Indian Banks Give Customer Service for Money Laundering

money laundering

Recently a string operation exposed money laundering services provided by some Indian private banks. The employees and bank managers were caught on camera advising the disguised reporter on ways and means he can convert his illicit money into legal money.

1. Caught in the act

Some of the helpful advice given by bankers included:

  1. Open multiple accounts so that the amount remains below the reporting limits. Do not deposit over Rs 10 lakhs (Rs 1 million) in a single instance.
  2. Obtain a demand draft from a Cooperative Bank and deposit the draft with us. Cooperative Banks do not require an account hence it will be easy to obtain a draft. Since cash would not be directly deposited and private banks do not have to check the source of funds, the deposit will not raise any alerts.
  3. Route the cash money through another bank to avoid detection.
  4. The Income Tax act prohibits keeping cash in bank lockers. However, if you do not inform the bank staff, they can look the other way.
  5. Open an NRI account and slowly transferring the money offshore. We need a passport and visa for opening an NRI account. No pan card required.  Deposit Rs 25 lakhs per month. Better still start by opening a NRO account.

The bankers offered to visit the client’s residence to open an account and collect the money. One has to watch the video clippings to see the level of customer service provided by the bankers. No one can say they were not being helpful.

2. Standard response from senior management

As expected the senior management of the banks denied all knowledge, claimed they maintained highest ethical standards, suspended the branch managers and the staff, and commenced an internal investigation. But this is an open secret. Every business person in India knows that the banks will help them convert black money into white and transfer illegal money. If it was not so, how can a parallel black money economy exist in India for so long. Did the expose really shock anyone?

3. Lip service by regulators

Of course Reserve Bank of India has given detailed guidelines on Know Your Customer and submission of suspicious transaction reporting. There is only theoretical application of guidelines of Financial Action Task Force (FATF) on Anti Money Laundering (AML) standards and on Combating Financing of Terrorism (CFT). The Financial Intelligence Unit of India received just over 30,000 suspicious transaction reports in 2011-2012. It received 100,00,000 cash transaction reports. If you read these numbers in reference to the size of banking business in India, it would not be even .01% of the total yearly transactions.

In February 2012, the director of the Central Bureau of Investigation had said that Indians have $500 billion of illegal funds in foreign tax havens, more than any other country. Some reports estimate the amount over a trillion.

Hence, can we actually believe that regulators and bankers are serious about preventing money laundering in India? The annual report 2011-2012 of Financial Intelligence Unit doesn’t really mention any investigations done that would make the bankers uncomfortable. In India the detection and investigation capabilities of financial regulators is still in nascent stages.  Unlike US which has full-fledged organizations and systems to check money laundering.

Closing Thoughts

In the pursuit of growth numbers bankers are willing to compromise ethics and legal requirements. However, in Indian society because of the high level corruption, most businesses are doing the same. In such a scenario, it amounts to pot calling the kettle black. Unless we really get serious about removing corruption, as a society we can’t succeed. Some things required are – public to withdraw support from companies using unethical practices to succeed, regulators take organizations to task, and government prosecutes politicians and other individuals for dealing with illicit money. Till this happens only media will benefit by doing exposes to improve their ratings.

References:

  1. Cobra Post Expose
  2. Financial Intelligence Unit India
  3. Black Money Market in India

Barclays War on Culture Change

Barclays is again in the limelight due to a damaging report on the deviant culture existing in the Investment division. After LIBOR rate fixing scandal and quick departures of senior managers, trouble is again brewing in Barclays. The COO of Investment banking division, Andrew Tinney quit when it was discovered that he shredded the only copy of a report that clearly stated the bullying culture of the organization. Then the new CEO, Anthony Jenkins discovered when an internal whistle blower mentioned it to him. He sent out a message to staff on culture change. Here are some insights into the story.

1. The Damaging Report on Dysfunctional Culture

Daily Mail story states that the report prepared by Genesis Ventures - “paints a devastating picture of incompetence and arrogance at the bank, showing that executives:

  • Pursued a ‘revenue at all costs’ strategy.
  • Fostered a culture of fear and intimidation.
  • Were ‘actively hostile’ to the idea of compliance with banking rules.
  • Presided over a ‘broken culture’ where problems were ignored or buried.
  • Allowed the business to spin ‘out of control.”

The senior management intentionally understaffed support functions, was hostile to compliance and attacked those who spoke contrary to senior management views. A senior manager threw the risk management report publically saying – “this is a piece of s***” showing utter contempt and disregard for the same.

The summarization of the report states – ‘The senior team portray themselves as all-powerful and all-knowing… and people chose to disagree with them at their own peril. It is a mentality of superiority which, when combined with other deficiencies, stops the team from tackling their blind spots. When those deficiencies are in compliance, this results in serious issues that no one else has the power to address.

The bank’s culture has become completely deviant, and it will be a long road ahead for significant change to occur. The problem is that this issue is prevailing in other banks also. They depict the same culture and attitude. Unless we understand why it is occurring and senior managers take sincere steps, nothing positive will happen.

 2. The Psychological Explanation

Western banks are known for their arrogant and aggressive culture. Some view arrogance as a positive trait and humility as a negative trait, while the opposite is true. Stanley Silverman developed Workplace Arrogance Scale to measure arrogance level in the organizations. He stated the arrogant people demean others to prove superiority and competence. However, as per his results arrogant people showed lower intelligence and self-esteem in comparison to their peers. He identified four red flags to identify arrogant behaviour:

  • Does your boss put his/her personal agenda ahead of the organization’s agenda?
  • Does the boss discredit others’ ideas during meetings and often make them look bad?
  • Does your boss reject constructive feedback?
  • Does the boss exaggerate his/her superiority and make others feel inferior?

