Follow Up: Proposed Standards of Conduct for BDs and IAs

First, an update on the proposed Standards of Conduct for Broker-Dealers and Investment Advisers. Several thousand comments were received by the announced end of the comment period, and the SEC’s website is reflecting comments received after the comment period closed. In this instance, it is probably in the SEC’s best interest to review as many comments as possible from a broad cross-section of financial professionals and investors. In addition to the written comments received (many anonymously and many from well-known names including members of Congress), the SEC Commissioners and staff representatives from the SEC had seven Investor Roundtables (with transcripts available on the SEC’s website), and hundreds of meetings with representatives from professional organizations representing Investment Advisers and Broker-Dealers, as well as large registrants (memoranda of these meetings are also available on the SEC’s website). If you want to hear a story of an investor being abused, read the first sixteen pages of the transcript of the Denver Investor Roundtable.

Second, Chairman Clayton gave a speech in New York City on June 18th of this year, addressing “Observations on Culture at Financial Institutions and the SEC,” which really seemed to be a good fit while we are talking about duties to one’s clients. I have identified some of the highlights of his speech, with the full text available at the link at the end of this column.

Culture is not an Option

To effectively manage, preserve and enhance your organization’s culture, you need to know your culture.

“I’ll make two related observations. First, to effectively manage the business of your organization on a day-to-day basis and over the long term, management needs to know what the culture of the organization is today, including the key drivers of that culture. For example, a new strategic initiative is much more likely to be successful if it is designed and implemented in a manner that is consistent with, and, hopefully, leverages the firm’s culture.

Second, over time, whatever the cultural goals for your organization may be, the chances of achieving them go up dramatically if you understand where your culture stands relative to those goals. In driving organizational culture, it is difficult, if not impossible, to get from A to B unless you have a clear sense of what A is.

There is a regulatory relations observation I will make that flows from the need to know what your culture is today if you want to preserve and improve culture for tomorrow. This observation is informed by my work as an adviser and now as a regulator. Assume a significant conduct problem occurs at a financial institution and the firm’s culture comes under regulatory scrutiny.

Let’s take as given that both the firm’s management and the regulator want the firm to have “good” culture, one, for example, that is consistent with long term shareholder, employee, customer and societal interests as well as law and regulation. In other words, we’re all trying to row the same boat in the same direction. However, if there is a disconnect between what management thinks the firm’s culture is today and what the regulator thinks the firm’s culture is today, agreeing on measures to enhance the culture will be difficult – very difficult. Said starkly, if the regulator is convinced a firm has a cultural problem and the firm continues to fight that conclusion, tension is likely to be high and progress — which involves fostering mutual regulator -firm respect and trust — will be slow and costly all around…”

“…While there is great importance in setting a positive “tone at the top,” an organization’s culture is, in large part, defined by the countless daily actions of its people. Culture is not just what is said by management to the work force, but what is done, i.e., what actions are taken, day in and day out throughout the organization, with colleagues, customers, suppliers and regulators.

To put this point in context, let’s look at the SEC. Yes, we have a Chairman and we have 4 Commissioners and a dozen or so other senior leaders, including the heads of our Enforcement, Trading & Markets, Investment Management, Corporation Finance, Compliance and Inspections, Economics and Risk Analysis, Office of Chief Accountant and our General Counsel. We each have a responsibility to set and act in accordance with the SEC’s cultural objectives, both internally and externally. But, while our actions may be relatively the most prominent, they are a small fraction of the internal and external interactions of the SEC.

Every day, our market participants — individual investors, issuers, asset managers, brokerage firms, rating agencies and other regulators (including many represented here today) — interact with the women and men of the SEC. In many cases, those interactions are very important to those participants, as well as many others. As I like to say, we have thousands of “at bats” a day where our culture is on display and being shaped. How we handle ourselves in these countless situations defines who we are. Are we zealously pursuing our mission? Are we consistent and clear? Are we fair? Do we listen? Do we learn? And, most important, are we striving to deliver for America’s long-term Main Street investors?…”

“…There are many familiar methods for communicating, monitoring and reinforcing cultural objectives — compliance programs, policies and procedures, training, personnel decisions (including evaluations and compensation), etc. I believe all of these methods are important and, in large financial organizations, essential. I also believe these methods are enhanced by, and in fact, to be effective over the long term, require, a clear, candid, easily understandable articulation of the organization’s core mission.

My view of this message for the SEC is furthering the interests of our long-term retail investors.

That short statement does not stand alone. As you would expect, we have many goals and obligations. For example, ensuring that trading — a largely institutional exercise — is fair and efficient is a critical part of our mission. Although it is a largely institutional market — and certain aspects of it are almost exclusively institutional (e.g., high yield bonds) — I believe the right question to ask is: are we seeking fairness and efficiency in this largely institutional market in a way that best serves the interests of our long-term retail investors. Is there a disconnect here? Why should we have retail on our minds when we are regulating an institutional market? There is no disconnect. Those institutions are holding and trading, in large part, the funds of retail investors. That perspective, or lens as we sometimes call it, should substantially inform how we regulate trading.

This perspective, this unifying perspective, this driver of culture, is similarly relevant when we look at investment products, corporate disclosure, and governance rules as well as when we set inspection and enforcement priorities. To be clear, and to give deserved credit to the SEC staff and those who came before me, this cultural dedication to our long-term Main Street investors has been deeply etched in the SEC’s slate for many years…”

Culture Beyond the Law and Regulation

“…Organizations with the most comprehensive compliance programs and policies and procedures will inevitably encounter circumstances not contemplated by their policies and procedures. In those situations, what drives how people will act? The law and regulations? What if those also do not contemplate the situation? Or, more significantly, what if the law permits a range of actions with some that, while legal, can cause significant harm. In these circumstances, those on the front lines, those making decisions, need a touchstone…”

“…A final regulatory observation before I conclude: human beings make mistakes and some break from cultural expectations and legal requirements. We all, including those of us at the SEC, recognize this fact.

When this behavior occurs, key questions a firm should ask include whether the conduct represented a clear breach of the firm’s controls and culture as well as whether the firm’s remediation efforts, in addition to any controls enhancements, sent an appropriate and lasting cultural message…”


“…Every organization’s culture should reflect 3 realities and these 3 realities need to be recognized by professionals at every level of an organization. First, it is a privilege to work as a professional in the financial sector. Second, firms have systemic responsibilities with widespread significance. Finally, firms and their professionals have important, individual responsibilities to real people that make up the investing public. We are counting on you, and, importantly, more importantly, the public is counting on you to develop cultures that recognize and responsibly address these realities.”

View Chairman Clayton’s Speech


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