Financial Markets Law International
Parlour's Five Compliance Forces Model
The Five Forces
Welcome to the science and appliance of compliance!
Compliance, like Leonardo Da Vinci's Vitruvian Man, is very much a living entity. It has five key forces, as indicated above, all of which are interconnected. This is vital to understand, since compliance effort in relation to one of the forces will have an effect on the other connected forces.
You can assess the fundamentals of how the five compliance forces work for yourself. Take a simple matter like driving, which nearly all of us do (though if you do not drive, imagine how your taxi driver or chauffeur feels). You are driving along a road when you come to a traffic light. The traffic light is on red. Do you stop? Why do you stop? Is it because you always obey instructions, is it because you remember being told to stop at a red light when you learnt to drive, is it because you think it is sensible to stop, is it because your peer group would stop, is it because you think you would be fined if you go across the red light, is it because you have seen a video camera attached to the red light, is it because you dont want to be involved in an accident? Why has the driver behind you, in front of you or to the side of you, stopped? Is it for the same reason as you have stopped? Would you stop every time? What if you were beckoned to cross the red light by a policeman, or if an emergency vehicle appeared behind you with its lights flashing and siren blaring, or if the red light appeared to be stuck and there was no sign of oncoming traffic, or if you have a passenger who needs urgent medical treatment?
The Five Forces Explained
Although the traffic light example mentioned above sets the scene, there are many reasons why target groups comply or not. Investigation has been undertaken into the detailed reasons why target groups comply with laws, policies, procedures, directions and orders, and have been grouped under five key headings, hence the five compliance forces. Many of these elements will be known to you, but the creation of a meta system is new. Unfortunately nowadays governments, regulators and those in similar positions, merely set laws and then enforce them with scant regard to the psychological elements, and even less to the forces of distortion and error. There is a growing tendency to be authoritarian, rather than authoritative, which is having a less than beneficial impact on the functioning of financial markets. The other key mistake is to look upon law and policy as some sort of ethereal matter, rather than a tool which needs to have various elements addressed properly in order for it to work. Let s look at the five forces individually, before considering the uses to which the model may be put, at whatever level, be that at the level of the market, a sector of it, a market participant, or sectors of that participant.
Authority
This is the starting point of the model. It is by far the cheapest method of securing compliance. Just remember back to your childhood, and the role model you had, whos every word you would hang on to, and follow, almost without question. Quick, easy, cheap compliance. How many figures like that do you know today?
Major issues relevant to this force are:
- Natural authority and leadership
- Clarity of objectives, data, laws, policies
- Speed of change
- Ownership
- Accountability
- Responsibility
- Assessment of issue type, size and impact
- Organisational structure
- Business or market rhythm
- Standard and default policies, procedures, processes, actions
- Risk management systems
- Strengths, weaknesses, opportunities, threats
- Planning
- Branding
- Analysis techniques
- Compliance metrics
- Management styles
Behaviour
This is the psychological force, and a very important one too. Psychologists generally have a 20:60:20 rule of thumb in this area. This means that out of any target group 20% are as pure as the driven snow and would not know how to commit a fraud. A further 20% are at the opposite end of the spectrum and are fervently spending every hour assessing how to milk the system. The remaining 60% are somewhere in the middle, displaying varying degrees of opportunism. This force is where improvement to compliance systems can be made, at greater cost than the first force, but far less costly than the control force.
Major issues relevant to this force are:
- Target group structure
- Target group makeup
- Target group dynamic
- Background
- Acceptability
- Personality
- Beliefs
- Reputation
- Habits
- Loyalty
- Ethos
- Ethics
- Perceptions
- Feedback, recognition, motivation
- Cost Benefit Analysis
- Whistleblowing culture and protection
Controls
This is when compliance starts becoming expensive. This is where there are no figures involved who have natural authority, where the key target group tries everything to avoid compliance, and where the regulator can only achieve compliance by enforcement. It is extremely costly, not only in financial terms, but in terms of the breakdown of the relationship between regulator and regulated.
