“It never gets easier. You just get better.”
— Jordan Hoechlin, Compliance Manager (ret.)
In my introductory article, I outlined how I intended to approach this series of articles.
This article is the first in a series designed to equip new compliance officers with the knowledge and skills they need to excel in their roles.
In my experience, not only is “Compliance” not properly understood, but insight into the topic is only often gained at great personal expense. The reality is that the discipline of Compliance is not just about understanding laws and regulations—it’s also about understanding people and human behaviour; in fact, this is the most critical part since conduct is at the core of the discipline.
“Flaws in forming and updating beliefs have the potential to snowball. Once a belief is lodged, it becomes difficult to dislodge”
— Annie Duke “Thinking in bets”
In this article, we’ll take a step back from templates and checklists to briefly explore the psychological principles that impact decision-making in compliance, and provide some real-world examples. To help you become a more effective compliance manager, we’ll identify some common heuristics and cognitive biases, but before that, it’s worth addressing the elephant in the room; the “Bad Apple” of poor reasoning, the Fundamental Attribution Error.
This cognitive bias, so well-entrenched in compliance, influences our judgment of others’ actions and leads us to attribute others’ conduct to their inherent character traits, overlooking context and environmental factors. This may be one reason why, prior to the Royal Commission, systemic compliance failures were presented as the misconduct of rogue agents (“bad apples”) rather than as the inevitable consequence of mismanagement and misaligned incentives. Of course, convenience and a desire to avoid accountability played their part, but misconduct is too easily ascribed to choice rather than context. It’s a simple explanation but seldom an accurate one.
Prior to the Royal Commission, there were several high-profile cases of misconduct and non-compliance that attracted media attention. In many, if not most, of these instances, Regulators, media, and the public attributed these compliance failures to the inherent dishonesty or incompetence, conveniently overlooking the influence of systemic factors and context.
For a compliance professional, mitigating the effect of Fundamental Attribution Error is difficult because embracing it requires far less effort than resisting it. Ascribing failures to “bad apples”, or to individuals’ personal decisions to act recklessly, negligently or criminally, provides absolution and reassurance to those who packed the barrels. Properly addressing the root causes of compliance failures, on the other hand, requires courage. First, you’ll need to drive a cultural shift within your organisation to position “Compliance”, not as a box-ticking exercise but, as an integral and desirable part of business operations. This involves fostering a culture of compliance, where every individual understands their role in maintaining compliance and is empowered to act when they see potential issues. This is not easy.
Even with the best of intentions, long-term success requires Regulators to take a more nuanced approach when dealing with non-compliance. Instead of focusing solely on punitive measures, they should consider the systemic issues that contribute to non-compliance and work with organisations to address them. As I’ve previously stated, the Financial Services and Credit Panel reflects this more nuanced approach to non-compliance. Based on a small number of matters, it does appear that the FSCP is providing clearer guidance on compliance requirements, offering training and support, encouraging transparency and open communication.
Regulatory technology, like OpenAFSL, can play a role in mitigating fundamental attribution error in compliance by using advanced analytics and mapping to identify potential compliance risks, investigate effectively and take immediate measures to address the root causes of these failures.
Common Heuristics and Cognitive Biases
Over the past few years, advisers have grappled with behavioural economics and tried to understand the mental shortcuts that people use to make decisions and judgments quickly. This is what heuristics are. While cognitive shortcuts can be helpful, they can also lead to errors. It’s far too complex a topic to address in a single post but if you are, or want to be, an effective compliance officer, you should at least acknowledge some common heuristics and cognitive biases including the:
- Availability Heuristic: This heuristic refers to a common tendency to rely on immediate examples that come to mind when evaluating a specific topic, concept, method or decision. For instance, you might overestimate the volume of poor-switching advice in your business if you’re currently dealing with a complaint about poor super-switching advice. This could lead to you refocusing attention on, and allocating resources to, super-switching advice at the expense of more important, but less recently observed, compliance failures. Accept that your first impulse is always wrong.
- Familiarity Heuristic: This heuristic refers to our tendency to prefer the “known knowns” and be reluctant to update or change outdated compliance procedures, even when you know more effective methods are available. For example, we often see compliance staff preferring manual process over an automated solution that is available, because they are simply more comfortable with the unthinking habit. Become comfortable with uncertainty.
- Representativeness Heuristic: This heuristic refers to our tendency to judge the probability of an event by reference to an internal model (or series of presumptions). For instance, you might presume that ostensibly successful advisers are less likely to engage in misconduct, based on your knowledge of other successful advisers. It can lead you to generalise from specifics and overlook misconduct or behavious’ that you see as inconsistent with your model. Trust, but verify.
- Affect Heuristic: This heuristic refers to our tendency to make judgments and decisions based on our current emotional state. For instance, if you are under a lot of stress, you might make more conservative decisions (and create roadblocks and bottlenecks) to avoid future problems. Stay within the flags but recognise that the flags are quite wide apart.
- Anchoring Heuristic: This cognitive shortcut is used to explain our tendency to rely too heavily on the first piece of information we receive (the “anchor”) when making decisions. For example, you might be influenced by an initial report or opinion, and that’s difficult to shake even when presented with new and contradicting information. In her book, Thinking in Bets, Annie Duke stated that “instead of altering our beliefs to suit new information, we do the opposite; altering our interpretation of that information to fit our beliefs”. This heuristic often leads Compliance Officers to ignore new information and, confidently, make sub-optimal decisions because they’re incapable of mentally shifting from that anchoring information. Obviously, this often leads to poor decision-making but so does the Recency Heuristic which is the tendency to rely too heavily (and perhaps exclusively) on the most recent piece of information received. Never be satisfied with the obvious answer.
Compliance officers aren’t psychologists, and don’t aspire to be, but if you understand these psychological principles, and how to mitigate their impact, you’ll be a much better thinker and an exceptional compliance officer. By consciously acknowledging their impact you’ll be able to make more informed decisions and be more effective.
In the next article in this series, we’ll discuss the legal framework and explore regulator’s expectations of advisers and licensees.
If you have questions about this topic, or require coaching and/or training, please reach out to us.