Observations on Culture at Financial Institutions and the SEC

Thank you Bill [Dudley] for that kind introduction and for inviting me to speak today.[1] I’m planning to speak for fifteen or so minutes and to open the floor to questions.

I want to extend my congratulations to Bill Dudley on a very successful term. You are now a member of the long line of former leaders and perpetual culture carriers at the New York Fed. The respect for the New York Fed, among national and international regulators and, importantly, market participants of all stripes, is remarkable, but clearly well deserved. Congratulations are also in order for John Williams, who begins his term today. John, my colleagues and I at the SEC are looking forward to working with you in your new role.

I recognize that there are many constituencies — regulators, market participants, etc. — in the audience today and it is a great privilege to have the opportunity to speak to you all about a subject of individual and collective importance.

I will return to that theme — individual and collective — more than once today.

Let’s turn to the topic for discussion: The importance of developing, improving and reinforcing positive culture in our financial institutions. I will offer some observations about culture at financial institutions and the SEC.

Culture is not an Option

The Financial Conduct Authority in the UK recently issued an illuminating discussion paper on the topic of culture in the financial services industry, with the fundamental observation: “Culture is not optional.”[2]

Every organization has a culture, and in some cases, the firm’s culture is in fact a collection of many sub-cultures.

While the leaders of our financial institutions often are tasked with driving positive changes in culture, they must recognize they are not writing on a blank slate or, for that matter, a single slate.

Know Your Culture

In order to effectively manage, preserve and enhance your organization’s culture, you need to know your culture.

Returning to the “not a blank slate” comment, the slate may have a lot of chalk marks. The most recent cultural initiative may be written in large, bold letters. But, below the chalk, there may be etchings, sometimes deep etchings in the slate. For the positive etchings, be thankful, very thankful. They take time and effort to develop and can carry an organization through challenges of many types. For the negative etchings, know there is work, perhaps painful work, to be done. If you ignore them, they are likely to get deeper and, at some point, will undermine the most well intentioned efforts.

Returning to knowing your culture, I’ll make two related observations. First, to effectively manage the business of your organization on a day-to-day basis and over the long term, management needs to know what the culture of the organization is today, including the key drivers of that culture. For example, a new strategic initiative is much more likely to be successful if it is designed and implemented in a manner that is consistent with, and, hopefully, leverages the firm’s culture.

Second, over time, whatever the cultural goals for your organization may be, the chances of achieving them go up dramatically if you understand where your culture stands relative to those goals. In driving organizational culture, it is difficult, if not impossible, to get from A to B unless you have a clear sense of what A is.

There is a regulatory relations observation I will make that flows from the need to know what your culture is today if you want to preserve and improve culture for tomorrow. This observation is informed by my work as an adviser and now as a regulator. Assume a significant conduct problem occurs at a financial institution and the firm’s culture comes under regulatory scrutiny.

Let’s take as given that both the firm’s management and the regulator want the firm to have “good” culture, one, for example, that is consistent with long term shareholder, employee, customer and societal interests as well as law and regulation. In other words, we’re all trying to row the same boat in the same direction. However, if there is a disconnect between what management thinks the firm’s culture is today and what the regulator thinks the firm’s culture is today, agreeing on measures to enhance the culture will be difficult – very difficult. Said starkly, if the regulator is convinced a firm has a cultural problem and the firm continues to fight that conclusion, tension is likely to be high and progress — which involves fostering mutual regulator -firm respect and trust — will be slow and costly all around.

Culture is a Collection of Countless Internal and External Actions

There is another theme that runs through the FCA study I referenced and is central to much of the discussion of today: In my words, culture is collective.[3] What do I mean? While there is great importance in setting a positive “tone at the top,” an organization’s culture is, in large part, defined by the countless daily actions of its people. Culture is not just what is said by management to the work force, but what is done, i.e., what actions are taken, day in and day out throughout the organization, with colleagues, customers, suppliers and regulators.

To put this point in context, let’s look at the SEC. Yes, we have a Chairman and we have 4 Commissioners and a dozen or so other senior leaders, including the heads of our Enforcement, Trading & Markets, Investment Management, Corporation Finance, Compliance and Inspections, Economics and Risk Analysis, Office of Chief Accountant and our General Counsel. We each have a responsibility to set and act in accordance with the SEC’s cultural objectives, both internally and externally. But, while our actions may be relatively the most prominent, they are a small fraction of the internal and external interactions of the SEC.

Every day, our market participants — individual investors, issuers, asset managers, brokerage firms, rating agencies and other regulators (including many represented here today) — interact with the women and men of the SEC. In many cases, those interactions are very important to those participants, as well as many others. As I like to say, we have thousands of “at bats” a day where our culture is on display and being shaped. How we handle ourselves in these countless situations defines who we are. Are we zealously pursuing our mission? Are we consistent and clear? Are we fair? Do we listen? Do we learn? And, most important, are we striving to deliver for America’s long term Main Street investors?

Preserving and Enhancing Culture Through a Clear and Constant Mission

That last question — “Are we striving to deliver for America’s long term Main Street investors?” — provides a basis for discussing my next observation. If culture is defined by the collection of countless daily actions taken across the organization, how do you ensure those actions are consistent with the organization’s cultural objectives?

There are many familiar methods for communicating, monitoring and reinforcing cultural objectives — compliance programs, policies and procedures, training, personnel decisions (including evaluations and compensation), etc. I believe all of these methods are important and, in large financial organizations, essential. I also believe these methods are enhanced by, and in fact, to be effective over the long term, require, a clear, candid, easily understandable articulation of the organization’s core mission.