Major issues relevant to this force are:
- Control quality
- Control quantity
- Control density
- Control selectivity
- Intelligence function
- Monitoring system
- Investigation probability
- Detection probability
- Prosecution probability
- Conviction probability
- Sanction severity
- Quality and availability of information, intelligence, evidence
- Communication and consultation between relevant parties
- Structure of internal and external regulation
- Due and fair process
Distortion
This is the strongest force in the compliance model. It consists essentially of political interference where, for example, politicians act through a perceived need to be seen to be doing something, rather than following the correct path, or where the correct system has been established only for the boss to dismiss it on grounds of cost, perceived profitability, or ego.
Major issues relevant to this force are:
- Extraneous or hidden motives
- Alternative agendas
- Performance, reward or bonus structure
- Horse trading or plea bargaining
- Triumphs of perception over fact
- Cronyism, corruption, old school tie
- Support
- Conflict management
- Skew of other paradigms such as data protection, human rights
- Partial or distorted Cost Benefit Analysis
- Financial investment
- Blue on blue or "friendly fire"
- Standards of international, inter sector and inter party co-operation
Error
For those who may think error is a straightforward concept, try reading into error theory as applied to oil platforms, for example. It is a huge area, but one which is paid little attention. This covers training and awareness, neither of which are given much attention in senior circles, and are the first to be cut in any budgetary downturn. Much of the current global financial crisis can be put down to a lack of attention by those in authority to this compliance force.
Major issues relevant to this force are:
- Knowledge, understanding, dissemination, buy in
- Technicalities, practicalities, conflicts, impossibility
- Effectiveness of training, which should entice, inspire, inform and assess, be relevant, interactive, credible, and accord with learning theory such as accelerated learning and NLP. It needs to connect with the particular target group using the appropriate learning styles and in line with a full training needs analysis
- Lack of awareness, especially at senior level
- Target group having no model
- Target group having the wrong model
- Operation of presumption and assumption, usually based on little, no or the wrong foundation
- Lack of translation, whether linguistic of technical, cultural mismatch
- Promotion out of difficulty, or the management rise of the incompetent yet clean nosed
- Business continuity planning/disaster recovery
- Support, funding, equipment, people
- Competition and competitiveness
Unwrapping the Golden Egg
So what can be done with the Five Forces Model? The key to the model lies in its identification of all the elements of compliance, whether those are internal elements as in Forces A to C, or external elements, as in Forces D and E. If this model has identified all the elements of the compliance spectrum (and there is no evidence hat it has not), then by using various advanced questioning techniques (those designed to improve the accuracy of results, such as implicit confession and anonymisation), the true state of compliance can be assessed, in whatever target group, whether that be a broking team, a financial institution, a group of financial institutions, part of the financial sector, a countrys financial sector, or financial sectors as between countries. Not only will this identify the true state of compliance, but it will also identify the compliance gaps and weaknesses, and the best way in which to use a compliance budget to achieve maximum effect.
In initial tests of the model not only at market level, but also at that of market participants, there have been a number of interesting results:
- Profitability has a direct correlation to the strength and effectiveness of the compliance systems of a market or market participant (so why is it that the investment bankers and brokers secure the largest bonuses?)
- Self regulation works. Those jurisdictions which have ignored this element or removed it have missed a trick, ended up with far weaker regulatory systems and paid much more for them
- Leadership by example is vital
- Natural authority of governments, regulators and management is lower than it should be, almost everywhere
- Most laws, policies and procedures are seen as too complex, unclear, lacking in practicality, and even worse, conflicting, to achieve their aim
- Fraudsters have to be hung out to dry
- Enforcement focus on low hanging fruit does not improve the system as a whole
- Authoritarian measures and inconsistent enforcement has separated the regulators from the regulated and increase systemic weakness
- Some elements of financial market structures need to be seen as a service rather than as a commercial enterprise
- Using the model to predict compliance outcomes can ensure that dealing with both "kingpin issues" and related issues result in massive increases in system effectiveness and huge cost savings
- Investment in training (but only of the type explained above) and systems can be the key to profitability both of markets and participants, and more effective than a handbook rewrite
- Threat and vulnerability analysis is vital to success
- Feedback and recognition (not necessarily financial) is vital to success
- Human intelligence is far more effective than electronic
Contact us to try out the model on an aspect of your market or business, and see the results for yourself. To date, all such projects have resulted in effectiveness and efficiency improvements, as well as significant cost savings. Obtaining the best value from your project is therefore guaranteed.
