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Goldman Sachs and 1MDB: How a ‘power few’ can influence compliance culture

January 17, 2019

Goldman is under fire over its role in helping raise US$6.5 billion through three bond offerings for 1MDB. — Reuters pic

NEW YORK, Jan 16 — Problems facing Goldman Sachs over the 1MDB scandal in Malaysia may be symptomatic of a bigger issue found among many large, complex banks: a compliance strategy that sees employee risk spread evenly across the firm. In practice, compliance failures are often driven by individuals who have outsized “ethical influence” and power over the organisation, argues a new academic study. To mitigate the influence of the “power few” firms may need to adopt behavioural compliance intervention.

“In some ways I think (the Goldman case) is a really good example of behavioural risk and localised groups of individuals with outsized influence,” said Todd Haugh, professor of business law and ethics at the Kelley School of Business at Indiana University, and author of the study, “The Power Few of Corporate Compliance”.

“Although it’s pretty early in terms of what will come out of this, the question is going to be whether the compliance program missed the risk because it was looking too broadly, or whether there is some kind of deeper cultural problem at Goldman,” he added.

Goldman is under fire over its role in helping raise US$6.5 billion (RM26.7 billion) through three bond offerings for 1MDB, a Malaysia’s state development fund. The US Department of Justice has said about US$4.5 billion was misappropriated from 1MDB, including some money that the firm helped raise, by high-level officials of the fund and their associates from 2009 through 2014.

At the centre of the scandal is Tim Leissner, who was South-east Asia chairman for Goldman Sachs. Leissner has pled guilty to bribery, conspiracy and money laundering charges. His colleague, Roger Ng, a former managing director for South-east Asia at Goldman, was also charged in Kuala Lumpur with four counts of abetting misleading statements to financial regulators.

A Malaysian court last week declined to grant bail to Ng, pending his extradition to the United States where he faces charges related to suspected money laundering of funds siphoned off 1MDB.

Leissner, who had been a star deal-maker for the firm, now threatens Goldman’s reputation, as it battles one of the biggest crises it has ever faced. The bank has sought to distance itself from the alleged fraud by portraying Leissner as a “rogue” employee, but in November, as part of his guilty plea, Leissner said that concealing business activities from compliance staff was “very much in line” with the culture of the bank.

The flawed assumption underlying compliance

According to Haugh’s analysis, what might have occurred at Goldman reflects an underlying assumption by many firms that unethical and illegal conduct occurs more or less predictably. “That is, while corporate leaders may not know exactly when, where, or how compliance failures will occur, they assume that unethical or illegal conduct will happen according to a ‘normal distribution,’” writes Haugh. “Bad acts will occur here and there, and in line with historical trends, but extreme and pervasive wrongdoing is unlikely. Thus, it is believed, the company will face compliance risk, but in a manner that is manageable.”

As such, the compliance function at many firms is structured not to catch outliers like Leissner, who pose the greatest risk to an organisation, but rather to monitor and mitigate routine compliance lapses by employees. What firms ignore, at their peril, are individuals, who because of their past performance and reputation, can influence, cajole and in the worst case circumvent the compliance process through their dominant position.

“Extreme failures are more likely the result of small groups of individuals acting unethically or illegally, who by virtue of their social and organisational networks account for an outsized amount of bad conduct, and therefore harm,” says Haugh. “These individuals are the ‘power few’ of corporate compliance, the small fraction of those within an organisation able to generate significant compliance failures by fostering, amplifying, and spreading unethical behaviour.”

Case in point

Haugh cites the fake account selling scandal at Wells Fargo as a prime example of where influential bankers, sitting a few layers down from top management, were able to ignite the biggest scandal in the bank’s 167-year history.

As has been revealed through extensive examination of how the scandal emerged, two regions – Los Angeles and Arizona – had consistently underperformed when compared to other regions in sales and revenue targets. They were ranked near the bottom in terms of the so-called “motivator rankings” by the bank.

To turn performance around, “high pressure sales tactics” were adopted by the regional leaders of both areas which then led to widespread sales practice violations. Things got worse when CEO John Stumpf promoted banker Carrie Tolstedt to head the bank’s community banking group. “If the regional managers in Arizona and California were the epicentre of the false accounts scandal, its hypocentre appears to have been Carrie Tolstedt,” writes Haugh. Stumpf praised Tolstedt as the “most brilliant” banker he had ever met.

“Although Tolstedt was undoubtedly a talented banker, she was also responsible for installing a team of managers who spread unethical banking practices throughout Wells Fargo,” notes Haugh.

“By virtue of their social and organisational status, Tolstedt and her senior managers were highly influential,” he added. “As they exposed branch-level employees to high-pressure sales environments and gave them means to alleviate that pressure through unethical sales practices, wrongdoing increased. After seeing their friends and co-workers manipulate accounts, individual employees lowered their own thresholds to unethical behaviour… Wells Fargo was simply unequipped to handle this type of extreme compliance failure, one that grew ‘exponentially’ through the bank’s power few.”

Behavioural ethics risk management

How might large organisation re-tune their compliance programs to head-off the potential damage cause by the “power few?” Haugh has a number of recommendations, all of which focus on devoting resources towards identifying behavioural risk at an early stage.

For example, steps can be taken at hiring to identify the ethical decision-making process of potential employees. New recruits can be asked to take a “Defining Issues Test,” which questions respondents on how they would address a series of moral vignettes, allowing employers to gauge the ethics of possible future employees. The test, according to Haugh, “determines a person’s propensity toward ‘Machiavellian-type behaviour,’ which is the lack of concern with conventional morality.”

For current employees, Haugh suggests that firms seek to identify the “power few.” These are people who “by virtue of their position in the company’s hierarchy, their social connections with other employees, or their personal charisma, are ‘connectors’ — those prolific few who tie an entire network together.”

To identify such individuals, however, current compliance programs would need to devote resources towards employees who may exhibit “heightened behavioural ethics risk.”

“These employees should receive more training, more monitoring, and be subject to more investigative inquiries,” writes Haugh. “Compliance officers should be on a first-name basis with these employees, regardless of their titles, and compliance tools should be tailored to them.” — Reuters


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