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Compliance & Risk

DOJ leads regulatory “carrot & stick” strategy to push firms to boost compliance regime

Richard Satran  Financial Journalist, Thomson Reuters Regulatory Intelligence

· 5 minute read

Richard Satran  Financial Journalist, Thomson Reuters Regulatory Intelligence

· 5 minute read

The US Justice Department has begun work on an initiative to push financial regulators to improve Wall Street culture with a "carrot & stick" strategy

The initiative — which pushes rewards or penalties based on the specific steps financial services firms take in order to better compel compliant behavior — raises the prospect of firms paying higher compensation by providing incentives for compliance staff independence, but it also increases potentials risks for falling behind in updating technology.

Until now, the changing role of compliance has not featured largely in the wave of regulatory initiatives proposed by Biden administration regulators over the past two years as they seek to curb financial abuses and economic inequality while closing regulatory gaps opened with fast-changing technology. These new carrot & stick initiatives include:

      • First, the stick — Some firms have already been fined by regulators failure to maintain controls over personal devices use that included use by top managers. Firms must revamp controls over new technology that evades surveillance, modify behavior to end hidden practices, and align culture to serve clients’ interests. Independent consultants will act in the role of monitors until firms’ operations have transparent operations producing verifiable results.
      • Next, the “compliance carrot”— For the first time ever, the DOJ said firms should implement rewards for compliance officers for independence and decisiveness in response to misconduct. The DOJ’s enforcement unit is working to complete a proposal by the end of the year that uses concrete, measurable criteria of compliance actions.

Sources close to the DOJ say a wide a range of metrics and material factors are under consideration as the agency looks to compliance incentives to win more cooperation from firms, ranging from use of independent audits of bonuses to evidence-based instances of chief compliance officers deterring violators early in the act.

In a recent speech, Deputy Attorney General Lisa Monaco cited corporate compensation policies with penalties intended to deter misconduct, including effective claw-back provisions and the escrowing of compensation when potential abuses arise. “No one should have a financial interest to look the other way or ignore red flags,” Monaco said. “Corporate wrongdoers — rather than shareholders — should bear the consequences of misconduct.”

She added that “on the incentive side, companies are building compensation systems that use affirmative metrics and benchmarks to reward compliance-promoting behavior.”

Compliance pushed to play active role

Regulators’ crackdown and the compensation initiative were seen as efforts to empower compliance professionals to do their jobs better. Appropriate compensation that incentivizes independent compliance, the DOJ has decided, could bolster the authority of chief compliance officers (CCOs) and compliance staff within firms. Similarly, the CCO who finds instances of staff violating personal device policies can use the case to warn employees, from rank and file representatives up to C-suite executives, of the need to avoid the practice.

The DOJ initiative marks the first serious effort by an enforcement agency to tackle an issue that has largely been avoided by regulators. Financial enforcement has increasingly stiffened penalties for violations when investigators find firms have failed to provide resources, such as staffing levels, written supervisory procedures, or training and expertise based on specific risk factors faced by the firms.

The new initiatives show the agency raising its expectations for compliance compensation significantly. However, the initiative was not entirely “top down” thinking by the DOJ. Some firms, Monaco said, have already begun to rework compensation incentives for compliance. And the DOJ’s initiative could also eliminate roadblocks for those firms that are trying to craft more attractive pay packages to attract talent in a highly competitive market. Giving incentives to control staff members who have often been frowned upon in the industry may be a wise idea.

Skeptics say enforcement can’t change secretive culture 

Skeptics, however, say that efforts to bolster compliance could have a positive impact but would not address cultural problems in an industry reluctant to interfere with top performers who prefer to work outside the surveillance grid. Customers often prefer anonymity, and bankers and traders are often reluctant to expose their “secret sauce” that shows how they work or share details of client contacts they view as personal assets.

In the hyper-competitive, performance driven financial services industry, secretive behavior has become embedded within a culture that puts relationship-building in over-drive. The regulatory initiatives to change behavior “could raise awareness in the short term but does not address systemic problems,” said Jay Gould, special counsel at the law firm Baker Botts.

Changing culture happens gradually, and when regulators push for change, “culture will change, if it hasn’t already,” noted Brian Rubin, partner and head of the Washington, DC office of Eversheds Sutherland (US) and a former senior enforcement official at the SEC and the Financial Industry Regulatory Authority.

The growth of text messaging on personal devices became more widespread during the COVID-19 pandemic, pushing regulators to act more aggressively, Rubin explained. While some argue it is impossible to regulate the new technology, regulators have advanced their skills in detecting hidden messaging with technology tools such as forensic data analytics.

In addition, they are scouring network communications using parallel processing that correlates message patterns with transactions, finding gaps in the context of messages pointing to off-line conversations and also using metadata and internet service traffic that show suspicious messaging activity.

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