When U.S. regulators were investigating the massive rate-rigging scandal in foreign exchange markets, they encountered a disquieting reality: Some of the bankers who were implicated in the wrongdoing had quietly left their jobs and subsequently been hired by other banks.
The findings focused attention on what is known as the “rolling bad apple problem” — miscreants leaving one job in the industry and, because there is no black mark on their public record, moving on to another.
“It’s been observed since the financial crisis that some of the persons most directly responsible for misconduct were not first-time offenders,” Michael Held, executive vice president and general counsel at the Federal Reserve Bank of New York, said in a March 8 speech.
“They had records of misconduct at previous employers," Held said. "But their former employers did not share information about misconduct with their prospective employers. Thus, a banker with a record of misconduct could move from firm to firm, spreading bad practices.”
The basic problem is that individual banks have no incentive to share negative information about their former employees, even though their own hiring decisions would benefit from other banks identifying bad actors.
The New York Fed is promoting a potential solution — the creation of an industry-wide database that would enable prospective employers to check job candidates’ records.
The database would address a vexing issue that no individual firm can solve on its own, and the industry generally appears to be on board with the idea. But the proposal also faces challenges that highlight several key obstacles to conquering the bad-actor problem. Among them: how to ensure that former employees’ rights are adequately protected.
In his remarks at Yale Law School, Held offered a detailed outline of the New York Fed’s database proposal. He said that former employers would have a duty to report misconduct, and prospective employers would have a duty to check the database before job candidates are hired.
“An offer of employment would be contingent upon a database inquiry. The prospective employer could withdraw its offer if it were not satisfied with what it sees in the database,” Held said.
The database was first proposed by New York Fed President William Dudley in 2014. Last fall, at a conference focused on reforming corporate culture in the financial services industry, representatives of some large banking firms agreed that a database of banker misconduct would be useful, according to a summary of the event published on the New York Fed’s website.
Perhaps the biggest obstacle the proposal's backers will have to overcome is banks’ fear of being sued for disparaging their former employees.
In Wednesday’s speech, Held said that a new federal law would be necessary to assuage bankers’ worries. He said that Congress could pass a statute that would protect banks against money damages in civil lawsuits by former employees.
At the same time, the law could provide protections to ex-employees who are being victimized by former colleagues with an ax to grind.
“To guard against abuse by banks, the statute should entitle employees to prompt notice and two options to pursue redress in the event that they believe a report about them is false: a low-cost, fast-track ombudsman hearing, or a full judicial review in federal court,” Held said. “Remember that most people who work in financial services firms are not millionaires.”
But other concerns regarding the proposal have yet to addressed, including how banks would determine which infractions should be reported to the database. In certain parts of the banking business, there are no clear standards regarding what constitutes employee misconduct.
Anand Raman, a lawyer at Skadden Arps who represented Wells Fargo in connection with the recent regulatory probe of phony customer accounts at the bank, cited sales integrity violations as an example of the gray areas that currently exist.
“There are clearly situations where an employee has engaged in conduct that warrants significant discipline, including termination," Raman said. "But it is important to realize sales integrity violations come in many different flavors. And while institutions take them all seriously, there’s nothing yet akin to standardized terminology and classification.”
Michael Selmi, a law professor at George Washington University, said that banks will need a clear understanding of when they should report to the database. “For something like this to work, it would have to have a clear definition with little discretion,” he said.
The Wells Fargo scandal also highlights another potential problem with the database. Depending on how the plan is implemented, it could be ripe for abuse by banks seeking to punish whistleblowers.
Democratic Sens. Elizabeth Warren of Massachusetts, Ron Wyden of Oregon and Robert Menendez of New Jersey have raised concerns that Wells Fargo may have used reports on the terminations of certain former employees as a way to retaliate against whistleblowers.
Wells filed those reports with the Financial Industry Regulatory Authority, the self-regulatory body for the securities industry, which maintains a database that is somewhat analogous to the one the New York Fed is proposing for the banking industry.
The New York Fed has not said whether the proposed database should be maintained by a regulatory body or an industry group. But banks would feel more comfortable with the idea if the database had regulators' seal of approval, said Robert Rowe, vice president and associate chief counsel at the American Bankers Association.
“The idea is a great idea,” Rowe said. “It’s just, OK, how do we get through all the details?”
William Black, a law professor at the University of Missouri-Kansas City and a former bank regulator, argued that the Fed and other banking agencies already have the tools necessary to crack down on recidivists.
In the wake of the financial crisis, regulators have not made aggressive use of civil lawsuits and lifetime bans from the industry as a means of identifying bad actors, he said.
“You can use the existing law. And they’ve failed to use the existing law, which is why they have the problem,” Black said.