The pressure to stamp out non-financial misconduct is adding more weight to the already heavy burden carried by compliance and market professionals; can technology help?
Non-financial misconduct is increasingly a supervision priority for regulators, but questions remain over how to properly assess the true culture of a firm and how to go about changing it from within.
Under existing accountability programmes, financial services regulators in the UK and the US can hold senior management liable for misconduct or a failure to comply with laws and regulations individually or where it is carried out by persons under their watch.
However, a new form of oversight is catching fire where regulators grade management and their staff inside financial services firms on their behavior within the workplace.
“The way firms handle non-financial misconduct, including allegations of sexual misconduct, is potentially relevant to our assessment of that firm, in the same way that their handling of insider dealing, market manipulation or any other misconduct is,” said UK Financial Conduct Authority supervision chief Chris Woolard in a recent speech to City executives.
Non-financial misconduct is still misconduct
One of the key messages in the speech is that how a firm approaches diversity and inclusion tells the FCA much about its culture, said Luke Rodgers, of law firm Norton Rose Fulbright. “The FCA’s message to firms is clear: non-financial misconduct is misconduct, plain and simple,” Rodgers said.
The need to root out behavioural related workplace misconduct alongside the regular role of ensuring alignment with more stringent regulations is putting considerable pressure on compliance professionals.
Executives report increasing amounts of time spent firefighting and remediating audit findings, yet too often there is no warning of when or where the next risk might materialise.
“The FCA’s rulebook and focus used to be quite narrow; financial crime, market abuse, the usual stuff,” said a CCO at a tier one UK investment bank. “The regulators approach has evolved to something much broader, and they are far more likely to intervene now on things like whistleblowing, bullying; they want to know what our plan is to deal with this kind of problem. So we have this and all the other stuff to worry about now”.
A steady drumbeat from the FCA on culture has been sounding for several years and will be amped up into 2020. Lawyers say all firms should be considering how good culture is embedded within their organisations, from the top down. This is particularly relevant to fitness and propriety assessments, both for businesses already within the Senior Managers and Certification Regime, and those that will come into scope on December 9, 2019.
“Whilst the criteria set out in the FIT section of the FCA Handbook does not explicitly refer to them, the regulator has made clear that, for the purpose of a fitness and propriety assessment, non-financial behavioral and cultural issues may be taken into consideration,” said Paul Fontes, partner at law firm Eversheds Sutherland.
In the context of sexual harassment, Megan Butler, executive director of the FCA, said in a speech: “When we talk about being fit and proper, we are not merely talking about financial decision-making but also in terms of culture. We do not compartmentalise what makes people fit and proper.” Following Butler’s speech, the FCA received its highest number of whistleblower disclosures, including disclosures about gender, racism, bullying and homophobia.
“The FCA would see a culture where sexual harassment is tolerated as being indicative of an overall culture which does not allow for decisions to be challenged and consequently would fall below the standard the FCA expects,” said Paul Ellison, partner at Macfarlanes law firm in London. He noted that the regulator is taking a holistic approach to evaluating a firm’s culture, considering the extent to which it is shaped by factors such as remuneration, inclusion and diversity.
“Given this approach it is vital that firms review their culture holistically to ensure that the firm is not only upholding the FCA’s standards in relation to financial conduct, but also personal conduct,” Ellison added.
In the US, the birthplace of the #MeToo movement against sexual harassment and workplace bullying, regulators are also grasping the nettle over conduct failings, and are helping to refocus banks’ attention on areas of persistent conduct failure, and providing insights and lessons learned from across the industry.
The US’s Securities and Exchange Commission (SEC) chairman Jay Clayton has made no secret of his desire to root out bad behavior and the importance of developing, improving and reinforcing positive culture at financial institutions.
How do we define good culture?
William Dudley, until recently the president and chief executive of the Federal Reserve Bank of New York, described culture as “the implicit norms that guide behavior in the absence of regulations or compliance rules”.
The FCA and the SEC consider a good culture to be one where behavioral misconduct is not tolerated, as senior managers are more apt to make the most appropriate business and risk decisions with respect to financial matters.
Regulation has a back-seat role to play in the sense that culture cannot be mandated or defined by rules. Experts say, however, it can be an effective tool in outlining basic principles, refocusing firms’ attention on areas of persistent conduct failure, and providing insights and lessons learned from across the industry.
Ultimately, supervision can have a hand in monitoring and providing feedback to firms that can aid the board and senior management in addressing culture and conduct issues.
The regulators say improvements in the years since the 2008 financial crisis are certainly evident; many recent statements make it clear that they consider that more needs to be done to transform culture within firms.
Not there yet
“Have we gotten as far as we need to go? No. Have we made a lot of progress? Yes,” Dudley said recently.
This sentiment is shared by many international regulators, with Hong Kong and Australia quick to follow the individual accountability examples set by the West, and even get ahead of them in some cases; Australia is considering embedding supervisors in the boardrooms of some of its worst-behaved banks.
Wherever a firm operates in the world now, culture remains at or near the top of the regulatory priority list; it is not going away.
Industry-wide dialogue and sharing of best practices is key to regaining trust and strengthening the global financial services industry; the cultural health of the industry as a whole will benefit everyone in the ecosystem.
The “tone from the top” is a familiar refrain in supervisory statements on culture, as boards and senior management undoubtedly have a significant influence over the culture within a firm and are expected, ultimately, to be accountable for it.
Supervisors, in turn, expect the board to lead by example, role‐modelling desired behaviors and showing how these support the firm’s culture and values. Setting tone from the top requires the leadership to demonstrate the behaviors that exemplify the target culture.
“Experience of culture change programmes launched by boards has often been patchy,” said Andrew Bulley, partner in the risk practice at Deloitte. “There is the widely perceived ‘permafrost’ syndrome, whereby middle and lower management and operational layers remain strongly attached to certain values and outlooks that the board wishes to change and are highly resistant, albeit often covertly, to the behavioral changes the board wishes to effect.”
Industry norms can also hinder progress, Bulley said, by creating a perceived first‐mover disadvantage in cultural reform. “Mergers and acquisitions, through forcing together two businesses (or parts of a business) with separate cultural identities, can frustrate or stall progress on cultural reform within a group,” Bulley added.
By repeatedly emphasising the importance of the tone from the top, supervisors can move the firm’s approach to culture towards leadership taking more responsibility for setting and embedding an appropriate culture within their firms.
However, as Dudley has observed, culture does not change simply by exhortation, it can only occur with open dialogue and a willingness to embrace change; the leadership should “expect and respect challenges, and in turn must challenge ideas themselves”. Having a laser-guided insight into the behavioral patterns of employees through data analysis – the “shop floor sentiment” – could be key to helping companies transform unhappy, stressed, at-risk staff into healthier and more productive individuals, as well as satisfying regulators that a holistic view of risk, financial and non-financial, is being covered.