Goldman standards review reflects new compliance landscape

May 30, 2013

By Nick Paraskeva, for Compliance Complete

NEW YORK, May 29 (Thomson Reuters Accelus) – Goldman Sachs’ report on new business ethics and practices voiced lofty ambitions that are both frequently aired and difficult to implement. But it also articulated higher standards on issues such as reputational risk, suitability and conflicts of interests, which are increasingly demanded by customers, regulators and investors.

The 30-page report was adopted by Goldman Sachs after an extensive review in the wake of financial-crisis scandals that saw it hauled before Congress and pilloried in the press. Violations of compliance standards such as those at Goldman also emerged at several other firms in the post-crisis period. This misconduct has hurt the reputation of the entire financial industry.

Last November, for example, JPMorgan, and Credit Suisse agreed to pay more than $400 million to settle SEC charges that they mislead investors on the quality of underlying mortgage in securities sold. In 2011, Citigroup agreed to pay $285 million to settle SEC charges that it mislead investors on collateralized debt obligations, in which they did not disclose they had influence over the selection of assets and took short position against these.

The response has been a flurry of legislation and regulation around the world aimed at reining in abuses, and internal reviews at many major firms.

Goldman chief executive Lloyd Blankfein headed the firm’s business standards committee which issued the report.

The effort involved “tens of thousands of hours” planning and execution and 100,000 hours staff training and development, the firm said. Two consulting firms were also engaged to provide independent advice.

“Our clients’ interests always come first,” the report’s opening line says. It adds, “our experience shows that if we serve our clients well, our own success will follow.” The report’s standards address relationships with clients and conflicts of interest, with emphasis on ensuring that clients understand the complex structured products and derivatives transactions they are dealing in. Practices for client transparency and disclosure, and firm governance and training are also specified.

Ambitions like these are frequently aspired to in public policy statements, but are difficult to effectively implement. Responsiveness to client wishes and “getting the deal done” are often conflicting factors. In the profit-led and bonus-driven culture of Wall Street that led up to the financial crisis. Such a culture is most prevalent among traders and front-office staff, but it can also influence compliance and control functions.

The Goldman Sachs report is in line with regulators’ emphasis on management responsibility for high standards. Practices in the report may also be relevant to other firms concerned with reputational risk, including those with less complexity than Goldman. One measure of the effectiveness of such standards is the deals a firm does not conduct, despite the client’s desire to execute, and sacrifice of short-term profits it would generate.

The report also represents a shift in tone from past attitudes.

“I don’t believe there is any obligation” to tell investors, Blankfein said at a Senate hearing in April 2010 when asked to described a firm’s disclosure obligations when it sells a security to someone then bets against the instrument. “In the context of market making that is not a conflict” said Blankfein. In contrast, the assumption of a fiduciary duty to the client would require it to look out for that clients’ interest.

Regulators now expect banks to assess product suitability beyond their dealings with retail clients. Local authorities and small companies in the U.S. and Europe were saddled with large losses on finance trades involving derivatives. Many such entities are seeking restitution from regulators or courts on the basis that they did not understand the deals, which were unsuitable, and had been recommended to them by banks.

Suitability as a systemic issue

Suitability has moved beyond being a business-conduct rule for protecting retail customers. Systemic risk regulators established after the crisis also recognize the need for suitability from a safety and soundness perspective. Certain business practices and products are now constrained by powers that U.S, EU and UK authorities were given post-crisis, such as geared mortgages, with the aim of limiting asset bubbles.

Regulators are also stressing that firms need to do a better job of managing their own reputational risk. This includes activities that may not violate regulation or law, but where publication by press or legislators would damage the firm’s reputation and business. In serious cases, this may lead to a drop in share price and future profits, which could create difficulties in raising capital or rolling-over existing funding sources.

Goldman said it is “dedicated to complying fully with the letter and spirit of the laws, rules and ethical principles that govern us.”

The report’s standards encompass a wide range of themes, and there are numerous specific policies which can apply to many organizations besides Goldman Sachs. They are outlined below.

Types of standards

  • Pre-transaction sales practices, involving heightened due diligence before a trade is executed;
  • Product and client suitability, by comprehensive standards for product and transaction approvals;
  • Disclosure and control standards for riskier trades with client, including for conflicts of interest;
  • Documentation that is more standardized and organized around escalation of potential violations;
  • Employee performance reviews and rewards that assess reputational risks, provision of training.


Suitability of Clients and Products

  • Classify clients into clear segments, such as professional investors, institutional investors and high net worth accounts. These will allow application of clearly demarcated suitability standards.
  • Develop a framework to assess if a client has experience and capacity to understand possible outcomes of a transaction. This particularly applies for transactions that are complex or material to the client.
  • Senior levels must vet complex new products before the firm engages in them, to assess if appropriate for the market or certain customer segments, and that the risk factors are addressed and disclosed.
  • Adopt automated suitability tools to assess suitability, including the types of transaction that a client is pre-approved to transact. Highlight the escalation process for any transactions that are not covered, with clear method to apply.
  • Ensure that the investment objectives of high-net worth accounts cover client return objectives and risk appetites. Describe objectives and risk implications in plain language. To utilize these, further information may need to be collected on each client’s financial position, portfolio goals, risk tolerance and experience.

Conflicts of Interest and Disclosure

  • Clearly communicate with clients on any potential conflicts, and inform investment banking clients of other activities that the firm may continue to perform while acting as an advisor.
  • Ensure that marketing materials, client onboarding documentation and client reporting procedures are consistent with the firm’s suitability and conflicts policy, as well as being user-friendly and in plain language.
  • Perform post-transaction analysis of structured products and derivatives deals conducted with clients. The firm’s relationship manager should communicate the performance to clients where appropriate.
  • Disclosure standards for offering documents should include a visible and readable discussion of risk factors. They should identify risks arising from product structure, leverage and underlying assets. Investment vulnerability from changes in the level of market, credit and reputational levels must also be disclosed.
  • Procedures must prevent “wall crossing” between departments in the firm that have a relationship with the client or interest in the client’s activity. Regular surveillance of information barriers and an updated list of restricted securities should be maintained.
  • Disclose balance sheet assets by business unit and level of liquidity. Add information to public filings on the firm’s liquidity and risk management structure and processes, including practices to mitigate operational risks.

Performance and Training

  • Revise annual performance review process to place renewed focus on reputational matters.
  • Give training to staff on conflicts of interest and suitability. Include content in staff orientation and promotion programs. Develop new training content courses and provide online delivery to staff.
  • Senior management must regularly reinforce the firm’s culture of reputational and ethical excellence.

“Investors face a wide array of new and complicated products with features and risks they don’t always understand” said Rick Ketchum, head of the Financial Industry Regulatory Authority (FINRA), in a recent speech addressing the “crisis of confidence” among investors. He added “think carefully how to explain the possible negative scenarios that can impact an investment to your clients and your financial advisers”.

Other large firms have made improvements in practices similar to Goldman. However, the principles of better communication and fewer conflicts also apply to smaller firms serving retail investors. Such firms may consider whether revised standards would improve their compliance posture with regulators and limit their reputational risks. If they can be adhered to — a big if — Wall Street may begin to see its reputation restored.

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. Compliance Complete provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges. Follow Accelus compliance news on Twitter: @GRC_Accelus)

(Nick Paraskeva is principal of Reg-Room LLC (, which provides regulatory information and consultancy. He covers various facets of the banking and securities industry and delivers exclusive analysis through Thomson Reuters. He can be contacted at (212) 217-0403 and Follow Nick on Twitter@regroom.)

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