The role of supervisors in enabling or preventing employee misconduct is greater than the role of executives or the impact of other factors related to the firm.
A new study of employee misconduct in the financial services field reveals that supervisors have the most significant impact—negative or positive—on employee misconduct in their firms.
Based on 10 years of data from broker-dealer investment firms, the study by Zachary Kowaleski of University of Notre Dame’s Mendoza College of Business, Andrew Sutherland of the MIT Sloan School of Management and Felix Vetter of the University of Mannheim, shows that factors related to branch supervisors have more than twice the impact on employee misconduct than any factors related to the firm or to executives. Broker-Dealer firms are firms whose employees act as brokers who offer investment advice or dealers who execute investment purchasing orders. Employees in these firms must register with industry regulator FINRA, which maintains a public database that includes records of customer complaints and disciplinary actions taken against employees. The researchers used this database for their research.
A number of factors can influence employee misconduct in a company. Top-level executives may model wrongdoing or fraud, which leads to a culture of misconduct throughout the organization. Less spectacularly, weaknesses in firm-level systems and processes, such as compliance systems or governance, may inadvertently enable or encourage misconduct.
The study found, however, that supervisor-related factors were most responsible for employee misconduct in the firms studied. These factors included delegated authority, personnel decisions and attention to employees with past misbehaviour, and industry rules and ethics training.
A number of circumstances and situations can lead firms to delegate significant decision authority to supervisors. One factor is the distance of the branch from the headquarters of the firm. Distant branches, perhaps 500 miles or further, are more difficult to monitor. Another factor is the range of investment products offered at the branch: product mix complexity requires a supervisor empowered to make decisions in a timely manner. The experience of the supervisor and a record clear of any misconduct are further reasons for delegating decision authority. The data showed that branches led by more qualified, experienced and trustworthy supervisors without any record of misconduct had significantly lower instances of misconduct than other comparable branches. (The researchers used proportion of employees rather than number to compare branches so that results were not skewed by the branch size.)
Since wrongdoers are 5 times as likely as non-wrongdoers to commit new offenses, how supervisors treat employees who have been guilty of misconduct in the past can also make a difference. Some supervisors will be wary of such employees, and impose additional training, restrict their duties or ensure that their activities are closely scrutinized. Others refuse to hire or promote past wrongdoers. The data confirms that supervisors’ personnel decisions, including their attention to past offenders, impact the level of misconduct in their branches.
A third factor is the training of supervisors in industry rules and ethics. Although financial services managers must pass a multitude of exams, one early exam offers a clear link between training and ethical behaviour. The ethics and rules section of this exam, known as a series 66 exam and required to become a registered investment adviser, was significantly reduced in 2010 to make more room for technical content. In comparing training with branch misconduct, the researchers found that supervisors with more ethics training oversaw branches with less misconduct.
The research was based on public data collected by investment industry regulators covering the years 2007-2017; the data pulled information from nearly 5,000 firms, representing a total of 45,000 branches and 123,000 supervisors. Misconduct incidents recorded in the data included unsuitable investment recommendations, misrepresentation, unauthorized activity, omission of key facts, commission-related issues and investment fraud.
Employee misconduct at a branch can harm a firm’s reputation, lead to sanctions and scrutiny from regulators, and impact or influence behaviour from other employees. The role that supervisors play in reducing employee misconduct is often understated. More attention is paid to such firm factors as compliance systems, compensation, governance and auditing. This study reveals that supervisors are more influential in preventing fraud and other misconduct than C-Suite leadership or firm systems and processes.
In addition, while this study focuses on the financial services industry, the supervisor-related factors described above can apply to misconduct in other areas, such as deceptive business practices, bribery and corruption.
In short, supervisors and middle managers are on the front lines of the fight against misconduct, and should be given the training and authority they require to ensure ethical and legal behaviour from their employees.
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