Conduct risk within the United States financial sector

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ABSTRACT

Conduct risk in the Financial Services sector has become an area for research especially since the 2008 financial crisis. New and revised regulations and guidelines are being implemented in an effort to, on the one hand facilitate regulatory censure and on the other hand to guide and ensure better behaviour amongst senior management and their decisions in relation to incentive policies. This paper provides a micro-level examination of conduct risk events within financial institutions sanctioned by the Securities and Exchange Commission. From these risk events a number of internal organisational failings were then extrapolated and categorised, and further conceptualised within the Hofstede cultural perspective of organisational decision-making in relation to financial services behaviour.

KEYWORDS:

• Conduct risk
• financial sector
• Hofstede
• culture
• decision making

1.0 Introduction

Ever since the 2008 financial crisis there has been a new wave of financial regulation and oversight introduced for both European and United States financial institutions. The introduction of the Dodd–Frank Act and the plethora of new guidelines issued by the European financial regulators, are just two examples of how legislators and regulators have sought to address the problems that triggered the 2008 crisis. However, if one examines the enforcement regime of the Securities and Exchange Commission (SEC) in the United States since 2010 to 2019, it becomes clear that a new field for regulatory censure and rebuke has emerged. Although this field of conduct risk, has many different strands to it, the underlying cause of this new risk facing financial institutions relates to how senior management within these institutions and their front-line employees interact with and incentivise each other. After the financial crisis uncovered excessive remuneration at board room level, regulators and industry experts started to examine whether financial incentives also played a role further down the managerial chain of responsibility within financial institutions. A new term began to take hold to better categorise this risk of misaligned incentives within the banking sector, namely the term ‘conduct risk’.

Conduct risk mainly relates to the risks posed by how individuals within a financial institution may behave and how this behaviour impacts on the wider organisation. For most financial regulators, the term has come to primarily define the risks associated with sales incentives and other target-based practices. For the Securities and Exchange Commission, conduct risk remains a constant in the enforcement body’s roll call of enforcement actions over the last eleven years since the financial crisis. However, there remains a considerable lack of academic analysis and research in teasing out the exact causes and reasons as to why conduct risk may arise within a financial institution. While the macro-level explanation may remain rooted in how financial institutions design incentive policies for their employees, a more in-depth examination of how employees behave within financial institutions is it is posited required. This paper aims to provide a micro-level examination of conduct risk events within financial institutions sanctioned by the Securities and Exchange Commission. From these risk events a number of internal organisational failings were then extrapolated and categorised. This exercise in turn helped in developing a wider picture of the organisational environment in which conduct risk poses the greatest threat. A populated enforcement database with an associated Hofstede Cultural Grid should allow for employees, management and regulators, to consider their own findings and see if these align with the positions as set out in this combined approach. From this, these stakeholders may then be better able to detect organisational challenges and operational failings within the financial institution via reference to pre-existing enforcement actions and the cultural aspects of these failings. 

The remainder of the papers is organised as follows: Section 2 reviews the  regulatory supervision and enforcement action against conduct risk breaches by the SEC and how conduct risk may be broken down into different categories. From this approach, the next steps in developing an SEC enforcement action database are then set out. This section also examines the possible grounds for why conduct risk has become prevalent within the United States banking sector with particular focus on regulator capture. Section 3 considers the Hofstede Culture attributes as a mechanism to explain aspects of culture that facilitated misconduct and dubious decision making. This is followed by an analysis of the conduct risk events identified and the potential link with the Hofstede cultural dimensions. Finally, the benefits of compliance are then considered in the conclusion section.

2.0. Conduct risk and the SEC’s enforcement regime: breaking down misconduct sanctions

By examining a selection of the SEC’s enforcement actions since the 2008 crisis against the largest financial institutions, one can better extrapolate the exact regulatory failings that these financial institutions had fallen prey to. In most of these examples, the sanctioned financial institution had adopted a business policy that facilitated individual employees to engage in misconduct. For instance, as seen in Figure 1, UBS was subject to an enforcement action in 2015 as it had failed to inform clients that one of their investment funds had altered its investment strategy and so was more likely to generate losses for its investors.

