Environmental, social and governance (ESG) has evolved to become a significant contributing factor to all sides of business operations within financial services. However, despite the intention to deliver good, the pursuit of ESG goals can ultimately turn sour if not managed and mitigated correctly.
In anything but just another article on ESG effectiveness, here Stuart Breslow provides The Fintech Times with a fascinating insight into the negative externalities of achieving ESG initiatives, and more specifically, on ESG’s relationship with personal securities trading.
Breslow is an independent board member at the financial compliance software solutions provider StarCompliance. He is a prominent senior executive with 30+ years of experience in world-class financial services, consulting, and technology organisations.
Here, Breslow details the reputational risks involved in personal securities trading and how their impact can be mitigated through the adoption of automation:
With investors’ current focus on ESG, corporations need to be alert to regulatory and reputational risks that they may not have considered previously. This is especially the case with the ‘G’ — governance — where potential landmines may not be obvious. One landmine, in particular, is personal securities trading by corporate executives and employees.
Financial services providers have long adopted policies and processes to understand and monitor executive and employee personal securities trading activity, not just because it was required by law and regulation, but also to protect their most precious asset: their reputations.
Keeping the status quo isn’t enough
Corporations outside of financial services have generally understood their executive and employee personal securities trading obligations to be limited to adopting policies with guidelines for such trading, directed brokerage for employee stock plans, and with respect to a very limited number of corporate insiders, often-manual trade preclearance and reporting processes.
News alert: Policies without robust processes to enforce them just don’t cut it these days.
Corporations need to consider the legal and reputational risk that executive and employee securities trading may expose them to. Most corporations think about trading in the context of the securities they themselves issue, and they caution executives and employees not to trade those securities when they are in possession of material non-public information and, with some groups, during allowable window periods only.
The perceived enforcement mechanism for that policy aspiration is that executives and employees will be aware of those policies and trade the company’s securities only through accounts the corporation has directed for the deposit of compensation awarded securities.
But what about the securities of competitors that may be affected by developments at the company? For example, what about securities the executive or employee may have bought (or sold short!) in the open market in other accounts? What about the securities of potential merger or acquisition targets? In these situations and others, the corporation, its executives, and its employees may face legal and reputational harm.
Risk mitigation via compliance automation
What can be done? In these times, corporations, at a minimum, must consider the risks that executive and employee personal account trading exposes them to and ensure their policies provide adequate risk mitigation. Beyond those table stakes, there are relatively low-cost compliance management processes that corporations can adopt to protect themselves and their executives and employees.
First, corporations should define the group subject to trade preclearance and post-trade monitoring. That group should definitely include all senior executives and employees understood to have access to non-public information. If needed, that group could be broadened to include entire areas (e.g., finance, strategy, investor relations) or, depending on the size of the organisation, all employees (e.g., frontline employees who may become aware of production problems or researchers with knowledge of trial results).
There are fintech solutions in the market that address the challenge from start to finish, though corporations underutilise them. First, executives and employees should be required to disclose all their securities brokerage relationships in an automated solution.
There are compliance automation providers who can then connect with the disclosed brokers so that end-of-day reports of trades are sent electronically to the corporation. Those trades can be fed into highly developed monitoring routines which can, among other things, assess prior trading by an individual, look for patterns of trading by more than one executive or employee, and layer in trading activity in the securities in the market or news about the securities. Compliance or legal analysts at the corporation, upon reviewing the activity, would follow up as necessary or close the review in an automated workflow.
Does adopting a programme like this provide complete comfort to a corporation or its investors? No, because as we all know, criminals intent on criminal activity will find ways to evade controls. However, from an ESG perspective, corporations will be well served. It will be clear to law enforcement and investors that they had considered and established robust controls (a significant governance positive) and that the criminal conduct had occurred only because the executive or employee had violated the corporation’s policies and processes designed to enforce those policies.