Government Shakedown

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If financial institutions once did finance, now they seem to practice law.   And if regulators once did regulation, now they seem to raise capital. Government seems to be in a shakedown motion.

The switch of roles was mostly a consequence of laws such as Dodd-Frank and many others that seem to become an opportunity for regulators to promote their careers, to jump to the private sector and a way to raise funds for the newly created Consumer Financial Protection Bureau.

The regulation at the Federal level has greatly expanded the burden and costs for the financial sector in every way possible, from amount of litigation and settlements financial firms face, having to increase the size of compliance departments, payments to outside law firms and lost opportunities for profit.

Industry that struggles to regain confidence is being scrutinized without fear or favor. But considering the role of financial institutions in the recent crisis, it is no surprise the financial sector is under siege, facing attack from all directions. Financial companies face audits, investigation, prosecution, litigation, private party law suits and almost daily hostile media coverage as never before.

The overlapping layers of regulators and litigators have all expanded rapidly in the short number of years.  There are more than 100 units at Federal agencies ranging from the Securities and Exchange Commission (SEC) to the Department of Justice (DOJ) drawing a bull’s-eye on Wall Street.  Considering the multi-layered business structure of financial institutions, firms are regulated by several government agencies simultaneously.   As the result, all of these agencies can start its own inquiries of the same firm.

In addition, Congress, by far the most powerful investigative force, will be bringing the tremendous weight of its fury down even more upon the financial sector.   However, it is hard to argue that the current approach serves justice; thus, making lawsuits and investigations looking like a government shakedown.

What is not warranted, however, is the scope of the assault and merit of complaints filed by regulators against financial firms.

According to economic consulting firm NERA, the SEC collected $414 million in fines and $1.5 billion was collected in settlements in 2011.   And in the course of fiscal year 2011 and the first half of fiscal year 2012, the SEC reached 13 settlements of $5m or more with big financial firms. All settlements were announced on the same day the SEC filed its complaint, which makes it almost impossible to know whether complaint had merit or if the firm is being wrongly attacked.

The Department of Housing and Urban Development was involved in a $25 billion mortgage settlement struck with big banks earlier this year.  State regulators have also been active.     Further, Standard Chartered’s recent $340m settlement over allegations of evading Iranian sanctions with the New York Department of Financial Services (DFS) sharpened the incentives to “prosecute by press release”, if only because the rewards for being the first to file can be great.

To make things worst, a settlement with one regulator does not mean settlement with them all.   Unlike individuals, double jeopardy does not apply to an institution and the end of an investigation by one agency does not prevent further investigation by another.    Like a cockroach, there is always more than one lawsuit when a target with deep pockets comes into the crosshairs increasing the amount of paperwork.

In fact, it is not uncommon for a financial institution to receive thousands of legal orders a week.   Wells Fargo gets around 5,000 weekly, requiring two processing centers.    A group of 25-30 senior people work on prioritizing bank’s response to subpoenas and sort out these requests.       In addition, outside legal counsel can cost around $1000 an hour.  The lost productivity and misallocation of resources is even more draining.

To cope with complexities and amount of litigation, firms are rushing to hire ex-regulators as the legal framework is simply too chaotic to be fathomed by anyone outside the system.   This is hardly in the consumer interest as needed are firms that respond to the demands of the public efficiently and effectively, rather than having to endure the expenses of an overzealous legal behemoth, both public and private.

As the process keeps getting out of hand, the most immediate way to assess the total cost is the falling stock prices.  JP Morgan, widely considered to be the best run bank, is now trading around $40.  In 2007, JP Morgan was trading at over $50.  JP Morgan aided the Federal Government by purchasing Bear Stearns and Washington Mutual in 2008, moves it now regrets.  The appreciation shown has been lawsuits, not to mention private litigation.  Just last month, the Federal Government announced its support against JP Morgan for a lawsuit accusing Bear Stearns of “massive fraud in deals involving billions in residential mortgage-backed securities.

The fear of complex litigation and negative press creates incentives to settle fast through negotiations.   That is rarely the best tactic for an innocent company.  When a firm, as Goldman Sachs did, settles quickly, there is a tremendous loss of face in the marketplace.  In addition, there is forever damage done with regulators and the press.

Far better is to assert one’s position as forcefully as possible with the government.  Former Bear Stears hedge fund managers Ralph Cioffi and Matthew Tannin, without any institutional support, were acquitted.    Not to say that financial firms are guilt free, but standing up when they are will do much to truncate this aggressive and excessive government shakedown benefit?

Financial institutions should not be collecting money from investors and paying off to regulators and lawyers.    Regulators should not be extracting cash from firms through settlements, promoting their own careers using justice system and further creating competition between agencies.

Eventually these costs will have to be paid by the public, either in lost jobs if financial firm closes its door, higher fees for services or lower stock prices for financial companies.


Anna Timone (195 Posts)

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