Figure 1. Extract from SEC enforcement actions database.

On further analysis micro-failings were evident within this financial institution (“SEC,” 2015). These micro-failings can in fact be categorised across different strands of a tailored PEST analysis (Sammut-Bonnici & Galea, 2015). Under a PEST analysis, an organisation is able to consider the possible threats or opportunities facing their business by reviewing resources and practices under four headings. These include, political, economic, social and technological. However, for the purposes of categorising micro-failings within financial institutions, a tailored PEST analysis is required as the above headings are not directly translated in the context of the banking sector. Therefore, when developing an SEC enforcement action database, a new set of headings was devised. These include (1) people, (2) economic, (3) structure and (4) technology. Each of these headings refers to the specific elements an enforcement action may relate to. For example, in cases where an individual or a group within a financial institution have engaged in misconduct then this particular aspect of the enforcement action is labelled under the ‘people’ heading. However, this aspect alone may not be the only reason as to why the SEC executed an enforcement action against the financial institution in question. There may also be other elements behind this enforcement action, for example, it may be there was an economic incentive in place for individuals to engage in acts of misconduct. The structure of the financial institution may also have contributed to how these individuals behaved as there may have been limited oversight exercised by a parent entity or another business function. For these reasons, the enforcement action in question will not only have an underlying causation factor that falls under the ‘people’ category of the tailored PEST analysis, it will also have causation factors that fall under the ‘economic’ and ‘structure’ categories as well. From this categorisation process, one can delve deeper and better understand the organisational factors that may encourage misconduct on the part of individuals within a financial institution.

Hence, if one returns to the example of UBS above, this enforcement action fell across two of the three different categories of the tailored PEST analysis. These are the ‘people’ and ‘structure’ categories. But one can extract further actions from the examples of misconduct that fall under these three headings. For instance, as noted above, individuals within UBS did not disclose how the investment fund in question now had a higher risk exposure (“SEC,” 2015 at para.16). This meant that individuals had omitted to disclose pertinent facts to their client base. One could label the structural failure in this case as one of internal communication failing as employees within UBS did not know that they could challenge or question the investment strategy of the sister investment firm Willow Management (“SEC,” 2015 at para.27). By drilling down each individual enforcement action in this way, one is better able to appreciate the challenges facing financial regulators such as the SEC. However, each enforcement action is itself evidence to some degree of how financial regulators have failed as supervisory authorities. Examples of misconduct events from across different financial institutions illustrate how within these organisations there appeared to be an environment that facilitated or actively promoted misconduct. This in turn may suggest that the possible oversight of the relevant financial regulator, in this case the SEC, was not considered an active barrier to engaging in misconduct. Furthermore, the possible sanctions that might be imposed on these financial institutions did not it seem constitute an effective counter against both institutions and individuals to mis-sell products and other malpractices.

2.1 Misconduct within the United States banking sector

There may be a number of reasons as to why the enforcement policies of the SEC have not yielded the desired behaviour from financial institutions. One possibility is that the SEC along with other US regulators became captured or co-opted by the banking industry. This will be examined in further detail below. However, another possibility is that financial institutions have weighed the consequences of misconduct and have concluded that financial and reputational censure are additional costs to business that need to be met alongside other operational costs. This again returns back to the role of the regulator in utilising their powers in an effective manner against financial institutions that engage in misconduct and whether these powers are exercised in a constrained manner due to the possible presence of regulatory capture or co-option. Both sides will now be further examined below.

