This is the final installment of a 3-part series exploring structural solutions to certain deficiencies in corporate cultures that can lead to major wrongdoing
UK’s Senior Managers Regime (SMR)
In contrast to the regimes discussed earlier, the clear linkage of penalty to misconduct in one’s defined area of responsibility is central to the SMR.
SMR’s rules, which are nearly finalised and scheduled to go into effect on 7 March 2016, are based on PCBS’ recommendations to improve professional standards and culture within the UK banking industry by knocking down the accountability firewall.
The rules apply to banks, building societies, credit unions, certain investment banks and branches of foreign banks operating in the UK (and are proposed to be rolled out, together with the related certification regime, to other financial services firms by 2018).
Under the SMR, firms need to
ensure that each head of business line(s) or function(s) (senior manager) has a statement of responsibilities setting out the areas for which he is personally accountable (including certain prescribed responsibilities relating to culture and standards);
introduce a firm-wide responsibilities map reflecting all of these responsibilities, with no gaps or excessive overlaps in the allocation of responsibilities; and
ensure that all senior managers are pre-approved by the regulators before carrying out their roles.
The aim of such exercise is to ensure that each senior manager, the firm and the regulators agree from the outset on who is responsible for what area of business or function. This type of clarity should overcome the structural diffusion of responsibility discussed earlier.
As originally proposed, senior managers would be subject to a “presumption of responsibility”, i.e. a senior manager would be presumed to be culpable (and subject to disciplinary action) if his firm breaches a regulatory requirement in an area for which he is responsible, unless he can prove that he took reasonable steps to prevent the breach from occurring or continuing.
This “reverse burden of proof” was recommended by the PCBS as necessary to overcome the accountability firewall.
However, in a surprising announcement on 15 October 2015, HM Treasury proposed replacing the “presumption of responsibility” with a “duty of responsibility”, which would require each senior manager to “take reasonable steps to prevent regulatory breaches in the areas of the firm for which [he is] responsible, but the burden will be on the regulators to prove that a senior manager has failed to do this.”
Perhaps the change reflects the UK government’s acknowledgment of concerns from the industry that the “presumption” risked frustrating the recruitment of top talent by UK banks, and dampening even proper risk-taking by senior managers.
Regulators have downplayed the significance of this change. For example, the head of the Prudential Regulation Authority, a key regulator under the SMR, has argued that “substituting ‘duty’ for ‘presumption’ changes the mechanism of enforcement not the substance of the requirement on senior managers…”
However, as Lord Eatwell of the House of Lords argued during its second reading of the bill implementing the change:
“If [the ‘presumption’ is the same as the ‘duty’], why bother to amend it? … but if [amending] is necessary then the ‘underlying obligation’ cannot be the same. The Government cannot have it both ways.”
In short, the status and implications of the “duty of responsibility” are somewhat unclear at this stage. Compared to the “presumption”, might the “duty” – if the switch stands - reduce a senior manager’s incentive to stay vigilant on misconduct in his area?
The SMR in its currently proposed form would still keep the spotlight on the senior manager and the question of whether he took reasonable steps to prevent the breach in his area. Simply pleading ignorance of the misconduct would no longer suffice.
The regime also contains a criminal offense of reckless misconduct by a senior manager leading to insolvency of a bank. Although this is expected to be invoked rarely, it should add to bank senior managers’ interest in ferreting out potential misconduct.
Perhaps those aspects of the currently proposed SMR would be enough to keep senior managers on top of their risk management game by improving controls and culture? That may yet be the case if the regulators enforce the regime capably.
Promising works in progress
This article is not meant to be an exhaustive, final discussion of, or legal advice on, each trend in the US and UK to increase senior officer accountability for corporate misconduct; rather, it seeks to highlight some of the more salient trends and draw lessons on how structural solutions might be fashioned to foster more open, ethical cultures.
Certain variables appear to underlie differences among the regimes discussed above, likely reflecting, inter alia, differences in the industries being regulated, organizational structures of companies in such industries, policy drivers, ease of enforcement considerations and/or availability of regulatory resources. Such variables include the following:
1. Category of senior officers subject to the regime
The clawback rule and Zipes may cover a broad swath of senior officers, regardless of whether they had authority or control over the area in which the violation occurred.
The Park Doctrine contains a somewhat vague criterion of whether the senior officer held authority to prevent or correct the violation.
In contrast, the SMR seeks to match the misconduct with the senior manager in whose defined area of responsibility such misconduct occurred.
2. Time period for determining liability
Related to the first point, if this is a one-size-fits-all approach, the results could seem arbitrary.
