WASHINGTON—Federal Reserve officials sent a warning shot across Wall Street on Monday, telling bank executives they must do more to curb excessive risk-taking and improve employee behavior at their firms or face stiff repercussions, including being broken into smaller pieces.
Federal Reserve Gov. Daniel Tarullo and Federal Reserve Bank of New York President William Dudley , in closed-door speeches Monday to bank executives gathered at the New York Fed, said Wall Street must clean up its behavior and image, according to copies of their remarks provided by the Fed. The regulators made it clear they aren’t satisfied with bank’s efforts in the six years since the financial crisis shattered public trust in big banks, citing ongoing probes of banks for currency-market and interest-rate manipulation, tax evasion and efforts to skirt international sanctions.
Mr. Dudley raised the specter of breaking up big banks, saying if firms don’t prove they can comply with the law, “the inevitable conclusion will be reached that your firms are too big and complex to manage effectively. In that case, financial-stability concerns would dictate that your firms need to be dramatically downsized and simplified so they can be managed effectively.”
Regulators, law-enforcement officials and bank executives were among the roughly 90 people who attended, according to a list provided by the New York Fed. They included Morgan Stanley Chief Executive James Gorman, J.P. Morgan Chase & Co. General Counsel Stephen Cutler and Chief Operating Officer Matt Zames, and executives from Credit Suisse Group AG and Goldman Sachs Group Inc.
Board members from several major firms attended, as did the chief executives of American International Group Inc. and GE Capital, two nonbanks that U.S. regulators have singled out for tougher Fed oversight by because of the threat they pose to the financial system.
Also in the room were law-enforcement officials including Cyrus Vance, the Manhattan district attorney, and Leslie Caldwell, the Justice Department’s assistant attorney general for the criminal division.
The group dined on chicken and salmon for lunch, according to those in attendance.
One attendee characterized the tone of the day as “collegial, probably a little too collegial,” in that the panelists and those in the audience appeared to pull punches and avoid harsh criticism. “This was an establishment crowd,” the person said, noting the cadre of senior bank executives, regulators, and academics there. “There was not a lot of heated controversy.”
Wall Street executives have been unsure of the Fed’s intentions regarding ethical issues, and have been working on how to respond and head off new regulations. The Clearing House Association, a trade group, circulated “messaging themes” among executives at its member banks, according to people familiar with the document. The memo suggested executives should emphasize that they view a strong internal culture as essential to banks’ success, and that the industry has been focused on the topic since the financial crisis.
The talking points also said banks themselves should take the lead in initiating changes rather than having them come from the outside. Privately, bank executives have discussed an industry-led body that would set ethical standards, according to a person familiar with the discussions.
A similar independent-standards board has been set up in the U.K., but is struggling to find its legs. The Wall Street Journal reported Monday that firms such as Goldman Sachs have been reluctant to join, in part because the council’s standards could overlap with regulatory requirements.
One banker who attended Monday’s event said financial firms and regulators already have adopted a number of new rules and policies, and that the focus now should be on ensuring that bankers comply with those standards and are disciplined if they don’t.
But Mr. Tarullo, who sits on the Washington-based Fed board that writes regulations, suggested that some on Wall Street aren’t taking the Fed’s efforts seriously, and lamented what he sees as continuing efforts by some banks to do the bare minimum to improve their ability to police risk.
“My expectation is that if banks do not take more effective steps to control the behavior of those who work for them, there will be both increased pressure and propensity on the part of regulators and law enforcers to impose more requirements, constraints and punishments,” he said.
Some firms “address the deficiencies identified by the Fed in a discrete, almost check-the-box fashion,” he said, adding, “The supervisory reaction in such cases is quite likely to be an inclination toward greater scrutiny.”
“I sense a new and I think higher bar for behaviors and outcomes” at financial firms, said Eugene Ludwig, chief executive at Promontory Financial Group, which advises banks on regulatory matters. “While the area of culture has gotten attention, it hasn’t gotten as much attention” as other regulatory requirements adopted since the crisis, he said.
Mr. Dudley, whose reserve bank oversees many of the largest U.S. banks, reiterated his view that Wall Street is plagued by cultural problems even after the excessive risk-taking that contributed to the financial crisis, and the slew of regulatory changes that followed. “I reject the narrative that the current state of affairs is simply the result of actions of isolated rogue traders or a few bad actors within these firms,” he said.
He said big banks might more readily change behavior if senior management bears the financial brunt of regulatory fines levied for wrongdoing, and suggested the creation of a sort of “performance bond” that would put senior management on the hook for a sizable portion of any fines. Such an arrangement would increase the incentive for senior management to ferret out and expose “bad activities” early on or prevent them from happening at all, he said.
For lower-level employees, Mr. Dudley suggested the creation of a central database, maintained by regulators, that would track the hiring and firing of traders and other financial officials across the industry. The goal: to stop an employee fired for ethical problems at one firm from quickly getting a job at another firm. Mr. Dudley pointed to a similar registry in the broker-dealer industry and suggested regulators explore adopting the model in the banking industry.