Upgrading Ethics in Financial Services

Carol M. Beaumier and Bernadine Reese


February 3, 2020

The financial services industry is based on trust. Industry stakeholders need to believe that financial institutions are treating them fairly and that good conduct is an institutional imperative. Yet, more than 10 years after the end of the global financial crisis, which was fueled by conduct failures, the financial services industry still needs an “ethics upgrade,” Christine Lagarde, then-chairwoman and managing director of the International Monetary Fund, said in early 2019. This view comes despite a widespread regulatory call-to-action following the global financial crisis, reinforced by strong words and actions ranging from personal accountability regimes, a focus on compensation schemes, guidance on sales practices, and massive financial penalties for poor behavior. Why has trust remained elusive for the industry? Analyzing some of the common indicators of conduct failure and their root causes may provide an explanation.

Both in the aftermath of the financial crisis and more recently, examining conduct risk failures has identified scores of potential causes. Five of these reverberate as recurring themes: lack of leadership; poor management of the product life cycle; inadequate employee training and oversight; inappropriate incentives; and inadequate management reporting and escalation.

Conduct is strongly influenced by a company’s leadership. The mission, vision and core values of nearly every financial institution state a commitment to the fair and transparent treatment of all stakeholders. However, in many financial institutions, actual practices differ from the stated goals. Rules of engagement may not be adequately communicated or documented, leaving employees without proper guidance to determine circumstances that may create potential conflicts of interest. The organization may not encourage consultation and may explicitly or implicitly discourage escalation of potential issues. Senior management may fail to model the behaviors it dictates for others or standards may not be applied uniformly to every department, meaning that a highly profitable business unit might escape scrutiny even when it reports suspicious results that should raise red flags.

Most financial services companies have seemingly well-defined processes for evaluating the risks of new products and services, yet they may fail to address these risks responsibly throughout the product life cycle. Some do not have defined product governance processes or product inventories, and do not adequately consider expected or unintended market impact or customer outcomes, particularly when dealing with vulnerable customers. Others are unwilling to walk away from potentially lucrative products or product features, or implement appropriate safeguards for such products, even when possible customer/market risks are identified. And some companies simply do a poor job of following the clues provided by complaints of potential or actual problems, often addressing a symptom rather than the cause of the issue.

In some financial services companies, uninformed staff or other representatives (such as third-party agents) may unwittingly create conduct risk. These individuals may not have the tools they need to ensure that customer and market interactions are undertaken fairly and transparently. They may not completely understand the product features and related risks, or where to turn for answers to their questions. Policies and procedures may not provide adequate guidance and clarity. The appropriate oversight of company representatives, including third-party relationships, is a key part of any conduct risk framework, and inadequate oversight of these individuals may allow poor sales practices to continue unchecked.

The well-chronicled influence of incentives on behavior also needs close examination. In too many cases, remuneration schemes still emphasize production and revenue over conduct. When this imbalance in performance incentives cascades down into the organization and across functions and business units, it is a proven recipe for disaster. Even where a financial institution has modified incentive plans to align compensation better with the company’s values and meet regulatory requirements, revamped programs tend to apply to more senior level management and not necessarily to the customer- and market-facing staff.

Finally, management reporting may be deficient and escalation channels may be unclear. These circumstances create an environment where transparency is lacking, and the institution’s leaders are missing or failing to act on changes in business realities.

Ultimately, these common indicators of conduct risk failure all point to the same source: a company’s culture. And changing culture is very difficult.

Despite regulators’ best intentions, it is often challenging to compel a company to behave appropriately if it does not inherently believe that ethics are more important than profits. Companies that are committed to being ethical leaders are self-driven. They embed conduct risk principles seamlessly in their culture, regardless of regulatory requirements. They do this by influencing and continually reinforcing the behaviors they expect. While their tactics may differ, there are some commonalities in the way ethical companies tend to operate.

Ethical leaders not only espouse and commit to ethical values, they also realize that continually challenging the status quo is a strength. Therefore, leading companies are likely to encourage and support wide diversity within their boards and senior management ranks to get the best thinking on actions taken to support the organization’s mission, vision and core values.

Ethical leaders do not leave compliance with their values to chance. They educate and continually remind employees of real, potential or perceived conflicts of interest, as well as the risks and potential impacts on their market and customers. They want to know what is happening in their organization. They foster a safe environment in which employee feedback is encouraged and valued.

In an organization where ethics is a priority, leaders try to identify potential problems early by optimizing available data, such as sales statistics and related bonuses, customer complaints, analytics into customer behaviors and buying patterns, issue escalation and resolution information, whistleblower reports, ethics hotline reports, unstructured social media/message board data, and turnover statistics including feedback from employee exit interviews.

Ethical leaders proactively look for cracks in their culture by conducting employee surveys, performing culture assessments and engaging in focus groups with stakeholders. They back their words with actions by, among other things, recognizing and rewarding good behavior. They also design and implement incentive compensation programs that do not favor production over conduct and are consistently applied and enforced across the organization.

Real conduct change in the financial services industry can only come from the strong leadership of board members and senior executives who accept responsibility and accountability. They must also understand and support the role financial institutions must play in balancing shareholder desires with the need to protect customers and markets. Many boards and senior management teams have stepped up to meet this challenge, but more must follow. Until that happens, regulators will keep trying to fill the void, but their actions alone will not restore trust in the industry.

Carol M. Beaumier is a senior managing director in the risk and compliance practice, and the Asia-Pacific financial services leader at global consulting firm Protiviti. Bernadine Reese is a managing director with the risk and compliance team at Protiviti.
Carol M. Beaumier is a senior managing director in the risk and compliance practice, and the Asia-Pacific financial services leader at global consulting firm Protiviti. Bernadine Reese is a managing director with the risk and compliance team at Protiviti.