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LEARNER GUIDE
COMPLIANCE AND BROKERAGE THEORY, NQF LEVEL
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Learner Guide Introduction

About the Learner This Learner Guide provides a comprehensive overview of the Compliance and
Guide… Brokerage Theory, NQF Level 5, 12 Credits, and forms part of a series of Learner
Guides that have been developed for Compliance and Brokerage Theory, NQF
Level 5, 12 Credits.. The series of Learner Guides are conceptualized in modular’s
format and developed for Compliance and Brokerage Theory, NQF Level 5, 12
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enabling them to effectively and efficiently complete specific tasks. Learners are
required to attend training workshops as a group or as specified by their organization.
These workshops are presented in modules, and conducted by a qualified facilitator.

Purpose Compliance and Brokerage Theory, NQF Level 5, 12 Credits.

Outcomes  Compliance and Brokerage Theory, NQF Level 5, 12 Credits.
Assessment Criteria The only way to establish whether a learner is competent and has accomplished the
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Compliance and Brokerage Theory

In financial services, a broker-dealer is a natural person, company or other organization that engages in

the business of trading securities for its own account or on behalf of its customers. Broker-dealers are at
the heart of the securities and derivatives trading process.

Although many broker-dealers are "independent" firms solely involved in broker-dealer services, many
others are business units or subsidiaries of commercial banks, investment banks or investment companies.

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When executing trade orders on behalf of a customer, the institution is said to be acting as a broker.
When executing trades for its own account, the institution is said to be acting as a dealer. Securities
bought from clients or other firms in the capacity of dealer may be sold to clients or other firms acting
again in the capacity of dealer, or they may become a part of the firm's holdings.

In addition to execution of securities transactions, broker-dealers are also the main sellers and distributors
of mutual fund shares.

Main points of activity

 Professional participant in securities market who carries out dealer activity shall be called dealer.

 Announcing the price, the dealer is committed to announce other essential conditions of the buy-
sell contract of securities: minimum and maximum number of securities subject to purchase
and/or sale, as well as the term of announced price's validity.

Functions

 All the functions of broker including financial consulting

 Organization and support of turnover (liquidity), or market-making (price announcing, duty of

sell and buy of security at announced price, announcing of min and max number of securities that
can be bought/sold at announced price, implementing time periods when announced prices are
available)

 Dealers are large financial institutions that sell securities to end users and then hedge their risk by
partaking in the interdealer market. Interdealers facilitate price discovery and execution between
dealers.

A brokerage firm, or simply brokerage, is a financial institution that facilitates the buying and selling
of financial securities between a buyer and a seller.

Brokerage firms serve a clientele of investors who trade public stocks and other securities, usually
through the firm's agent stockbrokers.[1] A traditional, or "full service," brokerage firm usually undertakes
more than simply carrying out a stock or bond trade. The staff of this type of brokerage firm is entrusted
with the responsibility of researching the markets to provide appropriate recommendations, and in doing
so they direct the actions of pension fund managers and portfolio managers alike. These firms also

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offer margin loans for certain approved clients to purchase investments on credit, subject to agreed terms
and conditions. Traditional brokerage firms have also become a source of up-to-date stock
prices and quotes.

Discount brokers

A discount broker or an online broker is a firm that charges a relatively small commission by having its
clients perform trades via automated, computerized trading systems rather than by having an actual
stockbroker assist with the trade. Most traditional brokerage firms offer discount options and compete
heavily for client volume due to a shift towards this method of trading.

Other ways to lower costs for these brokers is by executing orders only a few times a day by aggregating
orders from a large number of small investors into one or more block trades which are made at certain
specific times during the day. They help lower costs in two ways:

 By matching buy and sell orders within the firm's order book, the overall quantity of stock to be
traded can be reduced, thus reducing commissions payable to others by the brokerage firm.

 The broker can split the bid-ask spread with the investor when matching buy and sell orders - a
win-win situation in most cases

Since investor money is pooled before stocks are bought or sold, it enables investors to contribute small
amounts of cash with which fractional shares of specific stocks can be purchased. This is usually not
possible with a regular stockbroker.

Distributor

Many broker-dealers also serve primarily as distributors for mutual fund shares. These broker-dealers
may be compensated in numerous ways and, like all broker-dealers, are subject to compliance with
requirements of the Securities and Exchange Commission and one or more self-regulatory organizations,
such as the Financial Industry Regulatory Authority (FINRA). The forms of compensation may be sales
loads from investors, or Rule 12b-1 fees or servicing fees paid by the mutual funds.

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Brokerage Company

What is a 'Brokerage Company'

A brokerage company’s main duty is to be a middleman that connects buyers and sellers to facilitate a
transaction. Brokerage companies receive compensation by means of commission once
the transaction has successfully completed. For example, when a trade order for a stock is executed, an
investor pays a transaction fee for the brokerage company's efforts to complete the trade.

BREAKING DOWN 'Brokerage Company'

The real estate industry also functions using a brokerage company format as it is customary for real
estate brokers to collaborate, each company representing one party of the transaction to make a sale. In
this case, both brokerage companies divide the commission.

Choosing a Company

A brokerage company is also called a brokerage. Investors have a range of options when choosing a
company to work with. An investment brokerage is authorized to trade securities for buyers and sellers.

Brokerage commissions erode returns, so investors should select a company that provides economical
fees. Before opening an investment account, do research and compare fees, products, benefits, customer
service, reputation and the quality of services provided.

Full-Service Brokerage

Full-service brokerages are also known as traditional brokerages. These companies offer estate planning
services, tax advice and consultations. These companies also offer up-to-date stock prices, quotes, and
research on economic conditions and market analysis.

Traditional brokerages charge a fee, commission or both. For example, a brokerage may charge a load fee
up to 5.75% for mutual funds. Broker commissions average about 2%. In addition, brokers sell their
clients’ additional products to earn supplementary fees.

Discount Brokerage

A discount brokerage typically charges less than a traditional brokerage. Several companies also offer
advice at a lower cost. However, the depth of the advice depends on the size of an investor’s account.

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These types of companies charge a lower commission by having their clients conduct trades via
computerized trading systems.

These companies may do business over the phone or on the Internet. These companies charge a minimum
commission of $5 up to a higher rate of $45 for a broker assisted trade. Clients can wire money to their
account and access tax documents.

Online Brokerage

Online brokerages only offer a website for investors to conduct transactions on their own. Clients can
communicate by email or phone to conduct trades or ask questions. These companies offer their services
at a discounted rate because they don't offer investment advice.

Captive Brokerage

Captive brokerages are affiliated with a specific mutual fund company. Captive brokers are biased and are
persuaded to recommend and sell mutual funds that the mutual company owns. As a result, brokers may
sell client’s products that are not in their best interest.