If you link back to the damaging report, the senior management at Barclays showed these traits in abundance. Even during the financial crises, the bankers didn’t feel apologetic and showed no humility. Now, being in such senior positions one cannot say they lack intelligence, however, questioning their self-esteem is definitely a valid path.

In another psychological study conducted by Angela Y. Lee, a professor of marketing at the Kellogg School of Management, it was determined that people with low self-esteem defend the brands more when their favourite brands are attacked. This explains why bankers refused to change and continued their behaviour when under attack during the financial crises.

3. The CEO Message for Culture Change

Deal Book reported that Anthony Jenkins, the CEO of Barclays sent a mail out to the staff with a clear message – “change or leave”. He categorically stated the values – Respect, Integrity, Service, Excellence and Stewardship – to be adopted by Barclays employees. He further added that those who do not change their behavior are free to leave. His words were – “My message to those people is simple: Barclays is not the place for you. The rules have changed. You won’t feel comfortable at Barclays and, to be frank, we won’t feel comfortable with you as colleagues.

He highlighted that in the last two decades financial institutions pursued profits and compromised integrity and reputation of the organization. He said there is no choice between values and profits. Employees must pursue profits while maintaining values. Evaluation of ethical behaviour will be incorporated in performance appraisal process.

That is a very strong message from the CEO of the organization to transform the culture of the organization. Two questions in everyone’s minds are – will they succeed and how long will it take.

Closing thoughts

Bill Gates had famously said – “The world won’t care about your self-esteem. The world will expect you to accomplish something BEFORE you feel good about yourself.” Maybe organizations should care about the self-esteem of their employees and their senior management team. Studies have shown that people with higher self-esteem show more ethical behaviour and are less likely to get involved in wrongful acts. The present trend of pursuing material gains at the expense of personal values destroys self-esteem in the long run. Bankers have shown extreme tendencies to flaunt expensive toys to feel good and build a superior image. In all probability, they are caught in a catch-22 situation at a psychological level. It might not be possible to change the culture without addressing the core issues faced by the staff.

References:

  1. Exposed: The regime of fear inside Barclays – and how the boss lied and shredded the evidence
  2. Identifying the arrogant boss
  3. Leave My Brand Alone – Kellogg School of Management
  4. New Barclays Chief Tells Staff to Accept Changes or Leave

 

 

Risk Management Lessons Learnt in 2012

For risk managers 2012 was an eventful year. The frequency of ethical breaches, regulatory failures, operational disasters and natural calamities ensured that risk managers have their hands full and are not going to run out of work in 2013. In effect, risk management function is at a strategic inflection point and is facing disruption risks. Globalization, rapidly changing technology, economic recession in Europe, political turmoil in Middle East, growth of emerging markets and global warming has changed the risk landscape. Throw out of the window the old stance of managing risks by implementing controls and focusing just on financial processes and operational risks. The 21st century demands risk managers to focus on strategic, cultural, leadership and human resource risks. This is a bold statement to make, so here are my reasons for making the same. Do you think I am on the right track?

1.      Banking Sector Culture Needs Overhauling

Though I have not done a tally of regulatory fines paid by banks during the year, the numbers are awesome. It the status quo remains the same, paying billion dollar fines will soon become fashionable. The way bankers are behaving, if culture does not change, they will start a competition on who pays the biggest fine and gets away with it. It is clear that bankers gave a lot of lip service of changing to the public after the financial crises. Nothing much changed and they remained complacent with their ability to escape any personal loss due to reckless behaviour. Even with fines, it is investor loss with hardly any personal responsibility. 2013 will determine whether bankers can do the right thing for the right reasons in the right way.

2.      No One is Too Big to Go to Jail

2012 showed that breaking the law isn’t an option for top guns. Big names, for instance, Rajat Gupta and Rebecca Brooks realized the arms of law are long enough to reach them. The psychology that it only is a crime if one gets caught needs to change. A connection even with the Prime Minister doesn’t insulate a person from being held legally accountable.

The downside of capitalism is that business ethics are put on a back burner in pursuit of profitability. 2013 will see the trend of businesses focusing on building ethical cultures.

3.  Senior Management Fails At A Higher Rate

Throughout the year, one heard senior managers being fired for poor performance, regulatory breaches, criminal acts or inability to keep their pants zipped. Tragic but true, that senior managers are failing to walk the talk and assume leadership is about playing power games. They ignore everything in pursuit of a bigger pay packet. It isn’t that leaders didn’t fail previously, but now they make headlines at global level.

Additionally, social media and increasing percentage of women in the workforce has made old management and leadership styles redundant. Flatter organization structures are replacinghierarchical styles. Collaboration is in focus rather than competition. Boomers are leading most organizations, and their style of leadership is passé. Hence, in 2013 we are going to witness higher leadership failures unless organizations start managing leadership risks.

 4. Regulators Take A Tougher Stance

Worldwide regulators have changed their stance. Be it Comptroller and Auditor General of India, Department of Justice of USA or Financial Services Authority of UK, regulators are beating the drums for better compliance. From asking the biggest names in banking to give explanations to holding government accountable for incorrect decisions, they are leaving nothing out of the ambit. They are leading the path for risk managers to follow. In 2013, we are going to see a spate of disclosures from regulators.

Closing Thoughts

Whether we see the banking failure reports, or other aspects of business, risk managers knew and understood the risks. However, they decided to play it safe and not bell the cat. Challenging and confronting business leaders at the expense of ruining ones career can be a tough decision. One avoids the decision, especially when, the lines of accountability state that final responsibility of managing risks lies with the business leaders. However, in the times ahead risk managers won’t have this luxury. They will have to stick their neck out to ensure organization stays legally compliant and manages risks optimally.  I don’t know whether this makes risk managers happy. In my view, in 2013 we should take it up as a challenge and change the dynamics of the risk management function.

