Some reflections in the aftermath of the Financial Crime Compliance Workshop on Retooling Under the New Compliance Rules: The 4th Money Launder Directive held at Astana, April 2017

May 2, 2017

Prof. Emmanouil Ioannidis, Eurasian Compliance Association Compliance Committee Member

As I noted throughout April’s FCC workshop, improving business culture in the financial services industry is an extremely important issue, which has its roots in any Organisation’s senior leadership. What is meant by the term ‘leadership’ was logically asked by the delegates. On many occasions, I underlined that the term leadership refers to Board Members and to Senior Management because it is their core oversight duty to encourage, promote and enhance continuously better business culture and behaviour within the Organisation, that is, any organisation.

The Culture Problem

Back in 2009, James O’Toole and Warren Bennis authored an article at the Harvard Business Review (June 2009) titled, “What’s Needed Next: A Culture of Candor”. In my view, they captured the problem in a single phrase: “Ethical problems in organisations originate not with ‘a few bad apples’ but with the ‘barrel makers’”. If you substitute the term ‘barrel makers’ with senior management you cannot miss the central corporate governance point.

This also means that ‘misconduct’ problems emanate from the very ‘culture’ of organisations. And, it follows logically that any organisation’s culture is shaped mainly by its leaders. Consequently, the solution to the ‘culture’ problem must come from within organisations, i.e. from within the financial services industry, and more specifically, from organisations’ senior leadership.

Admittedly, it is equally important to define culture itself. In the context of the risk and compliance disciplines, culture reflects the business attitudes, behaviours and mentalities within any organisation. It is therefore important to appreciate that, the issue at hand, is not only how employees react to ‘straightforward’ situations, but also to all the ‘less straightforward’ or ‘grey’ situations where there is plenty of room to exercise discretion and rationalisation in decision-making.

Undoubtedly, financial institutions exist to create and protect their shareholders’, employees’ and corporate clients’ wealth. This is called profit and value maximisation in all free and open financial markets. However, let us recall that market freedom comes with certain key responsibilities. More specifically, in the aftermath of the 2008-2009 financial crisis, we have come to appreciate all the more so that organisations exist to also benefit the public. This is precisely the reasons for which regulators around the world aptly remind us that one of the key duties of the financial services industry is to rebuild public trust.

The Central Role of Senior Leadership

But to change a firm’s culture is a marathon not a short race called sprint. It requires stamina, persistence and endurance especially for long-term performance. It is for this reason that senior leaders are expected to take responsibility for ‘what’ it will actually take to turn their firm’s culture. They are thus expected to communicate frequently the solutions they wish to implement at the enterprise-wide level by strengthening continuously the ethics base of their organisation. Simply put, Boards of directors must set not just the ‘tone’, but also the ‘conduct’ at the top by playing a central role in holding senior leaders accountable for delivering sustainable progress within the firm. Of course, it is important to realise that, without good corporate governance, compliance cannot ensure that a ‘healthy’ culture in the organisation will become self-sustaining. This is perhaps widely known as the problem of ‘box-ticking’ or ‘paper’ compliance programmes.

Some Best Practices

Organisations’ approach to improving their culture must be holistic and comprehensive. It must therefore encapsulate the alignment of the following ‘elements’ with the ‘behaviour’ and ‘culture’:

  • Recruitment
  • Onboarding
  • Career development
  • Auditable and continuous training
  • Performance reviews
  • Pay and promotions
  • Succession planning
  • Anonymous comprehensive culture surveys conducted annually by an independent third-party and sharing of results with supervisors to promote benchmarking and accountability for progressive development on culture and behaviour. A healthy business culture is all about how small problems are identified early and promptly addressed before they become too big to measure and manage
  • Enterprise-wide annual compliance awareness programme promoting a corporate culture that focuses on the importance of compliance with laws, regulations, internal policies and consumer protection

In practice, this can help personnel distinguish clearly between the application of the ‘should we’ versus the ‘could we’ business decisions that must be taken at the workplace within the context of the organisation’s well-communicated risk appetite and risk-management policies. This is how organisations identify and control conduct risk and assess ‘how’ compliance breaches can be prevented and controlled.