Independent Brokerage

Independent brokerages are not affiliated with any mutual fund company. They function similarly to a
full-service brokerage. Typically, these brokers are not biased and can recommend and sell client’s
products that are in their best interest.

Full-Service Brokerage Accounts

Investors seeking the expertise of a financial advisor should look to the services that are provided by a
full-service brokerage firm. The most well-known full-service firms are Merrill Lynch, Morgan Stanley,
Wells Fargo Advisors and UBS. Financial advisors are paid to help their clients develop investment plans
and execute the transactions accordingly. Financial advisors can work on either a non-discretionary basis,
where the client must approve any transaction, or on a discretionary basis where client approval is not
needed.

What Is a Brokerage Account and How Do I Open One?

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If you want to save, you open a savings (or money market) account. If you want to invest, you need a
brokerage account.

What is a brokerage account?

A brokerage account allows you to buy and sell everything from stocks and bonds to mutual funds,
currency, futures and options contracts, depending on the broker.

Over the long term, the return on a diversified investment portfolio is much greater than a savings account
interest rate, which likely won’t beat inflation. Brokerage accounts also differ from savings accounts in
the following ways:

 Savings accounts don’t offer you access to investments; instead, you’ll earn an interest rate on
money deposited.

 The money in a savings account is FDIC insured up to $250,000 per depositor, per insured bank.

 FDIC coverage does not insure investments, including stocks, bonds and mutual funds. Brokerage
accounts carry a different kind of coverage, called SIPC. This coverage protects customers if a
SIPC-member broker fails, but it does not protect against investment losses. SIPC coverage is up
to $500,000 per customer per institution, with a $250,000 limit on cash.

There are also some key similarities:

 You can deposit as much money as you’d like and withdraw that money at any time (though, with
a brokerage account, you may have to sell investments to do so).

 You can set up automatic transfers from another bank or brokerage account, or deposit checks via
mail or, in some cases, a mobile app.

 Like banks, many brokerages also offer checking accounts. You wouldn’t purchase investments
through a brokerage checking account, but it could be linked to your investment account, making
for easy transfers back and forth.

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Brokerage accounts vs. retirement accounts
Brokerage accounts are sometimes called taxable accounts, because the money you earn from investments
sold within the account can be subject to capital gains taxes. (Interest from savings accounts and other
bank accounts is taxed as income, not capital gains.)

That term also differentiates a standard brokerage account from tax-advantaged retirement accounts, like
an IRA or a Roth IRA.

These accounts also allow you to invest, but with money specifically designated for retirement. In fact,
there are annual IRA contribution limits (See our post on Roth IRA contribution limits) and also IRA
withdrawal penalties for removing the money before age 59½ (See Roth IRA withdrawal rules).

If you’re a beginner investor and your goal is retirement, you should use a tax-advantaged retirement
account. If you’ve maxed out your retirement accounts for the year, or you have another goal for which
you’d like to invest, you should consider a brokerage account.

Selecting an online broker

You’ll likely want to open an account with an online broker, which will allow you to trade investments
easily via its website or trading platform. The best of these brokers also provide research, analysis tools
and educational support to get you started.

Before you open an account, survey the options to figure out which online broker is best for you, based on
key factors:

Commissions: Nearly all online brokers will charge a trade commission, typically $5 to $10 per trade.
(The notable exceptions: Robinhood and Loyal3 offer commission-free trades.) A broker’s commission
will apply to trades of stocks, options and exchange-traded funds. You may also be charged a transaction
fee for buying mutual funds. However, many brokers offer commission-free ETFs and no-transaction-fee
mutual funds that can be purchased with no transaction costs.

Account fees: These include annual fees, inactivity fees, and extra charges for trading platforms, research
and data. These charges can be avoided completely in many cases by choosing the right broker.

How often you plan to trade: If you plan to trade frequently, you’ll want to find a broker with low
commissions. If you don’t anticipate trading often, be sure the broker doesn’t charge inactivity fees.

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Support: What trading technology, educational resources and customer support do you need?

Minimums: A broker’s minimum deposit requirement can range from $0 at a broker like TD
Ameritrade or OptionsHouse to $2,500 or more.

Understanding The Theory and Practice of Islamic Forex Trading

Before we understand Islamic forex trading we need to acquaint ourselves, albeit briefly, with
Islamic finance.

Islamic forex trading will increasingly be in demand. Before we understand Islamic forex trading we need
to acquaint ourselves, albeit briefly, with Islamic finance.

Islamic finance

The theory and practice of finance according to Islamic principles is called Islamic finance. Islamic
principles determine the objectives and the operations of Islamic finance. Modern finance theory informs
today’s conventional finance while ethical imperatives drive Islamic finance. The principles and
prohibitions of Islamic finance are expounded in the Shari’a or Islamic law.[i]

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Two features of Islamic finance distinguish the system from conventional finance. First, Islamic finance
proposes a risk-sharing philosophy whereby the lender must share in the borrower’s risk. According to
the Islamic view, a non-Islamic, interest-based loan guarantees a return to the lender but the burden of
risk falls disproportionately onto the borrower. This unequal distribution of risk where the borrower bears
more than the lender is exploitative, socially unproductive and economically wasteful.

Secondly, the purpose of Islamic finance is to promote economic and social development, through
specific business practices. Conventional finance has profit maximization as the goal, whereas Islamic
finance is driven by ethical and religiously inspired goals as stated in the Shari’a.

The Shari’a is the religious law Allah directly gave to his Prophet (peace be upon him). As such, the
purpose of Islamic finance is ethically driven because the aim of the Shari’a is also the aim of Islamic
finance because finance is only one part of life and society. The objective of Shari’a is the happiness and
well being of the people in this worldly life as well as in the life Hereafter. Accordingly, the objective of
Islamic finance is also the well being of people in this life and in life Hereafter. Islamic finance must
contribute to the development and the good of the Islamic community. How finance achieves this purpose
is guided by principles written down in the Holy Qur’an. Not surprisingly, therefore, the fundamental
feature of Islamic finance is socio-economic and distributive justice.

Prohibitions

All business and financial contracts in Islamic finance must conform to Shari’a rules. Basic prohibitions
in Islamic finance are:

(1) Interest or riba.

(2) Excessive risk or gharar.

(3) Speculation or gambling

Prohibition against interest (riba)

There is little or no disagreement among Islamic scholars and legal scholars about the prohibition against
interest. Making money from money is not Islamically acceptable and interest based transactions are a
sin. Primary sources of Shari’a i.e. the Holy Qur’an and the Sunnah, are quite clear in condemning the
practice.

