Know-your-customer isn’t the only motto financial firms should live by. The US Securities and Exchange Commission has put human resource, compliance and risk departments of financial institutions on high alert that they have to know a lot more about candidates for internships and employment, as evidenced in a recent multimillion dollar penalty paid by BNY Mellon for violating the US Foreign Corrupt Practices Act (FCPA).
The regulatory agency’s decision against the world’s largest custodian bank shouldn’t be viewed as extending the reach of the FCPA, which prohibits US companies from bribing foreign officials for government contracts and other business. It is simply the first time the SEC has applied the rules to a global financial services firm.
“The SEC regards employment and internships as falling within the statutory term of anything of value,” explains Jeffrey Maletta, a partner with the law firm of K&L Gates in Washington, D.C. “This position is consistent with what the SEC and Department of Justice have said for some time.”
BNY Mellon may be the only bank penalized for violating the FCPA so far, but others aren’t far behind. JP Morgan is now also under investigation by the SEC and Department of Justice for hiring relatives of government officials in China. In March 2014, the SEC reportedly sent letters to Credit Suisse, Goldman Sachs, Morgan Stanley and Citi about their employment decisions in Asia. The SEC investigated BNY Mellon for four years before it levied its penalty, so it could be some time before competitors face the same fate. In 2010, the SEC’s enforcement division created a specialized unit to enhance its enforcement of the FCPA, enacted in 1977.
In August 2015 BNY Mellon had to pay a total of US$14.8 million for giving internships to relatives of decisionmakers at an unnamed Middle Eastern sovereign wealth fund in exchange for additional business. Because the sovereign wealth fund was a state-owned enterprise, its personnel were considered government officials for the purpose of complying with the FCPA. BNY Mellon’s fees, according to the SEC, came from the government contracts awarded to the bank. In 2010, the bank held US$55 billion of the foreign fund’s assets in its global asset servicing unit — responsible for custody and other middle and back office functions — and US$711 million in its global investment management business.
The timing of the internships were suspect: the Middle Eastern sovereign wealth fund increased the value of its assets under the bank’s custody after the internships were offered. BNY Mellon also gave the three individuals– two sons and a nephew of the foreign government officials a free pass; they didn’t have to meet the bank’s usual stringent criteria for highly sought after internships. They were recent college graduates, but not pursuing any degree at the time of their internships. Their performance during their internships was described as “less than exemplary” and lasted longer than the standard summer season.
The US isn’t the only country cracking down on corrupt business practices. The UK, Germany and Switzerland have also put their financial institutions on notice to comply with local equivalents to the FCPA, but the US is considered by legal experts to be the most aggressive. followed by the UK, Germany, and Switzerland. “The hiring and other business practices of US banks overseas fall under the jurisdiction of the FCPA and the SEC which enforces the law. So do the hiring and internship programs of foreign banks which do business in the US or are listed on a US exchange,” says Riyaz Dattu, a partner with the law firm of Osler, Hoskin & Harcourt in Toronto. A global bank could end up having to follow the FCPA and local regulations of multiple countries, including their home country and where they do business overseas. Case in point: a Canadian bank listed on the New York Stock Exchange with operations in the Caribbean might have to comply with at least three legal systems.
The BNY Mellon fine raises the question: How can a regulator prove that the internship or employment opportunity violates the FCPA? The evidence could be circumstantial. In the case of BNY Mellon, there was little doubt. In their e-mails, bank executives discussed how offering the internships in 2010 and 2011 was necessary to retain or grow business with the Middle Eastern fund. Officials at other financial firms might not be as foolish in their email communications. The SEC never disclosed just how much in additional fees the bank earned from the Middle Eastern sovereign wealth fund or why its penalty was so high. The Middle Eastern sovereign wealth fund transferred an additional US $689,000 in assets to BNY Mellon’s asset management unit in June 2010. The fund had been a client of the bank since 2000 and, based on emails of BNY Mellon employees uncovered by the SEC, the employees were concerned that the government officials affiliated with the Middle Eastern sovereign wealth fund would move their account to a rival bank if the internships weren’t granted.
