NY Regulators Pose New Challenges to Compliance Officers

The phrase “new sheriff in town” may be a cliché, but it seems to fit nevertheless when referring to New York’s Department of Financial Services.

Created in 2011, the NYDFS is a state agency that regulates financial services and products within its borders. Benjamin Lawsky, previously an assistant U.S. attorney, was named to head the new regulator, and during his tenure the agency has taken a prominent role alongside federal regulators. In fact, by doing away with political niceties, the NYDFS has proven to be faster and harsher when meting out punishment.

While federal regulators talk a good game about holding individuals personally accountable for regulatory failures, for example, their track record doesn’t quite support that claim. In February, Attorney General Eric Holder started a 90-day clock for the Justice Department to determine whether it can charge individual Wall Street executives for crimes related to the financial crisis. That’s a departure from the usual federal approach: agree to big money settlements, and move on.

In New York, enforcement is much more personal. Last year the NYDFS forced French mega-bank BNP Paribas to fire 13 employees, including its chief operating officer, following sanctions violations. The chairman of Ocwen Financial was also forced out by the agency as part of a settlement over mortgage servicing violations. Royal Bank of Scotland’s 2013 settlement for sanctions violations included firing the head of an international banking unit plus three other employees, and clawing back bonuses from eight others. Credit Suisse Group, Deloitte, MetLife, and PwC have all felt the wrath of the young agency.

“The NYDFS has a somewhat broader set of authorities than most of the banking departments around the country. They are one of the few states that have their own criminal prosecutorial unit, and having such a uniplays a huge role in how it is approaching these issues.”
Carol Van Cleef, Member, Manatt, Phelps & Phillips

In many ways, the headline-grabbing efforts of the NYDFS, and to a lesser degree the state’s attorney general Eric Schneiderman (who just proposed a new whistleblower program for the financial industry), is made possible by New York’s unique position compared to other states. If you are a bank, especially one that does business internationally, you need to be in New York and you need to be licensed there. So you cannot escape the NYDFS and the state attorney general.

“The NYDFS has a somewhat broader set of authorities than most of the banking departments around the country,” says Carol Van Cleef, a member of the banking practice at the law firm Manatt, Phelps & Phillips. “It is one of the few states that has its own criminal prosecutorial unit, and having such a unit plays a huge role in how it is approaching these issues."

“The New York regulators tend to be leaders on the regulatory and enforcement side amongst states, but it reflects a general trend of states getting more actively involved,” says Andrew Sandler, chairman of the law firm BuckleySandler. He views the NYDFS as “a bellwether for issues of concern to the broader regulatory community.”

Lawsky’s debut was a series of enforcement actions action against international banking giant Standard Chartered in 2012. The NYDFS extracted a $340 million settlement from the bank after threatening to revoke its license over allegations it willfully ignored Iranian sanctions. The big fine came independently of negotiations between the bank and federal regulators, and not without a fair share of political squabbling. The message sent to big banks: worry about New York, it can be even tougher than traditional bank regulators.

“I remember thinking that this could forever change the way state banking regulators do things, certainly the way things get done in New York,” Van Cleef says. “The gloves came off.”

Gauntlet Is Thrown

One of Lawsky’s boldest announcements came in a February speech at Columbia Law School. Citing the importance of stamping out money laundering, he pledged to redouble his agency’s efforts to go after the individuals involved, as well as to routinely audit AML controls and focus on transaction monitoring and filtering systems.

