FINRA: Making Compliance a Way of Life

Culture of compliance.

Those three words recently uttered by the US Financial Industry Regulatory Authority (FINRA) as being one of its priorities during its exam process this year hasn’t exactly taken broker-dealers or their legal counsel by surprise. After all, broker-dealers know they have to fulfill regulatory requirements.

Yet the term is generating plenty of talk simply because it appears to mean much more than just ticking off the boxes. Broker-dealers will need to “reengineer” how their employees think about compliance and make it a must-do in their daily work lives.

“FINRA’s priority isn’t all that new. The culture of compliance has been a regulatory buzzword since early 2000, but FINRA thinks that firms have simply spent far too much time writing down their policies and procedures, but not enough time enforcing them,” says Aegis Frumento, a partner with the law firm of Stern Tannenbaum & Bell in New York. The evidence is that broker-dealers have not been all that convinced when it comes to compliance is noteworthy: FINRA says that US brokerages have spent over US $300 billion in fines and litigation costs over the past five years.

The culture of compliance isn’t simply the culture of enforcement. The regulatory agency apparently now wants to be reassured that broker-dealers understand what the rules are, what they mean to work process, and why they are so important. It defines the culture of compliance as “the set of explicit and implicit norms, practices and expected behaviors that influence how employees make and carry out decisions in the course of conducting the firm’s business.”

FINRA is testing whether that definition is being met in a sweep of an undisclosed number of broker-dealers. They must answer eight questions posed by FINRA in three broad categories by March 21. The categories are: does your firm the firm have policies and procedures to establish cultural values that create a tone from the top; does your firm have metrics to assess compliance with the policies and procedures to deal with breaches of the cultural value policies; and does your firm incentivize compliance with the cultural policy.

“Naturally, broker-dealers shouldn’t be inviting a FINRA audit,” cautions Frumento. “They should take their responses seriously and not be silly enough to show how lackadaisical they are.”

It stands to reason, he argues, that broker-dealers have already developed written policies and procedures. Policies reflect the concepts which must be followed to match regulatory requirements while procedures are the steps that must be followed to comply with the policies. Those policies likely include explicit descriptions of the ramifications of violations which can range from a verbal warning to a written reprimand all the way to being terminated. Just how many verbal or written warnings are considered sufficient or the number of violations which merit dismissal is subject to a firm’s discretion. Some brokerage firms have a policy of one-strike and you’re out, while others take a gentler approach and try to offer additional educational coursework.

Finding the Metrics

The bigger issue for firms to address in FINRA’s recent mandate is how they will show whether they have been successful in implementing a culture of compliance. The regulatory agency has come up with some guidance, leading legal and compliance experts to suggest that at at minimum firms must implement an effective compliance program that detects violations of FINRA’s rules, quantifies the number and types, and imposes the appropriate remedial action to prevent future violations. “Ideally, firms with effective compliance programs will likely have fewer violations especially with the number of repetitive violations from the same employee or others in the same unit employee or others in the same unit,” says Charles Field, an attorney with the law firm of Sanford Heisler Kimpel in San Diego.”Likewise, an increase in the number of violations would suggest an ineffective compliance program and a breakdown in the culture of compliance.”

The tone of compliance must naturally come from the top. “Chief executives must ensure that their chief compliance officers has access at all times and are given the necessary resources,” says Field. Chief executives must understand and emphasize that meeting regulatory requirements should always trump profit-making. A single fine could not only wipe out hard-earned revenues, but create reputational risk which will hurt the future bottom line.

Just what are those resources that compliance officers will use? “Trading surveillance systems, compliance trading applications and other decision-making tools are critical to monitoring potential illegal trading activities but they can only go so far.” says Nick Fera, chief executive of Firm58, a trading technology shop in Chicago. “When violations are discovered they must be investigated and addressed immediately.” Doing so requires trained staff who won’t hesitate to ask the tough questions and won’t stop asking unless they are satisfied with the answers.

Likewise, compliance officers must be given the clout to do their jobs effectively. A title with no teeth can be ineffective, if not outright dangerous. “Compliance officers need to know that their decisions on investigating potential wrongdoing, documenting it and addressing it will be supported at the highest levels,” says Thomas Grygiel, principal consultant for ACA Compliance Group, a regulatory compliance consultancy in New York.”No one’s interest is served if the CCO’s decision isn’t backed by upper management.”

