Financial Compliance

Financial Compliance is operating in accordance with or adhering to the rules and regulations defined by regulators. This may be specific to financial institutions and the regulations they follow while dealing with financial matters. Compliance (financial or otherwise) may be universal or specific to an institution following internal policy guidelines.

The ability to initiate significant changes in accounting practices, information systems, organizational responsibilities, and control systems makes compliance a strategic activity. On the other hand, non-compliance is the failure to comply with the required laws, rules, regulations, standard practices, and code of conduct. It may result in risks such as legal and regulatory sanctions, reputational damage, or financial loss, among other grave repercussions.

Key Takeaways                                                               

• Financial compliance means adhering to the guidelines defined by the relevant governing bodies (government or other institutions) and ascertaining if all financial reporting and disclosure requirements have been met.
• Such guidelines generally cover matters related to adhering to the rules governing businesses and financial markets. These regulations ensure fairness, help manage conflicts of interest, oversee product and service quality, etc.
• To enforce such rules, governing bodies pass legislation and issue standards at local and international levels, depending on the law in question.
• Financial compliance ensures organizations meet legal and regulatory requirements, pay taxes on time, manage finances well, mitigate risks, and boost investor confidence.

Financial compliance refers to the steps taken to comply with statutory or other requirements. It also means abiding by the guidelines and recommendations financial institutions issue to enable entities to deal with financial matters. Financial compliance rules and laws have various origins. They generally cover matters related to adhering to proper standards of conduct for business and in financial markets.

These regulations help manage conflicts of interest, facilitate the fair treatment of customers and other stakeholders, ensure the delivery of quality services, enable accurate and timely tax payments, etc. The scope of this function is wide, and these regulations also aim to prevent serious threats like money laundering, terrorist financing, and monetary and other criminal offenses.

Financial compliance guidelines come from various sources, including primary legislation, statutory regulations, and standards issued by local and international bodies. For instance, Basel Committee regulations apply to banks, and the Generally Accepted Accounting Principles (GAAP) are applicable in accounting. In the US, the Federal Reserve, the Central Bank of America, ensures compliance with monetary policy. Similarly, the Securities and Exchange Commission (SEC) looks into the regulatory issues related to financial markets.

Different regulatory authorities may deal with compliance, depending on local and international regulations. Certain industry associations, market conventions, internal conduct practices of supervisors, etc., may define and propagate specific codes of conduct. When every company in an industry ensures proper compliance, it promotes healthy competition. The spectrum of compliance goes beyond egalitarian standards and involves an issue of ethical conduct and integrity.

Regulations

Companies follow different rules and standards based on their industry and reporting requirements. KPMG, a renowned professional services company, shared guidelines to help companies streamline compliance in financial services. This paper was first published in 2019. It was later revised to incorporate the post-COVID-19 changes in business. Certain functions an organization must follow to ensure compliance have been outlined in this published paper. Some of them have been listed below:

• The compliance processes organizations employ should support the business by adapting to industry changes and business requirements.
• These processes must enable companies to operate in a fashion that promotes transparency, shows strategic vision, and delivers results suited to the modern business environment.
• They should focus on practical and proactive methodologies or systems.
• They should be defined based on the skills and capabilities of the people in an organization. It recommends periodic assessments across departments and suggests gaps should be filled regularly.
• Technology should be incorporated wherever required, such as deploying financial compliance software, and processes need to be optimized whenever required.

Let us discuss some examples in this section to explain the concept further.

Example #1

Suppose Dan, the owner of XYZ Enterprises, encounters an accounting issue where a significant revenue transaction was recorded incorrectly, leading to an overstatement of financial performance. Recognizing the importance of financial compliance, Dan takes several steps to rectify the situation. He consults with a GAAP-specialized CPA to understand the relevant accounting standards and identify areas for improvement. He strengthens internal controls, such as segregation of duties and regular reconciliations, to prevent future errors.

In addition, he works with his finance team to strengthen control procedures, such as task segregation, process documentation, and regular reconciliations, to prevent future accounting errors. He also instructs the finance team to review and adjust the company's financial statements per GAAP guidelines. To ensure ongoing compliance, Dan organizes training sessions for the team to enhance their understanding of GAAP principles and procedures.

Example #2

Toronto-Dominion Bank was in the news due to anti-money laundering allegations, which surfaced when the bank published the financial reports for the 3rd quarter. This prompted an investigation into its operational and financial records. The bank has received inquiries pertaining to adherence to the provisions of the Bank Secrecy Act. The bank’s implementation of the AML Compliance Program is also under scrutiny.

The news report says the US Department of Justice will be involved in this investigation. TD Bank may be required to pay penalties shortly when the inquiry concludes. This shows the effects non-compliance or alleged non-compliance can have on an organization.

Organizations have different methods of implementing financial compliance regulations. Most focus on shifting company culture—a shared set of values—which shows an organization's fundamental philosophy. It is fundamental to how an organization and its employees think and act. People's views on, say, customers and compliance are shaped and influenced by the culture. Integrating compliance into the organizational culture is essential for strong compliance within an institution.

It is possible to build an entity's functions in a way consistent with its goals, where employees are guided by organizational culture. Their everyday practices and habits must mirror the values and ethics a company follows.

Compliance processes must outline how financial and human resources will be distributed across various tasks. This ensures compliance becomes an integral part of organizational behavior. For the compliance culture to be effective, consistency is needed at every level across the organization.

Financial compliance is crucial for businesses due to various reasons. They have been discussed below.

• Legal Requirements: Compliance ensures every activity in an organization is legal, as requirements outlined by financial regulations, laws, and reporting standards are adequately met. Failure to comply can lead to penalties, fines, and legal consequences. It may damage an organization's reputation.
• Trust and Transparency: Financial compliance fosters trust and transparency among stakeholders, such as investors, shareholders, customers, and the public. It shows the organization's commitment to ethical and responsible financial practices.
• Effective Financial Management: Financial compliance helps establish strong financial management practices, including accurate record-keeping, timely reporting, and effective internal controls. These practices support sound decision-making and risk management and promote financial stability.
• Investor Confidence: Compliance with financial regulations boosts investor confidence. Investors look for accurate and transparent financial information to make informed investment decisions. This may pave the way for additional investment opportunities. On the other hand, non-compliance can discourage potential investors and erode existing investors' trust.
• Risk Mitigation: Compliance aids in identifying and mitigating financial risks. Implementing proper controls can reduce the risk of fraud, errors, and financial mismanagement. Financial compliance software can help with this goal. This protects a company’s assets and preserves its reputation.