A CALL TO STATE REGULATORS

The following are selections from a Feb. 25 speech delivered by Benjamin Lawsky, superintendent of Financial Services for the State of New York, at Columbia Law School. In it, he addressed the role of his agency, “financial federalism,” and why states should take a more active role in financial regulation.
We have a great deal of respect for our counterparts. At the federal level, they very often have expertise and resources that state regulators simply cannot match. And the people who work at the federal regulatory agencies are exceptionally talented. But there have been instances – and, again, I think this is something most people will admit – when certain aspects of financial regulation went off track.
State governments can often serve as incubators for new approaches to vexing policy problems. States can experiment. Try new things. And if their ideas prove effective – and rise to the top of the crowded marketplace of ideas – those policy proposals may be adopted beyond their borders. However, the “laboratories of democracy” concept is not typically applied in the context of financial regulation. To be fair, there are some reasonable explanations for that. In an increasingly mobile and global financial landscape – where money moves around the world in a matter of milliseconds – there are risks associated with fragmentation in financial regulation. Market actors can potentially try and move their operations to dark, unregulated corners of the globe – a concept known as regulatory arbitrage.
State financial regulators, then, can and should play a similar role to the state-level reformers of the early 20th century. We should strive, of course, for a collaborative and cooperative relationship with our federal partners. That is certainly our goal at DFS. But states also should not be afraid to speak up and act if we spot new risks emerging in the market. If we believe that certain regulatory protections are not sufficiently robust to root out reckless behavior that threatens the health of our economy. If we think that current approaches to enforcement and prosecution are not effectively deterring wrongdoing on Wall Street.
It should be noted that federal regulators have to deal with an extremely broad expanse of issues. Put simply, no matter how well intentioned, they have a lot on their plate. So there is a risk that certain issues fall through the cracks. Financial federalism can help address that issue. Of course, state regulators by no means have a monopoly on the truth. And there is a risk that they will become captured by and beholden to the industries they regulate. Or create fragmented rules across jurisdictions. Indeed, it is important that states proceed with an appropriate sense of humility. But if we get things right, if our efforts prove effective, we can perhaps serve as positive examples and help spur a race to the top.
Source: New York Department of Financial Services.

Given the hundreds of millions of transactions that move through a large bank’s payments system, banks rely heavily on automatic transaction monitoring and filtering systems to flag suspicious payments and bring them under the scrutiny of compliance personnel. Problems with these systems can be inadequate or defective design and programming, faulty data input, or a failure to regularly update detection scenarios.

Failures can also be “willful blindness or intentional malfeasance by bank management, or employees who, perhaps, turn down the sensitivity of the filters so the systems do not generate enough alerts and suspicious transactions go undetected,” Lawsky said.

Lawsky, therefore, wants to stop waiting for companies to self-report, and start studying those transactions in the NYDFS’ own filtering system—and then making senior executives, typically CEOs and CFOs, personally attest to the adequacy and robustness of those systems. It is an idea modeled on the Sarbanes-Oxley Act approach to accounting fraud.

“What regulators have not done is actively test the effectiveness of the filtering systems banks are using,” Lawsky said, blasting their “whack-a-mole approach.” 

His idea is a “game changer,” says Matthew Schwartz, a partner with the law firm Boies, Schiller & Flexner. “Senior executives will personally be on the hook for faulty AML controls, a potentially scary prospect, and one that should cause them to become as personally involved in AML compliance as they are in financial reporting. If you have ever talked to a CEO or CFO about the sort of work that goes into a SOX certification, you know it is an enormous change to have to do the same sort of thing with AML risk.”

Lawsky’s activities aren’t necessarily taking place in a vacuum of federal action. The Office of the Comptroller of the Currency, like other federal bank regulators, has made a push in recent months to demand that financial institutions focus on “culture” and “tone at the top.” New York’s push for executive accountability—in prosecutions, demands for termination, and attestation requirements—dovetails with Federal efforts to force executive oversight and empower compliance officers.

There are concerns about New York’s more aggressive approach, especially if compliance officers face as much heat as top executives when controls fail. Van Cleef says one compliance officer recently lamented to her: “Bank management has no problem going out and spending $2,000 in a day on the golf course, but to send me to training for three days is something they just don’t see the value in.” The point: Most in the compliance role do the best they can with the tools and resources they are allowed. Which isn’t the same as the tools and resources they would like.

“The regulatory community needs to be careful, because you want very talented people who understand regulatory expectations and are willing to serve in senior roles, particularly in the compliance function,” Sandler says. “If you create a situation of enormous personal liability, then the most able people are going to look for different kinds of professional opportunities. You don’t want to create a brain drain away from the risk and compliance functions that are needed by sophisticated financial institutions.”

Amid the ramped-up enforcement posture in New York, Sandler’s advice is to take things in stride. “There are always going to be different levels of aggressiveness among regulators,” he says. “All an organization can do is understand the best compliance and risk-management practices and ensure that their organizations are operating at that level. There is never going to be a magic bullet that keeps some regulator, somewhere, from coming after you.”

While most state regulators don’t have the resources or geographical importance of New York’s regulators, the Empire State’s actions could embolden others. That too may be a cause for concern.

“If all 50 state regulators try to be NYDFS, it is really going to be a problem,” Schwartz says. “If everyone jumps on the bandwagon … and we have to deal with more and more regulations from more and more regulators, it just makes it harder to do business. You already see companies leaving jurisdictions or leaving business lines that are profitable, but where the regulatory risks are just unacceptable.”