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Interest is any predetermined payment over and above the actual amount of principal of loans and debts,
regardless of whether interest is charged on commercial or personal loans. Islam allows only one kind of
loan and that is the interest free loan or the qard al Hassan (good loan).

Islamic scholars propose five reasons for prohibiting interest or riba.

 Interest is unjust. The generally accepted arguments are that earning money through interest
involves no self-exertion by the lender, and causes oppression to the borrower.

 Interest corrupts society.

 Interest implies the unlawful taking of property.

 Interest leads to negative growth. While riba increases money in quantitative terms, it does not
generate growth in social wealth.

 Interest demeans and diminishes the human personality. Charging interest affects a culture
negatively by distancing that which is human and focusing on that which is monetary.

Of course, there is a widely understood argument that interest carries benefits. The Shari’a does not
gainsay this argument but rather, it stresses that the danger of ribā is greater than its benefit.

Islamic Forex Trading

Accordingly, forex trading must also conform to Islamic finance principles. Forex trading generally
involves what Islamic finance terms as ‘ribā al-nasī’a’, defined as “[interest] in a money-to-money
exchange provided exchange is delayed or deferred and additional charge is incurred with such
deferment.”[ii] Thus, a nasī’a transaction can arise with respect to foreign exchange trading. When an
agreement between two foreign exchange traders calls for one of them to make (or receive) payment of a
currency on a delayed basis, then the transaction is characterized as “nasī’a.” As suggested, ribā al-
nasī’a is forbidden.

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An exchange of money-for-money of different currencies, but equal values – such as U.S. dollars for
Emirati dirhams of the correct foreign exchange value – is permissible. In other words, there is no interest
in a spot currency or foreign exchange transaction. The problem arises when one payment is deferred, or
delayed, as in a loan transaction, foreign exchange forward or futures contract, or currency swap.

The marketplace currently offers swap-free forex trading accounts allowing clients to trade in any
currency pair, carry it overnight and not have any reward or withdrawal. In an effort to
be Shari’a compliant, the accounts do not have interest involved but still allow open positions for
indefinite long periods. The result of trading then depends only on currency rate movements for that
period. In this way, the providers hope to emulate spot currency or foreign exchange transactions
permissible under Shari’a finance.

To be legitimately Shari’a compliant, financial mechanisms and transactions should be permitted

by Shari’a Supervisory Boards (SSB). The SSB seal of approval is mandatory to ensure financial
instruments and transactions are permissible according to Shari’a. SSBs review and endorse not only the
products and services but also all relevant documents pertaining to the products and services. Banks and
financial institutions should appreciate that clients who wish to be in accord with Shari’a finance seek
transactions and instruments that are SSB approved.

SSBs review financial transactions and services to ensure they do not involve interest (especially in a
surreptitious way) and also that they do not carry excessive risk. In the second installment of this series on
Islamic finance, I shall look in greater detail at risk or gharar, as it relates to currency and commodity
trading.

Behavioral Ethics, Behavioral Compliance

The design of an effective legal compliance system for an organization fearing prosecution for white-
collar crime or regulatory violations requires skill at predicting human behavior. The surveillance portion
of compliance involves estimates about who is most likely to misbehave, and when. The communicative
aspect—training and guidance—requires thinking about what kinds of messages and incentives are most

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effective. Forensics and resolution are about, at least in part, learning from the experience and applying
the lessons to future activity.

It’s entirely plausible to use the economist’s assumption of rational choice—opportunism with guile—in
making these predictions. But the realism of that assumption has been under attack for decades now, even
though it still offers appealing methodological traction. Psychologists assure us that people cheat less than
they could, even when assured of a gain. But they cheat more than they should, for reasons that are a
complex mix of dispositions, cognitive frames and situational influences. Sociologists, in turn, urge that
we look outside the individual mind for what drives compliance or noncompliance with law, to a variety
of cultural forces. All of this makes compliance-related predictions much more contingent and messy,
especially since there is no simple model to invoke and the research very much a work in progress. The
hope, however, is that it can make the predictions be more accurate.

The label “behavioral compliance” can be attached to the design and management of compliance that
draws from this wider range of behavioral predictions about individual and organizational behavior.2
Like conventional economics, it understands that incentives matter. Indeed, a core portion of work in the
psychology of ethical choice explains how and why people can behave selfishly or cheat but not construe
their own behavior as bad or wrong. But if that is so, their (or their team’s) moral compass becomes
unreliable as a matter of selfregulation, a particularly frustrating insight in the compliance realm: good
people doing bad things.

Behavioral Ethics and Compliance

Research in behavioral ethics uses “cheating” as its key word to describe what good ethics is not, and
treats illegal behavior as an especially troubling form of cheating. Many of the field’s insights relate
directly to legal matters. Furthermore, the line between law and ethics is very fuzzy, so that good ethics
are a worthy goal within compliance regardless of how a prosecutor or defense lawyer might characterize
some accusation. In that sense, behavioral ethics research is perfectly in synch with compliance programs
that seek to be valuesbased (see Tyler et al., 2008), rather than command and control. The connections
between ethics and compliance are also important to the debate about the optimal balance of emphasis
between law and ethics (e.g., the relationship between the domain of the chief legal officer and the
ethics/compliance function (Treviño et al., 1999, p. 146; Langevoort, 2012, pp. 499-502)).

We know from surveys of compliance officers that ethics is a potentially uncomfortable subject in
organizations (Treviño et al., 2014a). People tend to think of themselves as ethical, and that ethical
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dispositions have been formed via religion, education and the broader culture. That provokes some level
of defensiveness when the subject comes up in the workplace. One of the eyeopeners in using behavioral
ethics is how easily people take to psychological explanations when analyzing the riskiness of other
peoples’ unethical behaviors, as it then gradually dawns on them that they could not possibly be immune
to the same forces. That is key to ethical self-awareness, in compliance and otherwise.

To repeat the punch line for behavioral ethics: people cheat less than they could get away with, but more
than they should. The first part of that insight is heartening. There is indeed a great deal of pro-social
behavior—loyalty, cooperation, conscientiousness—because people want to think of themselves in such a
light, and want others to think of them similarly. Whether this is biological or learned behavior is deeply
disputed. Certainly there are evolutionary advantages in species that suppress selfishness, and economists
have long pointed out the value of a reputation for trustworthiness. No complex organization could work
well without a baseline of mutual trust, and much of the theory of corporate culture involves taking
advantage of these inclinations to build loyalty at the group level (Akerlof and Kranton, 2005). For most
people, it is good to be part of a team, something bigger than oneself (Kluver et al., 2014).