Wish you and your loved ones a very Happy New Year.

Bharti Walmart India – Internal FCPA Investigation – Part II

The previous post raised more questions than gave answers. In light of the on-going investigation, it is difficult to predict results. However, I looked at the recently released FCPA Resource Guide to the U.S. Foreign Corrupt Practices Act by the Criminal Division of the U.S. Department of Justice and the Enforcement Division of the U.S. Securities and Exchange Commission. It sets some clear guidelines and mentions earlier cases with similar issues. It is a good read for Indian managers working in multinationals dealing with FCPA compliance requirements. I am sharing below some insights about the implications of the case.

1.      Liability of Indian Employees

As per reports, the CFO and the legal team were suspended during the course of the investigation. If the US Department of Justice decides to pursue a criminal case, these employees can be prosecuted.

Interestingly enough, the Indian managers consider their capability to bribe various government officials to get a job done as strength. One often hears them saying – “Oh, I have a contact; s/he will do the job for X amount of money. Don’t worry about the legal provisions, they can be circumvented.” Since one rarely hears any action being taken by regulators on the provisions of Prevention of Corruption Act of India, hardly anyone hesitates to take or accept a bribe.

However, Indian employees working in multinationals have to think twice about paying a bribe to get a job done. The FCPA guidelines are strict. It states – “The FCPA’s anti-bribery provisions can apply to conduct both inside and outside the United States. Issuers and domestic concerns—as well as their officers, directors, employees, agents, or stockholders—may be prosecuted for using the U.S. mails or any means or instrumentality of interstate commerce in furtherance of a corrupt payment to a foreign official.” Hence, even sending mails to US boss or colleague that involves a discussion of a bribe payment can make an Indian employee liable. Considering the provisions, the best policy for Indian employees is to keep their hands clean and follow the legal process diligently.

Another aspect to note is that a bribe does not need to be paid to hold an employee liable. The guidance note says – “Also, as long as the offer, promise, authorization, or payment is made corruptly, the actor need not know the identity of the recipient; the attempt is sufficient. Thus, an executive who authorizes others to pay “whoever you need to” in a foreign government to obtain a contract has violated the FCPA—even if no bribe is ultimately offered or paid.” Hence, Indian management and employees both can be prosecuted on this basis.

2.      Challenges for Licenses

With the opening of the retail sector, multinationals need to obtain various licenses to operate in India. The challenge is getting the licenses according to their business strategy and plan.

For instance, IKEA recently obtained from Foreign Investment Promotion Board (FIPB) to invest euros 1.5 billion to open 25 stores in India. However, IKEA was granted permission to open single brand stores for furniture only. It was denied permission to sell textiles, office supplies, food and drinks.

Now the question is, under these circumstances what options will the foreign investor consider? Will they agree to sell products according to permission? The permissions maybe denied for the most profitable lines of products. It may not make sense to sell products with low margins. Hence, they will have the difficult choice of either not entering the Indian market or attempt to influence the government agencies to grant permissions for selling other products. If the second option is chosen, there is a high probability of bribes being paid. More so, since Indian government officials know what will hurt the business venture of the foreign company, they might use denial tactics to coerce the organization into paying bribes. Hence, it is a vicious circle.

A LinkedIn member gave a useful suggestion to curb bribes in the licensing process. Rangarajan Gopalan, Investigator US Department of Homeland Securities in New Delhi,  suggested a single window concept for obtaining licenses in retail industry. If government implements the suggestion, the retail companies will not have to run around 32 different agencies to get licenses.

3.      Partner Liabilities  

In the event of the holding-subsidiary relationship or joint venture partnership, the Indian company can be charged jointly and/or separately.

The guidance note illustrated the implications with a previous case. For instance, “a four-company joint venture used two agents—a British lawyer and a Japanese trading company—to bribe Nigerian government officials in order to win a series of liquefied natural gas construction projects. Together, the four multi-national corporations and the Japanese trading company paid a combined $1.7 billion in civil and criminal sanctions for their decade-long bribery scheme. In addition, the subsidiary of one of the companies pleaded guilty and a number of individuals, including the British lawyer and the former CEO of one of the companies’ subsidiaries, received significant prison terms.”

Hence, if the US company is ignorant of the bribes being paid by Indian employees to conduct business, the Indian employees can face criminal charges and the Indian organization may have to pay hefty fines.

Closing Thoughts

The Indian organizations need to assess their FCPA compliance level and not take the issue lightly. The repercussions of ignoring the issue are huge. The legal and reputation risks can put the company to a great disadvantage. Moreover, the employees must follow the legal process rather than find ways to circumvent it.

 References: 

  1. FCPA Resource Guide to the U.S. Foreign Corrupt Practices Act by the Criminal Division of the U.S. Department of Justice and the Enforcement Division of the U.S. Securities and Exchange Commission.
  2. FIPB clears IKEA retail store plan

Bharti Walmart India – Internal FCPA Investigation – Part I

Walmart after the Mexico US Foreign Corrupt Practices Act investigation identified India operations as a high risk. It commenced an internal investigation with the help of KPMG India and law firm Greenberg Traurig. Recently CFO and five officers of legal team were suspended. The legal team’s job entailed procuring licenses required for stores and other real estate approvals, taxation etc. Bharti Walmart has opened 18 stores till date. Hence, the suspicion is that these officers paid bribes to get the licenses.

According to the Economic Times article, multiple government permissions are required from the government. The Retail Association of India lists 51 different approvals from 32 different agencies. Seeing the corruption index of India and the way government departments’ function, I would be very surprised if an organization manages to obtain all the relevant licenses without any grease payments. Hence, the question is how will the organizations manage to function without paying bribes?

