U.S. bank registry for misconduct gains traction in quest to fight recidivism

May 24, 2016
NEW YORK  (Thomson Reuters Regulatory Intelligence) – The problem of “bad actors” who move from firm to firm within the U.S. banking industry has focused the attention of senior management and regulators, as frustration grows over legal impediments to uncovering past misdeeds of prospective employees. Among possible solutions is a registry of those who have been let go from firms because of misconduct, but there is also a broader slate of options for combating what some see is an important hurdle to cultural reform.The issue was highlighted May 3 at a Thomson Reuters conference on banking culture by Thomas Baxter, executive vice president at the Federal Reserve Bank of New York. Baxter lamented that there was no mechanism today by which banks could identify those who have been let go from former employers for misbehavior.

“This is a huge problem,” Baxter told the panel, which included U.S. regulators and bank executives. “We know that people are getting sacked at one institution and moving to another.”

Baxter laid much of the blame on legal advice which made banks hesitant to cite past misconduct in an employee’s record when they are shown the door.

“The legal profession is partially to blame,” said Baxter. “When you think about it, what lawyers are advising the institutions that are sacking these individuals is that if you disclose to the successor employer that you fired Mary because she was stealing money from customer accounts, that Mary might have a heck of a libel or intentional infliction of stress claim, so you better not do it.”

Issue extends beyond banking

The problem is not confined to banking, some experts said; it reflects current labor laws across industries in the United States.

“First of all this isn’t just a banking problem. This is America in the 21st century dealing with an employment law problem,” said Michael Wiseman, a partner at the law firm Sullivan and Cromwell. Wiseman, who has worked with numerous global banks, and has attended past New York Fed conferences on culture reform, said Baxter’s view was on target. The difficulties Baxter cited, however, were widespread across many industries and companies who were fearful of being sued by former employees should they divulge the reasons behind their dismissal.

For the banking sector, Wiseman said the issue was receiving considerable attention among general counsels at some of the largest U.S. institutions, many of whom have witnessed the high costs inflicted on their organization due to the actions of one of more individuals.

“I think there is a lot of discussion in the industry of what to do,” Wiseman added.

“Non-disparage agreements” seen common practice

Among widely-used practices in employment contracts, legal experts pointed to “non-disparage agreements” between the bank and employee that should there be a departure due to malfeasance, the employer would not divulge the reasons behind the separation.

Such agreements makes it easier to get rid of an employee. “The issue is that it’s a lot easier to encourage a problematic employee to leave if you don’t disparage them,” said Geoffrey Miller, co-director of New York University’s law school program on corporate compliance and enforcement. He added that the New York Fed’s Baxter “had put his finger on something important.”

While regulators could act unilaterally to throw repeat offenders out of the industry, Miller said such an approach was a time consuming and expensive, and would require considerable evidence to prove the individual had engaged in repeated acts of egregious behavior. What Baxter was searching for, said Miller, was “that banks themselves be more forthcoming about the character of their employees.”

Given the potential risks of lawsuits from ex-employees, the challenge for banks was how to provide greater transparency while at the same time limit future litigation.

Regulators could introduce “qualified immunity” restrictions

One possible option for regulators, said Miller, is to consider introducing “qualified immunity” regulation that would give them greater latitude when attempting to ban someone from the industry for repeated misconduct.

According to the Legal Information Institute , which is housed at Cornell Law School, “Qualified immunity balances two important interests—the need to hold public officials accountable when they exercise power irresponsibly and the need to shield officials from harassment, distraction, and liability when they perform their duties reasonably.”

In Miller’s view, this type of regulation would perhaps better insulate regulators against lawsuits from those engaged in egregious behavior.

Specifically, it might protect regulators from lawsuits alleging that they violated a former employee’s rights, and only allow suits where officials violated a “clearly established” statutory or constitutional right.

Banking registry for hired and fired employees

In the autumn of 2014, when New York Fed President Bill Dudley launched his cultural reform crusade, one of the proposals floated was “to create a central registry that tracks the hiring and firing of traders and other financial professionals across the industry.” Dudley acknowledged the complexities of doing this in a “manner that was both transparent and consistent with due process.” He also suggested that the database could be maintained by financial institution supervisors, based on information provided by supervised financial institutions.

A similar regime, said Dudley, already exists in the securities industry, in which supervised institutions are required to file U4 and U5 forms when they hire and part ways with licensed professionals. The U4 form, for example, includes a section on “Termination Disclosure.” The questions asked include:

“Have you ever voluntarily resigned, been discharged or permitted to resign after allegations were made that accused you of: (1) violating investment-related statutes, regulations, rules, or industry standards of conduct; (2) fraud or the wrongful taking of property; (3) failure to supervise in connection with investment-related statutes, regulations, rules or industry standards of conduct.”

The idea of a central registry for banking is still very much alive. At the most recent cultural workshop sponsored by the New York Fed in November, a discussion ensued about whether such an approach was feasible. According to a summary of the discussion provided the Fed:

“No participant raised an objection to the registry. Indeed, the discussion turned to the practical: How can a registry be built? One participant suggested a federally administered system modeled on the software platform already used by (the Financial Industry Regulatory Authority).”

In addition, the summary noted that one senior banker suggested such a registry “cover non-bankers too—compliance or IT personnel, for example. He observed that banks have become especially concerned about information security and cyber-vulnerability.”

Feasibility of a bank registry

In order to develop a banking registry similar to what FINRA has created for the securities industry, industry experts say that care needs to be taken to ensure that an individual rights are protected.

“It’s a good idea,” said Miller of New York University, and a “very promising approach overall. But on the other hand one needs to be careful not to create harm to peoples’ reputations.”

In addition, there needs to be industry-wide agreement on how long an industry participant would remain on such a list. Further, employees would need to be able to challenge and defend themselves against false accusations.

Still, a registry with all the safeguards that legal experts say need to be in place is something that might form a consensus across the industry.

“I do think there is support for (some type of registry),” said Wiseman of Sullivan and Cromwell. “There are people who go from one institution to another and if you don’t know who you’ve hired it can get expensive pretty quickly.”

Henry Engler is a North American Regulatory Intelligence Editor for Thomson Reuters Regulatory Intelligence. He is a former financial industry compliance consultant and executive, and earlier served as a financial journalist with Reuters. Email Henry athenry.engler@thomsonreuters.com. This article appeared initially on Thomson Reuters Regulatory Intelligence on May 3.

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