Culture Wars

Professor Justin O’BrienCentre for Law, Markets and RegulationUNSW Law

Presentation at Berle V, Sydney13 May 2013

The Problem Trust in our corporations and in our

institutions, both secular and religious, is at an all time low.

Corporate culpability for individual ethical failures is informed by the relative strength or weakness of organizational culture (i.e. the degree to which egregious conduct is informed by a disconnect between stated and lived values)

Observed and unobserved Societies, firms, professional associations,

specific industries and other groups (including regulatory actors), develop modes of preserving and transmitting through time and generations the mental programming that constitute routines, or the ways that things are done

Processes may be difficult to discern specifically, but are well understood not only by those who may be involved directly, but also by those who are not.

The Logic of Practice These mental programs interact with individual and

collective value systems, which simultaneously are reflexively interacting with prevailing cultural influences,

So, the City of London or Wall Street for example, develop patterned modes and mechanisms for evaluating issues and events that are transmitted within their core groups as well as to the broader populations as the routine and legitimate ways of doing business

In short, this becomes the operational culture of an industry

Theoretical Lenses Culture is a set of shared understandings that

permit a group of people to act in concert with each other (Becker 1982)

General culture (especially in a national context); social structures; law; regulatory traditions; and the practice of regulatory work itself interact within a ‘regime – a complex of institutional [physical and social] geography, rules, practice and animating ideas that are associated with the regulation of a particular risk or hazard’ (Hood, Rothstein and Baldwin 2001)

Importance of Culture ‘Societies that get “stuck” embody belief

systems and institutions that fail to confront and solve new problems of societal complexity’ (North 1994)

‘There is no escaping the fact that why one holds the required moral tastes matters as much as having the right kind of moral tastes (Rose 2012)’

How does one ensure integrated rather than decoupled corporate social performance?

Libor It is in this toxic environment that the London

Interbank Offer Rate (Libor) scandal emerged. To date, the still burgeoning investigation has

resulted in three multi-million dollar settlements against UBS, Barclays And Royal Bank of Scotland, which is rendered more embarrassing precisely because the institution is under effective taxpayer control.

More to come at public and private enforcement levels, notwithstanding SDNY complaints on how class action pleaded

Too Big to… Fail? Manage? Prosecute? Invest in? Change? ‘The standards and culture of Barclays, and

banking more widely, are in a poor state. Urgent reform, by both regulators and banks, is needed to prevent such misconduct flourishing (TSC 2012)

Bad Faith Seventeen senior financiers based in the City of London

committed to subjugating the profit motive of trading floors and financial advisors to what was termed ‘a larger social and moral purpose which governs and limits how they behave.’ Corporate responsibility to society, it was argued, could not be shirked nor delegated by the board and senior management:

Ultimately, it is the responsibility of the leaders of financial institutions – not their regulators, shareholders or other stakeholders – to create, oversee and imbue their organizations with an enlightened culture based on professionalism and integrity. As leaders of financial institutions we recognize and accept this personal responsibility.’ FT, 29 September 2010

Regulatory and Banking Industry Response ‘We all got probably too arrogant, too self-

convinced that things were correct the way they were. I think the industry needs to change,’ - Andrea Arcel, UBS 9 January 2013

‘Over the past year, the questions of competence have been supplanted by questions of conduct.. These abuses have raised fundamental doubts about the core values of financial institutions’ – Mark Carney, Governor Bank of Canada, 25 February 2013.

Can We Regulate Culture? The societal cost of the bifurcation

between stated and lived values a series of fundamental questions.

Can corporate culture be regulated?  If so, should it?

Thirdly, how does one ensure the ongoing accountability of regulatory intervention?

Blame shifting at RBS Following a standard script, the banking executives

were, in turn, shocked at the crookedness involved in the manipulation of Libor; dismayed at the lack of moral restraint; and keen to differentiate between ethical bankers and amoral traders.

As the elite blamed the collusion that undermined Libor on the traders, altogether it appeared a different breed that is governed (if at all) by elastic conceptions of probity, a familiar refrain was evident.

