Regulatory Compliance -- Pay Now Or Pay Later

In chickens-coming-home-to-roost news, there were a few developments and announcements this past week that should convince bankers that investing in compliance and risk management capabilities can't be avoided – in fact, the longer you hope these requirements will go away, the bigger the bill (monetarily and psychically) is likely to be when you inevitably have to make those investments.

[Risk Management Must Be Priority For All Banks, Not Just The Biggest]

The Wall Street Journal reports today that J.P. Morgan Chase will "spend an additional $4 billion and commit 5,000 extra employees this year to clean up its risk and compliance problems." This is in the wake of the bank's London Whale trading debacle and increased regulatory scrutiny (including four separate regulatory enforcement actions). Citing unnamed "people close to the bank," the article notes:

As part of a companywide effort, the bank is spending an additional $1.5 billion on managing risk and complying with regulations, including a 30% increase in risk-control staffing, these people said. In addition, it expects to add $2.5 billion to its litigation reserves in the second half of the year, these people said.

The spending will be on systems, staffing and legal fees. According to the Wall Street Journal:

The biggest chunk of the additional "controls-related expenses" stems from new staffing. This week J.P. Morgan reported it would add 3,000 people to the bank's control staff to work on legal and regulatory matters. An additional 2,000 employees have been assigned to the effort inside their business units. That brings the total control staff to roughly 15,000, up from about 8,000 last year. J.P. Morgan employs more than 250,000 world-wide. J.P. Morgan also has provided 750,000 hours of training on regulatory and control issues. The bank hired consultants from McKinsey & Co., Ernst & Young and other firms. J.P. Morgan already has disclosed that it spent $1 billion to add to legal reserves in the first half of the year and will spend at least $1.5 billion in the third quarter. The bank is likely to add about $1 billion to reserves in the fourth quarter, according to people close to the bank.

The Wall Street Journal also quotes CEO Jamie Dimon: "Fixing our controls issues is job No. 1. This is a huge investment of people, time and money … but it will make us stronger in the long run."

Umm … you're just figuring this out now? How bad do things have to get for bankers to understand that investments in risk management and regulatory compliance need to be made, need to be made as early as possible, and are actually strategic (versus "cost of doing business") because they put you ahead of the curve, help you avoid a complex and embarrassing reactive approach, and can actually provide opportunities to leverage those investments to advance market, growth and competitive strategies?

I've said many times that financial services regulation isn't going away -- resistance definitely is futile, as J.P. Morgan is now acknowledging. Suck it up, embrace the challenge, and move forward.

That's a lesson stock exchanges and trading firms would be well advised to heed, as there are new calls for improved technology to stave off future computer-related trading problems. On Thursday SEC chair Mary Jo White met with exchange executives to review recent outages and "glitches." She's asking for investments in so-called "kill switches" and other technologies intended to provide systems back-up. According to a New York Times report on the meeting, "Ms. White asked the exchanges ... to make the switches uniformly available, and to propose new rules that would force trading firms to use them, people at the meeting said."

Whether or not this would be enough to prevent future trading mishaps appears to be a subject of some debate -- which raises a bigger issue of compliance and commitment to change on the part of all the key entities (exchanges, regulators, traders, investment banks). Meetings and proposals come and go, and then it's back to business as usual for financial services firms. Sooner or later, however, the proverbial "big one" -- whether it's an historic hurricane, a huge trading loss or a systems meltdown -- occurs, and companies are forced to make changes and investments that could have been addressed earlier in a more collaborative and less-costly manner.

[Check out this session: IT Is Your Business, Run It Like One at Interop, which runs from September 30 through October 4 in NYC.]