Response to Self-Regulation Proposal
Standards and Culture in Self Regulation
Introduction
The pitfalls of self-regulation are not unknown: object lessons abound in Tyco, WorldCom, Enron, Arthur Andersen, and several others (Pritchard, 2003). What to make then of a proposal for the implementation of self-regulation, thus decreasing regulatory oversight of our company? On the one hand, few firms are going to reject such a proposal as it means less red tape for them; on the other hand, compliance is culture and a culture without it can quickly turn into a slippery slope down the same path taken by the companies already mentioned. Yet, as Omarova (2011) points out, an industry without self-regulation is one unlikely to address the problems that plague it: at some point, accountability and firm responsibility is needed to address issues that by and large elude regulators by more than a few paces. The problem of relying regulators and compliance has been seen again and again—particularly in the global context: regulators rely upon political accountability, civil support and competitive marketplaces—and if any of those are lacking, it makes regulation and enforcement virtually impossible (Arnone & Padoan, 2008). Omarova (2011) describes the problematic nature of third-party regulation best in our industry: “Given the complexity and global nature of the modern financial market, any government’s attempt to regulate it in a purely unilateral command-and-control manner will inevitably encounter the fundamental problem of regulatory arbitrage, whereby financial institutions find new ways to get around government rules, thus creating a never-ending spiral of rulemaking and rule evading†(Omarova, 2011, p. 416). With that point in mind, it does well to consider whether self-regulation can be an answer to the never-ending spiral of rulemaking and rule evading described by Omarova (2011). This paper will discuss the issue and show why, ultimately, I am in favor of self-regulation—on the one condition that certain standards and concepts are applied to ensure that self-regulation does not turn into a license to act unethically.
For Self-Regulation
One of the best reasons for self-regulation is that existing regulation regime is simply not an effective option (Greene & Odorski, 2015). The SEC for example will typically fine offending firms, but in many cases these fines do not cover the losses caused by the offending firm’s actions—nor are they more than a wrist-slap in financial terms (Greene & Odorski, 2015). The Fair Funds provision of the Sarbanes-Oxley Act (2002) was meant to ensure that fines were placed into a disbursement fund that would then pay out to victims of fraud or abuse. Since 2007, those funds have been decreasing—even though the number of firms being charged by the SEC has increased (Greene & Odorski, 2015). This is but one example of many that indicate the need for regulation of the regulators—which, of course, is the crux of the problem. Regulation can be piled upon regulation, but unless personal accountability and ethical leadership is demonstrated, the entire issue of regulation can never truly be saved. Thus, regulation is ultimately a culture issue. A company’s culture must be firmly planted on standards and concepts that promote accountability and ethical leadership. Only in this way can self-regulation be effective.
In the light of existing regulatory systems failing to produce the desired outcomes, it is reasonable to accept that self-regulation is a viable alternative. The way it would work is this: instead of complying with external standards, codes and rules, the company complies with internal standards, codes and values that both drive the company’s culture and the company’s performance. The firm must develop its own standards of conduct, and it must hold itself accountable: everyone from top level executives to lower level staff must be held to the same standards of conduct, the same principles guiding the company’s vision, and the same expectations of behavior inherent in ethical leadership. However, the firm must still be able to monitor activity internally and identify potential abuses or fraudulent activity, both through monitoring and routine internal and external auditing. Self-regulation is not a free pass to ignore internal conduct: if anything, it is the acceptance of even greater responsibility to monitor, assess and correct offenses and abuses on one’s own without relying on an external regulatory system to do it for oneself. It is the essence of self-determination in the free market system.
Omarova (2010) states that “any meaningful long-term regulatory reform in the financial services sector must seriously consider the potential role of industry self-regulation as a key mechanism of controlling and minimizing systemic risk†(p. 669). There are two reasons self-regulation is the key to controlling and minimizing risk in the industry: first, firms alone have the ultimate power to access and assess the information that is available—external regulators do not. Second, firms alone have the power to monitor and regulate their businesses across national borders—external regulators do not (Omarova, 2010). For these two important reasons, it can be seen that the best solution to the problem of regulation is self-regulation.
Is Self-Regulation Practical?
The question remains, therefore, whether self-regulation is possible, practical and pragmatic. The answer is that, with today’s technology, it is. As Arner, Barberis and Buckey (2016) show, FinTech and RegTech have reached a stage of development that they can properly and adequately assist firms in monitoring transactions, accounting, and all other activity internally. RegTech has become so advanced that it has “the potential to enable a nearly real-time and proportionate regulatory regime that identifies and addresses risk while facilitating more efficient regulatory compliance†(Arner et al., 2016, p. 371). Because the finance industry has integrated IT throughout its operations, the need for an IT-based regulatory monitoring system is evident: lacking such would not allow self-regulation to be possible. There are too many transactions made from day to day, and no other way to monitor and analyze the data. Using an IT-based solution solves that problem and gives the firm the option of using Big Data analytics to better understand what is going on in its own firm.