The Key Role of Compliance

A paragraph can suffice to explain that compliance is neither the ‘police’ nor the ‘big brother’ as some professionals have fallaciously come to believe. On the contrary, compliance investigates to confirm the facts. Compliance therefore looks backwards to put together the facts in those circumstances that rules and procedures were not followed by those individuals who intentionally engaged in misconduct. But it is important to note that the punishment for wrongdoing does not rectify the transgression. Firing or even prosecuting an individual for any criminal actions at the workplace merely sets an example for the others to refrain from behaviour that is not accepted within the organisation and the financial system as a whole. It merely roots out bad behaviours.

The Key Role of Compensation

An alternative way in which ‘incentives’ can be shaped is through the structure of compensation. How can this become a helpful tool one may ask? The answer can be found in the rationale behind aligning employees’ interests with the wider interests of the organisation in rooting out misconduct at the workplace. A good compensation system can be a good tool for strengthening culture, promoting stability in financial systems, and rebuilding the public trust in the financial services industry.

The added value in structuring compensation is that no institution is too big to fail, henceforward, a credible solution plan must not involve taxpayer money. Should taxpayer money come to be needed, it will be too late because large financial institutions will have to face insolvency. The key concept to grasp here is that good compensation policies can ‘complement’, but not entirely ‘drive’ an improved culture. They can thus play a positive role in reducing unethical and fraudulent behaviour at the workplace because those who wantonly break the rules or cross the compliance line, will usually do so in the context of an assessment of the risks they expect and a calculation of the rewards of their actions.

The Credible Solution for Compensation

A deferred compensation must have a horizon longer than the life of the trade in question. This way the financial institution can ensure that both its own and its employees’ incentives are aligned with a view to effectively mitigate the risks of unethical conduct centred around individual self-interest. And, this component of deferred compensation can take the form of cash, equity or even bonuses.

For instance, the deferred period may be set to five or seven years as a reasonable timeframe to allow for sufficient time and plenty of compliance ‘space’ for any illegal actions against the organisation’s culture to materialise, to come to the surface so that fines and legal actions be realised.

In practical terms, in the case of a large fine, the senior management and the material risk-takers would forfeit their performance bonus. This way, the incentive is maximised for professionals to identify bad activities within the organisation or even prevent them from taking place by flagging them timely. In summary, this structure can create a powerful incentive for professionals to monitor the actions of their colleagues, and to raise red flags before unwanted incidents happen.

Creation of a Central Registry to Track Hiring and Firing

Another additional powerful tool is that of creating a central registry to track hiring and firing financial professionals at the industry level within the country. This database can be maintained by the supervisors of financial institutions based on information provided by supervised – ‘obliged’ entities. Under this approach, any new regulations could require that all financial institutions must mandatorily search the database prior to hiring any financial professional, so that any and all prior reported events will be taken into account in by the nomination and remuneration committees of the organisation. For example, Section 19 of the Federal Deposit Insurance Act in the U.S. prohibits anyone convicted of a crime of dishonesty, breach of fiduciary trust, or money laundering from working at an insured depository institution or bank holding company. What can make the real difference here is to be able to use such a section to cover the entire financial services industry at the country level.

Conclusion

Stewardship of other people’s wealth is not an easy job. The regulatory landscape is increasingly evolving towards more transparency and quality assured practices. In the aftermath of the financial crisis we are continuously searching for proportionate solutions deriving from good corporate governance, good compliance and effective risk-management of socially meaningful financial institutions. Bad behaviour at the workplace will persist, but it can be properly managed. The cultural and ethical challenges must be addressed within organisations continuously and through auditable trails. The mission is not impossible, so let us all help our Boardrooms to turn into centres of good and effective risk-governance.