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Fed’s Dudley: Bad Bank Behavior Could Drive Break Up

* October 20, 2014

New York Fed President Suggests Putting Senior Management on Hook for Regulatory Fines

Federal Reserve Bank of New York President William Dudley said the government will have to consider breaking up large financial institutions if Wall Street doesn’t stop excessive risk-taking and breaking the law.

Mr. Dudley, in a speech sharply critical of bank behavior, also suggested top management bear the financial brunt of regulatory fines levied for wrongdoing.

His comments, at a closed-door meeting at the New York Fed with big bank executives, continue his campaign of publicly and privately criticizing what he sees as Wall Street’s ongoing ethical lapses.

Mr. Dudley said that if big banks don’t make significant changes to improve their ability to comply with laws, pressure to break up the banks will only increase.

“The inevitable conclusion will be reached that your firms are too big and complex to manage effectively,” he said. “In that case, financial stability concerns would dictate that your firms need to be dramatically downsized and simplified so they can be managed effectively.”

Mr. Dudley, whose reserve bank oversees many of the largest U.S. banks, reiterated his view that Wall Street is plagued by ongoing cultural problems even after the excessive risk-taking that contributed to the financial crisis. “I reject the narrative that the current state of affairs is simply the result of actions of isolated rogue traders or a few bad actors within these firms,” he said in remarks prepared for delivery.

Mr. Dudley said that correcting Wall Street’s ethical problems must start with senior leadership of individual firms. Still, he went on to float several ideas for regulatory proposals that could help big banks chart a straighter course.

For instance, discussing the role that a firm’s compensation practices can play in encouraging certain behaviors, Mr. Dudley suggested the creation of a sort of “performance bond” that would put senior management on the hook for a sizable portion of any regulatory fines levied against a firm for wrongdoing.

Currently, a bank’s shareholders pay these fines but have little control over the goings-on inside the firm. Mr. Dudley’s idea is to have compensation for senior managers and the firm’s “material risk-takers” made up of more of firm’s long-term debt so when a firm gets hit with a fine, “a sizable portion of the fine is now paid out of the firm’s deferred debt compensation, with only the remaining balance paid for by shareholders.”

“In other words, in the case of a large fine, the senior management and the material risk-takers would forfeit their performance bond,” Mr. Dudley.

Such an arrangement would increase the incentive for senior management to ferret out and expose “bad activities” early on or prevent them from happening at all, he said.

For lower-level employees, Mr. Dudley suggested the creation of a central database, maintained by regulators, that would track the hiring and firing of traders and other financial officials across the industry. The goal: to stop an employee fired for ethical problems at one firm from quickly obtaining a job at another firm.

Mr. Dudley pointed to a similar registry in the broker-dealer industry and suggested regulators explore adopting the model in the banking industry.

http://online.wsj.com/articles/feds-dudley-continued-bad-bank-behavior-could-necessitate-breaking-up-firms-1413837504

George.