2.2 Regulatory capture and misconduct

In most industries there are dual pillars, one represented by the industry actors themselves, be these manufacturers, technology companies, or indeed financial institutions, and the other the bodies seeking to regulate and supervise the first pillar. Yet there will be some form of wall or archway between these two pillars as neither can operate in complete isolation from the other. The first pillar will seek to interpret legislation and regulation to their advantage or in some cases seek to evade legislative and regulatory controls completely. Both objectives will though require some form of interaction and communication with the second pillar. For this second pillar of regulators and supervisors, in order to effectively review and consider the industry actors, communication will also be necessary. But with this interaction between the two pillars also comes the risk of regulatory capture. This may arise on the basis of two issues, one may be called the knowledge demand factor and the other the compromise and concession factor. The first factor, knowledge demand, refers to the limited pool of suitably qualified and knowledgeable individuals that both pillars seek to draw possible recruits from. Those individuals that have experience within the second pillar may have not alone certain regulatory knowledge but also inside knowledge as to how the regulatory pillar works and how to best meet the regulator’s objectives. This is where the compromise and concession factor may become evident. Although examining the regulator–regulatee relationship from an environmental enforcement perspective, Dupre et al. do raise the possible knowledge shortfall that a regulator may have in comparison with the companies they are charged with overseeing. The regulator’s objectives and resources may not be aligned and so this may result in conceding an advantage to the regulated company in question (Dupre et al., 2007, at pp.12–13). Similarly, when examining how United States regulators pursue enforcement actions against large financial and other institutions, a former Attorney General has conceded indicting financial institutions may harm the wider economy (Packin, 2014 at p. 1093). Therefore, regulators have to contend not just with a knowledge drain from within its own operations to the private sector, it may also have to concede resource advantages to the organisations under its watch and due to the complexity of certain cases and size of the organisation in breach, agree to a compromise settlement. Therefore, a former employee may be able to leverage these factors in their new position.

Within the financial industry there are a number of examples where individuals have left the regulatory pillar to instead seek employment in the first pillar of industry. For example, in the case of Riggs Bank, a former official from one of the U.S. regulators left his position to join Riggs Bank. This individual had been the embedded Examiner-in-Chief of the Office of Comptroller of the Currency and used this role to advocate on behalf of the financial institution (Riggs Bank Report, 2004, at pp. 88-91). There are other cases where former employees of a regulator have subsequently made the journey from oversight to corporate defender. Wilmarth has examined the level of cross-movement between politicians and the lobbying industry in the United States (Wilmarth, 2013). Former politicians are seen as having the required name recognition and contacts to further the objectives of the lobbying group they are appointed to represent (Wilmarth at p. 1408). However, those individuals that are appointed to senior regulatory positions within the United States also have a past record of banking sector experience. The archway between the industry and regulatory pillars is thread in the reverse manner in these cases (Wilmarth at p. 1411). Wilmarth also highlights the inter-linkages between former employees of the SEC and their large scale transfer to work within industry post-employment (Wilmarth at p. 1412). He also notes how these former SEC employees are then best placed to navigate their new employers through to special waivers from this regulator (ibid). When examining misconduct in the trading sector, Barkow posits that one of the grounds behind this may have related to (Barkow, 2010) the constant movement of former SEC employees to the banking industry (Barkow, 2010, at p.47). Barkow proposes that employees within the regulatory sector should be remunerated to compensate for an elongated time-bar against transferring to industry (at p. 49).

If regulators remain in lock-step with the sector they are charged with supervising and sanctioning, then this provides an opportunity within the regulated industry to avail of regulatory discretion where possible. Regulators become an extension of the industry itself rather than as an external agency. Misconduct becomes entrenched within the industry in question because the possible regulatory rebukes do not constitute a sufficient incentive for compliance. Where a regulatory authority is itself a disparate organisation with employees focusing on the next lucrative appointment the power dynamic shifts considerable in the favour of the financial institutions where these lucrative appointments can be found.

2.3 Incentives and misconduct

Before the financial crisis of 2008, the international banking sector went through a period of extended irrational exuberance. Langevoort describes this in terms of a dance where the participants become detached from the possibility of negative consequences that may arise from their actions (Langevoort, 2011 at p. 1225). However, this dance may be further entrenched if the environment in question rewards high risk taking and aggressive behaviour (Langevoort at p. 1226). Langevoort delves further into the morality of individuals within financial institutions prior to the financial crisis. For example, Langevoort highlights the role of Goldman Sachs as a market maker, a platform if you will, where other parties simply decided to trade on (Langevoort 2011, at p.1237). The actual level of knowledge or skills of these parties was not the market maker’s concern.

