It is no understatement that the regulatory world is in a state of upheaval. As President Trump and a Republican-majority Congress crunch into a promised agenda of deregulation, federal agencies will undoubtedly be slimming down their binders of rules and rethinking enforcement postures.
That paring back, however, could create a hole that some state regulators will be more than happy to backfill. The big question: Could efforts to weaken the Consumer Financial Protection Bureau and chip away at the Dodd-Frank Act embolden a new patchwork of state-driven regulations designed to replicate what was taken away?
“It is one of the big questions facing our department and fellow regulators around the country,” says Thomas Dresslar, deputy commissioner of policy and planning at California’s Department of Business Oversight.
California and New York are among the large states well suited for a frontline regulatory role. As home to the nation’s leading companies and a U.S. base for many foreign countries, both are uniquely positioned to enforce their own compliance demands. Where they tread, other states frequently follow.
Dresslar expects state regulators to quickly act if, for example, pending CFPB rules for payday lenders are rescinded or otherwise defanged. “If the rules go by the wayside, then states definitely would have an opportunity and more freedom to step in and adopt their own rules going forward,” he says.
As states seek to replace bank regulations or consumer protections gutted by either legislation or executive order, they run the risk of the federal government rolling back safeguards against the preemption of their regulatory authorities.
Dresslar recalls a “one-two punch” by the Bush Administration in the early 2000s. “You had the federal government deregulating in the financial services arena and, at the same time, there were aggressive moves by federal bank regulators to preempt state law and the states’ abilities to enforce their laws,” he says. “It would be a very disturbing outcome if, once again, the federal government was pulling back and, at the same time, making sure that states can’t step in.”
California is no stranger to that threat. Dresslar recounts the political atmosphere surrounding the California Financial Information Privacy Act. The state law, effective July 2004, established that a financial institution may not share or sell a consumer's “non-public personal information” without obtaining a consumer's consent.
“It is mind boggling to see, at the other side of the table, 20 federal and state regulatory agencies coming after clients for the same facts and the same grievances, only in different settings and jurisdictions.”
Thomas Vartanian, Partner, Dechert
“After we passed it, the federal bank regulators went to court, along with the banks, to try to block the law on a pre-emption grounds,” he says. “Ultimately they were not successful, but it shows what could happen and what state regulators are worried about throughout the country.”
That threat aside, Dresslar sees states as ready, willing, and able to accept an expanded role. “Since the election, there have been half joking comments, ‘So, are you guys going to be the new CFPB?’ A lot remains to be seen, but we will be birddogging it very closely and hopefully be nimble in reacting to what happens," he says.
As for the North American Securities Administrators Association, which represents the interests of state securities agencies, it is striking a more cautious tone.
“As we have for nearly 100 years during all administrations in Washington, state securities regulators will continue to work hard to carry out our responsibilities to protect investors and provide a regulatory framework for responsible capital formation,” NASAA President and Minnesota Commissioner of Commerce Mike Rothman said in a statement.
A textbook example of a state regulator creeping onto federal turf is New York’s Department of Financial Services. Taking advantage of its geographic importance to the global banking sector, it has churned out rule after rule for the financial world.
It was created in 2011 by merging the state’s former banking and insurance departments. Since that time, it has collected billions of dollars through enforcement actions.
As of Jan. 1, NYDFS has new, risk-based anti-terrorism and anti-money laundering regulations in effect. Its regulated institutions must maintain programs to monitor and filter transactions for potential Bank Secrecy Act anti-money laundering violations and prevent transactions with sanctioned entities. Institutions must certify compliance with the regulation annually to DFS.
The agency is also crafting “first-in-the-nation” cyber-security regulations for the banks, insurance companies, and other financial services institutions it regulates. Other rules and legislation would ban bad actors from banks and insurance firms doing business in the state.
“New York is the financial center of the world, and we have zero tolerance for those who seek to defraud customers and undermine the system," Governor Andrew Cuomo said in a recent statement. “New York, in its role as a regulator, is seeking to take bold steps to crack down on unacceptable behavior and ensure bad actors are barred from working in this industry once and for all.”