From a compliance standpoint, however, that is a mixed blessing. Precisely the same forces that create
internal bonding make it more likely— especially in the face of competition and rivalry—that the
cohesion will work to displace empathy and justify aggressive behavior against perceived outsiders
(Cikara et al., 2014). In business, those “others” can not only be competitors, but customers and even
other units within the firm that are viewed as threats to the group’s interests and identity. One of the most
potent incentives to cheat is in service of others: altruistic cheating (Ariely, 2012, pp. 222-23). Corporate
agents have ample room to rationalize compliance failures in the name of loyalty.

That also happens on an individual cognitive level, and takes us to the dark side of the punch line: in
general (but with many exceptions) people cheat more than they should. There are now many psychology
experiments built on a simple platform, testing the inclination to cheat in circumstances were detection
and punishment is impossible. A common form is to give subjects a somewhat challenging matrix-based
computation test (Ariely, 2012, pp. 11-22). The test is given to a control group and externally graded, thus
giving investigators the ability to see what honest performance is over a large number of subjects. The
same test is then given to the self-graders, who are told to shred their exams immediately after grading
and report the score to an administrator, who will give (real) money based on the number of questions that
were correct. The control group scores average around 4 out of ten. Under non-detection conditions,
people claim around 6. An obvious question, among others, is why not 10, which maximizes utility?
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There are different possible answers (e.g., people would feel ashamed when observed claiming 10,
because that seems like obvious cheating), but at least illustrates some form of ethical self-control. But
then why not be completely honest? One common interpretation is that people will cheat out of
temptation, but only to a point where they can maintain a self-image as a non-cheater. If the mind can
somehow rationalize the act as acceptable (e.g., I wrote down the wrong digit, or I knew the right answer,
or I’m really better at math than this), it selfjustifies the cheating. While the shredder tests are fairly
objective, you can see how much more easily this could occur in the face of subjective standards for right
and wrong.

So that’s the basic insight, suggesting that motivated inference allows people to maintain self-image while
pursuing self-interest more aggressively—but to a limit. From there, behavioral ethics asks when, why
and how this sort of rationalized self-interest occurs. Experimentally, what manipulations might make
cheating more or less likely? That is where the most interesting results come in terms of compliance,
because answers that describe real-life behaviors in the field might give compliance officials a better
opportunity to predict and deter lawrelated cheating behaviors where such forces might be especially
likely.

Cheating More

The experimental studies described in the prior section set in motion wideranging inquiries into what
dispositional or situational factors make cheating more or less likely. In the laboratory, that’s testable by
manipulating one potential factor while holding everything else constant, and the volume of such studies
is now large (Bazerman and Gino, 2012). But contemporary research is hardly limited to that particular
experimental design, especially because it has become recognized that ethics can be viewed as a form of
risk-taking, and judgment and decision-making in the face of risk is a much larger project in psychology
from and to which insights might be derived. For legal compliance, it’s especially noteworthy that self-
serving inference is indeed facilitated by ambiguity, either in the situational context or the ethical
demand. This strongly suggests that compliance-related distortion will occur especially easily when the
law is subjective rather than bright-line (Feldman and Teichman, 2009), as it so often tends to be.

This section will review some of the influences said to make cheating behaviors more likely. Because this
field is large and growing larger, we have to be both brief and selective. Readers wanting more can
consult any of a number of literature reviews and meta-analyses (e.g., Treviño et al., 2014b, and studies
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cited therein). Consistent with the primacy of psychology in behavioral ethics research, we will focus first
on individual-level insights, even though it is generally agreed that social forces are almost always at
work in serious instances of organizational misbehavior.

CONFLICTS OF INTEREST AND TRUTH-TELLING

Conflicts of interest create the incentive to act opportunistically notwithstanding some pre-existing
obligation (ethical or legal) to another, and so are of special interest in both law and behavioral ethics.
Regulation often seeks to dampen such conflicts, and a common legal strategy is required disclosure of
the conflict, on the assumption that there will be more cautious assessment of the discloser’s behavior.
Researchers, however, have found two unintended consequences (Loewenstein et al., 2011). Under
certain circumstances, the rate of opportunism in laboratory experiments went up after disclosure, not
down. This seems to be motivational: more unconscious “moral wiggle room” (Dana et al., 2008) to
justify the opportunism because the victim has fairly been warned of its likelihood. Compounding the
problem is that the victims became more trusting, not less (although this varied depending on how the
disclosures were structured). One theory is that when there is a pre-existing relationship between the
parties so that trust is present, the potential victim overcompensates in response to the disclosure to assure
the sender that the trust remains.

Patterns of communication can produce unethical behavior in other ways as well. Perhaps reflecting the
common moral intuition that acts of omission are less blameworthy than acts of commission (on which
there is plenty of psychology research in support), studies of what lawyers would call half-truths— and
what the researchers called “artful paltering” (Rogers et al., 2014)—showed a greater willingness to cheat
via saying something technically true but misleading than to lie affirmatively

COMPETITION

That intense competition produces unethical behavior is another nonsurprising finding. Competition
produces both the excitement of potential gain as well as the fear of loss, and so cheating goes up as the
goal gets closer but you’re a step behind. Cheating is more likely when the competitor is a well-known
rival, both because of the personal emotions and the ease by which rationalizations— they’d do it to us if
they could, or it’s just the way the game is played—can go to work (e.g., Pierce et al., 2013). Many
people have noted the common invocation of sports or military imagery in such settings.

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Risk-taking of all sorts—ethical and otherwise—is associated with a cluster of traits that enhance
competitive fitness, including a taste for excitement, a desire to dominate, and strong ego (Malhotra,
2010). It’s easy, then, to speculate about a link to testosterone, which much recent research in
neuroscience tries to chase down. In the investment world, there have been a number of studies on the
dynamics between hormones and risk-taking on trading floors (Coates, 2012). A study of corporate fraud
found a positive correlation with evidence that the CEO had the facial structure typical of high
testosterone individuals (Gia et al., 2014). Ethically, high testosterone leads to a more utilitarian, ends-
justifythe-means stance (Carney and Mason, 2010).

One obvious implication of all this is with respect to gender diversity, which is well studied in both risk-
taking and behavioral ethics research. On average, women are less competitive, less inclined toward risk,
and less likely to cheat than men. Many researchers thus believe that gender diversity in upper echelons
of organizations and other locations of economic power is a crucial step toward better ethics and
responsibility (van Staveren, 2014). This raises the much-debated problem, however, of whether women
who self-select into highly competitive fields are substantially different from men along these
dimensions. A research paper in the Proceedings of the National Academy of Sciences studied the
testosterone levels of MBA students at the University of Chicago, and found the expected differences
between men and women (Sapienza et al., 2009). But that small segment of women who chose investment
banking as a career had somewhat higher relative testosterone levels than even the men who were going
into investment banking. Hopefully, successful efforts at diversity would alter the desirability of entering
such occupations, and gradually change the cultural dynamics and expectations that today treat hyper-
competitive fields as the domain of alpha males.