“The government has the burden of proof if it brings charges, but if it identifies questionnable conduct in an exam or investigation, the financial firm takes on the burden of proving innocence in convincing the government not to bring charges in the first place,” cautions Maletta. “The firm must either show that no violation occurred, or if it did that the firm did all it could to prevent the improper conduct from taking place.”
What to Do
So how is a bank to stay on the straight and narrow? For starters, it should make certain that the candidate meets all the necessary educational and other qualifications. Lucinda Low, a partner at the law firm of Steptoe & Johnson in Washington DC also draws a parallel between financial firms providing internships or permanent employment and onboarding a new client. “If the basic qualifications are met, the firm’s HR department then needs to ask about any affiliations with politically exposed persons — foreign or US government officials or public figures for starters,” she recommends. “If the answer indicates an affiliation, the financial firm must then notify its compliance department to determine just how much of a regulatory risk the internship or hire will be.”
The process of risk-rating a candidate is similar to that which takes place when a new client is signed up. The higher the risk-rating the higher the potential for the client to either not be accepted or at least monitored more closely for potential change. “Critical to the decision-making process should be whether the hire or intern is related to any government official who has the power to influence whether the bank receives business or not,” says Dattu. “A candidate related to a low level government official should be ranked at a lower risk than someone who is a top-ranked leader.”
Human resource and compliance specialists will likely be the first to ensure that their financial firms don’t fall astray of the FCPA and similar regulations across the globe. Their decisions should fall in line with their organizations’ enterprisewide risk management program, according to Maletta. Financial firms that may have foreign governments, sovereign wealth funds or state-owned enterprises as clients should pay even closer attention to their internship and hiring practices, among other practices. Naturally, these firms should educate their HR, compliance and other business lines about the FCPA and the conduct to avoid. Executives need to spot red flags quickly so that potential problems can be elevated and addressed.
As the SEC noted in its settlement with BNY Mellon, the bank’s internal controls were not correctly tailored to identify the regulatory risk inherent in hiring referrals from clients and were inadequate to provide reasonable assurances that the bank’s employees did not violate its policy against bribery of government officials. BNY Mellon’s human resources department, in particular, was not trained to catch potential problem interns or hires.
The US$5 million civil penalty the SEC levied against BNY Mellon, as part of the US$14.8 million total penalty, was lower than originally intended because of the bank’s remedial actions, the SEC said. Some of those changes were taken before the SEC’s investigation started. The bank altered its anti-corruption policy to explicitly address hiring of relatives of government officials, mandated that every full-time hire or internship application be vetted through a centralized human resource process, and required that each employee annually certify that he is not responsible for hiring through a non-centralized process. BNY Mellon also required that each applicant indicate whether he is himself a government official or associated with one. If so, the bank’s anti-corruption office would have to review the hire.
Although the SEC will first look at the direct activities of financial institutions when it comes to how they comply with the FCPA, the firms aren’t off the hook when it comes to the practices of third-party vendors such as subcustodians across the globe. Dattu recommends that financial organizations ask those service providers for their ownership structure and ensure that they have a compliance program in place to not violate the FCPA and similar local regulations.
What happens if a financial firm discovers its hiring practice has violated the FCPA after the fact? Notifying the SEC isn’t always the right response, especially if it was an isolated instance, says Low. Instead the firm might consider what steps it could take to mitigate the regulatory risk such as either firing the candidate or transferring him to another position within the company. The firm should then document how the error was rectified and establish new policies to avoid a repeat scenario.
For financial firms who think that they don’t have to worry about the FCPA, think again. The SEC practice of paying whisteblowers may open the door to an investigation. “Current and former disgruntled employees might just decide to whistleblow the bad practice,” cautions Dattu. The SEC could subpoena e-mails and other records and find suspect conduct. At that point, the financial firm will have to prove its innocence, rather than the SEC having to prove its guilt.
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