New York’s Benjamin Lawsky Collects Scalps, Showing Regulators Can *Gasp* Regulate

Cynicism is a safe default assumption, but it sometimes leads readers to take the point of view that action is always futile and that any positive-looking action by someone in a position of authority must have a sneaky hidden motive that hasn’t been unearthed yet.

From this assumption, it follows that regulation will be ineffective because the regulators will be cowed, outmaneuvered, or corrupted by industry incumbents. And these days, that is overwhelmingly the case. However, in America, we’ve also had generation-plus periods were regulators on the whole have been public minded and believed in doing their job. We can’t turn the clock back, but it makes sense to look at exceptions to our generally sorry conditions to see when and how regulators have been effective despite the way the deck has been stacked against them (meager budgets, low pay, lack of status in regulatory jobs, among other impediments).

New York’s Superintendent of Financial Services, Benjamin Lawsky, has taken scored some significant wins from what would normally be a pretty disadvantaged spot. New York state not long ago combined its regulation of banks and insurers into a single function. But state regulators, who once has some clout on the securities and banking front, have seen their authority eroded over time through bank deregulation, unfavorable court rulings, and notions like “preemption” (that the OCC can wave state regulation of national banks).

Insurance is a bit of a different beast. Insurers have long been regulated on a state level, and (if you’ve ever looked at a statutory filing) the disclosure is simply remarkable. But with insurers typically putting insurance subsidiaries in multiple states (and in the property and casualty businesses, using reinsurers, some of whom are offshore), the clout any one state insurance regulator has is usually seen as limited.

Yet Lawsky, who was a Southern District of New York prosecutor before he became a regulator (as in he didn’t have a background in banking or insurance) has run rings around Federal banking regulators (not that that is all that hard). He became notorious in his initial salvo during the negotiation of the money laundering settlement for recidivist rule-breaker Standard Chartered, which persisted in dealing with Iran and scrubbing bank wires against the stern warnings of its outside counsel. Lawsky informed the Fed (one of the parties to the settlement, although the bank toady Treasury was the lead actor) that he’d like to pursue his own investigation and got the nod. Big mistake.

Lawsky filed a blistering order detailing the bank’s appalling conduct (it eventually admitted $250 billion of transactions were out of compliance) and threatened yanking Standard Chartered’s New York license. That was a huge threat, since that would also mean Standard Chartered would lose direct access to dollar clearing services. It could in theory go through correspondents, but that would signal its end as an international player. Both the Treasury and British regulators went to war against Lawsky, but there was nothing they could do, since he was operating within his authority. Well, take that back, they did get their revenge by excluding him from the negotiations (and hence key information) in the next big foreign bank money laundering settlement (foreign banks typically set up branches in New York, which also put them under New York’s purview), that of HSBC. Needless to say, there was a huge uproar at the failure to get indictments or meaningful punishment of individuals when the scale of its misconduct was made public.

Lawsky’s recent scores haven’t gotten the same level of media attention, but they are still important and show determination. After his $350 million settlement with Standard Chartered, he went after their partner in crime, Deloitte, fining them $10 million and barring them from taking new work for matters relating to his office for a year. The New York Times described how:

Mr. Lawsky’s office controls access to regulatory documents that consultants need before advising a bank. Mr. Lawsky will choke off access to firms that fail to meet a new set of standards introduced on Tuesday. The standards include a requirement that consultants disclose whether any bank has “substantively reviewed or commented” on reports that the consultants submit to regulators…

Under a 2004 agreement with state and federal regulators, Standard Chartered hired Deloitte to spot suspicious money transfers routed through its New York branches. But when it came time for Deloitte to submit a report to regulators, Mr. Lawsky said, the consultant caved to pressure from the bank and watered down its recommendations.

He identified 17 life insurers who had shifted $48 billion of liabilities to thinly-capitalized subsidiaries in other states . The effect, natch, is to allow them to operate with less in the way of surplus (insurance speak for capital) than New York requires so they could pay more dividends and bigger executive bonuses.

This is serious for several reasons. Of all the major types of financial products, life insurance is the easiest to abuse and hence one that is critical to regulate well. Insures take your money and then pay you later if/when something happens. If they don’t have the money when your claims come in, their answer is fraud, as in denying payment on valid claims. Insurance is regulates more strictly in the US than in other advanced because it is a much bigger component of our social safety net. And having looked at AIG’s reinsurance in its property and casualty subs (fiendishly complicated, a team of five, including two serious mathematicians and a former state insurance regulator) gave up after a couple of weeks at trying to analyze it because we lacked the manpower (note it took Lawsky 11 months to complete his probe). It isn’t just that this practice amount to regulatory arbitrage, but that it vitiates one of the important reasons for state-based insurance regs, namely that the regulator in each state can make sure state residents are buying decent products. This sort of “shadow insurance” means you can’t look at the detailed state regulator filings; the insurance company has effectively knitted the operations of insurance subs in several states together. And to make matters worse, state insurance subs can set financial statement closings on different states at different dates, making it impossible to analyze them based on the reported numbers alone.

Jonathan Weil at Bloomberg gives a good recap of Lawsky’s second score this week:

The superintendent of the New York State Department of Financial Services today said Bank of Tokyo Mitsubishi-UFJ Ltd. agreed to pay $250 million to settle allegations that it violated state banking laws when it carried out transactions with Iran and other countries subject to international sanctions. You have to wonder, too, what’s going on over at the Treasury Department’s Office of Foreign Assets Control.

In December, the Treasury division concluded a parallel investigation of Bank of Tokyo and settled for only $8.5 million. The contrast reinforces the perception that the feds are going light on large financial institutions, and that Lawsky is out to fill the vacuum where he can using New York state laws.

The disparity between the Treasury’s pathetic fine and Lawsky’s result should embarrass Federal regulators, but the DC crowd is deeply invested in protecting banks, no matter how terrible their conduct.

So what lessons can we derive from Lawsky’s performance?

First, the banks and their minions have snookered the public with trying to persuade them that only insiders can hope to keep up with them (and by implication, insiders will respect the industry code of omerta since they want to keep earning the big bucks). The fact is a lot of people leave the industry for a host of reasons and can provide the needed insight into tradecraft when it’s critical. But Lawsky hasn’t even needed to go deep into the woods to start attacking major abuses. This is, after all, a target-rich environment.

Second is that former prosecutors are a good pool for finding relentless regulators. Recall that Neil Barofsky also came out of the Southern District of New York and like Lawsky, had no background in finance. Yet he got high marks for his work at SIGTARP despite constant sniping from the Geithner Treasury.

Third is having a boss who is on board or otherwise having a fair bit of freedom of action. Governor Cuomo is backing Lawsky (and given the considerable animosity between Cuomo and New York attorney general Eric Schneiderman, Cuomo probably also relishes having Lawsky upstage the state AG, which is typically a much more powerful and high profile post). Barofsky was an inspector general, a supposedly independent post, and mirabile dictu, treated it that way. And item three is why Mary Jo White is turning out to be such a disappointment. It’s remotely possible she’ll file some cases that will redeem her (case development takes time) but she’s given so much ground on regulatory issues that that notion looks like wishful thinking. She clearly has the chops to be effective. While the SEC depends on Congressional appropriations and can (and has) had Congresscritters threaten its funding, she has enough of a reputation that she could get enough favorable media attention if she were to get serious about enforcement to blunt legislative counterattacks.

So let’s hope Lawsky continues to take ground against the banks. The more he brings big institutions to heel, the more he shows that there’s no excuse for regulatory cowardice.