NY-area bank regulators seek greater efforts on compliance and ethics

By John M. Pachkowski, J.D.

In the past several months, New York-area regulators have taken to the stump calling on financial institutions to take greater steps to ensure that their organizations’ compliance and ethics culture are above board.

Thomas C. Baxter, Executive Vice President and General Counsel of the Federal Reserve Bank of New York, has been one of the more vocal regulators on the subject. In a series of speeches, spanning from July 2014 to February 2015, Baxter has called on banks to: harmonize organizational values with legal compliance; promote a stronger ethical culture; and to adopt tools measure their compliance programs’ effectiveness.

Harmonizing values. Speaking at a July 2014 conference on new compliance landscape, sponsored by the Risk Management Association and Debevoise & Plimpton LLP, Baxter noted, “If organizational values do not support the rules that organizations use to guide the behavior of employees, and worse, if organizational values actually conflict with those rules, the organization is headed for troubled territory.”

He observed that the disproportionate number of economic sanctions cases brought by the U.S. government involving foreign financial institutions was due to the fact that foreign banks viewed economic sanctions differently than U.S. financial institutions. He noted, While U.S institutions generally understood that economic sanctions were narrowly tailored to accomplish a public purpose, the foreign financial institutions “looked at economic sanctions as technical ‘American’ rules that were not seen as consistent with the organization’s larger value system.” Baxter added that the foreign financial institutions “saw the situation as providing financial services to a country; not to a country committing genocide; not to a country building a nuclear weapon; and not to a country fostering an offensive ideology. This failure to correlate the rule with the value is the root of real mischief.”

During his remarks he also expressed his discomfort with a narrow exception the bribery prohibition found in the Foreign Corrupt Practices Act. From Baxter’s perspective, the narrow exception for “facilitating or expediting payments made in furtherance of routine governmental action” allows a certain limited form of governmental corruption. Baxter remarked, “While I understand that the exception is grounded in a practical reality, I feel that zero tolerance for official corruption would have been a better choice.” In his view, when an organizational policy permits “some types of official corruption (and we have come up with candy coated names for this, like facilitation or expediting payments), this diminishes the efficacy of compliance rules that are directed toward stopping official corruption. Again, the best compliance cultures are formed when the rules and the organizational value system are in perfect harmony.”

Stronger ethical culture. In January 2015 remarks at the Bank of England, Baxter highlighted important features of a strong ethical culture in the financial services industry. Although Baxter strongly supports enforcement actions to address bad behavior, he questioned whether the public good would be better served if something more forward looking and complementary were done to deter future bad behavior. He also noted that firms with a service provider business model “tend to have a better culture than those firms that consider their operational model as money maker.” Baxter concluded that changing the time horizon for compensation, so as to dissuade “short termism” will be a significant feature of meaningful cultural reform.

Measuring compliance. Finally, in February 2015 remarks at Fordham Journal of Corporate Counsel & Financial Law Symposium in New York City, Baxter noted the lack of a well-accepted measure of effectiveness of a company’s compliance program. One measure some companies use assess the effectiveness of compliance programs, according to Baxter, is the Program Effectiveness Index (PEI). PEI shows that companies combining their ethics and compliance programs tend to have better PEI scores. This is because ethics programs help to create a culture that is not only conducive to following rules that are embedded in law and regulation, but also conducive to compliance with company mores.
Baxter also addressed the sometime adversarial climate that exists between compliance officers and business leaders that own the risk. He suggested:

• embedding ethics and compliance issues in the disciplines that are more typical of governance issues involving the board of directors, like strategy, business goals, and risk management, all of which touch ethics and compliance; or 
• creating escalation pathways to the board of directors for resolving conflicts between the chief ethics and compliance officer and a senior business leader.

Stronger individual accountability. At the state level, New York Superintendent of Financial Services Benjamin Lawsky said the Department of Financial Services (DFS) is considering making senior executives personally attest to the adequacy and robustness of anti-money laundering (AML) systems. In prepared remarks at Columbia Law School, the Lawsky also stressed the need to hold individuals, not just corporations, accountable for misconduct.

Acknowledging that self-reporting by firms to gauge AML compliance is a “whack-a-mole” approach, Lawsky suggested taking a page from the Sarbanes-Oxley Act and require senior executives to personally attest to their AML systems’ effectiveness.

Another area where more individual accountability is needed is fraud. Many Americans have been “deeply disappointed” by efforts to hold individual, senior executives on Wall Street accountable for misconduct. It’s unsurprising that we continue to see fraud after fraud, said the regulator, because the individuals who engaged in wrongdoing rarely, if ever, face any real consequences.

Even if the misconduct doesn’t rise to the level of criminal fraud, regulators still have options, Lawsky said. In civil enforcement actions, the agency required the CEO of BNP Paribas and the chairman of Ocwen Financial to step down. The agency has also banned multiple senior executives from participating in the operations of regulated institutions.

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