Enron's chief financial officer appeared on both sides of a sale. Andrew Fastow managed partnerships that bought assets from Enron, sometimes with money Enron itself lent them. He could share in the partnerships' profits. As Enron's officer, he owed the seller his loyalty. As a participant in the buyers, he benefited from favorable purchase terms.
Jason Zweig recounts the arrangement in his early-2000s commentary on The Intelligent Investor. It appeared in the company's proxy disclosures, and the board had approved it. Recognizing the conflict did not require understanding every accounting entry or predicting Enron's collapse.
That is a useful starting point for Benjamin Graham's treatment of delegation. You may need someone else's expertise. You still decide what they are hired to do and whether their incentives and conduct serve you. Oversight reduces avoidable mistakes; it cannot expose every deception or guarantee profits.
Decide what you are buying
Good advice can help you organize finances, avoid concentrated risks and keep fear from wrecking a considered plan. Expecting an adviser to deliver exceptional returns makes extravagant promises attractive and useful ordinary work disappointing. Ask about an investment's safety, business value and price. A research service may supply excellent information while making forecasts you should disregard.
Then follow the payments. A broker earning commissions benefits when you trade, even when patient ownership would serve you better. A firm selling a new issue has a selling interest as well as expertise. Ask what the service costs in actual dollars, what could change the bill and who else pays the adviser. Urgency, certainty and effortless riches deserve scrutiny. They do not, alone, prove fraud.
A friend's referral starts an investigation. Verify credentials and disciplinary history independently, through organizations the adviser does not control. Discuss experience, investment philosophy and exactly which services are included. Have a sample account statement explained. If the explanation remains incomprehensible, supervising the relationship will be difficult. Qualifications indicate preparation, not a guarantee of loyalty or returns.
The adviser needs to understand your obligations, spending, goals and response to loss. Together, put the investment approach, allocation and permitted risks in writing. A conservative client should insist on conservative limits; unusual proposals require enough understanding to judge them. Review whether holdings still meet the agreed standards. A review need not generate trades.
Also distinguish selecting investments from holding them safely. Graham's account of historical brokerage failures shows why the custodian's financial soundness matters separately. Owning good securities does not settle every risk in the arrangements used to hold them.
Keep checking the job
For a fund, incentives change as money arrives. Growing assets can increase fee income while making the original strategy harder to execute. Buying a meaningful stake for a giant fund may require more shares than an attractive small company can supply at a reasonable price. Low expenses, managers investing alongside their clients and willingness to stop accepting money can indicate alignment. None proves investment skill.
Watch for changed strategy, higher costs or unexpected risk. Those can justify leaving. A period when the chosen investments are out of favor calls for patience and investigation, rather than automatic replacement with last year's winner. Patience still offers no promise of recovery.
Even the reported value deserves a check. Graham describes funds valuing restricted shares at the quoted price of freely tradable shares. The restriction that explained their purchase discount had not disappeared. An impressive account value could exceed what the holding would actually realize.
Follow the profits to their destination
At a company, shareholders own the business and directors supervise managers on their behalf. Read proxy statements for board choices, pay, ownership and insider transactions. Compare past promises with results and performance with peers. Managers cannot control each daily quote, but persistent weak operations deserve explanation. Voting and demanding an account from independent directors give owners a voice, even when an individual shareholder has little power.
Operating skill and skill at allocating cash are separate. Profits retained in the company are money owners forgo receiving now. Keeping them needs a convincing use, such as productive reinvestment or repairing weak finances. Graham wants evidence that retention improves earnings per share. Dividends provide usable income and leave less surplus to waste, but paying one does not establish that a business will prosper.
More shares alone create no wealth. A split changes the units while leaving your proportion of the business unchanged. Subscription rights, by contrast, invite you to put in more money; declining can shrink your ownership percentage.
A buyback needs a different calculation. The company spends cash to reduce the shares outstanding. Buying genuinely cheap shares can benefit the remaining owners. Paying too much wastes their cash, even if earnings per share rise afterward.
Zweig's Oracle example shows why purpose matters too. The company issued shares cheaply through executive options, then bought shares in the market at much higher prices. Repurchases could offset the new shares without giving owners a bargain. Examine both transactions; an unchanged share count can conceal the cost of compensation. Executive rewards should depend on sustained superior results, rather than merely an ordinary market rise.
You cannot supervise every decision. You can require understandable terms, candid explanations and evidence that the people using your money respect your interests. Trust has something to rest on when their actions keep meeting those tests.
Three things to keep
Agree on the job, verify credentials independently, and understand every source of compensation.
Judge a manager's conduct and continuing mandate, not one disappointing year's return.
Retained profits, executive rewards and buybacks need justification from the owners' perspective.