What fuels this gathering storm? Outright major misappropriations by the likes of Madoff and Peregrine's Wasendorf are part of the equation. In addition, events such as the LIBOR-fixing scandal at Barclays, J.P. Morgan’s “London Whale” trading losses, and MF Global’s failure to segregate customer funds serve as cautionary examples.
These stories highlight that a firm’s assets, reputation, and in some cases, even the firm’s fundamental viability are at stake when things go awry. As if that weren’t bad enough, senior executives face additional consequences. In these and other similar incidents, personal assets can be at stake even when others are the primary wrongdoers.
Think you are immune from these risks? Think again. Labaton Sucharow LLP, a plaintiff's law firm, recently published a unsettling study indicating that one in four financial industry professionals in the U.S. and U.K. believe wrongdoing is necessary for success. If this study is credible, the message it sends to the general public is highly negative. It speaks to senior management of alternative investment firms loud and clear: sometimes the best-intentioned executive may have an employee who hears an "unintended message" and veers off course. Intended or not, the executive may ultimately bear responsibility.
The first line of defense for an investment advisory firm and its executives is to build a culture in which the firm’s standards clearly and consistently meet all applicable regulatory and ethical expectations. It is particularly important for firm leaders to reaffirm these standards and expectations during times of economic and operational stress, when legal and internal requirements may appear to conflict with business drivers (such as maximizing short-term results). Employees must internalize that senior management will take the ethical route in order to maximize the long-term value of the firm—and expects them to do the same.
The second line of defense, at least in the U.S., is to develop a governance structure that satisfies the requirements specified in the U.S. Attorneys’ Manual. This manual offers incentives to companies that adopt a comprehensive compliance and ethics program (and take certain actions upon the occurrence of alleged missteps). A program that satisfies these requirements will contain elements in addition to those required by the SEC and CFTC. Complying with the U.S. Attorneys’ Manual can be an invaluable safeguard that reduces the likelihood of an executive or his firm being charged with criminal violations.
The third line of defense is to undertake an honest self-assessment, and to consider the types of pressures that senior management and employees will encounter should the weakened state of the global economy continue. Topics in the regulatory spotlight should be included in this assessment. The intent here is to prepare for the possible pressures employees and senior management might face, thereby reducing the chance that hasty decisions are made in the heat of the moment. Ill-considered actions can carry serious penalties and act as a lightning rod for litigation by regulators, investors, and other third parties (such as credit providers). Advance preparation will help your staff make faster and better decisions if the need should arise.
You can't always remove that bull’s-eye on your back, but you can at least make the target less bright.