Prior to the financial crisis, financial institutions had thus become disconnected from the parties at the other side of their transactions. Clients, be they institutional or personal, were seen as assets to be exploited where possible. Short-term profits and revenue increases were the primary objective for financial institutions. Success for both management and employee revolved around bonuses and sales volumes. Misconduct was not considered because the act of the sale was the process itself. With limited regulatory supervision in place, there was little if no consideration of possible individual fines or effective institutional-wide censure.

2.4 How to identify and detect misconduct incentives

One possible way in which both the twin-obstacles of regulatory capture and misconduct incentives may be overcome is via the establishment of a new cultural prism model. As set out above, if past enforcement actions can be categorised into misconduct events and then further assessed via specific cultural theories, then it may be possible to detect an underlying environment where misconduct is accepted and practiced.

3.0 Environments within organisations and Hofstede cultural principles

Hofstede in conjunction with other organisational behaviourists, has sought to map national characteristics onto an organisational setting. The considerable body of research undertaken by Hofstede and others in this field cannot be recounted and assessed within the confines of this paper. However, in the context of the organisational theory grid as set out above, one particular aspect of Hofstede’s work has particular value and helps root the above proposal in the wider organisational behaviour field. Building on the work undertaken by others in surveying the culture within a Danish insurance company, Hofstede, Bond and Luk, extrapolated six different categories of respondent answers (Hofstede et al., 1993). These included (1) alienation, (2) workaholism, (3) ambition, and (4) masculinity, (5) orderliness and (6) authoritarianism (Hofstede et al., 2010 at pp. 366-367). The first category mainly encompassed individuals that had a negative view of the organisation. Thus, some of the examples of this alienation as perceived by individuals included management distance from staff, colleagues were considered less trustworthy than in other organisations and the organisation was considered to be less orderly than those of the other respondents (ibid). In the second category, workaholism, was where the respondents had a strong motivation to work and their work was more important than leisure time (ibid). For ambition, individuals sought achievement within the confines of the organisation and the possible resultant promotions derived from this (Hofstede et al., 367). Masculinity, was where the family unit was expected to accept changes or sacrifices for the benefit of the man’s employment (ibid). Orderliness, referred to employees with ‘more orderly minds’ viewing their organisation through the prism of orderliness (ibid). Authoritarianism, was where employees did not seek to challenge or question the decision-making or authority of management. These six categories are in many ways derived from four of the five of the high-level original Hofstede cultural principles: (1) individualism versus collectivism; (2) power-distance; (3) uncertainty avoidance and (4) indulgence versus restraint (Hofstede, 2011, at pp.3-25) (Vitell et al., 1993 at pp.755–758)-replace Vitell reference here with Hofstede 2010. Individualism versus collectivism may be linked to both alienation, ambition and authoritarianism depending on what particular group environment is within an organisation. For instance, a strong individual may seek to preclude others from their work so that they can gain their own rewards and ambitions. In other cases, an individual may become alienated if they feel that they are precluded from a collective or peer group. Collectivism may very well engender authoritarianism as the collective objectives are pursued with no room for individual dissent. If one were to draw a link between power-distance and the six strands, again a number of overlaps become evident. Where the authority or decision-making is distant from front-line workers, then in time these workers may become alienated from the executive. However, according to Vitell et al. the greater the power-distance between decision-maker and decision-taker, the more likely the latter will obey rules and the less questioning of decisions there will be (Vitell et al. 1993, at pp.755-758 at p. 756). Translating this across to the six categories, one can therefore find a link with the authoritarian category as well.

