Part of the problem for banks is their closed culture, something regulation will not be able to change, argues Wilfred Chow


For all its complexity, the recently enacted Dodd-Frank Act seems to hold a simple premise: the U.S. banking industry cannot be trusted to manage its own risks and must be reined in by a host of new, external constraints.

Nevertheless, unless we are to believe that most if not all bankers in the U.S. are inherently unethical or irresponsible, can we give up hope that U.S. banks may yet govern themselves and manage their risks soundly?

In the backlash of cynicism toward Wall Street that followed the financial crisis, the question of how banks can voluntarily improve their self-governance may have taken a back seat to the push for more regulation.

Self-governance matters

However, this question remains terribly relevant – perhaps even for some non-U.S. banks - since financial regulation will always play catch-up to financial product “innovation”; there will always be loopholes in new regulations that clever minds can exploit. Ultimately, sound self-governance by banks is also needed to avoid the next financial crisis.

Bank governance can be roughly divided into two areas. The first involves substantive goals, such as devising more sustainable lending practices, or aligning pay with longer-term performance. The second area relates to process, such as the proper level of board activism, or the mechanism for vetting conflicts of interest.

The hypothesis advanced in this article falls into the latter category and seeks to mate the burgeoning field of followership with sound bank risk management; it argues that employees’ individual ethics sense has been under-utilized as a tool for ferreting out and checking at least some of the problematic business practices that underlie the financial crisis in the U.S., such as negative amortization loans and no-documentation or “liar” loans in the subprime mortgage market, and certain related securitizations and credit default swaps.

The inquiry starts with this question: how could legions of employees at the front lines of transacting the questionable financial products have seemingly participated in a race to the bottom, without there being much evidence that they effectively questioned such practices?

To be sure, there have been a few whistleblowers. However, by and large bank employees seem to have plodded along in peddling such products without much overt misgiving.

Hidden moral compasses

Having spent many years working on Wall Street (though not in the areas associated with the financial crisis), I do not believe that most of their employees lack ethics or a sense of duty to the stakeholders. However, there may be aspects of the corporate culture on Wall Street that impede expression of an individual’s moral compass.

In contrast to the open architecture-inspired governance model of some tech firms, Wall Street firms by and large hew to a seemingly archaic, top-down command structure, laden with hierarchies.

Regrettably, such structure does not foster an open culture where a marketplace of ideas can thrive. Notwithstanding the corporate speak regarding diversity and empowerment of employees, there may be great pressures at these firms to conform to existing business practices or the views of superiors.

Such conformist pressures may stem from a misplaced sense of loyalty to a superior, and/or plain old fear (of losing acceptance, a promotion, a raise or even one’s job). Whether resulting in groupthink or conscious self-suppression, such pressures, upon entering into any evaluation of existing or proposed business practices, tend almost always to distort the decision-making to the extent that legitimate ethics or similar concerns are stifled.

Speaking up counts

To combat the conformist mindset and groupthink that prevails on Wall Street, its leaders should strive to cultivate a meritocracy of ideas, in which issues or concerns about ethics or reputational risk can be raised, addressed or rejected by employees purely on merit and without fear of retaliation.

It is not enough to include comforting words in the corporate code of conduct about ethics hotlines or empowering employees to report potential violations. Certain U.S. firms that behaved abysmally in the run-up to the financial crisis had such types of wording in their code of conduct, with scant evidence that their employees effectively objected to the questionable practices.

The corporate leaders must by their daily words and deeds emphatically promote the new culture, so that there is a credible case for employees to feel rewarded for raising in good faith any ethics issues or concerns.

Preferably, concrete and visible action plans should be put in place by senior management, with the help and advice of in-house corporate responsibility and ethics functions and, absent those, outside experts.

It is beyond the scope of this article to fully address such plans, and there is no one-size-fits-all solution in this area, but the following may be a sampling of useful starting points for such inquiry:

• Periodic surveys should be conducted to probe employee perceptions of openness of the corporate culture and where the firm falls short in that regard.

• Given that an employee’s trust in his employer is largely a function of his relationship with his immediate superior, performance evaluation of a manager should include feedback from direct reports as to how much he encourages open debate about ethics and reputational risk issues and how effectively he addresses such issues when raised by his reports.

• Periodic training of management personnel as to how to model the open culture, and of employees in general as to interpersonal skills that help to minimize the downside of speaking up on ethics or reputational concerns, should be provided.

• An employee’s performance evaluation should include an assessment of the degree of his initiative in voicing, in good faith, ethics and reputational risk types of issues, and decisions about his incentive compensation and/or promotion should reflect such performance.

Through vigorous and open debate by relevant employees, questionable activities or products can be nipped in the bud before becoming real problems. Moreover, in such environment, any legitimate ethics or similar concern would hopefully drive vocal questioning among the ranks – compelling management to lend its ears - and forestall the lone whistle blown to the authorities.

It is true that, as the author Ira Chaleff has noted in his book, “The Courageous Follower”, corporate leaders will need to manifest the “courage to listen to followers” (see Chapter 8) to tap into the value of employee/followers who are willing to speak up.

Opening one’s initiatives to genuine debate may initially feel uncomfortable, and one better be prepared to address what he has heard. However, corporate leaders can distinguish themselves and their firms in this area.

Just smart management

For example, Ray Dalio, the head of Bridgewater Associates, a major hedge fund based in Connecticut, believes that “[g]ood management is most fundamentally about bringing problems to the surface”, as he stated in number 6 of almost 300 principles which comprise the Bridgewater philosophy (the “Bridgewater Manifesto”) .

Toward that end, he encourages his colleagues to pursue “radical truth and radical openness” as part of their culture (p. 23, Bridgewater Manifesto), and avers that “[c]onflict in the pursuit of excellence is a terrific thing and is strongly encouraged at Bridgewater, in fact demanded”.

The firm expressly encourages employees to surmount corporate hierarchy in such process: “every ‘subordinate’ is encouraged to debate with his or her ‘superior’ if he or she thinks they know the better way, and every ‘superior’ is required to encourage this”. There is some evidence, based on client and employee feedback, that Bridgewater’s culture does lead to superior results.

In time, bank leaders may come to consider a truly open culture as a competitive advantage - as an opportunity to effectively tap into employees’ collective wisdom on ethics and reputational risks. They may discover that ethics-related concerns of employees, when given free expression, comprise one of the best tools for managing risk and restoring trust in Wall Street.

Wilfred Chow is a U.S.-based lawyer and corporate governance researcher and writer. He previously served as a Managing Director and Associate General Counsel at a leading financial services firm in the U.S.

bank  finance reform  governance 

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