Mike Groll/Associated PressBenjamin M. Lawsky, New York’s superintendent of financial services.New York State’s top financial regulator is preparing to crack down on the consulting firms that banks hire to navigate legal problems like money laundering and wrongful foreclosures, according to people briefed on the plans.
In an attempt to force change upon a sector that operates with scant supervision and produces mixed results, Benjamin M. Lawsky, New York’s superintendent of financial services, plans to use an obscure state banking law to rein in banks’ use of consultants, these people said.
Among the aggressive moves under consideration, Mr. Lawsky is said to be weighing whether to ban temporarily at least one firm with a poor track record from advising banks chartered in New York. His office is also considering a new code of conduct for consultants, the people briefed on the plan said.
The state regulator’s plan is the latest threat to the multibillion-dollar consulting industry, which has already come under fire in Washington as it has evolved into something of a shadow regulator of Wall Street. In recent months, consulting firms have been faulted with inadequately handling several prominent bank regulatory problems. In a review of millions of home foreclosures nationwide, for example, consultants racked up more than $2 billion in fees while struggling to complete the assignment. In other cases, consulting firms have been accused of either underestimating the amount of tainted money routed through a bank or even enabling banks to escape regulatory scrutiny for wrongdoing.
The consulting industry, which includes some of the world’s largest accounting firms, has long defended the quality and independence of its work.
Yet the momentum for change stems from a fundamental concern about its business model: that it is fraught with conflicts of interest. While consultants are expected to take a critical look at banks, critics note, they are handpicked and paid by those same banks.
“It is worth considering the monitors’ lack of independence,” Mr. Lawsky said at a speech in Washington this year. “The monitors are hired by the banks, paid by the banks, and depend on the banks for future engagements.”
The move by Mr. Lawsky — who has a history of irking his federal counterparts by running ahead of them — could spur regulators in Washington to act against the consulting firms. After halting the foreclosure review amid the lingering problems, officials at the Federal Reserve and the Office of the Comptroller of the Currency, federal agencies that oversee many large banks, are already questioning the prudence of heavily relying on consultants, said people close to the agencies. In testimony before Congress in April, a senior official at the comptroller’s office said the agency was exploring new ways to curb the use of consultants and correct problems when they occur.
For now, according to the people, the agencies can instruct a bank to replace a consultant that has erred. And if the banks continue to run afoul of the law, the regulators have authority to punish them.
Still, the relationship with consultants is difficult to unwind. Regulators, grappling with scarce resources, rely on consultants to address weaknesses at banks that are hit with federal enforcement actions. Since the financial crisis, the comptroller’s office has forced banks to hire consultants after more than 130 enforcement actions, or roughly 15 percent of the cases, an analysis of government records shows.
Reinforcing their clout, consultants like Promontory Financial Group and Deloitte & Touche have established cozy ties to the regulators, routinely hiring from government agencies. Promontory was founded by Eugene A. Ludwig, a former comptroller of the currency, and nearly two-thirds of its roughly 170 senior executives once worked at agencies that regulate the financial industry.
In a previous statement about the review of foreclosed homes, Promontory said that “From Day 1, Promontory strove to conduct its review work as thoroughly and independently as possible.”
A spokesman for Deloitte said on Monday: “We share an important common goal with regulators — to safeguard the integrity of the capital markets. We welcome their insights into ways that we and others can improve our processes and procedures.”
Even if federal regulators were to take a tougher stance with consultants, they would likely face legal limitations. When the comptroller’s office fined a consulting firm in 2006, a federal appeals court later ruled that the regulator had “exceeded his statutory authority.”
At the Congressional hearing in April, the comptroller’s office petitioned Congress for greater authority. But lawmakers have yet to respond.
In the absence of federal action, Mr. Lawsky has been pursuing new avenues for regulating the consultants in New York, according to the people briefed on his plans. After searching local regulations, his office seized upon a little-known provision buried in New York state banking law dating back to the turn of the 20th century.
Under the law, the earliest version of which was created in 1892, Mr. Lawsky’s office controls access to certain regulatory documents that consultants need to review when advising a bank. The documents, including examination reports, are considered “confidential communications,” unless Mr. Lawsky’s office determines that their release will serve “the ends of justice.”
In the case of consultants, Mr. Lawsky is planning to choke off access to firms that fail to meet a set of standards, according to the people briefed on the plans. The standards Mr. Lawsky is likely to introduce would require, for example, that consultants disclose financial ties that could compromise their independence.
For consultants with a history of problems, he is weighing whether to revoke their access to the confidential information for as much as a year or more. Mr. Lawsky is considering such a move in the near future, the people said, though there are no indications of which firm he may target.
His use of the banking law mirrors how New York attorneys general have used a 1921 law, the Martin Act, as a cudgel against fraud. While Mr. Lawsky is not accusing the consultants of fraud, the banking law could enable him to take aim at their performance.
Mr. Lawsky has already criticized one prominent consultant. Last year, he accused Deloitte of helping the British bank Standard Chartered flout American sanctions on Iran. Although the bank hired Deloitte to spot suspicious money transfers from Iran routed through its New York branches, Mr. Lawsky said, the consultant instead instructed bankers on how to escape regulatory scrutiny.
Mr. Lawsky never took legal action against Deloitte, and federal officials have since placed full blame upon Standard Chartered.