In his recent book, The Economist’s Oath (Oxford University Press, 2011), economist and renowned ethicist Dr. George DeMartino described ethics in some of the same terms we normally reserve for fiduciary: loyalty and prudence. So, is there a difference? Can that difference be described as “one is legal and the other moral?” Moral is hard to put your finger on, as it develops in each of us differently from teachings and experiences at home, or in the church or synagogue, and from life. Everyone seems to know or have some understanding of ethics, and most see it as right vs. wrong. So is writing a code of ethics an attempt to convert from the moral to the legal, and thereby control ethical questions?

For a board of individuals given authority and trust to manage the funds of an organization, is there a defined set of rules to follow? To make all the heirs of Procrustes happy, most organizations establish a set of rules that addresses insider trading, receipt of gifts, inter-related party contracts, nepotism, pay-to-play, quid-pro-quo, third party relationships, former trustee/employee relationships, and whistle-blowers. These rules are then stretched or cut to fit each and every situation that comes along, which generally makes these rules ether too specific or too general. There may be too many rules, or too few. But are rules enough? Does the existence of a written policy ensure ethical behavior? How is behavior enforced, and what exactly is ethical?

Do ethics change if the actors change? Consider a PPM for Private Equity Fund presented by a salesman to your lawyer. Your lawyer approves the PPM; is it ethical or not for the salesman to fail to point out a clause that may not be in your best interest? What if he doesn’t tell you that a certain clause can be negotiated— is he unethical? It may not be nice or even what you would want, but is it ethical on the part of the salesman to contradict your experienced and sophisticated lawyer? Most would agree that the salesman has fully executed his duty to you and your lawyer (both legal and moral) if he discloses all of the facts. The PPM listed all the facts and that was the duty of the salesman; but does he owe an additional duty to you and your lawyer to interpret those facts? Probably not.

Does the answer change if the buyer is an 87-year-old retired fireman instead of a multi-million dollar fund with a dedicated chief investment officer? Does the answer change if the person promoting the investment is not the salesman, but a lawyer acting as advisor to the fireman? Definitely.

The SEC came in to do their standard exam of an investment advisor and, being generally nice people the advisor offered coffee and some muffins. The examiners made a very big point of refusing the muffins because it was against the written ethics policy—and they couldn’t be swayed. Really? If they could not be trusted to know what was a bribe and what was not, could they be trusted to do a fair and competent exam? If they could be bribed with a muffin, there is no wonder why Madoff was not caught sooner. If an ethics code was so narrowly defined, then anything not proscribed in the code must be okay. Right? If your code says no lunches may be paid for by an investment manager, then it must be okay if you pay the bill and the manager instead introduces you to the leading lights of your particular industry? If your ethics code says not to accept any solo (i.e., one-on-one) trips with a potential manager, then it must be okay if there are other potential investors present, right? I guess that weeklong Disney World trip for all the manager’s clients must meet your idea of ethical. There are hundreds of ways around a rule, but no way around true ethical behavior.

Not all ethical principles or policies apply to all groups equally or in identical ways. Ethics and policy must be tailored to each group, and even then there is inequality in applying the rules, which is why there is no “Uniform Code of Ethics for all Boards and Professions.” For example, if you only play golf at the local muni course, a few invitations to Augusta may impact your decisions, and thus an over-written ethics code may exclude any golf; but if you are a member at Augusta, is an invite to a local muni course going to sway your vote? Your moral compass may be unaffected, such that you are able to look past the golf. There is, however, the appearance of a conflict, and appearances might matter. So, are ethics not only what you do but also what it looks like you are doing, or even might be doing? Does being ethical mean becoming Caesar’s wife?

For a member of a board or investment committee, the primary concern is being and doing as a fiduciary: loyalty, care, skill, prudence, and diligence. DeMartino says, “They must take care to put the interests of those served above their own; and they must take care not to impose avoidable risks in hopes of bringing about favorable outcomes.” This is virtually the definition of loyalty and prudence used in the discussion of fiduciary duty in the last ­chapter. Does that mean that being ethical and being a fiduciary is the same thing? They certainly are similar, but do they come into conflict? They shouldn’t, but sometimes do.

Ethics in the sense of both “not harming” and “advocating for” your fund is part of the key, I believe. This is doing or not doing what is in the best interests of the organization or the fund. Where ethics and fiduciary part is when one begins to believe that what is in one member’s or the whole committee’s best interest is also in the fund’s best interest. It is service to the institution’s ends and not to one’s own ends that points to the difference between fiduciary and ethical. When one works only in the interests of the organization, one is both ethical and fiduciary. When one begins to include what is good for one’s self with what is good for the institution, one loses or violates ethics, even if you are convinced that what is good you is also good for the fund. What is interesting to note is that the same members being asked to be ethical and work only in the interest of the institution are the same members that establish what those interests are.

