The coronavirus (COVID-19) pandemic is drastically changing how firms conduct business, both internally within their own operations as well as externally with their clients and third-party service providers. These changes are creating a new set of risks and challenges for firms, particularly as relates to firms’ employees.
In fact, employee supervision is the most significant compliance program challenge related to COVID-19, according to attendees of ACA’s recent webcast, Best Practices and Strategies for Managing Business Risks Due to COVID-19 Pandemic.
From market volatility to cyber risks to staffing shortages, firms need to make sure they remain proactive and vigilant in monitoring risks related to their employees during this unprecedented time.
Historically, downturns have exposed a variety of compliance flaws, and this downturn, should it be prolonged, will likely be no different. Regulators don’t turn off their supervision in these times; in fact, they are keen to show they are effective and focused, and working to make sure markets are properly regulated.
In this blog post we detail the risks specific to employees that compliance teams need to be aware of during this time of uncertainty and market volatility.
Account for Risks Related to Remote and Distributed Staff
As part of pandemic response and the focus on social distancing, many firms have moved to work from home regimes. Staff will become increasingly unavailable as schools close and staff need to attend to children, or as they, unfortunately, become sick or preoccupied taking care of someone who is sick.
Running an effective compliance program with distributed staff and with reduced staffing comes at a time where compliance needs to be ultra-efficient:
- Personal trading will increase as staff try to protect their savings accounts or take advantage of the volatility themselves
- Firm trading volumes and quantity of trades will jump to trade through the volatility
- New tactical regulations will be released, intra-day, and require immediate implementation, e.g., with market/exchange-specific short-selling bans or reporting requirements on magnitude of moves
- Investors will have near-constant requests about risk exposures and returns, all which require disclosure and content reviews
Effectively executing compliance with reduced and distributed staffing, dynamic rule making, time-sensitive investor requests, and time-sensitive personal and firm trading requests will require a combination of technology and elastic staffing.
For example, just in the past three weeks, ACA has observed a 50% increase in personal trading activity by users of our ComplianceAlpha® Employee Compliance solution. Is it realistic that your firm’s compliance team can keep up while working from home with serious distractions (children home from school, personal illness, taking care of a sick family member)? Can your technology keep up? Can your team keep up?
Plan for Staff Losses and Distribution
Staff may get sick themselves or be preoccupied with personal matters. A distributed compliance team doesn’t have the ability to “overhear” things at the trading desk or to sit in on a private equity deal diligence meeting.
In this type of situation, technology can help with the distribution of tasks and workload. A technology solution for compliance management will allow you to track completion, allocate workload, and document for regulators what was completed and when. If staff become unavailable, technology can help make it obvious what needs to be reallocated.
Supplementing your staff with temporary or long-term support from a trusted partner can also help take things off your compliance team’s plate and ensure oversight remains consistent if your team becomes understaffed. Cloud computing has shown us the value of elastic computing capabilities through on-demand access to resources. Elastic staffing as a parallel allows you to dynamically supplement your team in bulk (e.g., with staff augmentation) or on a unitized level (e.g., reviewing a single marketing piece).
Guard Against Insider Trading and Other Misconduct
Significant market moves can lead to inappropriate behaviors: traders or portfolio managers may intentionally or unintentionally expose the firm to excess risk. It’s human nature to try to make up a loss, and intraday moves of 10%+ will lead to poor footing at some point that a trader or portfolio manager might try to over-correct for with trading or positions that could violate a regulatory requirement, an investor requirement (e.g. side letter requirement), or an investment mandate.
Staff may have personal portfolios that are significantly impacted. The temptation to use inside information, to take advantage of market liquidity issues to push a market, or otherwise manipulate or abuse a market for their own gain, will be at its highest as staff try to recuperate losses for both the portfolio and themselves personally.
It is critical to remain vigilant and proactive in your firm’s approach to trade monitoring and surveillance during times of market volatility. The regulators remain focused on protecting investors and the integrity of the markets. The Co-Directors of the SEC’s Division of Enforcement issued a statement reminding firms of “the importance of maintaining market integrity and following corporate controls and procedures,” particularly around MNPI, disclosure controls and procedures, insider trading prohibitions, and codes of ethics. The FCA has similar views, stating, “Firms should continue to take all steps to prevent market abuse risks. This could include enhanced monitoring, or retrospective reviews. We will continue to monitor for market abuse and, if necessary, take action.”
Surveillance technology coupled with in-depth analysis from experienced surveillance professionals can help your firm remain proactive and diligent – and detect misconduct before a regulator does. Moreover, making staff aware of the sophistication of your surveillance technology can act as a deterrent to bad behavior (i.e., succumbing to temptation is more likely if you think you can get away with it).
Adjust Your Surveillance Parameters
Basic surveillance algorithms will only search for large percentage moves to identify trades of interest. In a volatile market, this will create an unmanageable amount of false positives. Increasing the percentage rule will allow for too many sizable moves to go unnoticed.
For example, if a 10% move rule is in place, everything will flag nearly daily with the current market volatility. If you increase it to 20%, the flags drop, but the firm that just reported earnings and moved 15%, and that you traded ahead of, would not be caught.
To properly monitor and surveil trading activity in this environment, you need to connect data sets together (e.g., in the above example, pair earnings announcements with orders). Expanding restricted trading windows and double-checking parameters is also advised.
Document Your Process
There is a possibility that your firm may suffer serious losses in these markets, and regulators may question your risk posture, what was represented to investors, and how you responded to market risks. They will question your trading activity and the rationale behind it.
Maintain strong documentation of risk committee and investment committee meetings and decisions. Ensure trade rationale is written and captured and consistent with investment mandates.
ACA COVID-19 Resources
ACA is closely monitoring the coronavirus (COVID-19) pandemic and the new and emerging risks our clients are facing during this uncertain time. Visit our COVID-19 resources page for regulatory updates, resources, and best practices to help your firm stay up to date and manage business disruptions caused by COVID-19.
We Are Here For You
ACA is here to support your firm as you navigate this uncertain time. We offer a range of services designed to help firms address and mitigate the new and emerging risks resulting from the COVID-19 pandemic in order to maintain business operations and withstand the crisis. Our solutions include:
- Third-party risk management
- Trade surveillance solutions
- Compliance staffing and support solutions
- Cyber awareness training for staff
Please reach out if your firm needs support.