Behavioral Compliance

Most people find all the foregoing interesting and more or less intuitive. The question is whether it is
useful on the ground, in building a successful compliance program. Some of these are methodological
doubts, such as whether we should rely so much on experiments using ordinary people as subjects. These
are fair concerns, because lab results can easily be misconstrued and are sometimes misleading
(researchers have their own behavioral biases and selfinterests, after all). I will leave these challenges to
literature reviews, and simply note the volume of this work and that, increasingly, it involves professional

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subjects in the laboratory and field studies to confirm or refute experimental predictions. All social
science must be used cautiously, this included, in formulating practice and policy.

The increasing interest in adaptive biases also helps justify using this learning in sophisticated business
settings. We know that heuristics and biases don’t always translate well when applied in settings that
reward skill and savvy when mistakes are costly and there is opportunity to learn from experience. But
again, without undertaking to prove the point here, the case has been made in the best peer-reviewed
journals that certain biases help people compete and win. Anecdotal observation suggests that the
business world has more than its share of blind spots.

So if you’re a compliance officer and want to take this learning seriously, how would you do so? This
question connects to the subject of organizational correctives, which has been of interest for some
[Link] companies have shown an awareness of the risks of self-serving bias, and there are tactics to
combat it. Perhaps the best-known example is the practice of banks removing authority from the original
loan officers to renegotiate or work out arrangements when a large borrower is nearing default.
Otherwise, the loan officer is subject to an escalation of commitment, driven by the desire to justify the
original decision.

As this example shows, all organizational correctives are based on the particular challenge in question,
compliance included. For now, we’ll have to generalize, which is dangerous because compliance
challenges vary greatly. The template for a smart antitrust compliance program focused on potential cartel
activity (Sokol, 2014) poses different problems from the one a brokerage firm worried about financial
advisers pushing unsuitable securities on naïve customers might put in place.

SURVEILLANCE

Another core aspect of compliance is internal surveillance. Advances in information technology allow
extraordinarily sophisticated real time and retrospective observation of activity within a firm, albeit at
substantial cost. Both hard data and soft clues—scrubbing e-mail traffic for words and phrases of a
particular tone—can yield valuable compliance intelligence. Although we are still distant from this point,
it’s not hard to imagine the modern day compliance version of Jeremy Bentham’s prison “panopticon,”
which sees everything without being seen.

Short of that, all surveillance is necessarily risk-based, and behavioral ethics research can help inform
what to look for. Here again one size never fits all, and each compliance issue must be analyzed by

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breaking down the choice architecture of any sensitive decision to see who makes it, under what
circumstances, when and how. Once can then put the behavioral learning to work, looking for particular
temptations (goals gone wild), especially in the form of loss frames. Once again, sequentially high levels
of success can be a red flag, especially if you can’t figure out how they did it.

This suggests that the use of big data analytical tools may permit compliance departments to predict
misbehavior, based on the large scale analysis of prior failures and their precursors. Such efforts indeed
seem to be on the horizon.8 Given the rapidly growing body of research on the correlates with fraud and
other forms of wrongdoing, one can readily imagine a behaviorally attuned program that seeks to identify
markers as they point toward more intense motive and opportunity. MIT economist (behavioral and
otherwise) Andrew Lo (2015) has suggested that a linear factor model could eventually be constructed for
each executive that estimates risk appetite at any given time, and which in the aggregate might depict the
taste for risk in the firm as a whole, or in individual sub-units.

Three cautionary points have to be made. First, as Lo points out, such artificial intelligence—surely
helpful in at least allowing the centripetal processing of all available information about a persons and
situations—would have to have the capacity to learn and evolve. People surely do, as the 91 day rule
experience noted earlier shows. What happened in the past to produce misbehavior was the function of a
set of interpersonal and situational forces that may be gone by the time the model is built. The value-at-
risk models in investment banks in the time leading up to the financial crisis did poorly precisely because
the data inputs were from a time when housing prices rose consistently, because that had been the only
available prior experience. Second, any predictive software will inevitably generate a large number of
false positives (and false negatives), which may lead to behaviors by those in charge of responding that
are not optimal and leave hiding places about which people in the field gradually learn.

The third is a bigger point. One of the central insights in behavioral economics is that people react poorly
to close monitoring (Falk and Kosfeld, 2006). Heavy surveillance is a signal of distrust, which may
produce less trustworthy behaviors in response to expectations. Control has the ability to crowd out the
kind of autonomy that invites ethical behavior,9 and can make people less entrepreneurial and productive
(Tenbrunsel and Messick, 1999). Imagine a bank with a perfect panopticon. Though I concede the
experiment would be an interesting one, I would wager that over time its productivity and competitive
position would lag behind peers with less surveillance intensity, even if its compliance record might be
better (Langevoort, 2002). And given the capacity of complex human systems to frustrate even the best of
plans, I’m not even sure about the compliance superiority. Values-based compliance and risk
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management is important, by most accounts, to success (Trevino et al., 1999; Tyler et al., 2008). If so, the
best systems invite intra-organizational trust, even though the trust will sometimes be abused. (I wish
prosecutors and regulators understood this better, but suspect that the induced evolution of surveillance,
technology-driven and otherwise, will steadily be in the direction of more intensity and less trust.)

The optimal design of compliance-sensitive incentives is well beyond the scope of this chapter. There is a
school of thought among some behavioralists that aggressive incentives and quotas are not only
dangerous and less important to productivity than commonly assumed. They crowd out
conscientiousness. Others contest that and consider those arrangements efficient, even as they
acknowledge the compliance risk when they are baked into the organization’s strategic plan (for a review,
see Kamenica, 2012). Given the time lag between revenue (now) and a compliance sanction (later if
ever), attention to the former is fairly natural and increased all the more in the face of hyperbolic
discounting of the future over the present. Executive contracts might be designed to address this through
deferrals, clawbacks and the like, though that is certainly a contested topic. But much of the motivation
for wrongdoing isn’t entirely top down. As Chuck Whitehead and Simon Sepe (2015) point out, risk often
comes from the up-and-coming strivers, for whom mobility is important and hence incentive structures
have to be shortterm to attract the best talent. I confess some pessimism that entrenched incentive
structures will ever make compliance a priority in settings that are perceived internally as
hypercompetitive, or that there is a particularly productive way to do this by external regulatory fiat. The
genetic structure of firms seems to understand that survival and success come first, and that optimal
compliance is about the organization’s taste for risk. Given what we said earlier about biases that promote
competitiveness, both regulation and compliance will usually be chasing the greased pig from behind
(Langevoort, forthcoming).