The focus of most “ethics” discussions by boards revolves around obvious elements including insider trading, receipt of certain gifts, inter-related party contracts, nepotism, pay-to-play, quid-pro-quo, third party relationships, former trustee/employee relationships and whistle-blowers, plus attempts to get around the rules. But these discussions often don’t include the issue of personal feelings and benefits, even though the emphasis of the discussion is “what’s in it for me?” Most would say that doing those things in the above list are unethical and that they do not advantage the organization or the fund, but what if they did? If a board member accepted a “gift” for bringing an investment to the board, and the investment was truly in the fund’s interest, would it be unethical? We would have a hard time saying out of hand that either the investment tout doing the giving or the board member doing the receiving were being unethical. It probably would be situational depending on the member’s prior expectation as well as the size of the gift. Although not knowing the difference between accepting a trip to Paris and accepting a box of candy, or a bottle of Two Buck Chuck, may mean you need a new board member. A muffin at a morning meeting? Let’s not be silly.

One organization fired a long-time manager that they were happy with and who was doing a great job. They replaced him with a firm with a much higher profile only to gain that higher profile. Unethical? If they did it for status to benefit themselves at the club and to be able to say “we use such and such,” then very much so. It was discovered that the new group had ties to members on the board that were undisclosed. This failure to disclose, I would have to say, is the definition of unethical. Ethics aside, we would also say that this was definitely a breach of their fiduciary duty of loyalty to the institution.

We can look at a case study to see many of these issues and conflicts at play. A foundation adds a new member to its investment committee who also happens to be on the investment committee of a large national organization. The national organization uses a particular investment advisor, and the new member advocates strongly for that manager. The foundation’s investment officer does the diligence and finds several significant and serious issues that should keep the foundation from investing and strongly recommends passing. At the new member’s insistence, that manager is hired. It turned out bad.

Without ascribing bad intent to the new member, what could have been the ethical issues? What about the ethics of the other members? What about the fiduciary issues? What was the ethical dilemma of the new member? Should he have introduced the investment manager to the foundation? From both an ethical and fiduciary point of view, we would say that of course he should have made the introduction. Should he have participated in discussion and the voting? He probably should not partake in the discussion, and certainly should not vote.

What about the duties of the other members? Did the new guy have a better understanding of the manager? Did they have an obligation to listen to their designated expert, the CIO? Should the names of the money manager’s other clients matter? Did they have an obligation to take into consideration the relationship between the new member and the money manager? Should they ask why the new guy pushed the investment manager so hard? Was it just a simple mistake, or hubris on the part of the new member or leading from behind on the part of the other members of the foundation’s investment committee?

If the recommendation of the investment officer was accepted and no investment was made, then what was the new guy’s duty to his national organization? If he had negative information, should he pass it along to that national organization? What did this do to his prior acceptance vote at that organization? Should his responsibility to the other organization affect his conduct at the foundation? Was the information at the national organization higher in the food chain and therefore better because of the “brand?” Did he see his position of authority as somehow lessened by not pushing his view? Whatever the specifics, we should all see a mix of both fiduciary and ethical issues with no easy answers. The difficulty in writing a rule that encompasses all of these factors is that it does not affect the knock-on events, which then makes writing an effective rule impossible.

To our thinking, the new guy should have brought the investment manager to the committee. It would have been a shirking of his fiduciary duty not to. The committee should have discussed each of the questions and issues listed above without regard to the national organization’s decision to hire this manager. Then, since the diligence done by the CIO brought to light serious and significant issues, those issues should also have been discussed which most probably, would have led to the institution not hiring the advisor. The new guy would then have both a fiduciary and ethical duty to his other organization to relay the negative information to them.

So far the discussion has focused on acts committed, but what about acts omitted? An investment committee member uses a particular money manager but doesn’t bring that manager to the committee because he feels that pushing a private agenda is not ethical, and is somehow a conflict of interest. It seems obvious that because he continues to use the manager that he believes is “good,” he has done a certain amount of diligence and there is the possibility that this manager can help the institution’s fund. Is not telling the committee about a possible advantage really ethical? Here we are confronted not with doing but with not doing. It is definitely not acting as an advocate for the fund and it is not being loyal to the fund, but is it ethical to withhold? “Not harming” is a central point in both ethics and acting as a fiduciary, so one could use the greater harm rule to decide to act or to not act. We believe one should surface the name and then step out of the discussion and decision.

Ethics goes, as we have seen, well beyond a list of things that are objectively right and things wrong in all cases. No matter how big a list of rules, one can’t lop off or stretch every event to fit the rule. Ethics are situational and are dependent on the reason for whatever action or inaction taken. It requires a hard look at one’s self and an ability to know if the action is really in the best interests of the organization, or one that caters to selfish reasons. Not an easy task.