1.      Dubious Dealings

Considering the huge operations of Bharti group, I would be very surprised if the bribes were paid without senior management approval. Most of the liaisons work has senior managers’ tacit or explicit approval. Therefore, is it right to suspend some after obtaining licenses. What happens in such a case to the license? Will the license be revoked, cancelled, or returned? If not, what is stopping the organizations from first taking the licenses by paying bribes and then doing a clean-up exercise to show their commitment to ethics?

2.      Joint Venture Liabilities

The second issue that crops up is the working of the joint venture in such circumstances.  Let us assume the investigation reveals bribes were paid. In such a situation, will Bharti group be expected to pay back the bribe money? Secondly, if the US authorities under a civil case fine Walmart for FCPA contravention, will Bharti be expected to pay the fine. Seeing the trend the fine could be huge and would wipe out profitability of the company. Moreover, US Department of Justice can pursue criminal liabilities. Then will the Indian officers be implicated for the same.

3.      Foreign Direct Investment (FDI) in Retail Industry

The government has recently allowed FDI in retail industry. The challenge is that in India, most of the retail operations operate by paying bribes at different levels. Hence, a foreign investor will not get a level playing field as the anti-corruption laws of their country bind them. The situation is serious. For instance, the next stage after obtaining licenses would require importing goods.  The FCPA strictly prohibits paying bribes to custom officers whereas in India this is a common business practice. Can an organization wait for months to get its stock cleared by the custom officers? Now the foreign investors will analyse the reward versus risk scenario of their business plans for investing in retail industry in India.

Closing Thoughts

The case opens up interesting aspects of risks of doing business in India. Corruption poses serious obstacles in doing fair business dealings. The FCPA and laws of various countries strictly prohibit paying bribes to foreign officials. The US government has followed some stringent measures against companies contravening the laws. Under such circumstances will the joint ventures between foreign investors and Indian counterparts work?  India cannot change overnight, so what is the solution? Share your thoughts with me on this.

References:

Bharti Walmart suspends CFO, legal team due to FCPA bribery probe

Performance Appraisal for Risk Management Functions

Think of climbing into an aircraft that doesn’t have an aircraft control system and the Air Traffic Control rooms don’t function properly. Would you be willing to go for a free ride in the plane?

If I say risk management functions play the role of Air Traffic Control rooms and provide the relevant feedback to the business, you would mostly agree. But what are the systems in place to see whether the risk management functions are fulfilling the role of Air Traffic Control rooms properly. If Air Traffic Control rooms fail, the planes crash and the same happens in business. Isn’t then performance appraisal of risk management functions critical?

Generally, I have seen risk management functions do an appraisal within the team and sometimes take feedback from senior management. This is despite the fact that in most surveys conducted, the business teams respond that they face challenges with risk management functions and highlight quite a few shortcomings. As the year is ending, the functions would be busy preparing annual budgets and strategies. This would be the right time to obtain feedback and do a proper evaluation.

Let us take an example of the fraud department and study the process of performance appraisal for the department.

1.     Senior Management

Get uncensored honest feedback from the senior management. Not the form filling one, where meets expectations means haven’t committed a big blunder till date. Check whether senior managers are ticking the appropriate boxes to keep the risk management function out of their hair for another year or is it genuine support for improvement. Ask the probing and difficult questions to the audit committee and CXO level:

a)     Does the risk management function help you to perform better?

b)     Did the risk management function add value to the business during the year?

c)      Where you worried during the year that some unpleasant risks will appear that have not been identified before?

d)     Does the risk management function makes you feel confident that the business is running on course?

That will give out a message to senior managers that the function is geared to take up a bigger role in business and partner with them for success.

2.     Business Teams

Though the risk management functions issue reports relating to operation risks, the feedback of business teams is restricted to obtaining their replies to the observations made in the reports. Risk management functions rarely go back to business teams for an evaluation. One way is to conduct a yearly survey to obtain business teams assessment on performance. The other way is to incorporate a value scorecard system. This ensures that after every assignment,  the business teams’ feedback is obtained in the value scorecard. This enables the function to take corrective measures promptly to provide better service in the next assignment. Some of the questions to ask are:

a)     Did the risk management assignment offer value to your business operations?

b)     Did the risk management teams partner with you to solve your concerns? For instance, in a fraud investigation, did the report help them identify the suspect, and give a solution to prevent future frauds?

c)      Did the risk management team give you a practical solution or recommendation to mitigate the risks?

d)     Do you get prompt replies to your request for help or advice?

Build a value scorecard with 10-15 questions. A periodic assimilation of the responses will highlight the strengths and weakness in performance of the risk management functions.

3.     Other Risk Management Functions

If one wishes to breakdown the silo approach to risk management, then each risk management team should be evaluating and giving feedback to the other teams. For instance, a fraud department should get feedback from compliance and business ethics function.

This is the most beneficial of feedback, because other risk management teams actually understand the nature of work, issues and challenges. Obtaining feedback opens doors for sharing best practices and aligning the work. With numerous functions managing business risks, there are some un-addressed risks as each department assumes that the other is fulfilling the responsibility. Hence, some relevant questions need to be asked. Here are a few examples:

a)     Do you believe we are complimenting your work or are working at cross purposes?

b)     Do you get information on our work to tie up and give a joint strategy to address related risks?

c)      Do our teams collaborate well together on joint projects?

d)     Do we share our methodologies, knowledge and best practices to benefit each other?

Working in isolation isn’t going to help the function, other teams or the business. Hence, taking feedback from other functions is really important.

