Radar 11 Compliance

Moving Paper: How to Moderate the Most Powerful Motivator in the Financial World

Published On May 19, 2021
12 MINUTE READ

Radar speaks with Bob Mendelson about his renowned career in legal and compliance, and of the need for a symbiotic relationship between humans and technology in the modern era of compliance.

Bob Mendelson does not watch the hit TV show, Billions, which follows the hedonistic life of hedge fund CEO, Bobby Axelrod.

The former chief compliance officer at Sculptor Capital Management and senior advisor at FINRA said he does not tune in, “for the same reason that the police don’t watch cop shows and doctors don’t watch doctor shows. It’s very overdramatized.”

Despite this opinion, Mendelson, who is now retired, does have one or two Hollywood-worthy stories from his time in financial services. One of which occurred when he was a partner at Morgan and Lewis, and involved him jumping on a plane from New York to London in pursuit of US$11.1 million (£8 million) that a client’s “bad person” had stolen.

“I was tasked with doing what I could to get it back. So, my first call was to Scotland Yard, and after some brief dialogue with the Detective Inspector from their Financial Crimes division, I flew to London, but we missed him by a few hours. He left by ferry from  the port. They did track him to the mountains of Slovenia, though, and eventually extradited him. We also managed to get most of the money back for the client.”

The trans-Atlantic, James Bourne-esque dash aside, much of Mendelson’s career required a keen regulatory eye, a fine ear for truth, and a very grounded, feet on the ground, analytical approach to the nuances of trading.

“I spent 34 years as an outside lawyer, three years as a senior advisor at FINRA and three years as Chief Compliance Officer at Sculptor Capital Management, so I bring a broad range of perspectives to the legal and compliance world.”

Do You Know Who I Am?

In the 40-plus years in the industry, there is perhaps one moment that sticks with Mendelson more than any other, as it was quite emblematic of what he, and the FINRA team, regularly experienced.

He recalls that someone from the FINRA exam team was having difficulty with a member brokerage firm, and was subsequently objecting to some examination findings. 

This, Mendelson says, was not uncommon.

“Everybody that complains to the regulators always says we don’t understand their business. And I always tell people, ‘It’s your responsibility to make it clear to the regulators what your business is.’ So, I said, ‘Well, hello, (name of person who was a very senior executive whom he knew very well), Bob Mendelson here, how are you? Are you going to assert I don’t understand your business?’”

Understandably, the senior executive chose to not assert that.

In these types of situations, Mendelson says, it is important to reassure the client that the regulator’s problem is not that they don’t believe the client, but there is documentation required, and that the firm needs to provide that documentation.

Mendelson remembers the exchange vividly, “I said, ‘You’re telling us that you have the same 50 – 100 institutional customers that everybody else has. You’re still required to have done the work… to provide information to guarantee your clients’ trades.”

In his capacity as Senior Advisor at FINRA, Mendelson’s advice to brokerage firms, before an examination started, was relatively simple, yet one that many did not take the time to do: Put together a deck that explains your business; what you do, and who your customers are. This information will be extremely helpful to FINRA examination teams, even if they don’t ask for it, you should still do it, and insist on presenting it.

Moving paper

At its very essence, one of the principal roles of a compliance officer is to ensure that documentation is in order; that everything is correct and accounted for. That there is an audit trail, so that, if and when it is needed, it can be used to prove that the correct procedure has been followed. 

Although the process for doing this may have changed over the years, the principal remains the same.

“You literally could not do the job today without communication surveillance,” said Mendelson, while referencing New York’s “Paperwork Crisis” that happened in the late ‘60s.

Back then, the New York Stock Exchange’s trading volume was, on average, 12 million shares per day. Of course, before AI-powered surveillance solutions, every trade and every exchange required a papertrail of order tickets, execution reports, and so on. The paper-heavy process became such an undertaking that, in 1968, firms actually had to stop trading one day per week, on Wednesdays, just to make sure the back offices could catch up.

As a consequence, there were months of “fails to receive”, and “fails to deliver” that needed to be cleared up, and many firms went bankrupt.

“It was all moving paper. At that time, there were people who literally took the stock certificate, and the paperwork that went with the transfer, to the cashier’s window of the other firm. They would take it from you, give you a receipt saying they received it and you’d come back in an hour, and you’d either get a check or your paperwork back. It was viciously, paperwork-intensive.”

As such, Mendelson could not envisage such a process being used today, especially as increasing numbers of organizations look toward adopting a hybrid workplace, with some staff working from home, and others in the office: “12 million shares is probably less than a second’s worth of trading today. I can’t imagine surveilling all of the chat rooms people use, and all the different forms of e-communication without a modern tool.

“You can’t keep up with the communications around the trade, the information flow around the trade, or what the trade is without well-designed technology that brings exceptions to the fore. You need to have tools that will keep up with the pace and volume of the activity of the front office. You need to have technology that filters out and sends exception reports to people, so you can look at what happens.”

And, of course, nowadays, it is not only paperwork that needs to be audited and stored for ease of reference.

Traders are now communicating and collaborating via emails, chat apps, video conferences, and, of course, the telephone. It is imperative, therefore, that financial institutions adapt their surveillance technology to reflect how their traders are working. Surveillance methods need to adapt to reflect the times. 

In the early ‘00s, Mendelson remembers, it was slightly less sophisticated.

