition phase and these fundamental dynamics still exist. 

Ethical issues in Japan are rarely about the narrow pursuit of self-interest. If you take the extreme cases of scandals and fraud, they tend to be situations in which the senior managers hide something from the public because they tried to do something for the benefit of the company, messed up, and were too embarrassed to let the world know about it. This is never the case in the US - a lot of it has to do with the approach to capitalism and the structure and nature of the financial system.

BT: That is an intriguing case. For you as someone who has worked across borders, I’m curious to hear where you think the globalization of financial markets is taking us, and how the different regulatory environments and structures are taken into account in the global industry.

JC: The impact of globalization tends to be towards greater convergence. For instance, Japan is converging more towards our system. But Japan is a good example in that they’re not going to become the US financial system, they are always going to have a very Japanese form of capitalism. Even though they’re moving towards a form of shareholder capitalism, it’s going to be uniquely Japanese, and it will probably look more like a German or even Canadian form of capitalism than the US form. By the same token in the US, we’re inching our way towards a form of stakeholder capitalism, but it’s never going to look like a German form of capitalism for instance, where everything is about consensus and negotiations between different stakeholders. It’s going to be uniquely American. So globalization brings some convergence, but it doesn’t bring complete convergence, there’s always going to be national characteristics that will endure. 

BT: I really appreciate your insights on the ethics of finance and Asian capital markets. Before we conclude, I wanted to hear if you have any advice for students who want to enter the financial industry and aspire to become skilled professionals.

JC: I would start by saying be mindful of the challenges in the industry and the dynamics that have led the industry to have a lot of conflicts of interest. There are important trends to understand that are responsible for some of the challenges, some of them are structural, and some are behavioral. Overall, they tend to stem from structural changes, the most important one being the shift of large US financial institutions from private partnerships to listed public companies. That changes the incentives and creates greater conflicts of interest. So there’s certainly an educational component, which is to understand the structural challenges in the industry. 

The second piece is that the more you can understand the cognitive biases that you may be vulnerable to, the more you can potentially mitigate them. I think it’d be also helpful to understand what constitutes virtuous behavior. I offer a framework through the study of ethical role models, and there may be other ways to get to this, but I think it’s useful to go in with a roadmap. 

As you’re considering entering the industry, an easy way to address this issue early on is to pick your spot carefully. You can assess different areas of finance and different firms by applying that framework to understand the extent to which you’re going to find conflicts of interest on a daily basis. In an extreme case, if you went to work for Vanguard, I would venture to say that you’re not going to find yourself in ethical tight spots, since a lot of what Vanguard does is a force for good. Now, you will be where you will be and you will be faced with challenges wherever you are. My recommendations would be to ask pesky questions early on. A lot of bad behavior in finance has to do with not being mindful of the consequences of what you’re doing because of cognitive biases, not because you’re a bad person. The more you can create transparency around this, the more you’re helping these organizations be aware of it. 

The final suggestion is, at any given point, there tends to be a focus on a set of initiatives that are progressive and meant to improve ethics in the industry. That’s an easy way for you to take part in improving the industry, by raising your hand and saying that you want to be involved. Right now, ESG investing and diversity are fairly obvious ones and easy to get involved in.

BT: Those are great advice for students, I’ve certainly learned a lot! Thank you so much for your time and for sharing your insights.