Too often compliance officers are viewed by disgruntled employees as obstructionist and ignorant of staff’s real jobs. Such can especially be the case when it comes to traders whose work involves taking risks to make the most profit possible, and can skate the edge of violating a trading rule. FINRA is rightly concerned that trading desks can be subcultures of resistance to compliance which is why, say legal experts, it will likely pay close attention to any warning signs. Those may be suspicious trading patterns, or interactions with middle and back-office operations staff who could be involved with booking phantom or erroneous trades.

“It is necessary to foster a culture of change in how the compliance manager is viewed,” says Esdras Vera, global practice leader for the compliance solutions practice of Bates Group LLC, a financial services consultancy headquartered in Lake Oswego, Oregon. “Compliance directors and traders should ideally address each other in an interactive non-confrontational approach. Of course, the same applies to all business units.”

The tone of compliance is just as important as the content. “The discussion shouldn’t only be about what rules should be followed, but a more practical understanding of how to do the job in a way that falls within any rules. That involves a give-and-take conversation between compliance departments and business lines,” explains Vera.

If broker-dealers really want to ensure they have a culture of compliance, they may need to motivate their employees a whole lot better than just using a stick approach alone. In its questions, FINRA suggests that broker-dealers try the carrot: incentivizing their employees. Broker-dealers might want to consider bonuses for unit managers that either reduce the number of violations or have no violations of policies and procedures, say some compensation specialists.

Yet, they acknowledge that such perks won’t be all that easy to implement. “Fear of punishment tends to be a more  immediate motivator than the promise of some future reward. In addition, firms should think long and hard about whether they want to give someone a bonus for simply following the rules,” says one compensation expert at a New York financial services consultancy. “It doesn’t send a good message about personal responsibility.”

Mind Control

While chief executives and chief compliance officers debate just how they will need to instill the culture of compliance in their employees, staffers should be preparing themselves for a lot more visits from compliance officers out of centralized units. If they’re lucky, they might have dedicated compliance officers working in their own units, who understand more about specifics of their business. Two out of five chief compliance officers at US brokerages contacted by FinOps Report say that their firms are considering relying on specialist compliance managers to work at specific business units. Those units include the trading desk and IT departments.

That’s just for starters. All five CCOs say their firms will be starting training programs to explain the culture of compliance. However, they have yet to determine who will design those training programs and their specific content. The most popular option appears to be working with external compliance consultants and internal human resources departments for training advice. However, HR experts tell FinOps they are worried about how much of this responsibility they should take on. HR managers are perfectly comfortable executing a firm’s policies, procedures and consequences. But when to it comes to establishing the policies and rules, no so much. They would rather pass the buck to compliance departments when it comes to the hard decisions on how to manage conduct. “It will be the human element of meeting a culture of compliance that will end up being the trickiest,” cautions Fera.

Compliance managers, in turn, acknowledge they are also wading in unfamiliar waters. “We can tell our employees what to do and the consequences if they don’t and hope they will do the right thing,” says one nervous compliance manager at another broker-dealer. “Ultimately, implementing the culture of compliance will mean how well we can shape employees consciences. Do they know what rule they have to follow? Do they understand why? And do they feel they have a moral responsibility to do so?”

It’s hard to know if professionals can be trained in morality, but some employees already see the “culture of compliance” in a different way — the prospect of being micromanaged. “We are expecting to attend a lot more lectures on right and wrong in our training classes,” acknowledges one manager of trading desk support at a broker-dealer. “That’s okay. The problem will start when we have to deal with one question after another from our supervisors and compliance managers about what we’re doing. At that point, it interferes with our making money. Firms want to squeeze every penny they can from us, and you can bet that this is going to cost them profits.”

The line between browbeating an employee and managing his or her activities correctly can be thin. “Broker-dealers should review and address only potential problems,” suggests ACA Compliance’s Grygiel, also a former examiner for FINRA. Doing more than that, insists the trading desk manager, will be “counterproductive overkill.”