'Criminalized' compliance may backfire in quest for better Wall Street cultures

NEW YORK (Thomson Reuters Regulatory Intelligence) - A growing number of American experts have taken aim at U.S. compliance programs that are “criminally based,” or driven by the priorities and standards of enforcement authorities. They argue that the effectiveness of such efforts to curb employee misbehavior is questionable, and that firms should incorporate behavioral science principles to get at the roots of ethical lapses.

The handcuffs of inmates are seen during a play at a public theatre in Lima, June 20, 2012.

In a recent article published by New York University’s Program on Corporate Compliance and Enforcement(here), Azish Filabi, chief executive of Ethical Systems, a research organization, argues that despite continued efforts by companies to enhance their compliance functions to tackle bad behavior, the types of programs firms are employing may actually worsen the underlying problems.

“While companies have invested in building and expanding their compliance programs, researchers, practitioners and employees in some companies attest to a lack of corresponding reduction in misbehavior. Some even believe that the compliance programs may be a cause of increasing misbehavior,” says Filabi, who previously worked at the Federal Reserve Bank of New York.

“For many companies, the internal policies and procedures are established not only to prevent wrongdoing, but also to ensure that external investigators and prosecutors are kept out of the company. By demonstrating that they already have the matter under control through their own internal investigations and compliance systems, companies hope to keep the prosecutors at bay,” she added.

Much of what one sees at companies today, whether in financial services or in other industries, is a compliance regime that reflects the steady rise of U.S. regulations and the enforcement of those rules by government agencies. The interaction between company management and government regulators has contributed to the growth of internal compliance regimes that are designed to keep the latter out of the organization.

“Because government agents can so easily enter into corporations and affect their inner workings, company leaders have ramped up compliance efforts to ensure those agents are kept out,” writes Todd Haugh, assistant professor of Business Law and Ethics at Indiana University, in a recent Stanford Law Review article(here).

“Companies do this by hiring former prosecutors and regulators to develop cutting-edge compliance protocols . . . When those former agents are faced with preventing the very governmental intervention they used to lead, they fall back on their training and expertise as lawyers and investigators, treating compliance as a problem that can be solved with the familiar tools of the criminal law — aggressive enforcement and adjudication. This is how compliance becomes criminalized,” he added.


The adoption of criminalized compliance regimes leads to the second phenomenon, say researchers: unintended behavioral consequences for corporate employees. These consequences stem from how employees facing such programs rationalize their future unethical or illegal behavior.

“Rationalizations are the key component in the psychological process necessary for the commission of white collar crime — they allow potential offenders to square their self-perception as ‘good people’ with the illegal behavior they are contemplating, thus allowing bad conduct to go forward,” adds Haugh.

When compliance programs are perceived by employees as a way of protecting senior management, there is less belief and commitment towards adhering to the rules. Cynicism may begin to develop as employees see such “top down” programs as irrelevant to their day-to-day work.

“When employees perceive that a compliance program exists for the purpose of protecting top management . . . employee misconduct was higher, organizational commitment was lower, and employees were less likely to speak-up to management about misconduct they observed,” says Filabi of Ethical Systems.


Faced with such unintended consequences, Filabi and others argue that firms should examine the work being done in behavioral science that gets closer to the root causes of employee ethical lapses. In the UK, regulators such as the Financial Conduct Authority have already published a great deal on how behavioral science and economics can better address the underlying causes of employee misconduct.

Rather than developing compliance programs that mimic the criminal law, companies should focus their programs on the employees whose behaviors they intend to change.

Behavioral science models begin with studying the individual and working back to a prototype that suits the user’s needs and behavior. Such an approach seeks to tap into people’s basic desire to see themselves as ethical and designs a compliance program that encourages ethical behavior.

In the U.S., while there is growing interest in behavioral science within compliance functions, so far firms appear only to be supplementing their existing regimes with behavioral programs.

“What I see is not necessarily that (banks) are stopping their enforcement-based approaches, but they are layering behavioral science on top of their programs,” Filabi told Regulatory Intelligence in an interview.

“The challenge is that no one can really get rid of their enforcement based program until the regulators decide they want a different approach,” she added.

U.S. regulators such as the Federal Reserve Bank of New York(here), have shown an increased willingness for the industry to explore various ways in which behavior and culture are addressed, and also to perhaps look abroad at how other regions are tackling such issues.

A number of small companies emerging in the United States specialize in incorporating behavioral science tools into existing compliance programs. Some, such as Washington, D.C.-based Starling Trust Sciences, have recently hired former regulators Martin Wheatley of the FCA and Rick Ketchum of FINRA to their advisory board.


While behavioral science techniques and methods may be slowly gaining traction, a radical change of mindset is needed from the enforcement-driven approach, where “tone at the top” has become the embedded mantra for many in the industry.

“Culture is bottom up, not top down,” said Filabi. “The key for the banks is to assess their culture and do it in a systematic way.”

What banks and other firms need to do is regularly take the pulse of how employees perceive their culture. Over time, the incremental learning that evolves from such a process can improve a company’s culture, she added.

--FCA published Occasional paper on behavioral science and employee conduct: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