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Against big banks, state regulators flex their muscles

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When a little-known New York regulator this month threatened to revoke the charter of a major international bank for allegedly laundering money for Iran, the shock waves were felt in Washington as much as on Wall Street.

Federal regulators were furious. Some felt New York had jumped the gun, jeopardizing a more methodical investigation being conducted inside the Beltway, officials familiar with the matter said.

It was not the first time state officials had leapt ahead of federal authorities. State attorneys general were the driving force in reining in improper mortgage practices by big banks, a task federal regulators had repeatedly failed to accomplish on their own.

In the wake of the financial crisis, some state regulators and officials have been flexing their muscle against big banks blamed for nearly bringing down the financial system. And they have been using state laws to get some of the world’s biggest financial institutions to fall in line. The cases can result in big paydays for states, such as the $340 million settlement New York reached with Standard Chartered, the London-based bank accused of flouting U.S. sanctions by concealing $250 billion in Iranian transactions.

Some state officials say federal regulators have been too industry-friendly or too mired in bureaucracy to quickly react to misconduct. Federal regulators argue that coordinated action is the most efficient way to handle enforcement and that sudden moves by lone actors could compromise the larger efforts.

Competition between government authorities is a natural consequence of a byzantine regulatory system that requires myriad agencies to oversee the same firms.­­­

The New York Department of Financial Services is coming under fire for moving ahead of Washington with the case against Standard Chartered. Officials at the New York banking regulator said they told federal officials in April that they were moving ahead with the Standard Chartered case and received no push-back. Yet people familiar with the matter say federal agencies were not expecting Benjamin M. Lawsky, head of the state banking regulator, to act Aug. 13.

“They’re angry because Lawsky committed the cardinal sin in Washington — he embarrassed others by exposing their lack of action on evidence they’d been sitting on for two years,” said Neil Barofsky, a former special inspector general of the Treasury Department’s Troubled Assets Relief Program.

Standard Chartered said it alerted the Justice Department, the Federal Reserve Bank of New York and the New York Department of Financial Services in 2010 to Iranian transactions that were in violation of sanctions.

Lawsky’s office, created last year by merging the state banking and insurance departments, forged ahead with its investigation of Standard Chartered. Meanwhile, people familiar with the matter said, federal regulators were working together to build a case.

“Holding a bank accountable for past misconduct doesn’t need to take years of negotiation over the size of the penalty,” said Sen. Carl Levin (D-Mich.). “It simply requires a regulator with backbone to act.”

Bank’s license at risk

New York concluded its case Aug. 14 when Standard Chartered agreed to pay the regulator $340 million to settle allegations, under the threat of having its license to operate in the state revoked. Considering the significance of New York to the banking industry, that threat carries weight.

The case established Lawsky as an independent actor willing to confront big banks, while casting federal regulators in the familiar light of being slow to respond to abuses on Wall Street.

“It’s not surprising that New York acted” on its own, said Tariq Mirza, a former regulator at the Federal Deposit Insurance Corp. who is now a managing director at the consulting firm Grant Thornton. “New York has been fairly vigilant. It started with Eliot Spitzer, who was a very aggressive state attorney general that set the tone for successors like Andrew Cuomo.”

State attorneys general across the country have shown a penchant for going after troubling behavior by banks earlier than federal officials. They flagged abusive lending practices by banks, undertook investigations and sought to prosecute bad behavior, critics say, as federal regulators largely overlooked the problem and at times even impeded the efforts of state officials.

Richard Cordray, director of the Consumer Financial Protection Bureau, sued some of the nation’s largest banks during his tenure as Ohio’s attorney general, alleging that they had violated state consumer laws through a series of unfair and deceptive mortgage practices. Attorneys general in Iowa, Illinois and other states also were well ahead of federal regulators in trying to fight mortgage-related misdeeds.

“Let’s just debunk the myth that federal regulators did anything, because they didn’t. They’ve got a dismal track record,” Illinois Attorney General Lisa Madigan said in an interview with The Washington Post in 2010, amid a fight on Capitol Hill over whether national banks should continue to be exempt from state consumer protection laws.

Local officials outpaced federal regulators in identifying abuses of consumer protection laws, but observers say the story changes when it comes to maintaining the “safety and soundness” of banks. State banking regulators traditionally have been no faster to spot problems or to undertake enforcement actions than their federal counterparts, said Karen Shaw Petrou, managing partner of Federal Financial Analytics.

“Between the tortoise and the hare, they are all tortoises,” she said, adding that such laxity was especially true in the run-up to the financial crisis. “The problem here was not too many regulators falling all over each other to ensure a safe and sound banking system.”

Petrou said Standard Chartered and other banks have long sought state charters — partly because they are cheaper than paying assessment fees associated with federal charters and partly because the regulatory regime has widely been considered friendlier.

Petrou wrote in a recent memo to clients that “when a state regulator wants to, he or she can take the ‘dual’ in U.S. bank regulatory jurisdiction and turn it into a very powerful solo act.” Without commenting specifically on the Standard Chartered case, Petrou said she agrees that, ideally, federal and state regulators should cooperate whenever possible. But not necessarily all the time.

‘Multiple eyes’

Securities lawyer Andrew Stoltmann said competition among regulators helps ensure that bank misdeeds do not fall through the cracks. Having “multiple eyes looking at these problems at different times and moving at their own pace . . . is a good development,” he said. “There has long been a cozy relationship between federal regulators and the companies they investigate.”

Public outrage over the series of banking scandals coming out of the recession, Stoltmann said, has emboldened state regulators to step up enforcement. Whether this trend will have a lasting impact on the policing of the financial sector is difficult to tell.

Barofsky said he doubts any sea change is underway and suspects there will be more instances of federal regulators “putting the parochial interests of their reputations over the greater good.” Tensions exist not only between federal and state authorities, he said, but also among federal agencies.

“It’s like so many other things in financial policy — there are very good aspects of having multiple regulators, and there are frustrating aspects. It’s a balancing act,” said John Dearie, executive vice president at the Financial Services Forum, a group comprising the chief executives of the nation’s largest financial firms. “There’s a value to having multiple cops on the beat. . . . Having multiple perspectives is useful, to a point.”

Dearie, who spent nine years at the Federal Reserve Bank of New York, said that from a financial institution’s perspective, problems arise when regulators have different supervisory philosophies or expectations.

“That can be very frustrating, when you find yourself having to serve two masters who don’t agree,” he said, adding that it can be expensive for banks to comply with requests from numerous regulators. It also can endanger a company’s well being, he said, if the firm does not know what to expect from regulators at any given time. “At the end of the day, what supervision is about is maintaining safety and soundness.”

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