My view of this message for the SEC is furthering the interests of our long term retail investors.

That short statement does not stand alone. As you would expect, we have many goals and obligations. For example, ensuring that trading — a largely institutional exercise — is fair and efficient is a critical part of our mission. Although it is a largely institutional market — and certain aspects of it are almost exclusively institutional (e.g., high yield bonds) — I believe the right question to ask is: are we seeking fairness and efficiency in this largely institutional market in a way that best serves the interests of our long term retail investors. Is there a disconnect here? Why should we have retail on our minds when we are regulating an institutional market? There is no disconnect. Those institutions are holding and trading, in large part, the funds of retail investors. That perspective, or lens as we sometimes call it, should substantially inform how we regulate trading.

This perspective, this unifying perspective, this driver of culture, is similarly relevant when we look at investment products, corporate disclosure, and governance rules as well as when we set inspection and enforcement priorities. To be clear, and to give deserved credit to the SEC staff and those who came before me, this cultural dedication to our long term Main Street investors has been deeply etched in the SEC’s slate for many years.

Culture Beyond the Law and Regulation

I will turn away from the SEC and back to organizations more generally. There are many reasons why having a clear mission is beneficial to culture and improving culture. I’ll cite one in particular. It fills in the gaps. Organizations with the most comprehensive compliance programs and policies and procedures will inevitably encounter circumstances not contemplated by their policies and procedures. In those situations, what drives how people will act? The law and regulations? What if those also do not contemplate the situation? Or, more significantly, what if the law permits a range of actions with some that, while legal, can cause significant harm. In these circumstances, those on the front lines, those making decisions, need a touchstone.

To illustrate the point of how important the “gap filling” function of culture can be, allow me to put on my law professor hat for a moment. I will also reiterate the disclaimer that I am not commenting on behalf of the Commission or discussing any specific case that is or has been before the Commission. I will present my own hypothetical fact pattern.

Counterparty A, a sophisticated asset manager with years of experience in the fixed income market, including with illiquid and distressed securities, calls Broker B. Broker B is known as a market maker in the debt securities of an issuer, Issuer C. The fixed income securities of Issuer C, from time to time, have had limited liquidity. These securities are widely disbursed and have experienced price volatility in the past.

Counterparty A expresses interest in buying $10 million in face amount of Issuer C’s bonds and asks Broker B for a price. Broker B says I can “fill” that at 90 (i.e., at .9 of par or approximately $9 million). Counterparty A then asks Broker B, if the Issuer C bonds are held in inventory and, if so, at what price Broker B acquired the bonds.

Assume, Broker B acquired $20 million of the bonds a few days ago at 80 and has held them in inventory.

Let’s put aside the question of whether, it may be legal and appropriate for Broker B to charge Counterparty A 90 for these bonds. In fact, let’s assume for the sake of this hypothetical that a price of 90 would be consistent with FINRA rules, internal policies and procedures and all applicable securities laws regarding pricing.

Unfortunately, Broker B, or a few people at Broker B, lie. They tell Counterparty A the bonds were purchased at 81 when they know they were purchased at 80.

Let’s assume further that, after Counterparty A is told the bonds were purchased at 81 (when they were in fact purchased at 80), the legal department at Broker B reviews the matter and concludes this lie does not run afoul of the federal securities laws. Setting aside whether that advice is sound or accurate, does anybody really think it is a good idea to take that advice a step further and say a lie is acceptable?

Here is where culture comes in. The law may not prohibit all forms of lying, but your culture should reject it. Said another way, if any financial institution thinks behavior of this type is acceptable or does not require prompt, clear and significant action, that financial institution has a cultural problem. To me, there is no debate on that score. Faced with this or a similar scenario, the financial institution should not be asking “Do we have a problem?” It should be asking “What do we do to address this problem in a way that is clear, consistent with, and reinforces, our cultural goals?”

We do not Expect Perfection; We do Expect Commitment and Action

A final regulatory observation before I conclude: human beings make mistakes and some break from cultural expectations and legal requirements. We all, including those of us at the SEC, recognize this fact.

When this behavior occurs, key questions a firm should ask include whether the conduct represented a clear breach of the firm’s controls and culture as well as whether the firm’s remediation efforts, in addition to any controls enhancements, sent an appropriate and lasting cultural message. Turning back to my hypothetical, do the controls now make it clear that lying is unacceptable and that communications around mark-ups will be monitored. And, were the offending parties dismissed or otherwise meaningfully sanctioned. The actions we chose in these types of scenarios say a great deal about who we are — and what our culture is.

Conclusion

I will conclude by addressing the importance of the work that you all do in this particular profession. Professionals in the financial industry must recognize the pervasive reach of our markets and the importance of finance at an individual level. Every organization’s culture should reflect 3 realities and these 3 realities need to be recognized by professionals at every level of an organization. First, it is a privilege to work as a professional in the financial sector. Second, firms have systemic responsibilities with widespread significance. Finally, firms and their professionals have important, individual responsibilities to real people that make up the investing public. We are counting on you, and, importantly, more importantly, the public is counting on you to develop cultures that recognize and responsibly address these realities.

This is a continuous exercise. Markets will change. Organizations will change. Culture and the effective implementation of positive culture must keep up. We at the SEC will give you feedback on your culture and we, including me, want feedback from all market participants on our culture.

Thank you.