Tag: David Hechler

Did Compliance Programs Fail During the Financial Industry Meltdown?

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Most people would say yes to this question. I think the answer is more complex. A stand alone compliance program could not prevent the over-exuberance, excessive risk taking, and ethical lapses that lead to the meltdown.

The inspiration for this post came from an article by David Hechler, Risky Business: Did compliance programs fail the test during the financial industry meltdown? for the April edition of Corporate Counsel. Hechler focused on Countrywide Financial Corporation and Tim Mazur, who was an ethics officer at Countrywide. Hechler comes up with three lessons from

  1. Misaligned Compensation Mangles Companies
  2. You Don’t Build an Ethical Culture in a Day (or Year)
  3. Empowerment Is More than a Nice Word

The real problem was a failure of compliance at the structural level, not the program level.

Top-level executive compensation for public companies will be linked to stock performance. There are many people discussing the pros and cons of this approach and how it affects compliance. The more important place to look for misalignment of compensation is front-line employees and mid-level managers.

The examples in the story about Countrywide are a great example. Loan officers at Countrywide were paid higher commission for sub-prime loans than traditional loans. Wrong compensation. Those loans are riskier to the company so they should be less valuable and be subject to a lower commission. (You should also question why commissions would change from one loan product to another.)

The compensation to the loan officer is tied to origination of the loan with no compensation tied to the repayment of the loan. So of course, underwriting standards are going to deteriorate as the pool of good borrowers shrinks and you need to find less qualified borrowers to take on loans.

The managers of these loan officers were also similarly compensated based on origination of the loans so they were going to push for more and more loans regardless of the likelihood of repayment. There is a similarity to this structure and the the structure at Enron. In The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron, the authors paint a picture of Enron focused on origination of deals with little resources or focus on managing the deals.

You can’t build an ethical culture if the structure is not in place. Mazur contends that he did not have enough time to build an ethical culture at Countrywide. Unless he would have been able to change that front-line employee compensation model, I do not think he could have prevented the problems at Countrywide.

You need to align the institutional incentives of your company for a compliant and ethical company. You also need to align the personal incentives for employees throughout the company to match those institutional incentives.

See:

Update: fixed some typos

Short Bites

Here are a few stories and items that caught my eye, but I have not had time to build-out to a full post:

Reminder to Review Insider Trading Compliance by Melissa Klein Aguilar for Compliance Week

The SEC settled an administrative proceeding this month involving Merrill Lynch based on the firm’s failure to have adequate procedures regarding its “squawk box” to prevent day traders from overhearing and using material non-public information regarding unexecuted institutional orders. That case, along with a 2008 report of an investigation issued last year regarding the Retirement System of Alabama, suggest that “the prudent approach for issuers is to carefully review the adequacy of their procedures for handling inside information,” says Gorman. Those procedures should be carefully tailored to the specific business of the company.

Madoff to Stay Behind Bars Pending Sentencing from the WSJ Law Blog

The Second Circuit earlier Friday affirmed the ruling of the federal district court judge overseeing Madoff’s case, Denny Chin, who had ordered Madoff detained for the months leading up to sentencing, currently slated for June 16. A copy of the Second Circuit’s ruling; A LB post from last week on Madoff and his prison prospects.

Risky Business Did compliance programs fail the test during the financial industry meltdown? by David Hechler for Corporate Counsel

Cox got no argument from his audience of chief compliance officers. But the rest of us may be forgiven for wondering what the compliance officers, and the risk officers, and the ethics officers were doing at the financial services firms when their colleagues were placing those dangerous wagers. Weren’t all those internal controls supposed to protect companies from catastrophe?

Placebo Ethics by Usha Rodrigues and Mike Stegemoller

While there are innumerable theories on the best remedy for the current financial crisis, there is agreement on one point, at least: increased transparency is good. We look at a provision from the last round of financial regulation, the Sarbanes Oxley Act of 2002 (“SOX”), which imposed disclosure requirements tailored to prevent some of the kinds of abuses that led to the downfall of Enron. In response to Enron’s self-dealing transactions, Section 406 of SOX required a public company to disclose its code of ethics and to disclose immediately any waivers from that code the company grants to its top three executives. These waivers offer a unique window not only into ethical practices at public U.S. companies, but also into how disclosure works “on the ground” -whether companies are actually complying with disclosure rules and whether these rules prevent self-dealing transactions.

Federal Stimulus Bill and TARP Mandate Additional Corporate Governance Requirements by Corporate Compliance Insights

After The American Recovery and Reinvestment Act was passed, the Say on Pay provisions for executive compensation received a great deal of coverage and scrutiny from the national media. Certainly, the Say on Pay provision for companies participating in the Troubled Assets Relief Program (TARP) is one of the most important corporate governance mandates in the Stimulus Bill; but it is far from the only concern for companies receiving government funding.

Internal Audit: The Board’s Agent on the Ground by Mr. David Chiang for Corporate Compliance Insights

As the board chair of a university and a member of several audit and finance committees including that of billion-dollar community not-for-profit organization, I’ve seen first-hand why it’s critical to establish and support an effective internal auditing department. Internal audit needs to comply with industry best practices and develop a strong reporting relationship to the audit committee.

Audit Committee Brief – February 2009 (.pdf) by Deloitte

A recent Deloitte survey found that current market conditions have caused audit committees to change their focus. Today, audit committees are examining liquidity, impairments, enterprise risk management, and financial reporting disclosures more closely.