4.     Risk Management Team

Doing a fair and honest evaluation of team performance is of paramount importance. If possible, implement a 360 degree performance evaluation system. A top down evaluation system will not work for risk management function, as most of the interaction with business teams is done by middle and junior managers. They are aware of business team attitude towards risk management. Even the office rumour mill gives some useful information of acceptance and popularity of the risk management function. Some of the questions the team should be asking are:

a)     Are we viewed as business partners by operation teams and do they think we add value to their business?

b)     Are we doing the best possible work to mitigate the risks?

c)      Are we using standard tools, methodologies and knowledge to give the best possible service to business teams?

d)     Do we have a good talent pool that understands the business and associated risks?

Unless the risk management function does an honest self-evaluation, it is unlikely to find the gaps and improve. Hence, a good deal of time should be spent on it.

Closing thoughts

A good performance appraisal is possible after assimilating the information from all four sources and asking a lot of probing questions. Rather than shy away and get defensive it is best to take the feedback in positive light. Without feedback the function is directionless. Here is a small video pf HCL on performance appraisal. It brings the point home.

Ethical Decisions – Why Bankers Fail At It?

Last week I read the US Senate’s Permanent Subcommittee of Investigations report on “U.S. Vulnerabilities to Money Laundering, Drugs, and Terrorist Financing: HSBC Case History“. Since I am ex-HSBC I felt bad that an organization’s senior management took decisions for growth and profitability at the expense of world security.

I was personally horrified on the thought process of Christoper Lok, former Global Head of Bank Notes  relating to relationships with Al Rajhi Bank, Islami Bank Bangladesh Ltd and Social Islami Bank Ltd. The Compliance department in most of the cases had identified direct or indirect terrorist links with these banks. However, the business teams approached Mr. Lok to maintain relationships and sign off on the Know Your Customer documents. The logic given was that approximately $100,000/- per annum could be earned from these customers. Hence, approval was granted to pursue and maintain the relationships and most of the objections raised by Compliance department were over-ridden.

Bank Notes division had 800 customers. So if I assume that approximately  $100,000/- was earned from each customer, the total revenue would be $80,000,000/-. Though now the bank notes division is closed, but does a bank of HSBC level, need to pursue high-risk business for such immaterial amounts in respect to its total earnings.

With the controls so weak on transaction checks, even a single transaction of these three banks processed by HSBC, could result in terrorist funding. One doesn’t know, but there is a always a possibility that some funds may have been utilized for a terrorist activity somewhere in the world. A few people may have lost their lives. How does a person justify that his/her decision may result in death of some unknown person?

In the report it is mentioned that decisions were taken on Reward versus Risk parameter. Risk was generally considered about reputation damage and legal fines. As before none of the bankers were personally held liable, the maximum negative repercussion is job loss. The legal fines are paid by investor money. Hence, job loss is hardly a penalty, when after a time, the person joins another bank or financial services company. The rationalization given by bankers to self, I assume, is that the million dollar salary and bonus is worth the risk of death of someone else. Ruining life and happiness of some people, causing fear and terror in their life, does not appear in the Reward-Risk analysis. Can one be successful and happy when standing on the graves of innocent people?

The world is asking why do bankers take these decisions? Even after the financial crises, which caused so much suffering and pain to the general public due to job losses, retirement savings loss, and home losses, why do bankers persist in taking these decisions? Why don’t they change and take socially responsible decisions?

Though I am not a psychologist, my guess is two main feelings - cynicism and fear – makes them behave so. With +15 years of working in the financial industry, I know how easy it is to lose one’s idealism. With the whole society running after money, bankers see the worst behavior. They are surrounded with unknown people, friends, relatives, customers, suppliers etc. who all compromise a little bit of their ethics to get the deal, the loan, and better terms and conditions. When a person is dealing with large amount of money, the person witnesses greed of others every minute. It just seeps through the psychology, and greed becomes the paramount emotion.

Viktor Emil Frankl, world renowned psychologist and survivor of the Nazi camp gave an interesting metaphor on idealism and ethics. He mentioned that when we fly a plane from A to B destination, we do not follow a straight line due to the cross wind. So when we fly East to West, we fly at an angle towards North. The wind pushes the plane down and we reach the Western point of our destination.

Similarly in life, if we take a practical decision to operate on a straight line, the negative influences push us down to make unethical decisions. When we get cynical, and say “the society is doing negative behavior so why not me” ,we have already compromised on following the straight line. Our behavior falls below the straight line. However, if we manage to keep our idealism, we aim for higher ethical behavior. With all the negative influences in life, we then just about manage to live an ethical life. Hence, idealism actually motivates us to live an ethical life.

The next point is fear. Why do I think bankers are fearful and that is why they take these decisions? They are living a life which amounts to nothing. It is just money, more money and more money. Money buys comfort and luxury, it cannot buy self-respect and self-esteem.

Human consciousness is such that sometimes consciously we can fool ourselves. We think we know ourselves, but we at a conscious level don’t know ourselves, it is others who understand our behavior better. Hence, feedback from people is required for us to monitor our behavior. However, the more money and power one has, the lessor is the possibility of receiving honest negative feedback. Therefore, a senior manager’s moral compass at a conscious level can become distorted and he/she will remain completely unaware of the same.

At an unconscious level, our brain processes more information and keeps analyzing our actions, behavior and thoughts. We cannot fool ourselves at an unconscious level. The regulator inside us monitors our self-esteem. The right decisions and deeds deep down add to our self-esteem and self-respect. While our negative thoughts and actions erode the same. We compensate the lower self-esteem at an unconscious level, with a bigger ego at a conscious level.

The dilemma of maintaining ego to protect a low esteem causes irrational fear of loss. If internally we feel hollow, then fear of losing the external trappings is higher. Reason is simple, because the trappings is all the person has got. The pressure to maintain the facade is so huge, that it scares the shit out of people if they think they are going to lose it. Hence, fear drives the person to get more and more of the same trappings that they are familiar with and allows them to breathe in their comfort zone. Sometimes, it is sheer terror of losing it all that makes them sink deeper and deeper in the mud instead of breaking the mold for a better life. This reduces the possibility of bringing about a change in behavior. They can’t let go.

