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Steering toward responsible incentive compensation
Guidance for incentive-based sales practices
As regulatory agencies sharpen their focus on incentive compensation, three pillars can help financial services firms maintain ethical and compliant practices.
- Financial targets
- Conduct, culture, and ethics
- Governance and controls
- Data and analytics
- Business processes
Financial targets and improper behavior
Like other businesses, financial services organizations rely on sales to boost profits. But focusing on achieving financial targets may foster the wrong behaviors. Regulatory agencies are taking a closer look at practices that might lead to real or perceived misconduct where incentive compensation is concerned. Therefore, for banking sales, the time to act is now.
Regulators expect each organization to have an enterprise-wide framework to identify and manage abusive incentive compensation business practices. Such a framework doesn’t replace the compliance and risk structures already in place, but it is a necessary complement to them.
A strong culture that promotes ethical behavior and conduct of employees can help prevent unfair, deceptive, or abusive practices. True risk management brings together all of an organization’s human-, technology-, and analytics-based activities to form an “early warning system” that can find the seeds of trouble and keep them from taking root in the first place.
Conduct, culture, and ethics
The need to hit a revenue or sales volume target might create conflicts of interest for employees or the firm overall. Organizations need a clear view of the potential behaviors that could lead to misconduct.
- Step one: Have a clear conduct risk taxonomy
- Step two: Proactively mitigate the identified risks
Documenting what good employee behaviors look like and logging customer complaints are among the baseline inputs to a system of ethical monitoring. Other factors may include pockets of anomalous activity, such as spikes in the customer complaints or calls to an internal hotline.
Governance and controls
Explicit rules and codes of conduct and ethics can help align incentive compensation sales behaviors with legal and ethical standards, and tone from the top is a necessary component. But recent industry activity tells us that top-down imposition of standards isn’t enough. Organizations need to implement a robust governance structure and implement controls to mitigate conduct risk and reinforce culture. Enter the “three lines of defense”:
- The first line of defense: The business units themselves are accountable for risks inherent in day-to-day operations
- The second line of defense: The risk management function must build complementary oversight and execution activities to support whichever functions the first line is taking ownership of
- The third line of defense: The internal audit function serves as the board’s eyes and ears into where risk resides and what the organization is doing to mitigate such risks
The three lines of defense approach doesn’t emerge without hard work. Organizations typically struggle to operationalize key controls and the related oversight that each line of defense uses to identify, monitor, and mitigate risks. Therefore, appropriate delineation of roles and responsibilities is paramount.
Data and analytics
An organization’s compliance data regime needs to extend far beyond minimal requirements.
First, it should tap into relevant sources of data to catch any incentive compensation misconduct that’s already taking place. In addition to legal, compliance, risk management, and human resources data, business and operational metrics will also be critical.
The tools to operate this way are becoming more powerful and commonplace: Natural language processing, machine learning, and artificial intelligence can mine high-volume data in ways a manual system can’t. Visualization and other interface technologies can help decision makers interpret and act on new indicators in time to make a difference.
But technical, data-driven risk-sensing also requires a human element. Analytics can augment decision making—they don’t replace it.
When analytics help identify the danger of actions that appear innocuous, that can also help prevent the slippery-slope progression which often leads people off a compliant path. People are less likely to “ratchet” incrementally away from expected norms of behavior when their early steps sound an alarm. So they’re less likely to violate incentive compensation guidelines when robust standards and early-detection controls are in place.
Ethical and compliant business processes
Each of the three pillars that can help an organization
- Appropriate conduct, culture, and ethics framework
- Governance and controls to keep the organization in check
- Technological use of data and analytics
If you aren’t sure how well they’re connected, they’re not connected well enough. If you can’t declare right now that your organization is managing incentive compensation sales within the guardrails, you have work to do.
And the first thing you’ll need is a good roadmap.
To learn more about the Center for Regulatory Strategies, visit our dedicated services page.
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Rule still expected to be finalized next year