I must confess that my respect for historians went up manifold as I realized how difficult it is to get comprehensive and objective information chronologically, if at all, as you try to wade through pages of history and stitch them together in a logical and cohesive way.
Tracing the history of formal compliance initiatives in the financial services industry will not take us too far back because compliance as a distinct subject is fairly young. An attempt at formally defining “compliance risk” and acknowledgment of its place among the risk categories is as recent as the BIS definition in 2005. But rules and the expectation that they be complied with and the breaches thereof are as old as mankind itself. How old? Well, the first known compliance breach, like I mentioned in the preface, is as old as Adam eating the forbidden apple!
Through history there have been rules as well as people and organizations that have broken them, leading at times to dire consequences. The concern is that people and organizations have not learned from these consequences. It almost seems like organizations have developed a sense of selective amnesia with respect to the possible negative outcomes. They tend to do the same or similar mistakes, both consciously and unconsciously. Later in the book I will discuss examples of some of the large and prospering organizations that have disappeared from the face of the earth because of breaches explicit and implicit, under the heading “Lessons Not Learned.” For now the focus is on gaining a peek into the history of compliance in financial services.
Tracing the word compliance per the Merriam Webster dictionary, the first known use of the word is circa 1630. The first known use of its base word comply was 1602. The origin is from the Italian complire and from Spanish cumplir, which means to complete, perform what is due, be courteous, a modification of Latin complēre. Each of these components is applicable even in today's organizational context. However, since the effort here is to trace the concept in the context of financial services, the start date will be the twentieth century forward.
In financial services, it is not an exaggeration to say that the history of compliance is closely connected with regulations; and regulations have, more often than not, been after-effects of scandals or crises, incidents that shook the economy (call it panic or recession). In a way, tracing financial crisis points across time gives a fair idea of the development of regulatory framework and, by extension, implicit and explicit compliance expectations. The structured regulations for financial services have started evolving from the 1980s onward. The explicit callout of compliance with a formal structure is of a more recent origin, essentially a twenty-first-century phenomenon. This is because compliance is a post-regulation process and hence lags it.
The period from 1980 until now has seen more legislation and regulations affecting financial services industry than all other times put together. This directly correlates to the growth in complexity of the industry as well as breaches of expected fair business practices. A consequence, unintended of course, is the fact that compliance, once considered a dusty corner table function – dry, soporific, and uninspiring – is now animatedly debated among not just financial industry and regulators but also political and media circles as well. The effect is that both the industry and its regulators have to assimilate and adapt to the rapid changes and intense scrutiny.
As a representative sample of the evolution I have taken two sample countries, USA and UK, as they have been frontrunners of newer and deeper regulatory frameworks, which were largely followed with regional modifications by other geographies. I have focused on BIS norms at a global level as indicative of the history of growth of active regulation of the banking industry. These frameworks are shaping the formal compliance structures and expectations. I have, for completeness, added one sample each of the regional and industry bodies to illustrate the point that there are others that are joining the formal role holders in shaping the narrative of the compliance landscape globally.
United States of America
Tracing the history of recessions in the United States, their root causes, and the resultant regulations is a fascinating journey and provides some interesting insights. There have been recessions across time, like the recession of 1818 to 1819 that had claimed the Second Bank of the United States as its casualty, though how much of it was due to banking crisis and how much due to disagreement between the then-President of the United States and the head of the Second Bank is a historical debate. However, since the focus here is to understand the historical perspectives with respect to the growth of compliance, I am picking a few that had a direct or indirect impact on the industry's compliance culture and processes.
The first one on that list is the Panic of 1907 as it was the genesis of the Federal Reserve, one of the most important institutions that influence both regulation and deregulation of financial services. During the 1907 financial crisis the New York Stock Exchange fell by almost 50 percent of its previous-year peak with runs on banks and trust companies. This crisis strongly brought home the need for a central banking authority to ensure a healthy banking system. “The Federal Reserve Act was signed as a law by President Woodrow Wilson on December 23, 1913,”5 and the rest, as they say, is history.
The years 1929 to 1935 is the next period I chose as part of tracing the lineage of financial services regulations, as it had a significant regulatory impact for the United States with a lag for the rest of the globe. “In October 1929, the stock market crashed and the US fell into the worst depression in its history. From 1930 to 1933, 10,000 banks failed.”6 As an aftermath, significant changes in the regulatory landscape came about. The Banking Act of 1933, better known as the Glass Steagall Act, the establishment of the Federal Deposit Insurance Corporation (FDIC), the 1935 Banking Act, and the creation of the Federal Open Market Committee (FOMC) were all of this period.
During the same period, two significant acts to regulate the markets were passed. The first, the Securities Act of 1933, often referred to as the “Truth in Securities act,” had two basic objectives:
1. Require that investors receive financial and other significant information concerning securities being offered for public sale.
2. Prohibit deceit, misrepresentations, and other fraud in the sale of securities.7
The second was the Securities Exchange Act, which was enacted on June 6,1934. It established the Securities and Exchange Commission (SEC) that is responsible for enforcement of the act. “The act empowers the SEC with broad authority over all aspects of the securities industry. This includes the power to register, regulate, and oversee brokerage firms, transfer agents, and clearing agencies as well as the nation's securities self-regulatory organizations (SROs).”8 These regulations and the authorities tasked to ensure the compliance of those regulations played and continue to play a very important role in setting and shaping compliance expectations not just of the United States but the rest of the world as well.
While there have been regulations in the interim like the Foreign Corrupt Practices Act in 1977 and FIRREA (Financial Institutions Reform, Recovery and Enforcement Act) in 1989, the next critical milestones were from 1998 onward. This was the period where there was a huge demand for deregulation by the industry. The argument was that efficiency increases with fewer and simpler regulations and that it should be left for the markets to decide on organizational structures and their effectiveness. The deregulation of interest rates and the growth of globalization were among the outcomes of this. The biggest event that requires mention is the Gramm-Leach-Bliley Act of 1999, which was also called the Financial Services Modernization Act. It repealed parts of the Glass-Steagall Act of 1933, removing the barriers of consolidation of commercial and investment banks, securities firms, and insurance companies. The creation of “too big to fail” financial conglomerates and holding groups that threaten the safety and soundness of the financial environment is the biggest criticism against this act.
The September 11 attacks
“History of Fed Reserve” —www.federalreserveeduction.org.
Ibid.
“The Laws that Govern the Securities Industry,” US Securities and Exchange Commission, http://www.sec.gov/about/laws.shtml#secexact1934.
Ibid.