Closing Thoughts

Compliance officers gave excuses that their department was under-staffed or business teams over-rode their decisions. These cannot be considered justifications for failing to perform core functions especially when the transactions relate to drug money or terrorist funding. Both internal officers or external regulators, need to be far more vigilant in ensuring that the world is safe place to live.

For bankers it is a wake up call. They need to decide for themselves, whether they want to live in fear of losing everything, maybe going to prison, or adopt a more ethical life for their own happiness and safety. Going downhill is always easier than climbing uphill.

SEBI Revises Consent Process

While Rajat Gupta, ex-board member of Goldman Sachs is facing the trial by fire on insider trading charges in US, Stock Exchange Board of India (SEBI) has tightened the screws on the consent process for stock market manipulations and offences.

SEBI last week revised the earlier rules passed in March 2007. Some of the critical features of the revised consent process are:

1. Face the Music

Certain defaults including insider trading, front running, failure to make an open offer, redress investor grievances and respond to the summons issued by SEBI are excluded from the consent process. The defaults falling in the category of fraudulent and unfair trade practices, which in the opinion of SEBI are very serious and/or have caused substantial losses to the investors, shall also not be consented.”

The details are below:-

SEBI shall not settle the defaults listed below:
i. Insider trading i.e. violation of Regulation 3 and 4 of the SEBI (Prohibition of Insider Trading)Regulations, 1992;

ii. Serious fraudulent and unfair trade practices which, in the opinion of the Board, cause substantial losses to investors and/or affects their rights, especially retail investors and small shareholders or have or may have market wide impact, except those defaults where the entity makes good the losses due to the investors;

iii. Failure to make the open offer (except where the entity agrees to make the open offer or if in the opinion of the Board, the open offer is not beneficial to the shareholders and / or the case is referred for adjudication);

iv. Front-running; for the purpose of this circular, front running means usage of non public information to directly or indirectly, buy or sell securities or enter into options or futures contracts, in advance of a substantial order, on an impending transaction, in the same or related securities or futures or options
contracts, in anticipation that when the information becomes public; the price of such securities or contracts may change;

v. Defaults relating to manipulation of net asset value or other mutual funds defaults where the actions of the asset management company (AMC)/ mutual fund (MF)/sponsor, result in substantial losses to the unit holders, except cases where the entity has made good the losses of the unit holders to the satisfaction of the Board;

vi. Failure to redress investor grievances(except cases where the issue involved is only of delayed redressal);

vii. Failure to make such disclosures under the ICDR and Debt Securities Regulations, which in the opinion of the Board, materially affect the right of the investors Non-compliance of summons issued by SEBI;

ix. Non compliance of an order passed by the Adjudicating Officer (AO), Designated Member (DM) or Whole Time Member (WTM);

x. Any other default by an applicant who continues to be non-compliant with any order passed by the (AO) or (DM) or (WTM).”

This means that where SEBI considers breach of law or listing guidelines, the companies, investment managers, brokers etc. won’t be able to pay a fine and get away with it. Previously, on such charges, SEBI allowed them to pay the fine while not admitting guilt and sometimes by voluntarily agreeing to debar from the  from stock markets. Now without being allowed to go through the consent process, the organizations and persons alleged to have committed the above-mentioned acts will have to go through a legal process for criminal offences except in some exceptional cases. SEBI has allowed itself some room for maneuverability for some cases. In regular cases, now an organization can go through the consent process only for small technical breaches.

2. One Time Lucky

No consent application shall be considered, if any violation is committed within a period of two years from the date of any consent order. However, if the applicant has already obtained more than two consent orders, no consent application shall be considered for a period of three years from the date of the last order.”

Hence, this clause allows leeway once only in a couple of years. If an organization has already gone through a consent process, it is not going to get away easily without some criminal charges the next time round. The practice of organizations to claim a mistake has been made every year whenever they get caught will have to stop.

Closing Thoughts

The rules are good. SEBI is finally gearing itself to govern and regulate the stock markets properly. This move in the long-run will build investor confidence and dissuade asset managers, brokers and organizations from indulging in malpractices. Reliance Industries has an ongoing case for insider trading, along with a couple of other banks for front running and stock market manipulations. Reliance has appealed to the Bombay Courts to be allowed to go through the consent order process available before as it’s case is  from 2007.

The method SEBI chooses to deal with the older cases, will decide the fate of many organizations. It appears the organizations are worried, and that for regulators is a good strategy. The last high profile case of consent was of Anil Ambani group in which the group paid a Rs 50 crore (USD 8.93 million ) fine. Hence, in all likelihood the organizations with pending cases will either have to pay high fees or face criminal charges.

References:

  1. Streamlining of Consent Process
  2. Modified Consent Process Circular
  3. Reliance Industries moves Bombay High Court on new consent order rules

A Philosophical Discussion on Murder of Whistle Blowers

This Sunday, Anna Hazare is fasting in Delhi in support of Whistle Blower Protection Act. Indian laws don’t provide for whistle-blower protection and the damage is evident. Over the years, numerous whistle-blowers have lost their life. A few cases are covered up as personal dispute due to the high level corruption in the system.

Corruption benefits the majority, so does it make it acceptable? Legally, public will say – of course not. But even Hazare’s big protests in 2011 have lost public support. The government used delay tactics and maligned the name of key leaders of his team. Most state leaders didn’t want a Lokayukta in their states. There is no political will among the politicians, bureaucrats and business to pass a strong bill against corruption.

