Business Day

Fining Bankers, Not Shareholders, for Banks’ Misconduct

Fair Game

By GRETCHEN MORGENSON    FEB. 6, 2016

Ho-hum, another week, another multimillion-dollar settlement between regulators and a behemoth bank acting badly.

The most recent version involves two such financial institutions, Barclays and Credit Suisse. They agreed last Sunday to pay $154.3 million after regulators contended that their stock trading platforms, advertised as places where investors would not be preyed on by high-frequency traders, were actually precisely the opposite. On both banks’ systems, investors trying to execute their transactions fairly were harmed.

As has become all too common in these cases, not one individual was identified as being responsible for the activities. Once again, shareholders are shouldering the costs of unethical behavior they had nothing to do with.

It could not be clearer: Years of tighter rules from legislators and bank regulators have done nothing to fix the toxic, me-first cultures that afflict big financial firms.

Regulators are at last awakening to this reality. On Jan. 5, for example, the Financial Industry Regulatory Authority, a top Wall Street cop, announced its regulatory priorities for 2016. Among the main issues in its sights, the regulator said, was the culture at these companies.

“Nearly a decade after the financial crisis, some firms continue to experience systemic breakdowns manifested through significant violations due to poor cultures of compliance,” said Richard Ketchum, Finra’s chairman. “Firms with a strong ethical culture and senior leaders who set the right tone, lead by example and impose consequences on anyone who violates the firm’s cultural norms are essential to restoring investor confidence and trust in the securities industry.”

But changing behavior — as opposed, say, to imposing higher capital requirements — is a complex task. And regulators must do more than talk about what banks have to do to address their deficiencies.

Andreas Dombret is a member of the executive board of the Deutsche Bundesbank, Germany’s central bank, and head of its department of banking and financial supervision. In an interview late last year, he said he was determined to tackle the problem of ethically challenged bankers.

“If behavior doesn’t change, banks will not be trusted and they won’t be efficient in their financing of the real economy,” he said. “A functioning banking system must be based on trust.”

Mr. Dombret is a regulator who knows banking from the inside, having held executive positions at J.P. Morgan and Bank of America.

Most companies have codes of ethics, Mr. Dombret said, but they often exist only on paper.

Regulators could help encourage a more ethical approach by routinely monitoring how a bank cooperates with its overseers, Mr. Dombret said.

“How often is the bank the whistle-blower?” he asked. “Not only to get a lesser penalty but also to show that it won’t accept that kind of behavior. We are seeing more of that.”

Regulators may have other tools to curb dubious activities, he said. One idea is to increase the capital requirements of banks that are found to have violated rules and laws repeatedly. That not only enhances the safety of its operations but also imposes a real cost on future profits.

“If there was a series of misconduct, would that require increasing capital or asking for more equity?” Mr. Dombret asked. “We have to think through how you would penalize misconduct.”

A different proposal comes in a new book by Claire A. Hill and Richard W. Painter, professors at the University of Minnesota Law School. In “Better Bankers, Better Banks,” they argue for making financial executives personally liable for a portion of any fines and fraud-based judgments a bank enters into, including legal settlements.

The professors call this covenant banking. And it looks a lot like the kind of personal liability that was a fact of life among the top Wall Street firms when they were private partnerships.

With their own money at risk, partners of Salomon Brothers, Lehman Brothers and Goldman Sachs were much more careful about their business dealings. When these firms became public companies funded more by outsiders’ money, that self-discipline diminished.

“In the old days, because a partnership paid the fine, it would all come out of the partners’ pockets,” Mr. Painter said in an interview. “We’re not going to roll back the clock, but what we can do is come up with a contractual agreement in the compensation package that mimics some of that structure.”

Their plan contains a crucial element, requiring the best-paid bankers in the company to be liable for a fine whether or not they were directly involved in the activities that generated it. Such a no-fault program, the professors argued, would motivate bankers not only to curb their own problematic tendencies but to be on the alert for colleagues’ misbehavior as well.

This would help instill a culture, the law professors wrote, “that discourages bad behavior and its underlying ethos, the competitive pursuit of narrow material gain.”

Putting such a covenant in place would also help eliminate the problem of banking regulators who become captured by the institutions they are supposed to police. “Those in the best position to choose conduct that is appropriate may not be regulators but, rather, bankers with a stake in the bank,” the professors wrote.

If bankers aren’t willing to institute a system involving personal liability, regulators and judges could require it as part of their settlements or rulings, Ms. Hill said in an interview. “Something like covenant banking could be included in nonprosecution agreements, for example,” she said, or a judge overseeing a case in which a company is paying $50 million could require individuals to pay $10 million of that personally.

A regulator could give a company the choice of a far lower fine if it were to be paid by managers, not shareholders. A company choosing to pay the higher fine and billing it to the shareholders would have some explaining to do, Mr. Painter said.

While the idea of a covenant is centered on banking, it could easily expand to other businesses. But the focus on finance is justified, Ms. Hill said.

“We don’t take the position that this should only be about banks,” she said. “But banks can do huge damage, and we have seen this ethos in the industry that cries out for responsibility.”

Tighter regulations and billions in fines levied on financial firms have had little impact on banking culture, as the Barclays and Credit Suisse cases make clear. It’s high time to up the ante.

A version of this article appears in print on February 7, 2016, on page BU1 of the New York edition with the headline: Fixing Banks by Fining the Bankers.

© 2016 The New York Times Company