Uncertainty avoidance links with orderliness where there is a culture of strict adherence to rules within an organisation to ensure that order and efficiency are maintained, (Vitell et al. at p. 757). Authoritarianism may also fall under the uncertainty avoidance dimension as a strong command and control environment is also likely to be one that does not broker dissent or questioning from individuals. For indulgence versus restraint there may be an overlap with authoritarianism and alienation. Authoritarianism may give rise to several restraints on an inemployee's behaviour. While indulgence may be considered a negative within a peer group and thus lead to alienation. Although an institution may have an environment where misconduct is indulged and restraints not effectively applied as is referred to below.The final high level Hofstede principle, masculinity versus feminity, also aligns with the masculinity, ambition and workaholism categories. However, the Hofstede Cultural Grid for now does not include masculinity versus femininity.sted

Berger et al. have also examined how Hofstede’s culture dimensions may apply in a bank setting and how in particular certain specific dimensions may trigger bank failure (Berger et al., 2000). For instance, Berger et al. posit that in more masculine societies, bank managers may be more willing to engage in high risk lending (Berger et al. at p. 11). Power-distance may also result in bank failure either due to management not receiving information on underlying problems or conversely where power-distance between manager and customer is short, this may result in lax lending controls (Berger et al. at p. 11). The work of Berger et al. thus shows that there may not necessarily be a clear benefit where one cultural dimension is either in the ascendancy or in decline.One possible way to determine whether one of Hofstede’s cultural dimensions may give rise to a misconduct event may be to identify the possible links that may arise between a misconduct action and these dimensions. This will now be examined next.

4.0 Discussion: Hofested Cultural Grid and Selective Disclosure

If one examines these different categories, then a link may be made with the break-down of fines and enforcement actions that are placed through the Hofstede principles in the following table. The focus of this paper remains on one specific financial institution within the United States. However, the below table may be applied to other jurisdictions and indeed other organisations that handle and process confidential information that may have monetary value. The below extract examines how selective disclosure may be put through a Hofstede Cultural Grid. This particular category of misconduct, selective disclosure, was derived from a number of different SEC enforcement actions. In the case of the SEC 2016 enforcement action against Deutsche Bank, selective disclosure was the central misconduct activity within the financial institution (SEC, 2016). This is can be seen from figure 2 below.

Figure 2. Extract from SEC enforcement actions document. Different misconduct events are categorised under the tailored PEST approach. The above example is from the Personnel subdomain. For present purposes the misconduct action selective disclosure is place through the Hofstede Cultural Grid.

For instance, if one considers the selective disclosure strand and how this may apply in the context of power-distance, the grid statement refers to the following:

‘Selective disclosure may remain more common in an institution where the management remains disconnected from the front-line employees. The greater power-distance between management and employee may provide more of an opportunity for employees to selectively disclose information’ (In table 1)

Table 1. Hofstede cultural dimensions in relation to selective disclosure

Selective Disclosure	Description of Event
Power-Distance	Selective disclosure may remain more common in an institution where the management remains disconnected from the front line employees. The greater power-distance between management and employee may provide more of an opportunity for employees to selectively disclose information
Uncertainty Avoidance	Within an institution selective disclosure may actually be a regular practice by certain management and client facing employees, this may in time develop as an established institutional practice and so in time the uncertainty avoidance may see this practice spread as individuals may not seek to engage in the uncertain practice
Long-term versus short-term	Individuals with short-term interests or needs may be more likely to engage in selective disclosure to meet client targets or sale volumes and to achieve incentives
Individualism versus Collectivism	Both individuals and groups may engage in selective disclosures for their own benefit. But groups acting as a collective may also engage in selective disclosure where this is considered to be unauthorised but accepted conduct
Indulgence versus restraint	Selective Disclosure to a client may be an action that has management support and individuals have discretion to exercise selective disclosure where relevant. In contrast, restraint in this context would be either disclosing all relevant information to all clients or refraining from selective disclosure

If one compares this statement against the above categories, it is not difficult to draw a link with both the alienation and ambition viewpoints expressed by the respondents from the Danish insurance company. The level of power-distance between management and employee, allows for a vacuum to develop and within this vacuum may arise employee motivations and objectives that do not align with those of management or the wider organisation. In a similar vein, where an employee perceives to be alienated from the wider organisation, he/she may engage in misconduct that advances their own interests and needs. For example, under Cressey’s Fraud Triangle, an individual that seeks to commit a fraud may rationalise their behaviour and one possible reason for doing so is to retaliate against the organisation in question (Abdullahi et al., 2015, at p. 31). This may also point to an underlying ambition on the individual’s part to gain financially at the expense of others including the organisation, which may have to discharge any monetary sanction arising from this party’s misconduct. When examining the causes of the financial crisis, a number of studies found that those within a position of power within financial institutions sought to measure their success via compensation and other material goods (Hira, 2013, at p. 120). Therefore, individuals that participate in selective disclosure might also behave in a similar manner particularly where they see other participants of the scheme receiving reward and acclaim.

