Enterprise Compliance Risk Management. Ramakrishna Saloni

expectations. The structured regulations for financial services have started evolving from the 1980s onward. The explicit callout of compliance with a formal structure is of a more recent origin, essentially a twenty-first-century phenomenon. This is because compliance is a post-regulation process and hence lags it.

      The period from 1980 until now has seen more legislation and regulations affecting financial services industry than all other times put together. This directly correlates to the growth in complexity of the industry as well as breaches of expected fair business practices. A consequence, unintended of course, is the fact that compliance, once considered a dusty corner table function – dry, soporific, and uninspiring – is now animatedly debated among not just financial industry and regulators but also political and media circles as well. The effect is that both the industry and its regulators have to assimilate and adapt to the rapid changes and intense scrutiny.

      As a representative sample of the evolution I have taken two sample countries, USA and UK, as they have been frontrunners of newer and deeper regulatory frameworks, which were largely followed with regional modifications by other geographies. I have focused on BIS norms at a global level as indicative of the history of growth of active regulation of the banking industry. These frameworks are shaping the formal compliance structures and expectations. I have, for completeness, added one sample each of the regional and industry bodies to illustrate the point that there are others that are joining the formal role holders in shaping the narrative of the compliance landscape globally.

      United States of America

      Tracing the history of recessions in the United States, their root causes, and the resultant regulations is a fascinating journey and provides some interesting insights. There have been recessions across time, like the recession of 1818 to 1819 that had claimed the Second Bank of the United States as its casualty, though how much of it was due to banking crisis and how much due to disagreement between the then-President of the United States and the head of the Second Bank is a historical debate. However, since the focus here is to understand the historical perspectives with respect to the growth of compliance, I am picking a few that had a direct or indirect impact on the industry's compliance culture and processes.

      The first one on that list is the Panic of 1907 as it was the genesis of the Federal Reserve, one of the most important institutions that influence both regulation and deregulation of financial services. During the 1907 financial crisis the New York Stock Exchange fell by almost 50 percent of its previous-year peak with runs on banks and trust companies. This crisis strongly brought home the need for a central banking authority to ensure a healthy banking system. “The Federal Reserve Act was signed as a law by President Woodrow Wilson on December 23, 1913,”5 and the rest, as they say, is history.

      The years 1929 to 1935 is the next period I chose as part of tracing the lineage of financial services regulations, as it had a significant regulatory impact for the United States with a lag for the rest of the globe. “In October 1929, the stock market crashed and the US fell into the worst depression in its history. From 1930 to 1933, 10,000 banks failed.”6 As an aftermath, significant changes in the regulatory landscape came about. The Banking Act of 1933, better known as the Glass Steagall Act, the establishment of the Federal Deposit Insurance Corporation (FDIC), the 1935 Banking Act, and the creation of the Federal Open Market Committee (FOMC) were all of this period.

      During the same period, two significant acts to regulate the markets were passed. The first, the Securities Act of 1933, often referred to as the “Truth in Securities act,” had two basic objectives:

      1. Require that investors receive financial and other significant information concerning securities being offered for public sale.

      2. Prohibit deceit, misrepresentations, and other fraud in the sale of securities.7

      The second was the Securities Exchange Act, which was enacted on June 6,1934. It established the Securities and Exchange Commission (SEC) that is responsible for enforcement of the act. “The act empowers the SEC with broad authority over all aspects of the securities industry. This includes the power to register, regulate, and oversee brokerage firms, transfer agents, and clearing agencies as well as the nation's securities self-regulatory organizations (SROs).”8 These regulations and the authorities tasked to ensure the compliance of those regulations played and continue to play a very important role in setting and shaping compliance expectations not just of the United States but the rest of the world as well.

      While there have been regulations in the interim like the Foreign Corrupt Practices Act in 1977 and FIRREA (Financial Institutions Reform, Recovery and Enforcement Act) in 1989, the next critical milestones were from 1998 onward. This was the period where there was a huge demand for deregulation by the industry. The argument was that efficiency increases with fewer and simpler regulations and that it should be left for the markets to decide on organizational structures and their effectiveness. The deregulation of interest rates and the growth of globalization were among the outcomes of this. The biggest event that requires mention is the Gramm-Leach-Bliley Act of 1999, which was also called the Financial Services Modernization Act. It repealed parts of the Glass-Steagall Act of 1933, removing the barriers of consolidation of commercial and investment banks, securities firms, and insurance companies. The creation of “too big to fail” financial conglomerates and holding groups that threaten the safety and soundness of the financial environment is the biggest criticism against this act.

      The September 11 attacks of 2001, which led to the Patriot Act, and the Enron fiasco of playing a shell game with corporate accounts, which led to the Sarbanes-Oxley Act in 2002, are the next landmark changes. Sarbanes-Oxley can be credited to a large extent with bringing the compliance function to the limelight. That it is a global standard of maintaining a record of compliance is a valuable proof point. “The Act mandated a number of reforms to enhance corporate responsibility, enhance financial disclosures and combat corporate and accounting fraud, and created the Public Company Accounting Oversight Board, also known as the PCAOB, to oversee the activities of the auditing profession.”9

      Two of the major menaces that the financial services industry unwittingly has become a part of are money laundering and terrorist financing. Across geographies regulations against money laundering and terrorism have been passed and the expectations of their compliance are very strict. The United States covers these under BSA (Banking Secrecy Act of 1970); the USA Patriot Act (Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001); and through the OFAC (Office of Foreign Assets Control), an agency of the United States Department of Treasury under the auspices of the Under Secretary of the Treasury for Terrorism and Financial Intelligence.

      The next financial crisis, the crisis of 2007 that shook the western world, brought its slew of regulations. Notable among them was the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which is enforced by multiple agencies including FDIC (Federal Deposit Insurance Corporation), SEC (Securities and Exchange Commission), the Comptroller of the Currency, and the Federal Reserve. The focus of the act is to improve accountability and transparency, which would aid in promoting the financial stability of the United States. Consumer protection from negative financial services practices is another focal point of the act. This has created the CFPB (Consumer Financial Protection Bureau) and FSOC (Financial Stability Oversight Council). Per the US Securities and Exchange Commission, “The legislation set out to reshape the U.S. regulatory system in a number of areas including but not limited to consumer protection, trading restrictions, credit ratings, regulation of financial products, corporate governance and disclosure, and transparency.”10 From a compliance point, the 848-page bill poses a nightmare as its reach and expectation is so far and wide.

      FATCA (Foreign Account Tax Compliance Act), another 2010 act, while essentially a tax-related act, brings into its fold a compliance expectation from banks: foreign financial institutions (FFIs) having to directly report to the IRS (Internal Revenue Service of the United States) information about financial accounts held by US taxpayers or foreign entities in which

5

“History of Fed Reserve” —www.federalreserveeduction.org.

6

Ibid.

7

“The Laws that Govern the Securities Industry,” US Securities and Exchange Commission, http://www.sec.gov/about/laws.shtml#secexact1934.

8

Ibid.

9

“The Laws that Govern the Securities Industry,” US Securities and Exchange Commission, http://www.sec.gov/about/laws.shtml#secexact1934.

10

Ibid.