“Scotland Yard would send unmarked cars around to the office buildings that were known to have trading floors and video people talking on their cellphone in front of the building. They would then take pictures and go to the compliance departments that were in those buildings and say, ‘is this one of yours?’

“Because apparently the code word for ‘We need to be able to chat privately’ was ‘I’m going to take a cigarette break’.”

Going Rogue

Of course, a lot can change in a decade or two, and now rogue traders’ behavior has become even more sophisticated, requiring a much more modern, technology-enhanced approach to ensuring compliance.

Of course, there’s more to the role of a compliance officer than just relying on technology. Certain specifically human qualities, like relationship building and understanding the nuances of particular personalities, are some of the skills of the modern compliance officer.

For example, as well as ensuring compliance officers are “up on the trading jargon of the moment”, which Mendelson says is a never-ending challenge, they need to have a “fine ear” for whether traders are telling the truth or if somebody is not being straightforward.

Much of this, Mendelson believes, only comes with practice, and being familiar with the personalities and intentions of traders. 

Traders and Compliance Departments: A Harmonious Relationship

There are certain challenges in being able to foster a good working relationship between a firm’s front office staff and the compliance department.

Learning the best way of communicating with these members of staff, many of whom, according to Mendelson, are young and aggressive, and reassuring them that compliance departments are there to help, not hinder, therefore, becomes paramount.

“One of your jobs as a compliance officer is to learn which of the people in the front office are coming to you and are being straightforward, filling in the gaps, and making sure you get all the information, and which ones are trying to tell you something, so they’ll get the answer they want. There’s also the person who is coming to you for coverage, just so they can say, ‘I went to compliance’. Your job as a compliance officer is to read and know these people.

“Rogue traders are unbelievably clever. They also tend to be overly greedy. They’re on their way to being ridiculously rich by anybody’s standards, but they want to get there faster.

“Greed is a powerful motivator in the financial world, and you just have to make sure it doesn’t become an overwhelming motivator for somebody.”

Having a close relationship with these types of people, in order to understand what drives them, and ultimately be able to steer them in the right direction, is therefore an incredibly important element in the role and responsibility of a chief compliance officer.

“My advice to compliance officers is to build your reputation. You want to be the person who says, ‘Well, no, you can’t do that, but does this work? Or, let’s make sure we filled in all the background information and then yes, it’s okay.’ Embedded in that is to build your reputation as a pragmatic compliance officer, not a theoretical compliance officer, not someone who always says ‘no’, or always says ‘yes’, but as somebody who gives useful practical advice and has thought about situations.”

As a senior advisor, and chief compliance officer, Mendelson has seen some huge changes to the world of compliance throughout his career, not least of which is the impact that COVID-19 had on compliance officers being able to do their job, and the increased dependency on surveillance technology.

“What traders and investment professionals don’t get (from working from home) is the easy interaction and discussion of what’s happening among themselves in the office in the markets, and what’s happening with their particular security. That is the fertilizer that makes firms better than the sum of their individual parts. 

“Also, a lot of really important compliance is not done within the compliance department, but by the managers of the front office personnel. It’s why trading floors are open. You’re overheard. Supervisors, managers of trading units hear what’s happening. They’re sitting centrally to everybody else so they can hear. The reason they’re there is the ability to filter and hear what they need to hear about what’s happening around them.”

Everybody is a Business: Conduct Yourself Accordingly

Another change that has happened in recent years is the use of surveillance technology, typically used to safeguard against compliance breaches, to identify instances of workplace misconduct, such as sexual harassment or racism.

For Mendelson, and an increasing number of financial institutions, misconduct, whether financial or non-financial, should be regarded as the same. 

“When we in the financial world say compliance, we tend to focus on banking in securities law types of compliance, but everybody’s also, if you will, just a business. You have employees, you have conduct, you have huge reputational risks associated with workplace misconduct, whether it’s sexual harassment, racism, or creating an uncomfortable working environment. 

Many organizations would probably be well-served by having such kinds of surveillance designed to help address these risks. Particularly because one of the types of things that people say is ‘I was in an environment where coming forward would make it very difficult’. 

Having the sorts of systems that arm your HR professionals and your HR lawyers, with the ability to address toxicity before it turns into something (more) can only help.”

Mendelson essentially believes it depends upon where organizations decide to spend their resources, and has a simple message for financial institutions that may not perceive workplace misconduct as dangerous as traditional compliance breaches. 

“HR compliance is a real thing. In the current environment, a lot of complaints are more interested in having the problem addressed socially rather than legally, which affects your business because you could lose customers, and lose your reputation.

“So I don’t see why you wouldn’t want to protect yourself from that too. Just as we conduct securities regulatory training, you could do the same for conduct. In fact,I’ve never seen a decent-sized company that didn’t conduct HR compliance-related training, and [conduct surveillance solutions] would just augment that sort of thing.”

So what does Mendelson do now that he’s retired from the world of legal and compliance if it’s not binge-watching drama series that glamorize and over-dramatize the world of finance? Well, he still likes to keep up on the latest regulatory trends, especially in the securities regulatory space, but also spends some time every day, keeping himself physically fit and loves to cycle. 

“I am currently in Tucson, Arizona, which is high desert. We have three seasons every day in the Winter. It’s lovely.”

For highlights of the Bob Mendelson video interview, visit https://radar.behavox.com.