The financial crash has transformed the regulatory environment in more ways than one. Financial-services firms, from registered investment advisers and broker-dealers to asset managers and insurers, now find themselves far more heavily regulated than before.
However, it isn't just about the volume of new rules. Enforcement is also changing to a “broken windows” approach.
Alternative funds and
separately managed accounts are coming under unprecedented scrutiny from an increasingly proactive Securities and Exchange Commission.
The numbers speak for themselves: In 2013, new investigations rose 12% from the previous year, and formal orders of investigations were up 20%. Fines have reached record highs, and it's estimated that in this new environment, a whopping one in 12 firms will face action at some point.
As SEC Chairwoman Mary Jo White declared, “We are casting our nets wider, and using nets with smaller spaces.”
This isn't a reaction to increased wrongdoing within the industry. No such trend exists. Rather, it reflects a fundamental shift in the regulator's role. Whereas enforcement and investigation used to be last-resort measures, they are now increasingly being used as broad regulatory tools.
How should firms respond? As always, they should ensure they fully understand what is required of them and regularly review their compliance processes. Education of staff at all levels of the firm will remain crucial.
But given the new environment, it will also benefit executives to start to think about compliance in a new dimension – that of convenience.
NUDGE THEORY
Recent years have seen the rise of nudge theory. The root idea is that, deep down, humans are creatures of habit and convenience. Anti-social behavior can occur because the right action is too difficult or not obvious, rather than as a result of active malice or an intention to do wrong. Consequently, making the right thing as easy as possible is a crucial ingredient in creating a culture of compliance, equally, if not more, important than threats, education or moralizing.
The philosophy has been embraced by governments on both sides of the Atlantic, in part due to financial constraints. Nudges are generally less costly and drastic than more authoritarian policy alternatives.
For instance, encouraging shops to put fruit at eye level is a nudge, as opposed to simply banning junk food. The recent inclusion of donate-to-charity buttons on ATMs is another example — this makes donating to charity very easy and something you have to consciously choose not to do, rather than the reverse.
The concept is very applicable to the world of regulatory compliance and provides a new way for firms to think about their culture of compliance. The stereotypical compliance breach is the sensational one, such as intentional fraud. But in reality, the vast majority of compliance breaches are unintentional, the result of something not being filed quite right or a detail missed. And these are precisely the sort of housekeeping infractions that the SEC is now going after full throttle.
Nudge theory would suggest that in these cases, the most effective way to create a culture of compliance is not stricter rules, penalties or even endless education. Instead, the key is to make acts of compliance as convenient and simple as possible, so they fit as seamlessly as possible into an individual's day-to-day workflow.
THE ROLE OF TECHNOLOGY
Technology provides the obvious route to achieving this. Even the most well-meaning employee or firm is more likely to fall short of standards when compliance involves substantial distraction, time and effort, such as having to fill out arduous forms.
By contrast, if the process can be largely automated and transformed into something unobtrusive that doesn't take up substantial time or brainpower (for example, simply pressing a few buttons on your normal work screen), then compliance will improve – it's just human nature.
Recent developments in the world of music show a similar effect. The industry struggled with the transition from physical discs to downloadable music; a failure to adapt caused the emergence of a pirating epidemic. Yet innovations such as iTunes and Spotify gradually have reversed this trend. They have made it exquisitely convenient to access a wide range of high-quality music on demand with just the press of a few buttons. Most people don't want to pirate and are happy to pay for music. The missing ingredient was convenience, made possible by technological innovation.
This is why leading compliance consultancies are investing heavily in technology and, to some extent, transitioning to being tech companies themselves. A range of software products designed to make compliance convenient and easy – from self-updating calendars reminding users of important regulatory deadlines to algorithms that run client information against international watch lists – are starting to come to market.
Nudge theory and the rise of advanced technology promise new methods to fight the good fight in a world where the dangers of non-compliance have never been greater.
Bill Mulligan is CEO of Cordium US and Cordium Software and a member of Cordium's Global Operating Board.
