More Enforcement Actions Are Coming
Bankers are bracing for the start of more severe anti-money laundering exams as regulators rework their standards and prepare to issue another round of guidance tackling the issue.March 8
Criminal indictments of bank employees indicate a failure in the institution's governance, risk and compliance policies. Boards must take the time to improve their risk management systems.March 5
The enforcement landscape has been altered by Dodd-Frank's enhancement of bank regulatory powers and the creation of the Consumer Financial Protection Bureau. In addition to a continued focus on consumer protection, several other enforcement trends are likely to dominate in 2013.
Risk Management: Perhaps the most closely examined issue in the post Dodd-Frank era will be the management of risk, which was perceived as a contributor to the last financial crisis. Regulators are vigorously evaluating how banks and their holding companies manage, measure, control and monitor risk.
The record suggests that sound policies and practices are important, but not enough to avoid enforcement. Strong implementation and monitoring are also critical. Companies should focus on empowering their boards of directors to understand the measurement of risk so that they can satisfactorily perform their duties in the eyes of the regulators. Corporate records should similarly reflect the efforts of the company in all aspects of risk management.
Fair Lending: When we authored "The Fair Lending Guide" in 1995, the cases that we handled and wrote about were based on discretionary practices by lenders that resulted in adverse "treatment" of members of protected groups. Recent actions and statements by the Department of Justice, HUD and the CFPB suggest a new fair lending "perfect storm" for lenders.
First, future discrimination cases may be based on "facially neutral" economic policies that may have a disparate "impact" on protected groups. Under this theory, once such an impact is shown, the burden shifts to the lender to demonstrate a business justification for the challenged policy.
Second, the flight by lenders to quality borrowers that the CFPB's new mortgage rules may create will fan the flames of disparate impact theorists. As lenders adhere to underwriting, processing, servicing and foreclosure standards that reflect these new rules, declination rates may increase and may suggest an adverse impact on protected classes.
Greater clarity is necessary from regulators to provide brighter lines of demarcation if discrimination standards are going to become more subjective. Likewise, closer internal consideration of facially neutral policies which may create disparate impacts among borrowers is now a critical exercise for lenders.
Anti-money laundering, Bank Secrecy Act and Office of Foreign Assets Control: This area will continue to be a dominant concern of FinCEN and other regulators, particularly with regard to foreign banking organizations. Given the CFPB's broad jurisdiction with regard to consumer finance issues for large depository institutions, the bank regulators are likely to focus on AML/BSA cases which can also produce high profile and high value settlements.
This is an area where mistakes by people responsible for policies, procedures, filings and monitoring have caused significant problems. Institutions should make sure that their AML/BSA/OFAC compliance policies and procedures are top notch. But even more critical is the need for experienced people to oversee compliance, the role that internal audits play and scrupulous documentation of adherence to company policies and procedures.
Sources, amounts and quality of capital: Capital is and will continue to be king. As the quantity and quality of capital is scrutinized against evolving risk standards and new requirements, regulators will continue to want institutions to have more of it. The result will be the issuance of increased individual minimum capital orders as regulators attempt to customize an institution's capital to its risk profile.
The buyout or privatization of the Troubled Asset Relief Program, the phase out of certain trust preferred securities and the attitudes of current capital markets with regard to financial institutions will complicate the challenges that institutions face in responding to enforcement orders to raise capital.
Additionally, the new source of strength authority provided in Dodd-Frank underscores the renewed emphasis that regulators will place on holding companies – and foreign banking organizations – as being sources of strength to their banking subsidiaries.
Financial institutions should evaluate alternative ways of reducing or insuring asset and balance sheet risk, and be prepared to demonstrate their risk is calibrated to the amount and quality of their capital.
Civil money penalties: CMPs are being used far more often, and they are larger than ever. The fact that the CFPB's first orders issued in 2012 included significant financial penalties compared to what financial institutions have been accustomed to will likely impact CMP assessments by bank regulators.
CMP notices should be taken seriously. Institutions have the right to submit a cogent response demonstrating why an assessment should not be levied, and in doing so, should identify mitigating factors that may impact the regulatory determination of a CMP fine.
The environment, including the enforcement actions that it will produce, has and will continue to be challenging for financial institutions. But financial institutions are resilient and have always adapted to changing regulation. Who survives and who doesn't is usually a question of preparation, skill and will.
Thomas Vartanian is the chairman and Robert H. Ledig is a partner in the financial institutions practice at Dechert LLP. Former bank regulators, they regularly represent financial institutions in enforcement cases.