Supervisors on Supervision

“We took a deeper dive into how firms thought about setting the tone for the conduct that would be tolerated, how that is messaged to employees, and then dove deeper into whether firms recognized that corporate culture, in turn, sets the tone for what acceptable level of conduct is within an institution. 

The discussion with executive leadership at the firms sparked interesting realizations and helped us understand how the firms were thinking about that tie-in between conduct and culture. Some were quite sophisticated in their thinking around the topic, and clearly our inquiry was not the first time they had thought about this. Others were less advanced. Another interesting part of the dialogue was, when two firms merged, which culture dominated in the combined entity and what drove that result?”

“By participating in many discussions over the years related to conduct and culture, when I was a regulator, I was exposed to many international leaders at financial institutions and regulators across the globe. In my experience, there are different variations in the application of these ideas depending upon where you sit in the world, and the focus and energy that your local regulator has around this topic.

Traditionally, the focus on conduct was always after-the-fact, when issues had resulted in potential terminations and disciplinary actions, as well as regulatory actions by state, federal and self-regulatory organizations. This can be quite costly. Being more proactive, in a behaviorally predictive manner, can have the benefit of freeing financial institutions to spend their time and energy on higher-risk matters. Resources are not unlimited. 

In addition, the after-the-fact approach has not been demonstrably successful in decreasing enforcement actions. Training, coaching and getting ahead of potential trouble, when patterns of misconduct are observable, can provide a financial and reputational boost as such issues are caught, handled, reported and reviewed by the firms themselves, as opposed to receiving requests for information from regulators, hiring outside counsel, and trying to understand the underlying conduct being reviewed.”

“I think one of the organizations that helped ignite a lot of conversation around culture was the NY Federal Reserve Bank (FRB), under Bill Dudley. From a broker-dealer perspective, at FINRA, we started to examine the ties between culture and conduct, and we thought that sitting down with a number of large firms to ignite the conversation was consistent with FINRA’s mission. 

Since there are reporting requirements for certain disciplinary actions and terminations, FINRA can monitor, on an industry-wide basis, the level of conduct that was violative of firm policy, SRO rules and federal securities laws. Having that unique lens, we determined that understanding the tone, perspective and sense of accountability around the issue of culture would help us to identify conduct-related weaknesses which could potentially have an impact on the investing public.”

“Large financial institutions, by their nature, spend significant resources with respect to risk management and compliance. It is hard to measure the effectiveness of these programs unless you have the right metrics. When complaints and settlement amounts increase, everyone asks why this occurred and seeks to identify the root cause. Absent an issue with a particular product or volatile market, those answers may not be clear. 

Identifying the root cause of misconduct across the industry, with a focus on where it is not occurring and why, would be interesting to evaluate. Are the drivers found in the compensation models, in the failure of a firm to recognize and reward the strong culture carriers who set the tone on getting it right? And how can predictive modeling and a focus on behavioral science help to cut down on issues of misconduct in the industry? These are all questions we need to continue to ask.”

“Focusing on conduct and culture, and holding individuals accountable, can send the message that — regardless of who you are, the revenue you bring in, or the role you play — misconduct can be career-ending, or at least career-limiting. 

Demonstrating a focus on these issues can also result in a decrease in the amount of money paid in settlements to customers or regulators. Such settlements can have reputational impacts for the firm. And while not readily quantifiable in dollar terms, there is certainly a financial and reputational impact for recidivist firms.”

“Well, my view is that culture and conduct risk issues should be owned at all levels of management to have the broadest impact on the organization. But the tone at the top is critical, starting with the board and executive leadership and continuing with business line leaders. The first line plays a fundamental role in setting the tone around what is acceptable and what is not. The second and third lines also play an important role in the process, but the buck stops with the first line.

We can’t lose sight of the important role that middle management plays in setting the tone for employees who do not have regular exposure to senior or tenured leaders in the organization. It is impossible to hold C-Suite executives responsible for the conduct of a first-year analyst. It is the influence of those middle managers that will have the most significant organizational impact, establishing what it takes to be promoted.

Employees will take their lead and imitate the behavior of those with whom they work most closely: middle managers. What often motivates people is how they will be paid. So, the question that organizations should ask is, ‘how do culture and conduct issues impact compensation and promotion in the organization?’ If there is no impact, that sends a strong message that those things don’t matter.”

“Human beings are not machines, and their behaviors are not entirely predictable. That being said, looking at prior behavior to predict future behavior has value. But everyone should have a fair shake. Employees can learn and be coached. Not everyone subject to discipline in an organization is a repeat offender.
Proactive oversight, coupled with a way to close the gaps on opportunities or ensure more enhanced oversight, can have its benefits. You always want to prevent misconduct from occurring, particularly where it impacts clients, but models used to do so must be free of bias and recalibrated as new predictive attributes are identified. It is an art and a science, not pure science. If it was clear to predict who would have conduct issues in an organization, they would never get hired in the first place.”