Compliance risk and non-verifiable judgments

I’ve recently started reading Daniel Kahneman’s new book “Noise“. Like his previous book “Thinking, Fast and Slow” it’s what I would call a contemplative read, one that introduces concepts and stimulates thinking. I like these kinds of books. One of the concepts in “Noise” that he considers (in chapter 4, I’m still reading!) is that of verifiable and non-verifiable judgments.

Noise: The new book from the authors of ‘Thinking, Fast and Slow’ and ‘Nudge’ by [Daniel Kahneman, Olivier Sibony, Cass R. Sunstein]

In short, a verifiable judgment is one where the outcome can be verified. So predicting tomorrow’s weather is a verifiable judgment as you can very quickly validate whether the prediction of rain or shine was correct. In business and life, many decisions are verifiable but others, many of the most important ones you will make, are non-verifiable. This can be because at the point that the judgment is made they are impossible to test, have dependencies in how they play out, or that the time frame for validation is just too long.

Making a decision on the right business strategy. Selecting your partner for life. Lowering emissions to address global warming. At the critical decision point that these are made, these judgments all fall into the non-verifiable category. They may have been informed by the best available evidence, business trends, dating history, or scientific principles, but the timeline and dependencies make the actual judgments non-verifiable. As Steve Jobs suggests you need the luxury of hindsight to really prove you are right, so you have to trust in the judgments that you make.

“You can’t connect the dots looking forward; you can only connect them looking backwards. So you have to trust that the dots will somehow connect in your future”

Steve Jobs, 2005 Commencement Address

The world of risk, compliance, and financial crime prevention is full of non-verifiable judgments. As a financial crime officer, you have to make judgments on your risk policy and decide if it sufficiently protects your institution from financial crime or future regulatory action. In the last few years, we have seen a significant regulatory push for attestation and senior management accountability. This is all about trying to make those non-verifiable judgments verifiable, or at least to ensure sufficient due diligence is done in policy and process implementation and ongoing review.

Life would be easier if every judgment was verifiable. For this to happen we need things to be measurable, testable, and have rapid feedback to assess results and outcomes. We proved years ago that this is possible for sanctions filters, where outcomes can be measured against synthesized data and matched to the risk policy. There have been a few attempts to do the same for other areas of AML such as transaction monitoring but these are more difficult problems. It is possible to validate thresholds and settings of transaction monitoring tools but to answer the question of whether those systems are keeping money launderers at bay is one that puts us back into the land of non-verifiable judgments. This is especially true given a global regulatory framework that provides limited direct feedback on results against the millions of suspicious activity reports that are filed by banks and financial institutions annually.

In the new digital world, it is possible to verify the impact of website and mobile app changes, marketing campaigns, and sales initiatives in days rather than years or months. The speed of feedback for regulatory compliance looks archaic in comparison.

There are two take-aways here.

The first, that there is still a huge market opportunity for someone that can really crack the challenge of creating tools to make AML transaction monitoring and other compliance systems truly verifiable. Vendors continue to try, BAE Systems, Cable, AML Analytics, and others are moving in this direction but no one yet is doing it well. And anyway, shouldn’t these be capabilities be embedded in the AML transaction monitoring systems themselves?

The second, that there is no surprise that we already have evidence that fast feedback and qualified outcomes work. The UK National Crime Agency reports significantly better outcomes for Defence Against Money Laundering (DAML) over traditional suspicious activity reporting. DAMLs provide a fast feedback loop that allows iteration and improvement that helps make some of those non-verifiable judgments verifiable. One day all compliance will work this way!