Then it isn’t surprising, that even on  witnessing the death of whistle blowers, public doesn’t protest about it. On the other hand, most keep quiet, lest they become the target. In such circumstances, majority of the people have given implicit consent to murder for their own self-interest. Of course readers would be outraged by this suggestion and claim they were no way involved in the murder. They didn’t give implicit consent!

Let us discuss this from a philosophical lens. Micheal Sandel, the Havard professor discusses this point in his video lectures : Justice – The Moral Side of Murder and The Case of Cannibalism. In the episode “Moral Side of Murder” he discusses a hypothetical case:

“Suppose you were driving a trolley on a rail track and its breaks failed. Five workers are ahead on the track, if you continue to drive straight, all five will die. On the other hand, in a diverging track, there is just one worker.  If you change track, that one worker will die but the other five will live. What is the right thing to do?”

Most students responded that they will swerve to the diverging track and chose to kill one to save five. At a psychological level, they have given moral justification of murder. Then Mr. Sandel gives another example :

“Suppose you are standing on a bridge with the track below, and you see this trolley hurtling without breaks. There are five workers on the track. There is a fat man standing next to you. If you push the fat man over the bridge, on the track, the lives of five workers would be saved. Would you do it?”

Majority of the students said – “No, they wouldn’t do it”. The reason is that it would involve explicitly murdering a person. Can we conclude from these examples, that human race is fine with implicit consent to murder however have qualms on explicitly murdering?

Some whistle blowers due to the psychological torture have committed suicide. That is an indirect attempt to murder. The rich and middle class gain from corruption, hence they give an implicit consent to murder of whistle-blowers. Does this statement hold true, or would you debate it?

Mr. Sandel discusses this in the next part of the lecture on cannibalism. He discusses The Queen v. Dudley and Stephens case, and the facts are as follows:

“At the trial of an indictment for murder it appeared, upon a special verdict, that the prisoners D. and S., seamen, and the deceased, a boy between seventeen and eighteen, were cast away in a storm on the high seas, and compelled to put into an open boat; that the boat was drifting on the ocean, and was probably more than 1000 miles from land; that on the eighteenth day, when they had been seven days without food and five without water, D. proposed to S. that lots should be cast who should be put to death to save the rest, and that they afterwards thought it would be better to kill the boy that their lives should be saved; that on the twentieth day D., with the assent of S., killed the boy, and both D. and S. fed on his flesh for four days; that at the time of the act there was no sail in sight nor any reasonable prospect of relief; that under these circumstances there appeared to the prisoners every probability that unless they then or very soon fed upon the boy, or one of themselves, they would die of starvation.”

To protect oneself or the majority, is murdering someone else justified? The students raised interesting aspects :

1) Some said if selection was done by lottery, then maybe it is illegal but more acceptable. Reason given was they would consider it that all participants on the boat knew the risks of losing.

2) A few students stated that if the boy would have volunteered to die for the benefit of others, it would be acceptable. The boy was an orphan and all others had family responsibilities.

In case of whistle-blower murders, the person dies without have consented to die or being made aware of the decision of the most. The majority votes behind his/her back for murder to safeguard themselves. Does that make majority behavior acceptable?

Watch the hour-long video, and share your thoughts.

In whistle blowing, most feel threatened about the repercussions from people in power and say that they have family responsibilities and cannot expose themselves to the risk. Hence, it is better to go against the whistle-blower attempting to do the right thing, than the person who is doing the wrong thing. Do the same psychological reasons as given in the above mentioned case apply when society goes against whistle blowers?

References:

Harvard University – Justice with Michael Sandel

Comments on Basel Committee’s consultative paper – The Internal Audit Function in Banks

The Basel Committee on Banking Supervision issued a consultative paper on the internal audit functions in banks comprising of 20 principles. This is a revision of the 2001 document and aims to promote a strong internal audit function and supervisory guidance of the function in banks. This is definitely a step in the right direction, however it still fails to address some of the critical issues apparent during the financial crises. Below are some of my observations that may help the function to become stronger and more effective. I am being a devils advocate out here and invite you to debate with me on these aspects.

1.  Independence and objectivity of internal auditors 

Principle 2 of the paper covers independence and objectivity of internal auditors. Point 15 mentioned below discusses the remuneration of internal auditors.

The independence and objectivity of the internal audit function may be undermined if the staff’s remuneration is linked to the financial performance of the business line for which they exercise internal audit responsibilities or to the financial performance of the bank as a whole.

My contention is that internal auditors within the organization can never be fully independent as their job, salary and bonuses are decided by the CEO/CXO. However, internal auditors/ risk managers face the dilemma of getting appraised at year-end for being good critics of the decisions taken and work done by CXOs/CEO. Hence, there is high possibility of being unfairly appraised on issuing strong reports. Senior managers may turn vindictive. This impacts independence as job, salary and bonus is dependent on senior management feedback.

The second aspect is about how internal auditors/ risk managers should be given bonus. Should they be given stock options like other employees? The committee paper “Principles of enhancing Corporate Governancestates -

Banks should take other steps to better align compensation with prudent risk taking. One characteristic of effective compensation outcomes is that they are symmetric with risk outcomes, particularly at the bank or business line level. That is, the size of the bank’s variable compensation pool should vary in response to both positive and negative performance. Variable compensation should be diminished or eliminated when a bank or business line incurs substantial losses.

Compensation should be sensitive to risk outcomes over a multi-year horizon. This is typically achieved through arrangements that defer compensation until risk outcomes have been realised, and may include so-called “malus” or “clawback” provisions whereby compensation is reduced or reversed if employees generate exposures that cause the bank to perform poorly in subsequent years or if the employee has failed to comply with internal policies or legal requirements.”

Now my question is, if it is later discovered that internal audit function failed to identify some control lapses and risks that resulted in huge financial losses to the bank, should their bonus/stock options be reduced subsequently? My view is yes, if they are receiving stock options and failed, then they should be withdrawn. However, if possible their compensation should not have a high variable component.

