Reputational Risk in a
Post Dodd Frank world
Agenda
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1) Reputational Risk and Shareholder Value
2) Sources of Reputational Risk
3)Reputational Risk and Conflicts of Interest
4)Valuing Reputational Risk
The Complexity of Integrated Risk
Control
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Risk
Sovereign
Risk
Liquidity
Risk
Operational
Risk
Credit Risk
Market Risk
= Reputational Risk!!!
Operational Risk vs. Reputational
Risk- BIS
• People
– Internal fraud
– Clients, products and business practices
– Employment practices and workplace safety
• Processes
• Systems
• External events
– External fraud
– Damage or loss of assets, force majeure
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Reputational risk is driven by:
A) Firm strategy
B) Market and credit risk exposures
C) The quality of corporate governance
D) Regulatory compliance issues
E) All of the above
F) None of the above
Performance Gaps, Competition and
Conflict
• SOCIETY‟S GENERALLY ACCEPTED VALUES
– “Immoral Conduct”
• PEOPLE‟S EXPECTATIONS
– “Irresponsible Conduct”
• LEGISLATION
– “Illegal Conduct”
• ENFORCEMENT INFRASTRUCTURE
– “External Compliance Failure”
• FIRM CONDUCT
– Reputational Benchmarks
– Competitive Benchmarks
• MARKET-BASED COMPETITIVE PERFORMANCE
Decomposing Reputational Events in a
Going-concern Valuation Framework
Conflict of Interest
• Wholesale Domain Type-1 - Firm-client conflicts.
• Principal transactions.
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Abusive tying.
Fiduciary violations.
Self-dealing.
Front-running.
• Type-2 - Inter-client conflicts.
• Misuse of information.
– Client interest incompatibility
Conflict of Interest - Retail
Retail Domain
Type-1 - Firm-client conflicts.
• Biased client advice.
– Involuntary cross-selling.
– Churning.
– Inappropriate margin lending.
– Failure to execute.
– Misleading disclosure and reporting.
– Misuse of personal information.
Conflict of Interest - Hybrid
Domain-Transition
Type-1 -Firm-client conflicts.
• Suitability.
• Stuffing.
• Conflicted research.
• Proxy voting.
• Spinning.
• Laddering (ramping).
• Bankruptcy risk-shifting.
• Late trading.
• Market timing.
Conflict of Interest- A.G.N.Y.
ML’s Mission Statements
CLIENT DEDICATION
Our clients’ interest come first. By serving them well, we will also
succeed.
SUITABLE RECOMMENDATIONS
Our financial recommendations are consistent with our clients’
long-term goals, financial circumstances and risk tolerance.
FULL DISCLOSURE
We inform our clients of the costs and benefits of doing business with
Merrill Lynch.
THE INTEGRITY OF MERRILL LYNCH
Our principles, financial strength, service quality and market
leadership provide comfort and security to our clients through
good times and bad.
Citi & WorldCom, 2002
Example: GS & NYSE
???
Conflicts of interest are:
A) More serious in finance than in other
industries
B) Can be exploited even with under perfect
information
C) Can be exploited even with zero transaction
costs
D) Are more prevalent in the retail than in the
wholesale sector of industries
SSBs Near-death Experience, 1991
JP Morgan and Banco Español de Crédito, 1993
SocGen 2008
???
The shareholder costs associated with
reputation-sensitive events are:
A) Immaterial
B) Simply a cost of doing business
C) Disappear quickly from share valuations
D) Are easy to measure
E) Represent matters of serious concern to
boards
Optics
• “Image is reality. It is the result of your
actions.
• If the image is false and our performance is
good, it‟s our fault for being bad
communicators. If the image is true and
reflects our bad performance, it‟s our fault for
being bad managers.
• Unless we know our image we can neither
communicate nor manage.”
Mervyn King Bank of England
Too many in financial services have thought “if it’s
possible to make money out of gullible or unsuspecting
customers, particularly institutional customers, that is
perfectly acceptable”
Good businesses “keep a clear vision of who their
customers are, and are run by people who don’t think
they should simply maximise profits next week.”
In the past 25 years banks have increasingly “taken bets
with other people’s money”
“They didn’t understand the nature of the risks they were
taking”