Turf Wars: Tension Is Back Between State and Federal Regulators

When New York Attorney General Eliot Spitzer was earning his reputation as the “Sheriff of Wall Street” in the early 2000s clashes between state and federal regulators were common. Now, after a period of relative calm, those turf wars may be emerging again.

As state and federal regulators continue to pursue financial firms that were responsible for the financial crisis and mortgage mess and look to prosecute new fraud, squabbles are emerging over who should take the lead, whether state or federal agencies have the authority to pursue investigations, and how and if state and federal authorities should work together to pursue cases of potential fraud.

Consider last month's $340 million settlement between Standard Chartered Bank and New York's Department of Financial Services (DFS) over allegations the bank violated sanctions against the Iranian Government. Before the ink was barely dry on the agreement, numerous media reports emerged citing sources within federal agencies who said they were blindsided when the state jumped ahead on reaching a deal with the bank.

Sen. Carl Levin (D-Mich.), chairman of the Senate Permanent Sub-committee on Investigations, took a not-so-subtle dig at the bent-out-of-shape federal regulators who were negotiating with Standard Chartered. “[DFS] showed that holding a bank accountable for past misconduct doesn't need to take years of negotiation over the size of the penalty; it simply requires a regulator with backbone to act,” he said in a statement.

Mark Peters, a former senior public corruption prosecutor for New York's attorney general, says that state regulators taking a lead role where only federal regulators used to tread is a trend that will continue.

Companies, especially those in the financial sector, could find themselves caught in the middle. Peters—now a partner at law firm Edwards Wildman Palmer who works with companies that face proceedings before New York's DFS—says the turf battle between state and federal authorities forces financial firms to rethink how they weigh regulatory risks. They must now be prepared to answer to more than one regulator, often at the same time, a far cry from the “business as usual” approach of only working with federal regulators.

A consequence of having multiple, competing regulatory officials is that it may compress the amount of time in which investigations take place. “If the federal government is the only regulator in town, they can proceed with their investigation at whatever pace that makes the most sense to them,” Peters says. But when state regulators enter the fray, federal agencies start wondering if they can get across the finish line before the other guy does.”

Sometimes there is foot-dragging, strained resources, or politics to blame for agencies being out of sync, but many financial investigations legitimately require a more measured approach than public outcry might demand, Peters says. “Part of the process is not just being able to claim something was done wrong, but figuring out how to fix it, not just demanding fines,” Peters says. “That can take a long time. When the clock is ticking [because state regulators are ready to swoop in], it gets a lot harder to do.”

Keith Fisher, who specializes in financial regulation at law firm Ballard Spahr, says the angst over New York state beating federal investigators to the punch over Standard Chartered reminded him of similar controversies created by the pit bull approach of Eliot Spitzer, the state's former attorney general, and later governor, well-known for his willingness to step on the toes of the Securities and Exchange Commission and other federal regulators.

“It is beneficial to coordinate and send a unified message [with federal regulators], but we also know that we have the ability to act on our own.”

—Michael Stevens,

Senior Executive Vice President,

Conference of State Bank Supervisors

These territorial battles, however, are never as clear cut as they may seem, says Fisher, who once served as a special assistant attorney general for the State of Maryland. “If we believe in the deterrence of bad acts then it makes sense to have more law enforcers not less,” he says.

According to Fisher, there are numerous instances where federal regulators were “asleep at the switch,” requiring state authorities to act. “There is a whole lot to be gained by law enforcement authorities at the state and federal level cooperating, but I also recognize that there comes a time when things just aren't happening in any kind of a timely fashion and someone throws up his or her hands, and says ‘enough is enough.'”

Successes by one state regulator may, in turn, lead other states to take a similar approach. “Once more states see value in doing this, whether from a self promotion or enforcement angle, the private sector is going to have to face an even greater multiplicity of enforcers,” Fisher says. “It will be more expensive.”

Enter the CFBP

The creation of the Consumer Financial Protection Bureau by the Dodd-Frank Act could also heighten the tension between state and federal authorities, since it explicitly establishes state regulators as a front-line, boots-on-the ground defense against fraud. In creating the Bureau, giving it the ability to share information and to investigate with state authorities, Congress also sought to curb the preemption of state consumer protection laws. State agencies could see the CFPB as a new cop on the beat that will provide competition for the pursuit of financial consumer fraud.

Michael Stevens, senior executive vice president of the Conference of State Bank Supervisors, a nationwide organization of state banking regulators, doesn't see a system that's in need of repair. In fact, he thinks the tension in the system is by design.

