Developing a coherent and risk-based response strategy in advance of a regulatory examination or investigation can go a long way in mitigating the disruptive impact that these encounters often have on financial services institutions.
Increasingly aggressive and targeted actions by regulators around the globe are an expanding risk that can tax even the most vigilant compliance programs. Strategies for handling these potentially traumatic situations need to be an integral part of a firm’s compliance DNA. While specific best practices should be tailored to the specific jurisdiction (or jurisdictions) where the firm operates, the points discussed below offer a useful framework for successfully emerging from the regulatory crosshairs.
The tenor of an examination or investigation will be determined by the groundwork that financial institutions establish with their ongoing compliance and risk management practices.
- Establish a Compliance Mindset
Regulatory compliance that operates as a discrete, siloed, and reactionary function presents the ideal environment for fostering a culture that leads to the violation of applicable rules and regulations. Compliance with legal and regulatory obligations needs to be woven into the fabric of all levels of the enterprise, from product and service development, to performance evaluation, to employee training and accountability programs. Firms operating in multiple jurisdictions should ensure that, while compliance programs may need to be tailored to those jurisdictions’ specific risks and norms, the organization’s core values and ethical conduct standards remain agnostic to location. The importance of compliance needs to be reinforced by the leadership of the firm, its functions, and its lines of business. In addition, executive compensation and performance assessment tools should be structured and aligned to reward compliant behavior.
- Keep Compliance Resources Aligned With Needs
Institutions need to ensure that the staff and systems devoted to legal, compliance, audit, risk management, and governance keep pace with the growth and evolution of the business into new products and markets, shifts in risk profiles and appetites, and changing regulatory priorities. Employ appropriate technological innovations and data analysis to both structured and unstructured data sets to identify problems before regulators do.
- Safeguard Cyber Systems and Assets
Cybersecurity remains a primary risk for many firms—and thus a priority for regulators. Ensure that the firm’s approach to cybersecurity evolves with changing threats and covers not just external intruders but also insiders, who are an often-overlooked source of both accidental damage and malicious incidents. Data privacy policies must keep pace with changing regulations and provide the same level of protection to client information that the firm gives to client assets.
- Take a Comprehensive View of Risk
Traditionally, firms have looked at risk from an internal perspective, focusing on factors such as products, people, and infrastructure. In today’s business environment, however, risk needs to be viewed comprehensively and holistically. This requires expanding the scope of efforts to identify, mitigate, and disclose risk, and thinking creatively about the places from where risk can emerge. Material contingencies within a transaction need to be scrutinized so that possible risks can be identified and mitigated. Clients, investors, and other third parties need to be subject to due diligence that extends beyond traditional financial measures to encompass their risk mitigation strategies. A reputational or cybersecurity problem affecting a third party can quickly infect your own organization.
- Assess and Document
Institutions need to conduct regular assessments of their enterprise-wide risks and controls. Appropriate documentation of findings allows problems to be identified and remediated and evidences a vibrant and effective self-policing function. Make sure that key documents such as certifications and licenses, compliance manuals, codes of ethics, and supervisory procedures are readily available, tailored, accurate, and current.
- Have a Regulatory Crisis Team and Plan in Place
Whether crises hit suddenly or emerge slowly, the mechanism for dealing with them quickly and authoritatively must be established in advance. Identify and have on call legal counsel, subject matter experts, and crisis-management and other consultants who can be deployed promptly to minimize damage and find solutions. Establish an escalation framework that can be easily and uniformly applied by managers and employees. Because crises might be triggered by whistleblowers, ensure that a functional whistleblowing mechanism is in place, with appropriate protections for employees who report issues either internally to the company or externally to regulators or law enforcement.
Once the Regulators Surface and Scrutiny Begins
Once regulators begin the formal process of conducting an examination or investigation, response procedures need to be activated quickly. The following discussion identifies key factors that firms need in order to respond effectively under those high-pressure conditions.
- Involve Outside Counsel and Expert Advisors
Because regulators and law enforcement are much more coordinated in their actions than previously, treat every interaction with regulators—even a scheduled examination—as non-routine and potentially warranting specialized expertise and guidance. For example, for its fiscal year 2018, the US Securities and Exchange Commission reported that examiners made more than 160 enforcement referrals, resulting in the return of more than $35 million to harmed investors.1 Countless other referrals were undoubtedly made to prosecutors at the federal, state, and local levels.
- Know the Scope and Staff
Like a potential business transaction, an examination or investigation calls for thorough due diligence. In an investigation, there is a high likelihood that you will be compelled by subpoena to produce documents. Do not assume, however, that the subpoena is the only document from which you can glean valuable information about the scope and purpose of the investigation. Make sure, for example, that you obtain the formal order of investigation, which may not be volunteered to the party receiving the subpoena. Know which regulatory staff you will be facing and research the public actions in which they have been involved. (Pay particular heed to those who come from specialized units; their technical expertise signals that the matter may be sufficiently complex and warranting extra scrutiny.) In the case of an investigation, find out if there is a parallel investigation being conducted by other law enforcement or regulatory agencies.
- Engage and Negotiate
Establishing what information is produced and in what form is an important factor in complying with the regulator’s demands. In investigations, negotiate the terms of subpoenas or document requests; even in examinations, do not assume that there is no room for discussion regarding the specific requirements of document production. Engage and discuss with the staff.
- Be Judicious in Asserting Privilege
Documents that represent legal advice or attorney work product are generally privileged and protected from production to third parties. But the mere fact that an attorney was involved with the document is not in itself enough to meet that standard. Firms with advisors (either internal or external) who fill both legal and business roles, or who have business advisors with legal backgrounds, need to be careful to assert privilege only where it is warranted. Unsupported claims of privilege are a sure way to alienate the regulators assigned to your case and undermine your credibility—which can carry serious consequences and lengthen the investigation.
- Carefully Manage Documentation
When compiling documents for the examination or investigation, be sure to include all forms of communication, including emails and other electronic messages, handwritten notes, and documents stored in offsite locations. Establish controls to prevent documents from being fabricated or backdated, and ensure that documents created specifically to respond to the regulator’s requests are labeled as such. Promptly suspend deletion/overwrite schedules so that all communications are retained in original form and metadata is not destroyed or altered. In order to maintain the confidentiality of the produced information, take the appropriate steps in your jurisdiction to reserve the right to object should a third party request the information from the government, and request that the materials be returned at the conclusion of the matter or, at minimum, that sensitive materials be afforded heightened protections.
- Know When Cooperation Is the Best Course of Action
The increased use of disgorgement penalties and deferred prosecution agreements has raised the stakes in investigations, making cooperation and self-reporting more attractive alternatives than they once were. When the decision has been made to cooperate, know the guidelines that determine full credit and ensure that they are met: Perform a timely, comprehensive, and independent review; address deficiencies; make full remediation to harmed parties and full disclosure to all relevant regulatory agencies; and demonstrate that self-policing controls and capabilities are in place and have been adequately strengthened where needed.
Even under the best of conditions, regulatory examinations and investigations are trying. From a long-term perspective, however, the scrutiny of a regulatory examination can be beneficial, helping firms address problematic issues before they become full-blown crises. When investigations ensue, having effective and well-thought-out strategies can help minimize the downside exposure and expedite the firm’s ability to restore stakeholders’ confidence and refocus on its core mission. In either scenario, advance preparation is critical.
12019 Examination Priorities, US Securities and Exchange Commission Office of Compliance Inspections and Examinations, p. 3.
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