When applying the uncertainty avoidance principle of Hofstede to the misconduct act of selective disclosure, again one can ascertain a link between the relevant statement in Table 1 and the above five categories. The statement below refers to pre-existing practices within the organisation, in this case selective disclosure, and how this may impact the conduct of employees from an uncertainty avoidance perspective.

Within an institution selective disclosure may actually be a regular practice by certain management and client facing employees, this may in time develop as an established institutional practice and so in time the uncertainty avoidance may see this practice spread as individuals may not seek to engage in the uncertain practice.

The above statement shows the possible result of when selective disclosure is cross referenced with uncertainty avoidance. In this case, the certainty comes not from complying with internal procedures and applicable regulations in respect of withholding confidential information, but from non-compliance with these procedures and regulations. Within the organisation in question circumventing the rules is seen as a required course of action in line with the needs and objectives that the firm seeks to achieve. These particular circumstances within an organisation may point to a form of bounded rationality that has taken hold of both superiors and subordinates (Cyert & March, 1992, at pp.214–215). In other words, within the confines of the organisation in question, individuals cannot consider their actions in a different light as their rationality remains rooted in an established environment.

An organisational environment of this nature would then align with the workaholism and ambition categories above. Where individuals value their work more than other aspects of their lives, they may be more willing to follow the dominant practice within their work organisation if this ensures their position and recognition within the work sphere. Similarly, an individual that is ambitious may be more prone to adopting the common work practices within their work environment if this is seen as the best way to gain financial reward and professional advancement..

Ambition may also align with the intersection between selective disclosure and long-term versus short-term interests as can been seen from the below grid statement. As Hira states, certain individuals may decide to engage in high risk behaviour if this individual is under some form of emotional turmoil and fails to make rational decisions (Hira, at p. 123). In a target driven environment a trader may engage in selective disclosure to protect their own position within the organisation and to ensure that they are not seen as underperforming.

Individuals with short-term interests or needs may be more likely to engage in selective disclosure to meet client targets or sale volumes and to achieve incentives

However, alienation may also be present in the above example as an individual may have an independent incentive for monetary gain that is different to that of the organisation. In other words, the individual in this case utilises the organisation’s own business model for their own ends regardless of the actual ancillary benefit that may arise for the firm itself from this misconduct. This again aligns with the incentive for those in senior positions within a financial institution to increase profits and share value for the short-term without consideration of the longer-term costs that may arise.

Thus far, three of the above categories have been found to overlap with the grid statements derived from the intersection between selective disclosure and the Hofstede cultural dimensions. The three remaining categories, machismo, orderliness, and authoritarianism, have not yet mapped onto the grid statements in Table 2. However, in the two remaining grid statements, that of individual versus collective interests and indulgence versus restraint, one may be able to draw a link between these statements and a tailored form of authoritarianism. For example, as per the below grid statement referring to individual versus collective interests, there may be cases where within certain groups or units a peer practice develops that must be adhered to by all. In this way, the individual’s interest may become marginalised for the interests of the collective. Bénabou states how in certain environments wilful blindness is a more attractive stance for a group to take than actually considering whether or not their decisions and policies are incorrect (Bénabou, 2013, at p. 457). In effect, the group coheres around a common narrative or totem that for individuals within this group are unwilling or unable to challenge for fear or preclusion and isolation.

Both individuals may engage in selective disclosures for their own benefit but groups acting as a collective may also engage in selective disclosure where this is considered to be unauthorised but accepted conduct.