Compliance and Ethics in Risk Management

 1. Ethics is fundamental to the securities laws, and I believe ethical culture objectives should be
central to an effective regulatory compliance program.

 2. Leading standards have recognized the centrality of ethics and have explicitly integrated ethics
into the elements of effective compliance and enterprise risk management.

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 3. Organizations are making meaningful changes to embraced this trend and implement leading
practices to make their regulatory compliance and risk management programs more effective.

Ethics and the Federal Securities Laws

The debate about how law and ethics relate to each other traces all the way back to Plato and Aristotle. I
am not the Director of the Office of Legal Philosophy, so I won’t try to contribute to the received wisdom
of the ages on this enormous topic, [1] except to say that for my purposes today, the question really boils
down to staying true both the spirit and the letter of the law.

Framed this way, ethics is a topic of enormous significance to anyone whose job it is to seek to promote
compliance with the federal securities laws. At their core, the federal securities laws were intended by
Congress to be an exercise in applied ethics. As the Supreme Court stated almost five decades ago,

[a] fundamental purpose, common to [the federal securities]… statutes, was to substitute a philosophy of
full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics
in the securities industry…. “It requires but little appreciation . . . of what happened in this country during
the 1920’s and 1930’s to realize how essential it is that the highest ethical standards prevail” in every
facet of the securities industry.

Of course, what has happened through the financial crisis I believe is yet another reminder of the
fundamental need for stronger ethics, risk management and regulatory compliance practices to prevail.
Congress has responded once again, as it did after the Great Depression, with landmark legislation to
raise the standards of business ethics in the banking and securities industries.

The manner in which the federal securities laws are illuminated by ethical principles was well illustrated
by the Study on Investment Advisers and Broker-Dealers that the Commission staff submitted to
Congress earlier this year pursuant to Section 913 of the Dodd-Frank Act (“913 Study”).  As described in
the 913 study, in some circumstances the relationship is explicit, such as the requirement that each
investment adviser that is registered with the Commission or required to be registered with the
Commission must also adopt a written code of ethics. These ethical codes must at a minimum address,
among other things, a minimum standard of conduct for all supervised persons reflective of the adviser’s
and its supervised persons’ fiduciary obligations.

In other circumstances, an entire body of rules is based implicitly on ethical precepts. This is the case
with the rules adopted and enforced by FINRA and other self-regulatory organizations, which “are
grounded in concepts of ethics, professionalism, fair dealing, and just and equitable principles of trade,”

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giving the SROs authority to reach conduct that may not rise to the level of fraud.  This has empowered
FINRA and other SROs to, for example, not require proof of scienter to establish a suitability
obligation,  to develop rules and guidance on fair prices, commissions and mark-ups that takes into
account that what may be “fair” (or reasonable) in one transaction could be “unfair” (or unreasonable) in
another,  and to require broker-dealers to engage in fair and balanced communications with the public,
disclose conflicts of interest, and to undertake a number of other duties.  In addition to approving rules
grounded on these ethical precepts, the Commission has also sustained various FINRA disciplinary
actions utilizing FINRA’s authority to enforce “just and equitable principles of trade,” even where the
underlying activity did not involve securities, such as actions involving insurance , tax shelters, signature
forgery, credit card fraud, fraudulent expense account reimbursement, etc. 

Other ethical precepts are derived from the antifraud provisions of the federal securities laws. The
“shingle” theory, for example, holds that by virtue of engaging in the brokerage business a broker-dealer
implicitly represents to those with whom it transacts business that it will deal fairly with them. When a
broker-dealer takes actions that are not fair to its customer, these must be disclosed to avoid making the
implied representation of fairness not misleading. A number of duties and conduct regulations have been
articulated by the Commission or by courts based on the shingle theory. 

Another source by which ethical concepts are transposed onto the federal securities laws is the concept
of fiduciary duty. The Supreme Court has construed Section 206(1) and (2) of the Investment Advisers
Act as establishing a federal fiduciary standard governing the conduct of advisers. This imposes on
investment advisers “the affirmative duty of ‘utmost good faith, and full and fair disclosure of all material
facts,’ as well as an affirmative obligation to ‘employ reasonable care to avoid misleading’” clients and
prospective clients. As the 913 Study stated,

Fundamental to the federal fiduciary standard are the duties of loyalty and care. The duty of loyalty
requires an adviser to serve the best interests of its clients, which includes an obligation not to
subordinate the clients’ interests to its own. An adviser’s duty of care requires it to “make a reasonable
investigation to determine that it is not basing its recommendations on materially inaccurate or
incomplete information.”

While broker-dealers are generally not subject to a fiduciary duty under the federal securities laws, courts
have imposed such a duty under certain circumstances, such as where a broker-dealer exercises discretion
or control over customer assets, or has a relationship of trust and confidence with its customer.  The 913
Study, of course, explores the principle of a uniform fiduciary standard.

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Concepts such as fair dealing, good faith and suitability are dynamic and continue to arise in new
contexts. For example, the Business Conduct Standards for Securities-Based Swap Dealers (SBSDs”) and
Major Security-Based Swap Participants (“MSBSPs”), required by Title VII of the Dodd-Frank Act and
put out for comment last summer, include proposed elements such as

 a requirement that communications with counterparties are made in a fair and balanced manner
based on principles of fair dealing and good faith;

 an obligation to disclosure to a counterparty material information about the security-based swap,

such as material risks, characteristics, incentives and conflicts of interest; and

 a determination by SBSDs that any recommendations that they make regarding security-based
swaps are suitable for their counterparties.

Of course the Business Conduct Standards have not been finalized, but the requirements of Title VII
requiring promulgation of these rules, as well as the content of the rules as proposed, illustrate that ethical
concepts continue to be a touchstone for both Congress and the Commission in developing and
interpreting the federal securities laws.

The Relationship Between Ethics and Enterprise Management.

Ethics is not important merely because the federal securities laws are grounded on ethical principles.
Good ethics is also good business. Treating customers fairly and honestly helps build a firm’s reputation
and brand, while attracting the best employees and business partners. Conversely, creating the impression
that ethical behavior is not important to a firm is incredibly damaging to its reputation and business
prospects. This, of course, holds true equally for individuals, and there are plenty of enforcement cases
that tell the story of highly talented and successful individuals who were punished because they violated
their ethical and compliance responsibilities.