ENFORCEMENT/COMPLAINT COOPERATION

The following is an excerpt from the “Joint Statement of Principles on Consumer Financial Protection” between the Consumer Financial Protection Bureau and the Presidential Initiative Working Group of the National Association of Attorneys General.

Principles of Enforcement Cooperation.

Under the Consumer Financial Protection Act of 2010, the Consumer Bureau and the State Attorneys General are granted authority to enforce the provisions of the Consumer Financial Protection Act of 2010, and regulations issued thereunder, with certain exceptions, in order to secure the remedies provided by law. This new authority augments the existing authority afforded to State Attorneys General to enforce legal protections for consumers in a wide variety of markets, including those for consumer financial products or services. Therefore, the parties will seek to work together, where appropriate and to the greatest possible extent, to:

Develop joint training programs and share information about developments in Federal consumer financial law and State consumer protection laws that apply to consumer financial products or services;

Share information, data, and analysis about conduct and practices in the markets for consumer financial products or services to inform enforcement policies and priorities;

Engage in regular consultation to identify mutual enforcement priorities that will ensure effective and consistent enforcement of the laws that protect consumers of financial products or services;

Support each other, to the fullest extent permitted by law as warranted by the circumstances, in the enforcement of the laws that protect consumers of financial products or services, including by joint or coordinated investigations of wrongdoing and coordinated enforcement actions;

Pursue legal remedies to foster transparency, competition, and fairness in the markets for consumer financial products or services across state lines and without regard to corporate forms or charter choice for those providers who compete directly with one another in the same markets; and

Develop a consistent and enduring framework to share investigatory information and to coordinate enforcement activities to the extent practicable and consistent with governing law.

Principles of Complaint Cooperation.

Under the Consumer Financial Protection Act of 2010, one of the primary functions of the Consumer Bureau is to collect, investigate, and respond to complaints raised about consumer financial products or services. The Act contemplates that, to the extent practicable and consistent with governing law, the Consumer Bureau and the State Attorneys General will share such information to guide and inform their law enforcement efforts. Therefore, the parties will work together to develop protocols, processes, and procedures that govern how they may most efficiently and effectively:

Share, refer, and route complaints and consumer complaint information between the Consumer Bureau and the State Attorneys General;

Analyze and leverage the input they receive from consumers and the public in order to advance their mutual goal of protecting consumers of financial products or services; and

Create and support technologies to enable data sharing and procedures that will support complaint cooperation.

Sources: CFPB; National Association of Attorneys General.

“The state, as a chartering authority, has a special perspective and a unique interest because they are closer to the consumer and closer to the economic activity in the market,” Stevens says. “It is beneficial to coordinate and send a unified message [with federal regulators], but we also know that we have the ability to act on our own.”

“Even when the state and federal agencies have come together on an action, I guarantee you there was tension between the two of them to get to that point,” he adds.

For the past several months, Connecticut Attorney General George Jepsen has worked with his colleagues in New York City on an investigation into allegations that banking giant Barclays manipulated LIBOR, the London Interbank Offered Rate.

Beyond his multi-state efforts, he offers a diplomatic assessment of the relationship between state and federal regulators.

“It is important to give the states the support and latitude they need, but what I've found is that when all parties are respectful of each other's roles and responsibilities and maintain good lines of communication, we work very well together,” he says, pointing to “successful collaborations” on the national mortgage foreclosure settlement [a $21.5 billion payout that resulted from the combined efforts of 49 states] and ongoing pursuit of Medicaid fraud.

“In the case of the mortgage foreclosure settlement, the states had certain laws that addressed the problems in the form of unfair trade practices,” says Jepsen. “These laws enabled the states to focus on a broad scope of activity.”

Jepsen was appreciative of how the CFPB will further empower states, both individually and collectively. State attorneys general are frequently the first to receive complaints about unfair or deceptive practices, but often the perpetrator is based in another state, he explains. The CFPB's coordination with states provides interstate authority to pursue unfair practices beyond individual borders.

There is no shortage of critics of the CFPB's budding relationship with state regulators, however.  A recent survey of executives and lawyers at large financial institutions by the law firm Mayer Brown found what the firm described as “grave concerns” that go beyond just the threat of increasing compliance costs.

Eighty percent of those polled said they worry about providing privileged information to the CFPB, fearing that they might waive attorney-client privilege regardless of any CFPB policy to the contrary. This would get even more problematic if information is shared with state attorneys general eager to grab headlines and happy to pile onto an investigation.

Fisher thinks the concern of politicized state officials is overstated. “Nobody in a politically based system gets ahead by being perceived as not a tough cop,” he says. “You are never going to find somebody running for governor, or any attorney general or senator, who says, ‘Well, I'm not big on prosecuting people.'”