What the DOJ Wants When It Comes Knocking

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  • With the DOJ's increasing profile as a bank enforcement agency, policymakers should seriously consider whether the benefits of continually increasing the number of regulators and the scope of regulation justify the impact on the availability and cost of credit in this country.
    March 17
  • Internal documents reveal that the crackdown is targeting banks, not merchants and processors, because it requires less investigation into the facts. That should anger all Americans who care about due process and the rule of law, writes ex-FDIC Chairman Bill Isaac.
    July 18
  • Each bank has tended to tackle financial crime on its own — in effect, inventing its own wheel. The result: ballooning costs and redundancies. But compliance is not a competition.
    August 18
  • Since its inception, banking in America has been subject to regulation and supervision. For the most part, this relationship is symbiotic. At its best, regulation and supervision help prevent bad actors from undermining the reputation of the industry and hurting consumers; elevate good practices; and instill public confidence in the system.
    September 19

The Department of Justice has emerged as a formidable banking regulator, a fact underscored by its recent $16.7 billion mortgage settlement with Bank of America. Now the DOJ is investigating banks large and small in a variety of mortgage fraud and Operation Choke Point cases. By the time the DOJ confronts a bank with a threat of litigation, it has already conducted months of discovery, having foraged through emails, documents, testimony and a range of other discovery goldmines. Whether the assertions listed in the complaint are provable or not, they can be a motivating force toward settlement. And since most cases do settle, the scope of the law is actually being determined by the DOJ rather than the courts.

Given this reality, it is important to understand the DOJ's goals and standards in bank regulation.

First, the DOJ wants the target bank to admit specific facts regarding its conduct and to accept responsibility. This appears to be a non-negotiable part of the accountability formula.  As Associate Attorney General Tony West recently said in a speech in Washington, D.C., banks must be willing to explain to all Americans what the DOJ has discovered.

Second, the DOJ wants the targeted institution to pay a "meaningful" civil penalty relative to the alleged harm of its actions. Penalties in the recent mortgage and servicing fraud settlements have been enormous compared to past bank enforcement actions. The penalties in Choke Point third-party payment processing cases have been more modest. But the fact is that the 1989 Financial Institutions Reform Recovery and Enforcement Act gives the DOJ the broad authority to seek a $1 million penalty, which could be increased to as much as $5 million per day for continuing violations or the gains or losses actually incurred.

The bank regulatory agencies have for many years used a published matrix of factors that they balance to determine the size of a civil money penalty. Meanwhile, the DOJ determines its penalty based on its assessment of the egregiousness of the conduct,  the financial harm done, the evidence uncovered in the investigation, the bank’s view of its conduct and the corresponding penalty, the extent of its cooperation  and the remediation taken or to be taken.  While the banking agencies have significant civil administrative enforcement authority, the DOJ has the broadest investigatory tools and is able to bring a civil lawsuit rather than just an administrative enforcement action. Underlying all of this is the DOJ’s option to bring criminal charges against the bank.

Lastly, retribution is a significant part of the public policy that the DOJ seeks to demonstrate. The DOJ believes that mortgage fraud — particularly with regard to the issuance and distribution of residential mortgage-backed securities — contributed to a near-collapse of the economy. Therefore targeted institutions must satisfy the public thirst for payback in creative ways. That may include agreeing changes in practices, loan modifications, restitution, rebates, community improvement investments and support for affordable housing projects. 

With the emergence of the DOJ as a major banking regulatory power and the continuing trend of multiple federal and state enforcement actions based on the same set of facts, public policy would be best served by an evaluation of the efficiency of such a segmented and duplicative enforcement landscape. 

Bank enforcement authorities including the DOJ appear to have concluded that the chokepoint theory of regulation — deputizing financial institutions to monitor, police and weed out bad practices and actors — is an effective way of regulating market behavior. But there are real costs to this approach. Financial institutions in the U.S. will ultimately alter their businesses and behavior based on the responsibilities imposed on them, which will in turn impact credit standards, credit availability and the cost of financial services. And where banks are subject to the enforcement prerogatives of multiple federal and state civil and criminal authorities, they will ultimately withdraw from providing certain products and services rather than face the compliance and enforcement costs created by having to satisfy multiple regulators.

A better approach would be to leave the bulk of regulatory enforcement responsibilities to federal and state banking agencies, which already have vast enforcement authority over the banks they regulate. If they don’t do the job properly, legislators should deal with them and correct the situation — not create additional regulators.

The banking agencies best understand the intricacies of the business and how all the diverse operational and safety and soundness pieces fit together. They have also traditionally functioned with a sense of political independence. A regulatory enforcement mechanism that is certain, predictable and consistent is important to the health and efficient functioning of financial markets.

Thomas P. Vartanian is the chairman of the financial institutions practice at Dechert LLP and a former regulatory official at two different federal banking agencies.

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Law and regulation