From the May 2015 issue of Research Magazine • Subscribe!

The Age of Financial Secrecy Is Ending

Over half a billion years ago, the very primitive life forms that had existed for about three and a half billion years were simple, blind scavengers. But in an astonishingly short period of time, via what has been called the Cambrian Explosion, there was a sudden and dramatic growth and change in biological species. Organisms developed new body shapes, new organs, as well as new predation strategies and defenses to counteract them. How and why this happened, especially as if all at once, has been paleontology's greatest mystery.

According to the “light switch” hypothesis offered by University of Oxford zoologist Andrew Parker, it was an increase in the clarity of seawater that led to the evolution of eyes and thus to the advent of this explosive change. When your enemy can see you and find you, and vice versa, the dynamics of those relationships change dramatically, providing an impetus for all kinds of evolutionary adaptation toward hunting skills, armor, pursuit, evasive techniques and the like, all driven by vision. Whether or not Parker's hypothesis ultimately holds up, his approach makes great intuitive sense and offers real explanatory power, both about the past and about the future.

In the March 2015 Scientific American, Daniel Dennett of Tufts and Deb Roy of MIT, who is also Twitter's chief media scientist, analogized to Parker's “light switch” in writing about the society-altering consequences of digital transparency. Sunlight may be the best of disinfectants, as U.S. Supreme Court Justice Louis Brandeis famously wrote, but many modern institutions, including governments, businesses and markets, have developed in, as Dennett and Roy put it, a “relatively murky epistemological environment, in which most knowledge was local, secrets were easily kept and individuals were, if not blind, myopic. When these organizations suddenly find themselves exposed to daylight, they quickly discover that they can no longer rely on old methods; they must respond to the new transparency or go extinct.”

Digital communication and information access is (quite suddenly) lifting the veil around many institutions and sources of information that were once shrouded in mystery. The essence of this explosive change is transparency, Dennett and Roy argue, and it will transform 21st century culture no less than the Cambrian Explosion transformed paleontology:

“We can now see further, faster, and more cheaply and easily than ever before—and we can be seen. And you and I can see that everyone can see what we see, in a recursive hall of mirrors of mutual knowledge that both enables and hobbles. The age-old game of hide-and-seek that has shaped all life on the planet has suddenly shifted its playing field, its equipment and its rules. The players who cannot adjust will not last long.”

Avoid Extinction

As during the Cambrian period, organizations dealing with the onset of transparency today tend to respond defensively first. It's natural to want to protect current benefits when they are challenged. However, forward-thinking adaptation that takes advantage of the new reality is the longer-term key to survival.

The new transparency means that the balance of power between customers and those trying to serve and profit from them is unalterably changed and changing. Marketing could once overcome public criticism most of the time. The failure to act in the best interests of consumers could typically be kept out of sight.

No longer.

Large, monolithic organizations are no longer required to make a big impact upon society, culture and the markets either. Small groups of committed people, armed with social media skill, can excel, Dennett and Roy write, “at the kind of fast, open, responsive communication the new transparency demands.” Indeed, as “the pressures of mutual transparency increase, we will either witness the evolution of novel organizational arrangements that are far more decentralized than today's large organizations, or we will find that Darwinian pressures select for smaller organizations, heralding an era of ‘too big to succeed’.”

This new era is a reality, whatever one thinks of its likely features, benefits, problems and consequences. However, as Dennett and Roy make plain, there can be no denying that this “new transparency will lead to a … proliferation of tools and techniques for information warfare: campaigns to discredit sources, preemptive strikes, stings, and more.” Misinformation and exposure will remain constant threats.

Transparency can be a two-edged sword, of course. Secrecy can be dangerous indeed, but it is sometimes necessary. Businesses have an interest in protecting what is truly proprietary. One of the fundamental insights of game theory is the need for certain secrets to be kept if success is to be achieved.

The financial services industry has been particularly adept at thwarting transparency with respect to its goals, products and processes, keeping customers uninformed or misinformed about products and services. As a consequence, we feature money management strategies that don't work, products with hidden and excessive fees, and needless, often counterproductive, complexity. We avoid being really accountable to our customers. We push what is easily sold and what pays the most instead of what might actually work. We are not anxious to communicate clearly, thoroughly and accurately.

We talk a good game about serving our clients’ interests, but the key goals still generally remain market share, revenue enhancement and the limitation of liability. Our key tool is still misinformation, delivered by snail mail whenever possible. Efforts to adapt to the new digital transparency with consumer-friendly approaches and strategies are sure to be opposed at every turn by entrenched interests. But as Joel Brenner, former senior counsel at the National Security Agency, noted with respect to the sudden shift in the agency's operating environment (post Snowden): “Very few things will be secret anymore, and those things which are kept secret won't stay secret very long.”

In the financial services industry, there is precious little that ought to remain secret. Instead of trying to maintain the self-serving secrecy that has dominated our industry for so long, especially because such secrets will keep getting exposed sooner and sooner, the key to our longer-term survival will be to remake who we are and what we do to serve clients in a transparent future. That will mean true transparency—not the faux-transparency (think “disclosure”) our industry uses to protect its own interests. It will mean clearly and fully articulating what we do and why there are (data-based) reasons to think we can accomplish what ought to be accomplished. It will mean an honest appraisal of our fees and their justification. It will mean serving our clients’ interests instead of our own. It will mean more truth-telling and less sales pitch.

This new paradigm won't be ushered in overnight. The Cambrian “explosion” still took at least 10 million years. But make no mistake, the change is inevitable. Our choice is whether to delay, avoid and obfuscate to protect the status quo for as long as we can or to create new strategies, products, and structures that will survive and thrive in a new and fully transparent financial world.

With (half-hearted) apologies to James Brown, everybody uses what they got to get what they want. People will remain self-interested as long as there are people. But thanks to the transparency offered by digital media, what the financial services industry's got to work with is much less and much less potent than it used to be. We can still pull on the hot pants, but we don't look nearly as good as we used to. Maybe we should try on some new clothes instead.

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