Behavioral compliance: how to stop ‘good people’ from doing bad things

August 16, 2016

(Thomson Reuters Regulatory Intelligence) – Behavioral compliance is a relatively new way of thinking in combating bad behavior on Wall Street and beyond. Born out of frustration with repeated cases of misconduct and individual wrongdoing, both banks and regulators are looking outside their traditional toolkit in trying to curb unethical behavior. The effort is part of the ongoing cultural reform battle, and evidence of creative ways of leveraging other disciplines to tackle the problem is growing, say experts.

Researchers at several American universities, including Georgetown, Penn State and Notre Dame, as well as Federal Reserve Bank of New York, are at the forefront of the new approach to compliance. The core of their work is focused on what motivates individuals to cheat and behave selfishly, even in circumstances where they know they are wrong, and at risk of getting caught.

It is because such risk taking has been seen all too often, even after repeated warnings from internal compliance staff, as well as high profile dismissals and jail sentences, that there is a growing view that traditional programs are ineffective in preventing certain individuals from stepping over the line.

“In some sense it’s born of frustration,” says Donald Langevoort of the Georgetown University Law Center . “You try to use these policy tools and it just doesn’t work . . . I think ultimately the turn of a lot of people to behavioral compliance is borne of that frustration.”

People cheat more than they should

A large portion of the new thinking borrows from disciplines such as organizational behavior, psychology, behavioral economics, ethics and others. To get at the root of the problem, researchers are trying to understand human decision-making processes when it comes to cheating.

One common interpretation is that people will cheat out of temptation, but their actions will be limited. Many seek to maintain a self-image as a non-cheater. Self-rationalization becomes a fundamental component to the decision process.

“If the mind can somehow rationalize the act as acceptable . . . it self justifies the cheating,” says Langevoort, who has worked with the Federal Reserve Bank of New York and other Wall Street firms on employee behavior and compliance issues.

Behavioral ethics delves into the when, why and how this sort of rationalized self-interest occurs. For compliance professionals this is where the results can prove most valuable, because evidence that describes real-life behaviors might give firms better tools to predict and deter the impulse to cheat, say experts.

One of the key findings from research on behavioral ethics is that most people cheat less than they could get away with, but more than they should.

Many employees want to be seen as ethical, and expect ethical behavior from those they work with. But from a compliance standpoint, such an ethical stance may be a mixed blessing.

“Precisely the same forces that create internal bonding make it more likely – especially in the face of competition and rivalry – that the cohesion will work to displace empathy and justify aggressive behavior against perceived outsiders,” Langevoort added.

Perhaps the most illustrative examples of such bonding within large organizations were the cases brought against several global banks in rigging the Libor-setting and foreign exchange markets. The language and behavior of the traders involved demonstrated an intense internal loyalty, where the interests of the group overrode those of the banks they were employed by and the customers they served.

How employees interpret management intentions

Effective communication is seen as a critical aspect of the compliance function, and unfortunately, an area that some say there are major challenges. The type of compliance manuals and documentation that employees must filter through are often written in a type of legalese that many find as yet another part of corporate bureaucracy.

In addition, such messages are likely to be filtered by employees: many will hear what they want to hear, or question what the real message is from senior management.

In a case study by researchers from Suffolk University in Boston, a financial firm had become increasingly concerned that its insurance brokers might be churning policies – substituting an old policy for a new one for a customer in order to generate fees.

Insurance regulators had warned the firm about the practice, and it became a high priority compliance issue. To combat the behavior the management team instituted a compliance review of policy substitutions within 90 days of each other. While well-intentioned the action was received not as one might expect.

Performance and compensation expectations among brokers were related to a certain level of productivity, which included some amount of churning. The brokers were threatened by the new compliance demands, and when they saw the 90 day procedure they decided the churns could be done in 91 days. They were convinced that management didn’t really want the profitable practices stopped if their “solution” was such an easily evadable compliance procedure.

Their interpretation of the new policies was that of management winking: mere window-dressing designed to appease the regulators, but not cut into productivity.

“The story that ultimately emerges from this case is one of how a compliance program that generates compliance in name only can lead to a loss of legitimacy,” the authors concluded in their paper.

Streamlining compliance programs: simpler may be better

The problem of how management is perceived and the language they use to communicate with staff is not only a compliance issue in financial services. Other, non-financial organizations have also implemented changes to legacy programs to reflect more real-life examples of behavior and ethics.

Timothy Lindon, chief compliance officer for Philip Morris International, told Regulatory Intelligence that his company replaced their old code of conduct with a new guidebook that reflects a behavioral approach. Among the changes made, Lindon cited three important actions:

  • Tapping into the power of social norms and peer influence by focusing on fundamental shared beliefs that united and guide employees, rather than dictates from the company.
  • Stripping out ambiguity and euphemisms and using plain language in order to neutralize common rationalizations for misconduct; and
  • Making compliance the simplest path for employees, cutting out 11,000 words versus the old code of conduct, and making it easier for people to understand what they need to do.

“Many legal and other experts in compliance default to creating long and complex policies. It is almost as if they are paid by the word,” says Lindon. “We all need to realize that the real value we bring to our organizations often comes from removing complexity. The same goes for controls.”

“Comfort tends to increase with the number of controls, but at a certain point more rules become counter-productive to reducing misconduct,” he added. “An effective compliance program based on understanding human behavior needs to counter these tendencies.”

No simple corrective or common approach

Importantly, researchers say that behavioral compliance and how it is practiced will differ from company to company, as each firm has its own unique culture. What works for some may not work for others.

In addressing its own cultural and compliance challenges, JPMorgan , for example, had to go through numerous interviews across its global organization to better understand from employees what it means to have an effective culture. Only then was the compliance function able to work jointly with the business in developing tools that fostered a stronger culture, and to better monitor and identify those individuals who were likely to go astray.

“(Behavioral compliance) is not some new or different brand of compliance design, but rather an added perspective,” said Langevoort of Georgetown University. “Just as compliance requires good economics skills, it requires psychological savvy as well, to help predict how incentives and compliance messages will be processed, construed and acted upon in the field.”

(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 at

(This article was produced by Thomson Reuters Regulatory Intelligence and initially posted on Aug. 11. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @thomsonreuters)

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