 If the executives, ostensibly in control, were guilty of anything it was, according to the serving head of investment banking, John Hourican, ‘excessive trust.’

Blame Shifting II Mr. Hourican told the Commission; he had

resigned to take ‘ultimate responsibility’ for the failing exposed in the Libor rigging scandal.

The issue was not a core concern given the fact that ‘we [presumably meaning the board and senior executives] had to deal with an existential threat to the bank.’  

Instead of dealing with misaligned incentives, the bank had (it was inferred himself included) exhibited ‘blind faith’ in the actions of traders.

The Reform Agenda Scrap Libor and replace with observable

rates (see, however, Australia) Calibrate through a far-reaching reform

program Wheatley Review and IOSCO – do not

address the cultural deficit, instead there is a reliance on Approved Activity and Approved Person (is this credible post HBOS and Sir James Crosby?)

James M Landis and the Administrative Process Professor of Legislation at Harvard (1928) Critical figure in writing Securities Act and

Securities Exchange Act Commissioner on FTC and SEC Dean of Harvard Law School Author of The Administrative Process

(1938) Hearing Examiner in Bridges Case (1939) The Landis Report (1960)

The Plan of Action Three-stage process: trace rationale for

intervention; sketch explicit normative foundation of the underpinning legislation; evaluate the basis on which this was theoretically justified.

The normative question of why one regulates trumps the technical considerations of how one regulates, which is a second-order consideration.

Unless this lost dimension is restored, regulatory intervention will be incapable of changing practice.

The Normative Foundations

The only legislation ‘that is founded upon a moral background that has been passed in the past twenty years, is the Securities Act.’  Its aim was to ‘restore to a numbed national conscience some semblance of sensitivity…. It was of a spirit such as this that the Securities Act was born, free of vindictiveness that might easily have been attached to it, reasonable in its demands and build upon tried experience in their formulation.

It would be idle to pretend that it does not ask something of the security world, but it also promises much in return-the opportunity of creating a true and honorable profession by the assumption and adequate discharge of public responsibilities’ – Baldwin Bane (1933)

Building on the Foundation ‘We are seeking to recreate, rebuild, restore

confidence. Confidence is an outgrowth of character. We believe that character exists strongly in the financial world, so we do not have to compel virtue; we seek to prevent vice. Our whole formula is to bar wrongdoers from operating under the aegis of those who feel a sense of ethical responsibility.’

Joseph P. Kennedy (1934)

Shaking the Foundation The moral deficit revealed most recently in the

Libor scandals over market conduct underscores how ineffective the normative capacity of compliance is in embedding cultural change if perceived to be little more than a necessary minimum legal and mechanistic response to (unwarranted) external restraints.

Need for holistic approach to risk management at both corporate and regulatory level

A Paradigm Shift ‘What should matter to the regulator are

the outcomes that the culture delivers and that the firm can demonstrate it has a framework for assessing and maintaining it. The regulator must focus on the actions a firm takes and whether the board has a compelling story to tell about how it ensures it has the right culture that rings true and is consistent with what the firm does.’ – Hector Sants, FSA (2010)

CEDARCompliance

Ethics Deterrence

Account-ability

Risk

Mandate

Process

Agency

Conclusion I In the absence of the kind of catastrophic crisis witnessed

in the Great Crash of 1929 battles over financial regulation take piecemeal form through refinements to individual legislative clauses.

The fragmented and technical nature of this glacial process masks the cumulative effect of technical change. It can leave an outer shell of protection lacking the structural substance to withstand systemic shocks.

Unfortunately until the exposure of the Libor scandal, we were stuck in this dispiriting rut.

Regulators have a duty to ensure protection is offered and political actors an obligation to ensure the lessons of history are learnt.

Thought for the Day ‘One grasps for shadows, the better to

comprehend sunlight. One reaches into the past, more clearly to know today and tomorrow. It is the privilege of all who care about education to test the depth and quality of that shadow for there, perhaps more than anywhere, one must try to pierce the brilliance of continuing dawns’

- James M Landis (1937)