07 March 2009

Compliance: Workplace Security, Ethics & Governance...

Bernie Madoff clones and the 11,000 other unregulated investment advisors across the US will be subjected to increased scrutiny in 2009 and beyond. The SEC, FINRA, US Treasury FINCEN, FBI and the tribe of banking regulators are all gearing up for audits, inspections and more granular forensic accounting examinations.

Fraud and the corruption of corporate America is hard to detect. Even more difficult when the watchdogs are too busy or without the resources to do the job effectively. Post Enron and the whole SOX wave of documentation, controls implementation and testing the Big Four Accounting firms were very busy.

The cases are among a series of recent alleged frauds at financial firms. While they have been handled differently, they have shined a light on loopholes in federal regulations, such as fragmented regulations governing brokers, investment advisers, auditors and other firms. And the cases have underscored obstacles facing authorities, including inadequate resources for detecting wrongdoing and difficulties in gaining access to foreign financial accounts.

"Reform is needed to close the existing regulatory gaps that expose investors to risk," said Richard Ketchum, chief executive of the Financial Industry Regulatory Authority, Wall Street's self-policing agency.

SEC Chairman Mary L. Schapiro is looking to work with lawmakers to overhaul the nation's financial regulatory system. This week, the SEC announced that it would partner with a government-funded research center to study ways to better assess the thousands of tips and complaints that come in each year. The House and Senate plan to consider legislation as early as late spring that would bring all financial activities under federal regulation. The details, however, aren't clear.

At the SEC, Schapiro plans a new focus on spotting fraud and other market manipulation early on. She plans to create a large team to seek out where abuses might be occurring. Then she plans to direct the SEC's limited examination staff toward those places. "We've got to be able to conduct risk assessment that allows us to understand where problems might arise and connect the dots between different problems in different places -- whether they're generated by different products, different firms or different trends in the economy," Schapiro said in a recent interview.

The internal threat to your institution by your own employees who may do you harm, intentionally or not is just a core factor in day to day Operational Risk Management. Where it gets more interesting to plaintiff lawyers is when there is a clear pattern of ignorance or just plain lack of resource allocation or funding to policing the organization. The even more vulnerable facet of the OPS Risk mosaic could be the supply chain of companies and people who represent the vital outsourced functions. How many mission critical components of running your business have you handed over to call centers, ISP and hosting companies, distribution and delivery, back office administration including accounting and payroll?

One of the key areas of due diligence long overlooked at these investment advisers is the supply chain of feeder firms. The alternative investment industry has it's reach into the accountants and tax advisory services for a good reason. They are the ones who prepare your tax returns. Their insight into your cash flow, ability to invest and necessity for potential hedging of tax liability gives them the opportunity to be great referral agents. How many times has your tax advisor recommended you go see a friend in the alternative investment industry?

Creating awareness among the ranks of corporate America that everyone is going to be under the magnifying glass won't change the motivators:

  • Money
  • Ideology
  • Compromise
  • Ego

Economic challenges inside the corporation or on the home front can increase exposure to heightened threats in the workplace. These include violence, fraud and product theft at a minimum. However, the greatest asset of value being attacked, stolen and sold to the highest bidder is information. Corporate espionage and good old fashioned competitive intelligence is a 21st century Operational Risk Managers nightmare.

Workplace Security, Ethics and Governance programs will continue to be a focus for auditors and inspector generals. A lack of evidence of effective and robust efforts to deter, detect, defend and document withing the confines of the institution could be a differentiator when it comes time for any sentencing guidelines to be considered.

§8B2.1. Effective Compliance and Ethics Program

(a) To have an effective compliance and ethics program, for purposes of subsection (f) of §8C2.5 (Culpability Score) and subsection (c)(1) of §8D1.4 (Recommended Conditions of Probation - Organizations), an organization shall—

(1) exercise due diligence to prevent and detect criminal conduct; and

(2) otherwise promote an organizational culture that encourages ethical conduct and a commitment to compliance with the law.

Such compliance and ethics program shall be reasonably designed, implemented, and enforced so that the program is generally effective in preventing and detecting criminal conduct. The failure to prevent or detect the instant offense does not necessarily mean that the program is not generally effective in preventing and detecting criminal conduct.