Thursday, 23 January 2014

How Wall Street turns people into criminals

How Wall Street turns people into criminals

It is time to admit that Wall Street has lost its moral compass. Each day brings a new story of banks misleading clients, hedge funds insider trading or investment banks manipulating prices.

The tsunami of scandals cannot be explained away as the work of a few bad apples. Our financial services industry is in ethical crisis. To assess the depth of the problem, Labaton Sucharow, a law firm where one of us works, commissioned an anonymous survey of 500 financial services professionals in the United States and United Kingdom. The results are alarming.

More than a quarter of respondents reported they had personally observed or had firsthand knowledge of wrongdoing in the workplace. Given the human tendency to underreport bad behavior, the true figure is likely higher. Nearly 40% believed their competitors had engaged in illegal or unethical behavior; 24% thought you have to break rules to be successful. An astonishing 16% admitted that theyd engage in illegal insider trading if they would not be caught.

Waiting for a chance

When 16% of people working in financial services readily admit they would commit a crime if they could get away with it, alarm bells should be going off at the Securities and Exchange Commission and other financial regulators. True, Wall Street might attract more than its share of Gordon Gekkolike criminal personalities. But behavioral science suggests more is at work. The financial services industry has become a criminogenic environment that tempts otherwise ethical, conscientious people into criminal conduct they would never indulge in outside the workplace. Consider the tragic case of Rajat Gupta, a Goldman Sachs director and noted philanthropist who seemed a pillar of the community until he was recently convicted of insider trading.

How does the financial service industry transform otherwise ethical individuals into criminals? The modern infatuation with incentives has played a role 30% of survey respondents reported that their bonus or compensation plans created pressure to engage in unethical or illegal behavior. The dirty underbelly of pay for performance, rarely acknowledged by economists or compensation experts, is that it is almost impossible to design a compensation metric that cant be met through illegal behavior.

Why stay silent?

But a more disturbing part of the story lies in the question of why financial services professionals who observe illegal behavior and dont stand to personally profit from it nevertheless remain silent. Like bank robberies, corporate scandals are rarely oneman jobs, and there are almost always witnesses. It is highly unlikely that more than $1 billion of client funds could disappear at MF Global, or that Libor could be manipulated by Barclays, without many people knowing about it. If more than a quarter of the individuals in the financial industry have firsthand knowledge of illegal or unethical activity, as the survey found, why arent they reporting this? Where are the whistleblowers?

Answering this question could be essential to figuring out how to cure the ethical rot thats eating away at many financial services firms. Even in the best of environments, some people will engage in misconduct when the opportunity for personal gain becomes too great to resist. But when a substantial percentage of financial services professionals tolerates misconduct by others, that speaks to a deeper problem. In the language of social science, the financial world is a social context that tolerates and encourages illegal or unethical behavior. In lay terms, the problem is Wall Streets culture.

Culture the mlange of social signals we receive about what our superiors expect, what our peers are doing and how our acts harm or help others in our ingroup can be hard to change. But though changing culture is hard, its by no means impossible. Obvious first steps include giving the SEC and other regulators greater resources; making sure that whistleblowers are rewarded and protected from retaliation, and that potential whistleblowers are aware of those rewards and protection; and examining payforperformance plans with a skeptical eye to make sure they arent really payformisconduct schemes.

But as we recently passed the second anniversary of the DoddFrank Wall Street Reform and Consumer Protection Act, its time to recognize that regulation wont work alone. The first step the financial services industry needs to take toward recovery is to admit it has a corporate ethics problem. On political and policy matters, we publish opinions from across the political spectrum.

Roughly half of our columns come from our Board of Contributors, a group whose interests range from education to religion to sports to the economy. Their charge is to chronicle American culture by telling the stories, large and small, that collectively make us what we are.

We also publish weekly columns by Al Neuharth, USA TODAYs founder, and DeWayne Wickham, who writes primarily on matters of race but on other subjects as well. That leaves plenty of room for other views from across the nation by wellknown and lesserknown names alike. Jordan Thomas, chair of the whistleblower representation practice at Labaton Sucharow LLP, is a former assistant director in the SECs Enforcement Division.

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