Another way of saying this is that a corporate culture that reinforces ethical behavior is a key component
of effectively managing risk across the enterprise. As the Committee of Sponsoring Organizations of the
Treadway Commission (“COSO”) put it, in articulating its well-established standards of Internal Control
and Enterprise Risk Management:

An entity’s strategy and objectives and the way they are implemented are based on preferences, value
judgments, and management styles. Management’s integrity and commitment to ethical values influence
these preferences and judgments, which are translated into standards of behavior. Because an entity’s

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good reputation is so valuable, the standards of behavior must go beyond mere compliance with the law.
Managers of well-run enterprises increasingly have accepted the view that ethics pays and ethical
behavior is good business. 

In the wake of the financial crisis, enterprise risk management is a rapidly evolving discipline that places
ethical values at the heart of good governance, enterprise risk management and compliance. For example,
organizations such as COSO, the Ethics Resource Center (ERC), the Open Compliance and Ethics
Guidelines (OCEG) and the Ethics & Compliance Officer Association (ECOA) have developed detailed
guidance, from the board room to business units and key risk, control and compliance departments, on
implementation of effective enterprise risk management systems. Industry and sector specific guidance
has flowed from these general standards. As COS notes, integrity and ethical values are the pillars of an
effective compliance culture.

The effectiveness of enterprise risk management cannot rise above the integrity and ethical values of the
people who create, administer, and monitor entity activities. Integrity and ethical values are
essential elements of an entity’s internal environment, affecting the design, administration, and
monitoring of other enterprise risk management components.

Nowhere should this be more true than in financial services firms today, which depend for their existence
on public trust and confidence to a unique degree. Expectations are rising around the world for a stronger
culture of ethical behavior at financial services firms of all types and sizes. As the Basle Committee on
Banking Supervision recently stated:

A demonstrated corporate culture that supports and provides appropriate norms and incentives for
professional and responsible behaviour is an essential foundation of good governance. In this regard, the
board should take the lead in establishing the “tone at the top” and in setting professional standards and
corporate values that promote integrity for itself, senior management and other employees. 

As the standards for ethical behavior continue to evolve, your firms’ key stakeholders – shareholders,
clients and employees will increasingly expect you to meet or exceed those standards.

In my first speech here at the SEC I outlined ten elements I believe make an effective compliance and
ethics program. These elements reflect the compliance, ethics and risk management standards and
guidance noted above. They also reflect the U.S. Federal Sentencing Guidelines (FSG), which were
revised in 2004 to explicitly integrate ethics into the elements of an effective compliance and ethics
program that would be considered as mitigating factors in determining criminal sentences for
corporations. These elements include:
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 Governance. This includes the board of directors and senior management setting a tone at the top
and providing compliance and ethics programs with the necessary resources, independence,
standing, and authority to be effective. NEP staff have begun meeting with directors, CEOs, and
senior management teams to better understand risk and assess the tone at the top that is shaping
the culture of compliance, ethics and risk management.

 Culture and values. This includes leadership promoting integrity and ethical values in decision-
making across the organization and requiring accountability.

 Incentives and rewards. This includes incorporating integrity and ethical values into performance
management systems and compensation so the right behaviors are encouraged and rewarded,
while inappropriate behaviors are firmly addressed.

 Risk management. This includes ensuring effective processes to identify, assess, mitigate and
manage compliance and ethics risk across the organization.

 Policies and procedures. This includes establishing, maintaining and updating policies and
procedures that are tailored to your business, your risks, your regulatory requirements and the
conflicts of interest in your business model.

 Communication and training. This includes training that is tailored to your specific business, risk
and regulatory requirements, and which is roles-based so that each critical partner in the
compliance process understands their roles and responsibilities.

 Monitoring and reporting. This includes monitoring, testing and surveillance functions that assess
the health of the system and report critical issues to management and the board.

 Escalation, investigation and discipline. This includes ensuring there are processes where
employees can raise concerns confidentially and anonymously, without fear of retaliation, and
that matters are effectively investigated and resolved with fair and consistent discipline.

 Issues management. This includes ensuring that root cause analysis is done with respect to issues
that are identified so effective remediation can occur in a timely manner.

 An on-going improvement process. This includes ensuring the organization is proactively keeping
pace with developments and leading practices as part of a commitment to a culture of ongoing
improvement.

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In addition to the effective practices above, the NEP has also seen firms that have focused on enhancing
regulatory compliance programs through effective integration of ethics principles and practices. These
include renaming the function and titles to incorporate ethics explicitly; elevating the dialogue with senior
management and the board; implementing core values and business principles to guide ethical decision-
making; integrating ethics into key leadership communications; and introducing surveys and other
mechanisms to monitor the health of the culture and identify emerging risks and issues.

The Relationship of Compliance and Ethics with Enterprise Risk Management.

We can expand the discussion above beyond compliance and ethics to address enterprise risk
management and risk governance more broadly. These same program elements, and ethics considerations,
are equally critical, but the scope of risks expands beyond regulatory risk to also include market, credit
and operational risk, among others. The roles and responsibilities also expand to include risk
management, finance, internal audit and other key risk and control functions. Whether we’re talking about
compliance and ethics or we’re talking about ERM, it is important to clarify fundamental roles and
responsibilities across the organization.

 1. The business is the first line of defense responsible for taking, managing and supervising risk
effectively and in accordance with the risk appetite and tolerances set by the board and senior
management of the whole organization.

 2. Key support functions, such as compliance and ethics or risk management, are the second line
of defense. They need to have adequate resources, independence, standing and authority to
implement effective programs and objectively monitor and escalate risk issues.

 3. Internal Audit is the third line of defense and is responsible for providing independent
verification and assurance that controls are in place and operating effectively.

 4. Senior management is responsible for reinforcing the tone at the top, driving a culture of
compliance and ethics and ensuring effective implementation of enterprise risk management in
key business processes, including strategic planning, capital allocation, performance management
and compensation incentives.

 5. The board of directors (if one exists in the organization) is responsible for setting the tone at
the top, overseeing management and ensuring risk management, regulatory, compliance and
ethics obligations are met.

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While compliance and ethics officers play a key role in supporting effective ERM, risk managers in areas
such as investment risk, market risk, credit risk, operational risk, funding risk and liquidity risk also play
an important role. As noted above, the board, senior management, other risk and control functions, the
business units and internal audit also play a critical role in ERM. As ERM matures as a discipline, it is
critical that these key functions work together in an integrated coordinated manner that supports more
effective ERM. Understanding and managing the inter-relationship between various risks is a central tenet
of effective ERM. One needs only reflect on the financial crisis to understand how the aggregation and
inter-relationship of risks across various risk categories and market participants created the perfect storm.
ERM provides a more systemic risk analysis framework to proactively identify, assess and manage risk in
today’s market environment.

