DFS Adopts Fitness and Character Guidance

Financial regulators in New York have introduced new guidance on the character and moral fitness they expect to see for senior executives at banks and other financial firms working in the state — a big step forward in the quest to be sure that corporate executives are, ya know, ethical and stuff.

The New York Department of Financial Services unveiled the guidance — a list of 20 questions meant to help financial firms evaluate executives’ character and fitness — earlier this week. State banking rules require firms to “develop, implement, and maintain a framework” to vet the character and fitness of senior executives, and the 20 questions issued by NY-DFS are meant to be examples of the criteria your framework could use.

dfs“New York consumers and businesses should feel confident that their money is being managed by ethical and law-abiding individuals,” DFS superintendent Adrienne Harris said in a statement. “Entities have a responsibility to assess the character and fitness of executives not just upon hiring, but on an ongoing basis to protect consumers and ensure the safety and soundness of the institution.” 

NY-DFS first proposed these fitness and character standards last year, so they’re not much of a surprise. Moreover, federal banking regulators such as the Federal Deposit Insurance Corp., the Federal Reserve, and the Office of the Comptroller of the Currency all have their own versions of fitness and character standards, as do banking regulators in the United Kingdom. So the NY-DFS rules are a welcome addition to the family, but they are not news.

That said, the DFS regulations do cover a large pool of people: the board of directors; as well as any senior officer, defined as anyone “who participates or has authority to participate in major policy-making functions.” Anyone who participates in major policy-making functions qualifies as a senior officer regardless of his or her actual title, but typically senior officers will include the chief executive officer, chief financial officer, chief operations officer, chief legal officer, chief risk officer, president, senior executive vice president, executive vice president, and — wait for it — the chief compliance officer! 

Questions, Questions

OK, so what questions does NY-DFS recommend you ask as you assess the fitness and character of the brass? Let’s consider a few, straight from the guidance. 

  1. During [the time under review], have you been charged with, indicted for, or convicted of a crime, and/or pleaded nolo contendere in any criminal matter (including, but not limited to, driving under the influence, reckless driving, and/or disorderly conduct)?
  2. Have you ever been dismissed or asked to resign from past employment, including a less than honorable discharge from military service? 
  3. Has anyone in your immediate family or an individual living in your household worked for the covered institution or an affiliate in [the time under review]?  If so, please state their name and their relationship to you. 
  4. Please describe in a separate attachment any litigation (unless described above) or bankruptcy proceedings of which you have been a part during [year(s)] and provide copies of all relevant documents.
  5. Have you filed/paid all of your required income and other taxes for [the time under review]?

Notice how these questions are trying to determine whether the executive has any legal trouble (questions 1 and 4), employment trouble (question 2), financial trouble (question 5) or conflicts of interest (question 3). In one way or another, the other 15 questions recommended by NY-DFS drive at those same issues. 

Those are the broad categories of “human risk” that your hiring, promotion, and other HR practices should be trying to assess. 

Beyond asking those questions, however, NY-DFS also expects financial firms to have a process in place to assess those answers and make determinations about the character and fitness of those senior officers. Specifically, state banking rules say a firm should: 

  • Update its policies and procedures to require vetting of senior officers at onboarding and on a regular ongoing basis;
  • Inform NY-DFS promptly if your firm determines that a previously vetted executive is no longer fit to perform his or her current function;
  • Vet each senior officer at the time he or she becomes a “designated person,” regardless of whether the executive was previously a designated person at another firm;
  • Define indicators that will trigger additional scrutiny, such as if the executive held a senior position at another firm subject to a regulatory action or some similar proceeding. 

DFS examiners will be looking at firms’ policies and procedures for vetting executive officers. The whole point of this is to avoid a repeat of something like Signature Bank’s sudden collapse last year, when NY-DFS and the FDIC had to swoop in over a weekend to seize the bank’s assets. Regulators later blamed Signature’s collapse on poor management

Fitness for the Rest of Us

For compliance officers outside the financial services sector, this fitness and character guidance provides food for thought about how to weave ethics concerns into hiring and promotion practices. 

For example, consider Question 3, asking about any family members working for the firm or its business partners. That’s a question any company should ask as part of annual requests for employees to disclose potential conflicts — but can you cross-reference those disclosures against actual spending at your company or reports to the internal hotline, to identify employees who might be lying about their conflicts? 

Along similar lines, does your HR team perform background checks on all key employees to find incidents of criminal or civil litigation? Do you have a list of key roles, and a policy to re-perform background checks any time someone rises to the rank of “key”? Has the company ever audited its process for background checks, to confirm that key employees are researched at regular periods, and according to your criteria for fitness and character?

Plus, let’s say you do have an executive who flunks the fitness and character test. What then? Who decides how to handle that executive? If you don’t have a written process already in place, and outside counsel or the board are making that decision on the fly, that sounds like a recipe for aggrieved, now-former executives to file a civil lawsuit.

So yet again, success depends on senior leaders defining the ethical standards they want themselves and others to achieve. Everything else flows from there.

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