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Ignacio J. Martínez-Moyano and David P. McCaffrey, Ph.D.

Rule Dynamics Competing Pressures in Norm Formation: Effectiveness Erosion of Control Systems in the Securities Industry. Ignacio J. Martínez-Moyano and David P. McCaffrey, Ph.D. 8 th MIT-UAlbany System Dynamics PhD Research Colloquium Sloan School of Management, MIT April 30th, 2004

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Ignacio J. Martínez-Moyano and David P. McCaffrey, Ph.D.

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  1. Rule DynamicsCompeting Pressures in Norm Formation:Effectiveness Erosion of Control Systems in the Securities Industry Ignacio J. Martínez-Moyano and David P. McCaffrey, Ph.D. 8th MIT-UAlbany System Dynamics PhD Research Colloquium Sloan School of Management, MIT April 30th, 2004 Cambridge, MA

  2. Overview • Purpose of the Research • The Case • Dynamic Hypothesis

  3. Financial SectorThe Problem and Motivation • Incredible attempts to change the way business is run in the Financial Sector that seems to be not effective. • Sustained increment in sanctions (leading to the $1.4 billion settlement between SEC and financial firms related to the Research Analysts’ Case)

  4. Financial SectorThe Problem and Motivation • Managers in Financial Firms are subject to pressures to produce and pressures to comply with the rules • Financial Firms are interested in playing fair and square to (1) gain reputation in the market, and (2) to protect the market. • Financial Firms are interested in avoiding regulatory action against them.

  5. Purpose • Elaborate a Dynamic Theory of Compliance in Securities Industry

  6. Market Behavior

  7. Policy Structure in Financial Sectorwith Multileveled Control Mechanisms

  8. Layers of Control… • Self-regulatory Organizations • NYSE, NASD • Public Regulators, Prosecutors • SEC oversees SRO’s (NYSE, NASD) • SRO’s oversee and set rules for Broker-Dealer Firms

  9. Layers of Control… Attorney representing firms: “[Representative John] Dingell beats on the SEC, the SEC beats on the Exchange, and the Exchange beats on us.” • Congress • Can redefine the rules and exert pressure on the system for change.

  10. Data • SEC’s Documentation of the $1.4 billion “Research Analysts’ Case” settlement with financial firms • Supplementary data from NYSE, NASD, and other sources • Legal cases, industry conference proceedings, reports, Congressional hearings, trade press, and other documents • Interviews with individuals across different levels of regulatory system and experts in securities regulation • Coding of NYSE disciplinary cases: • Cases from 1990-2003

  11. Hypothesis

  12. Control Systems vary in Effectiveness Interactive Layers of Actors in the System manage to deal with complex problems through informal ‘networked’ arrangements Also, informal networks can come to “live with” certain questionable practices (the “normalization of deviance”) Control Systems seem to respond to ‘external’ shocks from other layers in the system. Some Inferences

  13. Mix of: Rule-following preferences Propagation of changes in systems of rules Erosion of compliance standards (change in norms) Erosion of risk-perception capacity Modeling Effort—Financial Sector

  14. Questions?

  15. Thanks!

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