Struggle for the Soul of Wall Street

Not just “can we do this”, but “should we?”

Sir Hector Sants’ sudden leave of absence from Barclays Bank last month epitomizes the intense ethical struggle now engulfing the financial industry.

Sants, 57, was brought in earlier this year by CEO Antony Jenkins to help reform a bank that has featured in virtually every financial scandal of the past several years.  Sir Hector was clearly the right man for the job since it was he who had expressed concern about Barclays’ culture back in 2010 when he headed the UK’s Financial Services Authority.   Sants also knows the investment banking business firsthand from previous senior stints at UBS, Warburg, DLJ and Credit Suisse.

It took only 10 months at Barclays, however, for Sir Hector to realize what he had taken on, and so he told the bank that he needed at least 3 months’ sick leave to recover from “exhaustion and stress.”

Compensation and status

As we all know, executives on Wall Street and in the City of London are doing everything they can to preserve a way of life that has served them well.  They are also painfully aware that they can only attract top talent by offering attractive financial incentives and superior social status.

iStock_000027572499SmallThere’s no question that banking reputations have been severely harmed by the chicanery unmasked since the financial crisis.  The rigging of LIBOR and the current investigation into the manipulation of the foreign exchange markets go way beyond individual wrongdoing and have gobsmacked even hardened industry veterans.  The same could also be said about rampant insider trading by hedge funds.

The world’s most generous compensation packages are also under pressure, initially across the EU, but now also in the US.  While banks and hedge funds still pay their employees well above any other industry, the tarnished image of Wall Street and just about all other financial capitals is substantially degrading what used to be the plummest jobs in town1.

At Harvard Business School, for example, only 27% of the class of 2013 took jobs in financial services, the first time that figure ever fell below 31%2.  Investment banking, in particular, was the big loser, dropping from 12% of HBS graduates in 2007 to 5% this year.  In recognition of that unfortunate trend, Goldman Sachs just announced that it no longer expects associates to work on weekends and, at Barclays, you can now wear jeans.

Inside the banks and now even the hedge funds, reformation must be feeling inexorable.  The big cases against Raj Rajaratnam and Stevie Cohen have already sent a very clear message to be careful in pursuing public company information.  Even Goldman Sachs has had to eat crow for putting its own interests before those of its customers, and JPMorgan’s $23 billion legal reserve speaks for itself.

Compliance as an end in itself

There’s every reason to believe that Sir Hector Sants had the gravitas to take on the Barclays workforce.  Under Antony Jenkins, he was certainly given the authority to implement the bank’s ‘Transform programme’ and he certainly understood the business.  So what was he up against?

 “If you really could open the box at companies where compliance officers have quit, it’s probably because they were trying to do their jobs well”

“If you really could open the box at companies where compliance officers have quit, it’s probably because they were trying to do their jobs well,” according to Donna Boehme, founder of Compliance Strategists and a director of the Society of Corporate Compliance and Ethics.  “A compliance officer is trying to introduce a new order of things into an organization, and it’s disrupting the power bases.”

Generally speaking, financial firms have not taken compliance seriously until misconduct was discovered.  Internal controls have typically been insufficient to cover business and investment risks and managements commonly prioritized profits and personal gain over openness to clients and strict compliance with the law.  Compliance officers generally haven’t had adequate independence, authority or protection from retaliation to do their jobs.  Firms typically ‘pushed the envelope’ on legal and ethical obligations, were overly technical in their approach to issues of ethics and professional responsibility and restricted the access of their legal and compliance personnel to senior management.

The “London Whale” episode at JPMorgan is a good example of management’s not taking its ethical responsibilities seriously.  Although a highly regulated institution, JPM nevertheless failed to oversee its traders as they overvalued a complex portfolio in order to hide massive losses.  When senior management did discover the breakdown in internal controls, it deprived the firm’s board of critical information needed to determine whether investors and regulators were getting accurate reports.

Another dramatic example is SAC.  Stevie Cohen was running a hedge fund that sported a professional-looking compliance department, but whose top brass knew exactly how to skirt the firm’s surveillance procedures whenever vital trades were on the line.  According to Preet Bahara, the US attorney prosecuting the criminal case against SAC, the hedge fund “talked the talk, but didn’t walk the walk.”

Not just “can we do this”, but “should we?” 

Wall Street is resisting the transition from grudging acceptance of the rules to truly incorporating them into its business decision-making.  I know one case where the latter really does work, but it requires compliance’s having the final say in any matter touching on regulation.  Compliance also needs to have direct access to senior management and an independent voice in the approval of all organizational initiatives.  It needs to be, in effect, the judicial force of the organization.

Compliance alone, however, cannot and does not control the values and culture of a company.  The entire staff – front office, middle office and back office – must always ask not just “can we do this” but “should we?”  It requires a senior management that really values ethical behavior and rewards it accordingly.  Employees have to trust that they can raise concerns confidentially, anonymously and without fear of retaliation.  They also have to know that reported matters will be effectively investigated and resolved fairly and consistently.  According to Stephen Cohen, Associate Director of Enforcement at the SEC, “whistleblowers who don’t report internally repeatedly tell us they believe they will be retaliated against if they raise significant issues to management.”

In addition to the mountain of regulations with which compliance officers have to deal3, there is the deeper question of whose side they’re on.  Unless and until the people responsible for making sure that an organization plays by the rules – even rules management considers stupid – are treated as if they are members of the team rather than the police, cultural do-gooders like Sir Hector Sants are going to be fighting a grinding, uphill battle.

1 Ironically, the hottest jobs on Wall Street and in the City of London these days are in compliance. There’s a shortfall of qualified staff and compensation packages for top compliance officers have increased by 50% or more in the past two years. Hector Sants’ pay package at Barclays was reportedly ₤3 million.

2 Technology and telecommunications, on the other hand, was the big gainer, going from 8% of newly-minted Harvard MBAs to 18% between 2010 and 2013.

3 Wall Street is now spending prodigiously on compliance. According to a recent study of the hedge fund industry, smaller funds are spending an average of $700,000 a year on compliance while larger funds are spending as much as $14 million. Compliance costs constituted over 10% of the operating expenses of more than a third of the surveyed funds managing less than $250 million.

  • Nicholas

    Very interesting article and it goes to the heart of the problem. Not can I but should I. For some reason over the last thirty years there has been a gradual erosion of both ethical and moral values. I wonder as part of the induction course both at college and in businesses there should be a compulsory course on this. The real change though has to come from the top. Big Bang and everything else moved the posts from earning money to making money. Perhaps when financial institutions realise that they should be wealth creaters and earn the money rather than wealth gathers i.e. just collect money rather than create it then there will be hope for the system.

  • M. Little

    Thanks for the great overview of the challenges with compliance. It’s disheartening that the system could defeat someone like Sir Hector. But as long as there’s a financial incentive to cheat (and that may always exist), the Sir Hectors of the world are going to need a lot of fortitude.

  • sreela banerjee

    An article showing a deal of moral courage – thank you for being open and objective – not a lot of it about these days in many fields.

    Sir Hector probably did need the rest; let us hope that he will come back.

    The FSA (now FCA) has prosecuted Barclays for a particularly pernicious kind of program trading, I found in my inbox of FSA updates – the program put up a big hoax trade on the other side, bidding the price up, and then sold, almost simultaneously making the big trade ‘disappear’ – shows that the lack of understanding or morality is absolutely firmly embedded even in the technical infrastructure of the institution….

    I wonder how many others use the program or perhaps it was proprietary, designed to Barclays specifications.