Lastly, rotation of internal auditors, a point that I consider relevant for maintaining independence is not covered in the paper. Depending on the size of the bank, internal audit function key staff  should be rotated to other subsidiary organizations or different functions every 3 to 5 years. Here the logic is same as applied to external auditors, with deepening business relationships objectivity may be compromised.

2. Regulatory Compliance for Capital Adequacy and Liquidity

Principle 7 mandates that  “internal audit function should ensure adequate coverage of regulatory matters within the audit plan.” One of the critical points covered relates to capital adequacy and liquidity assessment. The scope of audit should check compliance to regulatory framework and assess the adequacy of capital resources in relation to bank risk exposures and minimum ratios.

From a banking perspective I believe this is the crux of ensuring applicability of going concern concept for banks. As seen from the financial crises, the banks that failed basically had insufficient liquidity.

My argument here is about what happens when internal audit function does mention the problems in the report. Let me take the case of RBS failure. RBS faced liquidity crunch as the CEO had taken a strategic decision towards “capital efficiency” due to which it heavily relied on wholesale funding. As per the report   “the main weakness was the firm’s use of a 96% confidence interval in its assessment of how much capital it should hold, rather than the ‘standard’ 99.9%.” Secondly, the Supervision team was “concerned that the firm was underestimating the amount of capital that should be held.” The internal audit report also highlighted a few weaknesses relating to capital adequacy. A long term plan was developed to improve capital adequacy, however no change in capital efficiency strategy was envisaged.

Now my question is, in this scenario where internal audit function highlights key gaps and the same are ignored, what should be done? The FSA report on RBS failure states that no legal action can be taken as -

There is neither in the relevant law nor FSA rules a concept of ‘strict liability’: the fact that a bank failed does not make its management or Board automatically liable to sanctions. A successful case needs clear evidence of actions by particular people that were incompetent, dishonest or demonstrated a lack of integrity.

Errors of commercial judgement are not in themselves sanctionable unless either the processes and controls which governed how these judgments were reached were clearly deficient, or the judgements were clearly outside the bounds of what might be considered reasonable. The reasonableness of judgments, moreover, has to be assessed within the context of the information available at the time, and not with the benefit of hindsight.

According to the report, if senior executives ignore the internal audit reports and thus the firm suffers huge losses and goes bankrupt, they are not really legally liable. In my view, this is a flawed approach and encourages high risk taking since there is no downside to bad decisions.

My suggestion might raise a few eyebrows, nonetheless I think it is required to avert further financial crises. A few penal clauses should be incorporated in the guideline that ensures high risks/ control gaps are addressed by senior management. If senior management/board chose to ignore high risks they can be penalized by removal and/or not getting a similar position in any other bank.

3. Review of Internal Audit Function by Board

Principle 9 mentions responsibilities of board of directors and senior management in respect to internal audit function. Para 43 states that -

At least once a year, the board of directors should review the effectiveness and efficiency of the internal control framework based, in part, on information provided by the internal audit function.

My contention is that an annual review is too little. Keeping in view the dynamic banking environment and global impact review of internal control framework for banks should be done quarterly. If not, at least it should be done half yearly.

Additionally, para 72 states that -

Supervisory authorities should receive periodically (e.g., on an annual basis), or upon request, the main internal audit findings and recommendations as well as the corrective measures taken or to be taken in response to the weaknesses identified, in the same way the audit committee is informed.”

My view is the same here, it would be best to review the observations and weaknesses quarterly. An annual review would be historic and no corrective action would be possible.

4. Impact on bank’s Risk Profile

Principle 19 states that “supervisory authority should consider the impact of its assessment of the internal audit function on its assessment of the bank’s risk profile and on its own supervisory work.” In para 92 it further adds -

Where remedial actions cannot be agreed upon or where the bank faces ongoing delays in remediating the identified weaknesses, the supervisory authority should consider the impact of this on the bank’s risk profile.

A good example of this case is the CitiBank Rs 400 crore fraud (USD 76 million) conducted by employee (now ex) Shivraj Puri. The fraud case was filed with Gurgaon police in 2010. An internal report of Citi Security and Investigative Serivces (CSIS) was submitted five months earlier before the date of police case filing. Moreover, unusual activity in Shivraj Puri and his wife’s account was detected in its initial stages in 2008 by fraud risk management team. The media report states that senior officials were aware of it, were involved in discussions, however did not take any action.

My argument here is the same as given in point 2. If there is failure to act on high-level risks, specially fraud risks, senior management/board can be treated as accomplice to the fraud. Hence, the guideline should include a few penal clauses on failure to respond timely  on identified risks and control gaps.

Closing thoughts

The framework fortunately does not subscribe to the COSO definition of internal controls and covers strategic risks. It also provides detailed guidelines on a number of aspects, including outsourcing of the function and managing the function in subsidiaries.

However, my view is that the guideline should be more stringent and include a few penal clauses. This might raise questions, as the guideline cannot replace the laws of the country. I understand that, so even a recommendatory guideline would be helpful. The logic behind this suggestion is that financial crises occurred due to bad decisions and high risk taking. It is unlikely that internal auditors/ risk managers of the banks were entirely clueless about the high risks. In all probability management chose to ignore those warnings hence the crash. Therefore, to avoid a similar disaster some measures need to be incorporated to ensure that management/board cannot override high impact risks that exceed the risk appetite/tolerance of the bank without being personally laible and accountable.

References:

  1. Citibank failed to act on Puri scam warning signals, says probe report - Economic Times
  2. The internal audit function in banks – consultative document – Basel Committee
  3. FSA RBS Failure Report
  4. Principles of enhancing corporate governance – Basel Committee