For years, bankers complained that the section 20 firewalls were expensive and inefficient due to the required separation of people, products, and information between banks and their broker-dealer affiliates.
So a collective hurrah could be heard throughout the banking industry when the Federal Reserve announced in 1996 that it would lower a few of the 28 firewalls. The Fed then received a standing ovation when it raised the much anticipated ineligible revenue limit to 25%, prompting major acquisitions such as Bankers Trust/Alex. Brown and CIBC Wood Gundy/Oppenheimer. Just imagine the ticker-tape parade the bankers will give Alan Greenspan when the remaining firewalls disappear Oct. 31.
However, these bankers should temper some of their exuberance and focus on the compliance challenges ahead because of the Fed's firewall actions.
Ironically, lower firewalls will mean bigger compliance risks around "Chinese walls," insider trading, and safeguarding nonpublic client information. Clients of these banks will watch closely to ensure that their bankers continue to safeguard their confidential information in accordance with federal securities (rather than banking) laws. And violating these laws could mean serious damage to your reputation, significant penalties, and an abrupt halt to a bank's capital markets expansion plans.
Bankers and compliance officers can meet these challenges by following three basic rules of thumb:
Educate bankers and management about the key differences between firewalls and Chinese walls.
Balance management's ex-pectations to integrate products and services with clients' demands to segregate confidential information.
Anticipate changing roles and responsibilities due to the disappearing firewalls, but do so in the context of Chinese walls.
Fresh compliance training, a fundamental understanding of Chinese walls, and anticipating change effectively will enable banks to achieve the higher returns senior management and investors expect while meeting regulatory and client demands.
Safeguarding a client's confidential information is the cornerstone of the trust that clients place in a bank, its corporate lenders, and merger and acquisition and corporate finance specialists. This fundamental responsibility to maintain a client's trust does not disappear with the end of the firewalls. If anything, the responsibility grows. It is therefore crucial that fresh compliance training be given to all employees-including senior management-to highlight the differences between firewalls and Chinese walls and to emphasize that all employees must continue to prevent confidential client information from getting into the wrong hands.
Compliance training also should underscore that bankers who possess nonpublic client information are the first line of defense against insider trading.
As always, significant regulatory change means a retooling of knowledge of what can or cannot be done to make a bank more efficient and profitable. Without compliance training, senior management of banks will understandably expect that the elimination of the firewalls will mean more integration of information flows, processes, products, and services between the bank and its section 20 affiliate.
Or bankers might mistakenly assume that the disappearance of the firewalls will permit the sharing of all information within the firm - regardless of the recipient's roles and responsibilities - without realizing that the public release of such information may cause irreparable harm to the client, the bank, or both. Bankers will also want better access to the trading floor to discuss deals with their derivatives marketers, and traders may mistakenly believe that they should have access to the corporate bankers' floors. (The bankers' floors must remain off-limits to the traders.)
In contrast, regulators like the Securities and Exchange Commission, New York Stock Exchange, and the National Association of Securities-and the bank's clients themselves-will continue to expect that nonpublic client information remain strictly confidential and that there be a continued segregation of such information away from trading and sales personnel regardless of whether the employees work in the bank or the broker-dealer. It is therefore important to know and balance what can be integrated and what must remain segregated.
The challenge ahead for bankers will be to anticipate change and integration in the context of Chinese walls. Bankers must fully understand each person's roles and responsibilities and whether such roles will change in response to the Fed's firewall actions.
Compliance officers, human resource managers, and business and other functional heads should therefore anticipate plans by and work proactively with senior management to reorganize or consolidate departments, processes, and information flows to integrate bank and broker-dealer functions.
Policies and procedures must be revised to not only reflect the new operating standards and existing laws intended to replace the firewalls, but also to ensure that the Chinese wall, "need-to-know," insider trading, and confidentiality policies are current to prevent violations of the securities laws. And of course, fresh compliance training must be implemented.
