June 13, 2018 / 6:49 PM / in 8 days

BOOK FEATURE: 'Bad apples' vs. 'corrupting barrels': a new view of banking misconduct

NEW YORK (Thomson Reuters Regulatory Intelligence) - Large banks have a huge blind spot in their conduct and cultural reform programs by focusing their efforts too narrowly on individual employees rather than understanding the climate of the teams in which they operate. In other words, they look for “bad apples” and ignore the corrupting role of the barrel.

Wieke Scholten

This is the premise of a new book, “Banking on Team Ethics” by Wieke Scholten, Head of Audit for Behavioral Risk at RBS in London, who argues that firms need to incorporate tools from organizational and social psychology if they want to better understand what drives bad behavior, and more proactively address a firm’s underlying problems.

(Wieke Scholten will take part in a Thomson Reuters forum on behavioral science and culture reform on June 28 in London. Also participating are Orlando Ruiz Fernandez, Technical Specialist: Governance, System and Controls, Bank of England and Alex Viall, Head of Regulatory Intelligence, Behavox. To find out more about the forum, please contact: lmsevents@tr.com).

With regulators urging banks to address their culture and conduct issues, yet refraining from advancing a set of rules or roadmap that firms can follow and comply with, the reaction within the industry has been to take a legalistic and, what some call, “criminally-based” approach towards misconduct and unethical behavior.

Conduct and culture issues have largely fallen within the scope of compliance and human resource functions at many organizations. These functions, particularly in compliance, are often staffed with trained lawyers, former regulators, and sometimes ex-prosecutors.

According to Scholten, who prior to RBS worked as a senior supervisory officer in behavior and culture supervision at the Dutch National Bank, the focus of many of these professionals is the so-called “bad apple”, an employee whose behavior crosses the line within the organization and risks infecting others around him.

In Scholten’s analysis, which focuses primarily on behavior on the trading desks of large investment banks, the bad apple approach has shortcomings. These include:

— It fails to explain why there are some corrupt trading desks while at other desks there is no misconduct;

— It does not offer ways to reform misconduct in an individual. It also assumes that the best way to prevent misconduct is to the keep bad apples out of the organization through changes in “recruitment procedures,” for example;

— It omits responsibility for the organizational culture.

— In addition, when misconduct occurs, most financial organizations react by seeking to:

— Contain the misconduct and focus on damage control,

— Take disciplinary measures against the “bad apples,” i.e., specific traders, and

— Increase controls aimed at mitigating opportunities for bad apples to cross the line.

Misconduct cases are seen as a legal liability, says Scholten, with the organization placing the blame on the individual. Information is provided only on a “need to know” basis. “However, withholding relevant information about past misconduct from others within the organization prevents them from drawing important lessons,” she writes.

“CORRUPTING BARRELS”: WHERE THE PROBLEM STARTS

Many people like to view themselves as ethical individuals, and for the most part, many are. However, within the context of a large investment bank, or any large, complex organization, individual behavior is often shaped by the norms and standards of the group or team.

“[G]roup members help to establish a standard for ethical behavior through their actions and omissions. These actions and omissions provide information on the relevant social norm within the group,” says Scholten.

“This social norm tells its members what (ethical) behavior is expected in a certain context and is considered appropriate or inappropriate. So, when analyzing the root causes of unethical behavior of traders from a social psychological perspective, the trading team should constitute the appropriate level of analysis and is an important source of information,” Scholten adds.

Enter the concept of “corrupting barrels,” a theme that runs through Scholten’s book, including an approach to analyze and better understand such barrels, or teams, in a proactive way. The way in which most organization’s currently address misconduct cases avoids an understanding of how the team in the which the individual operated may have contributed to the bad behavior – hence, the “blind spot.”

“The team climate perspective is a blind spot for banks and financial supervisors. Attempts to prevent unethical behavior focus on organizational level (i.e. values, culture change programs) or individual level (i.e. ethical recruitment tests, disciplinary measures),” writes Scholten.

“Team climate, that harbors social psychological root causes of unethical behavior, is not a perspective used by banks when analyzing misconduct. So, for bank, team climate is simply not in sight,” she adds.

("Banking on Team Ethics" can obtained via the following website: here)

(Henry Engler is a North American Regulatory Intelligence Editor for Thomson Reuters Regulatory Intelligence. He is a former financial industry compliance consultant and executive, and earlier served as a financial journalist with Reuters. Email Henry at henry.engler@thomsonreuters.com)

This article was produced by Thomson Reuters Regulatory Intelligence and initially posted on June 11. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @thomsonreuters

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