For the final grid reference on selective disclosure below and how this may arise in an environment where indulgence conflicts with constraints, one may be able to align four of the six categories with either indulgence or restraint. Where an organisation allows for selective disclosure, then there may be underlying incentives such as ambition or workaholism at work on an individual’s part. This ambition may easily reside alongside misconduct where the end result may be recognition and monetary award. While an individual that values their work above all else is likely to also engage in selective disclosure if this is seen as an organisational practice that has become part of everyday operations. Indulgence may also be tolerated as those in authority benefit from individuals or groups breaching compliance norms. For example, in the case of Barings Bank, certain senior executives protected Leeson as they saw his actions as beneficial for the financial institution and failed to examine the underlying basis for his financial performance (Greener, 2006 at p. 432). In other words, the internal politics and structure of Barings Bank allowed for Leeson to indulge in rogue trading without any effective restraint on this misconduct.

Selective Disclosure to a client may be an action that has management support and individuals have discretion to exercise selective disclosure where relevant. In contrast, restraint in this context would be either disclosing all relevant information to all clients or refraining from selective disclosure

Alternatively, there may be restraints in place within an organisation that make it difficult for an individual or a collective to engage in selective disclosure. In these cases, the category that may best represent the organisation in question may be authoritarianism. If a strong leadership is in place and seeks to enforce good conduct, then a number of restraints may be applied to individual conduct and discretion to ensure that no selective disclosure is possible. However, what forms these restraints take may depend on the resources available to the financial institution in question and whether their remains sufficient deterrents against those that engage in misconduct. One possible restraint may be to develop a positive form of peer pressure within the institution whereby compliance is rewarded based on a group’s performance but also non-compliance is penalised at a group level as well (Mani et al., 2013, at p. 2).

4.1. Hofstede Cultural Grid and Overcoming Causative Factors of Misconduct

Developing a Hofstede Cultural Grid should allow financial institutions and indeed financial regulators to better detect the causes and amplifying factors behind misconduct events. This grid may allow for financial institutions to reconsider their incentivise policies and how these may adversely impact on employee conduct. For regulators, applying this grid may also curtail to some degree the advantage financial institutions avail of by employing those that have inside knowledge of how regulators operate. Regulators will now be able to better garner a picture of the possible environmental factors at play within these organisations. From this more informed position the regulator in question should then be better able to determine the most effective sanction or measure to resolve the underlying environmental factors uncovered. This may include placing restrictions on incentives and thereby resolving another causative factor for conduct risk.  

5.0 Conclusion

What the above examples illustrate is that the proposed cultural grid does overlap with the six categories of organisational environments as established by Hofstede et al. This in turn points to the value in such a grid as it provides management and compliance officials with a dual insight of how an organisation may operate in respect of both the underlying cultural prism in the grid and certain specific organisational environments. From this duality, a number of objectives can then be achieved. First, the organisation, in this case a financial institution, will be able to ascertain the exact incentives or objections at play both from the perspective of the respondent and from further mapping with the six environmental categories. This in turn should aid the relevant compliance function in detecting where possible adverse incentives have taken hold. Second, where a large subset of the respondents indicates that there is a power-distance or short-term versus long-term failing within the financial institution, then specific steps can be taken to resolve these findings. These steps should in turn also seek to reposition the financial institution into a new category that management and employees agree to develop within the institution. Third, this grid should help in identifying possible additional concerns that employees may have without necessarily having to engage in conflict or internal strife with colleagues or management. The statements are developed from past enforcement actions within the United States that are then contextualised to the specific cultural benchmark in question. In this setting, the respondent should be more comfortable in engaging with the grid in a transparent and open manner. Finally, the compliance function or management regime within a financial institution that utilises this grid model will be able to cross reference the respondent findings back to the relevant misconduct act and then in turn back to a specific enforcement action. From this, the compliance function or management regime can then undertake a practical operational comparison between their own procedures and controls against those of the enforcement action. In this way, the grid reference not only provides a high level overview of a financial institution’s internal cultural dynamics but also the lower level operational matters.

Disclosure statement

No potential conflict of interest was reported by the authors.

Additional information

Funding

This work was supported by the Enterprise Ireland [CF-2018-0976].