OCIE Considerations

As I discussed earlier, there is an ethical component to many of the federal securities laws. When NEP
staff examines, for example, an investment adviser’s adherence to its fiduciary obligations, or a broker-
dealer’s effective development, maintenance and testing of its compliance program, our examiners are
looking at how well firms are meeting both the letter and spirit of these obligations. In addition, our
examiners certainly examine specific requirements for ethical processes, such as business conduct
standards.

There is another way in which the ethical environment within a firm matters to us. As you know, our
examination program has greatly increased its emphasis on risk-based examinations. How we perceive a
registrant’s culture of compliance and ethics informs our view of the risks posed by particular entities. In
this regard we have begun meeting boards of directors, CEOs and senior management to share
perspectives on the key risks facing the firm, how those risks are being managed and the effectiveness of
key risk management, compliance, ethics and control functions. It provides us an opportunity to
emphasize the critical importance of compliance, ethics, risk management and other key control
functions, and our expectation that these functions have sufficient resources, independence, standing and
authority to be effective in their roles. These dialogues also provide us an opportunity to assess the tone at
the top that is shaping the culture of compliance, ethics and risk management in the firm. If we believe
that a firm tolerates a nonchalant attitude toward compliance, ethics and risk management, we will factor
that into our analysis of which registrants to examine, what issues to focus on, and how deep to go in
executing our examinations

Forced compliance theory

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Forced compliance theory is a paradigm that is closely related to cognitive dissonance theory. It
emerged in the field of social psychology.

Forced compliance theory is the idea that authority or some other perceived higher-ranking person can
force a lower-ranked individual to make statements or perform acts that violate their better judgment. It
focuses on the goal of altering an individual's attitude through persuasion and authority.

Festinger and Carlsmith

Leon Festinger and James M. Carlsmith (1959) conducted an experiment entitled "Cognitive

Consequences of Forced Compliance". This study involved 71 male students from Stanford University.
The students were asked to perform a tedious task involving using one hand to turn small spools a quarter
clockwise turn. The purpose was to make the task uninteresting and unexciting enough that none of the
participants could possibly find it enjoyable.

The experimental condition involved telling the subject before the experiment started that it would be fun,
while the control condition did not set any expectations for the task. The control subjects were asked to go
to a room to be interviewed. The experimental condition involved giving either $1 or $20 to try to
convince the next participant that the experiment was fun.

The results showed a significant difference between the groups. Another large difference was observed
between the $1 and $20 groups. However, no significant difference emerged between the $20 group and
control group. The results indicate that the smaller reward group ($1) had convinced themselves that the
experiment was fun.

Cognitive dissonance theory

Forced compliance theory is essentially a subset of cognitive dissonance theory. Cognitive dissonance
theory describes the unpleasant feeling that results from believing two contrary ideas at the same time. It
is most persuasive when it comes to feelings and thoughts about oneself. It is also a strong motivational
tool in influencing us to choose one action or thought over another.

Forced compliance theory is being used as a mechanism to help aid in projections of cognitive dissonance
theory.

A review of compliance theories

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Compliance and noncompliance are complex behaviors linked to a wide variety of causes that cannot be
easily brought together in a parsimonious whole (Coombs 1980; 2 This definition is close to Coombs’
(1980). It is more inclusive than “conformity with the law” (Hutter 1997: 16-17) because regulatees may
be asked to conform to expectations communicated in non-legal form (Hopkins 1994; e.g. Thaler and
Sunstein 2009). It is also less normative than “conformity with policy objectives” since expectations
communicated to regulatees may not be appropriate or sufficient to reach policy objectives (Coombs
1980; e.g. McBarnet and Whelan 1991).

Mitchell 1996).3 Some of these behaviors can be “automatic”, the product of habits and routines. By
contrast, “planned” compliance or noncompliance may epitomize the intentional pursuit of various goals,
such as to maximize one’s utility, fulfill a moral obligation such as duty or trust, or dispose of one’s fear
of sanctions. They may also sometimes be explained as the result of regulatees’ incapacity, incompetence,
ignorance or misunderstanding of regulatory prescriptions (e.g. Brehm and Hamilton 1996). Compliance
theorists usually focus on compliance as “planned” rather than “automatic” behavior. In agreement with
the Weberian approach to explaining behavior, they consider goal-oriented action as a satisfactory
approximation for actual action processes. This has led to many insightful analyses. Yet, to this day
fundamental problems remain unsolved, that have hampered the continuous development of compliance
theory. Two of them call for attention. Firstly, compliance theory should account for the empirically
demonstrated tendency of regulatees to pursue simultaneously several, heterogeneous goals.

Empirical studies show that there can be a combination of material, emotional and normative goals at
play in compliance and noncompliance behaviors (int. al. Alm et al. 1995; Fisman and Miguel 2007;
Gezelius 2002; Haines and Gurney 2003; Hutter 2001; May 2005; Parker 1999, 2006; Simpson 2002;
Tyler 2006; Wenzel 2004, 2005). For instance, a given regulatee may be trying to make a profit, protect
oneself against a potential loss, have fun, and act appropriately, all at once. These goals do not easily
translate into a common measure of utility. Hence, compliance theories relying on only one kind of these
motives, especially rational actor models of compliance (starting with Becker 1968) ignore and fail to
explain a significant share of the empirical reality, as numerous empirical studies have shown ([Link].
Braithwaite and Makkai 1991; Grasmick and Green 1980; Paternoster et al. 1983; Paternoster and
Simpson 1996).

Various ideas have been put forward to address this problem, but most of them are unsatisfactory. The
most common response by compliance theorists has been to combine several models of action. Taken
individually, each of these models ignores the complexity of motives observable in realistic settings. Yet,
taken together, these models can account for most observations, given that the population of compliers

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and non-compliers can be divided into, for instance, utilitarian “amoral calculators” (Kagan and Scholz
1984), “bad apples” (Bardach and Kagan 2002) or “opportunists” (Hood 1986) on the one hand, and
dutiful “virtuous” actors, “citizens”, or “good apples” on the other hand. The best known example is the
work of Ayres and Braithwaite (1992). It combines two incompatible theories: rational choice theory
(game theory) and the idea that norm internalization in trust relations may overcome opportunistic
temptations not to comply. This compromise between “a logic of consequences” and “a logic of
appropriateness” (Mitchell 2007) is representative of many contributions to the regulation literature (int.
al. Gunningham and Grabosky 1998; Gunningham et al. 2005; Hood 1986; Kagan and Scholz 1984;
Mitchell 2007; Scholz 1984; Sherman 1993; van Snellenberg and van de Peppel 2002).

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