In other words, without RegTech, self-regulation would be impossible from a monitoring and evaluating point of view. Instead of an external agency doing the monitoring, the firm must use RegTech to monitor “trade reporting systems of securities exchanges to detect unusual behavior which can serve as a trigger for further analysis and potential regulatory investigation and enforcement†(Arner et al., 2016, p. 399). This is not the only digital tech imperative placed upon the firm, however. There is also the need to enhance cybersecurity to protect against hacking and digital theft.
Policy and Standards
Aside from the technology “how†regarding self-regulation, there is the question of “whatâ€: what will be the standards to which the company holds itself in order to maintain an ethical posture? Whatever the standards are, they must be of a sufficiently high quality, and they must be communicated as a matter of policy throughout the organization so that they are known, accepted and complied with internally at all levels of the organization.
Coordinating policy standards is a necessary step. The IMF and World Bank have both provided standards and guidelines for firms in the industry—so it is not a matter of firms being left to their own devices. The Code of Good Practices on Fiscal Transparency, The Code of Good Practices on Transparency in Monetary and Financial Policies, and the Special Data Dissemination Standards and those within the General Data Dissemination System are just a few of the many examples of standards provided by the IMF and World Bank for firms to utilize and implement or to use in the creation of their own standards. The important point is that the firms have standards in place. Without them, there is nothing to internally comply with.
Culture and Leadership
Once the standards are decided upon, the company must then initiate the development of the culture of compliance via an ethical leadership approach. Ethical leadership emphasizes transparency, accountability, and adherence to a system of ethics that reflects the values and principles of the community. An ethical system of Egoism, for instance, would not be adequate and would likely lead to the type of internal ruin seen at firms like Enron, where egoism ran amok. A better system would be a deontological one or a system of virtue ethics. Whatever the system is, however, it should be promoted and communicated throughout the organization and embraced and embodied by the leaders of the organization—for it falls to them to set the example for the rest of the workers in the firm.
The culture must then be supported by practical, every-day communications and activities—messages that inspire and motivate workers to seek compliance and to honor the code that the firm puts forward. The firm must not be remiss, however, in giving workers an avenue or means of reporting if they do observe unethical practices in their line of work. A whistleblower hotline has become one option that firms use to allow workers to report misdeeds without fear of blowback: a hotline protects the reporter’s identity and allows anonymous reports to be made that the administration can then investigate and verify if true. However, the culture of honesty should be promoted to facilitate this type action—as many employees will fear retribution if they perceive that leadership does not care about ethical violations. Unless the culture of compliance is promoted and demonstrated from the top down, employees are not likely to want to assist in the process of self-regulation.
Conclusion
Self-regulation is not only a viable alternative to external regulation by third party agencies, it is also a necessary step towards the reduction and management of risk. Companies alone have the most access to records and numbers, to workers and actions that may need investigating: external regulators do not generally have this access, and it can take substantial time for them to gain it and put a case together. Companies alone also have the power to monitor their own actions on the international stage. Third party regulators do not. Companies also have the means to monitor and regulate: RegTech has advanced to a point where information can be monitored, collected, analyzed and evaluated nearly instantaneously thanks to Big Data analytics. Finally, the company itself has the capacity to create the internal culture of compliance through ethical leadership needed. For these reasons, self-regulation is recommended.
References
Arner, D. W., Barberis, J., & Buckey, R. P. (2016). FinTech, RegTech, and the reconceptualization of financial regulation. Nw. J. Int’l L. & Bus., 37, 371.
Arnone, M., & Padoan, P. C. (2008). Anti-money laundering by international institutions: a preliminary assessment. European Journal of Law and Economics, 26(3), 361-386.
Greene, E., & Odorski, C. (2015). SEC enforcement in the financial sector: addressing
Omarova, S. T. (2010). Rethinking the future of self-regulation in the financial industry. Brook. J. Int’l L., 35, 665.post-crisis criticism. Bus. L. Int’l, 16, 5.
Omarova, S. T. (2011). Wall street as community of fate: Toward financial industry self-regulation. University of Pennsylvania Law Review, 159(2), 411-492.
Pritchard, A. C. (2003). Self-regulation and securities markets. Regulation, 26, 32.
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