The threat of federal preemption of state laws is, perhaps more so than in other states, a dilemma for New York’s officials. Several federal laws, including the Truth In Lending Act, empower state attorneys general enforcement authority. A handful of states give securities regulators the authority to bring criminal cases.
New York, specifically and uniquely, also benefits from the Martin Act, which empowers the state’s attorney general to file civil and criminal charges with a lessened burden of proof in securities cases. The misrepresentation or omission of a material fact is sufficient to bring a case.
THE MARTIN ACT
The following is a selection of the text of New York’s Martin Act.
The attorney general, his deputy or other officer designated by him is empowered to subpoena witnesses, compel their attendance, examine them under oath before him or a magistrate, a court of record or a judge or justice thereof and require the production of any books or papers which he deems relevant or material to the inquiry. Such power of subpoena and examination shall not abate or terminate by reason of any action or proceeding brought by the attorney general under this article.
No person shall be excused from attending such inquiry in pursuance to the mandates of a subpoena, or from producing a paper or book, or from being examined or required to answer a question on the ground of failure of tender or payment of a witness fee and/or mileage, unless at the time of such appearance or production, as the case may be, such witness makes demand for such payment as a condition precedent to the offering of testimony or production required by the subpoena and unless such payment is not thereupon made. The provisions for payment of witness fee and/or mileage do not apply to any officer, director or person in the employ of any person, partnership, corporation, company, trust or association whose conduct or practices are being investigated.
If a person subpoenaed to attend such inquiry fails to obey the command of a subpoena without reasonable cause, or if a person in attendance upon such inquiry shall without reasonable cause refuse to be sworn or to be examined or to answer a question or to produce a book or paper when ordered so to do by the officer conducting such inquiry, or if a person, partnership, corporation, company, trust or association fails to perform any act required hereunder to be performed, he shall be guilty of a misdemeanor.
It shall be the duty of all public officers, their deputies, assistants, subordinates, clerks or employees and all other persons to render and furnish to the attorney-general, his deputy or other designated officer when requested all information and assistance in their possession or within their power. Any officer participating in such inquiry and any person examined as a witness upon such inquiry who shall disclose to any person other than the attorney-general the name of any witness examined or any other information obtained upon such inquiry except as directed by the attorney-general shall be guilty of a misdemeanor.
Source: State of New York
New York Attorney General Eric Schneiderman forcefully responded to reports that President Trump was considering ways to dismantle state consumer and investor protection statutes, also known as Blue Sky laws.
“In many cases, these anti-fraud statues are consumers’ and investors’ first line of defense against exploitation, particularly when retail and institutional investor dollars are in the hands of increasingly complex and opaque financial institutions,” he said. “Any attempt to gut these consumer and investor protections would severely undercut state police powers and only embolden those who seek to defraud and exploit everyday Americans.”
“At a time of regulatory uncertainty at the federal level, it is essential that we maintain the very laws that have helped state and local law enforcement keep consumers and investors safe for over 100 years,” he added.
Roughly 35 years ago, Thomas Vartanian, now a partner at the law firm Dechert and head of its financial institutions practice, predicted that the dual system of state and federal banking regulation would eventually fade away, leaving the latter with sole oversight.
“Just the opposite has happened, particularly with the advent of state attorneys general taking on a more aggressive and active role in the area of consumer protection,” he says.
In his view, and that of many financial institutions, it is not a laudable development.
“We are now at the point where something has to be done to evaluate the overall regulatory burden, both federal and state,” Vartanian says. “It is mind boggling to see, at the other side of the table, 20 federal and state regulatory agencies coming after clients for the same facts and the same grievances, only in different settings and jurisdictions.”
The process, he says, needs to be more streamlined.
“Something has to be done … whether it is memorandums of understanding between the regulators or some sort of treaties or statutes, but there is no reason that one regulator cannot be designated to take on an issue with others taking a background role, just as a matter of efficiency,” Vartanian says. “We can’t keep heaping on, year after year, more regulators and more and more rules and think that it is going to create more efficiency and better more safety and soundness. It doesn’t.”