Zipes’ regime could capture an officer who, by virtue of newness in that position, had practically little chance of gaining information on or control over the activities resulting in the misconduct, even if the latter occurred in his area of responsibility.
The same concern could apply to the Park Doctrine and SMR but, presumably, this factual issue would be vetted in those cases during exercise of prosecutorial or regulatory discretion.
The clawback rule might capture someone who was an executive officer at any time, however long or briefly (and regardless of whether the noncompliance occurred while he served in such capacity), during the performance period(s) for the recoverable incentive-based compensation. Moreover, an incentive award granted (during any of the three fiscal years preceding the restatement) before an individual became an executive officer would be captured if the individual became such at any time during the award’s performance period.
3. Look-back period for recovery of compensation
Under the clawback rule and Zipes, the length of this period can bear upon how large the monetary penalty will be.
4. Standard of individual’s liability for firm’s misconduct
This varies from essentially strict liability in the case of the Park Doctrine, clawback rule and Zipes, to a more moderate “duty of responsibility” under the currently proposed SMR.
5. Penalties for liability
This ranges from criminal convictions or pleas, fines and/or administrative sanctions in the case of the Park enforcement, to fines and/or suspensions in the case of SMR, to monetary penalties in the case of the clawback rule and Zipes.
It is always a challenge, vis-à-vis any industry, to devise the appropriate mix of these types of factors in any regime to remove the accountability firewall while minimizing unintended or unfair consequences.
If the aim of a regime is to incent senior officers to be more vigilant of potential misconduct, it is unclear how such aim is served by netting executives who, whether due to their area of responsibility or timing or length of their tenure, had no effective control over, or access to information as to, the violation triggering the penalty.
If the net is cast wide to exact a pound of senior executive flesh where available, the odds of unintended or unfair consequences of such regime may rise. Such consequences may in turn lead to industry push-back against the regime.
As the PCBS advised in its 2013 review, “the need for a more effective enforcement regime does and should not arise from a public demand for retribution. It is needed to correct the unbalanced incentives that pervade banking.” This is sage advice for any industry.
The SMR, even as currently proposed, represents a relatively balanced approach to reversing both the legal and structural disincentives to sound, open culture. Arguably, given the relatively precise targeting of senior managers based on the business function in which the misconduct occurs, the regime, if properly enforced, can incent them to be vigilant and foster openness even with a more moderate standard such as the “duty”.
In fact, the SMR could provide a useful blueprint for regimes in the US or other industries in the UK where the accountability firewall is an issue, and societal welfare demands better conduct risk management through sound culture.
However, in adopting that blueprint, policy makers should decide, based on the targeted industry, whether the “presumption” or “duty” of responsibility, or even tougher liability standard, such as Park’s strict criminal liability (for when life or limb is at stake), would work best.
Regimes similar to the SMR might require substantial regulatory and industry resources in delineating senior manager functions, drawing responsibilities maps and monitoring senior managers. Moreover, while the regulatory discretion inherent in such regimes allows for nuanced, targeted approaches to senior officer accountability, such regimes will need to be enforced vigorously but fairly to achieve their purpose.
Perhaps not every industry will require such level of resource commitment, and that is where market-driven solutions, borrowing elements from Zipes’ approach, or regimes with a more mechanical approach, borrowing features from the clawback rule, may have useful roles.
For example, Zipes’ or the clawback rule approach might work for some companies if it contained an SMR-style delineation of areas of responsibility for each senior executive, so that the latter incurs penalty only for a violation occurring in his area of responsibility (after having had reasonable opportunity to take preventive or corrective measures).
Not all senior executives are powerless to surmount the accountability firewall on their own, and removing the firewall does not guarantee sound, open cultures.
However, the failure by many corporate leaders to overcome the firewall contributes to poor cultures that sprout scandals.
Senior officer accountability regimes could potentially reverse the disincentives inherent in the firewall, but should be evaluated mainly on the basis of ability to improve risk cultures.
Companies should welcome opportunities to work with policy makers and regulators to ensure proper functioning of, or improve upon, any applicable accountability regime, or proactively devise new ones for their industries.
A regulatory regime that optimally balances the types of variables discussed above for a given industry can help to level the playing field in that industry for investing in sound, open cultures that enhance risk management and employee engagement.
Where a regulatory regime is deemed not optimal for an industry, companies might consider adopting market-based solutions to the accountability firewall in order to distinguish themselves from competitors based on investment in their cultures.
Wilfred Chow is a US-based researcher and writer on corporate responsibility, governance and ethics and sustainability. He previously served as a managing director and associate general counsel at a leading financial services firm in the US.banking accountability corporate accountability compliance culture