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Law360: Robert Rostan on “Regulators Have Few Tools To Rein In Bank Consultants”

By Evan Weinberger

New York’s top financial regulator on Monday pushed his federal counterparts to claw back compensation for bank consultants and limit their power to get new business if they perform shoddy work, but analysts say regulators may not have the necessary reach to crack down on the compliance consulting industry.

In a speech to the American Bar Association, New York Superintendent of Financial Services Benjamin Lawsky said federal regulators should take his lead and impose tough penalties when banking consultants fail to live up to their responsibilities to help financial institutions comply with regulations and enforcement actions.

Even if regulators are able to impose the tough penalties similar to the hurt Lawsky put on Deloitte LLP last week, the diverse, unruly consulting market may mean that any enforcement measures will have only a limited effect, according to Robert Rostan, chief financial officer of Training The Street, a training firm for financial professionals.

“That’s going to be tough to police,” Rostan, a certified public accountant who formerly worked at Deloitte, said.

Banks and regulators frequently turn to consultants to help implement new regulations and comply with enforcement actions. Largely this is due to the limited resources available to financial regulators to monitor compliance, and the high cost of hiring permanent compliance staff for many banks.

“The banks, especially the smaller ones, have to look to third-party institutions to comply with these regulatory requirements,” said Patricia Trendacosta, managing shareholder of Frandzel Robins Bloom & Csato LC.

But the cozy relationships between banks and the consultants they hire have come under increased scrutiny in recent months, driven by the astronomical fees consultants charged to implement the Independent Foreclosure Review program, part of a settlement with major mortgage servicers. The Federal Reserve and the Office of the Comptroller of the Currency canceled the program in January and reached a separate, $9.3 billion settlement with the same banks.

Then in June, the New York Department of Financial Services barred Deloitte Financial Advisory Services LLP, a unit of the giant accounting firm, from advising any New York-state chartered bank and fined the firm $10 million over allegations that it it did not demonstrate the proper autonomy required by consultants performing regulatory work and disclosed its other clients’ confidential information to Standard Chartered PLC.

Deloitte was hired under an agreement between Standard Chartered and DFS to provide guidance to the bank after DFS uncovered money laundering in its New York branch.

Lawsky said Monday that other regulators should use his settlement with Deloitte as a model when bank consultants fail to meet their responsibilities.

“Regulators basically hold the keys to the kingdom for consultants in the form of access to confidential supervisory information. We have the power to shut off the spigot. Using that authority could be a way to impose accountability in an area that’s seen precious little of it,” Lawsky said, according to prepared remarks.

So far, there has not been an indication that federal regulators are looking to take quite as aggressive a line against bank consultants as Lawsky has. The OCC says it is reviewing the relationships between banks and their consultants on compliance projects, but few details have emerged.

Lawmakers, however, want to see some changes. In a Friday letter to Fed Chairman Ben Bernanke, Sen. Sherrod Brown, D-Ohio, urged the central bank and the OCC to increase oversight of consultants advising large financial institutions. Among the measures Brown wants to see are concrete standards and regulations to ensure that independent consultants are properly overseeing the regulatory compliance of the banks they advise.

“Because these firms work for the banks that they oversee, there needs to be more transparency and accountability when private consultants are involved in regulatory action,” Brown wrote.

However, the diffuse nature of the bank consulting business and the lack of any regulatory infrastructure for the industry may make such measures difficult to enforce and limit their effectiveness. Even if regulators cut off consultants’ access to confidential supervisory information, the firms would be able to rack up business by doing work that does not require such access, like advising banks on customer service and pricing models, Rostan said.

“Regulators do have that weapon available, but that’s on the push side,” he said. “On the pull side, who’s going to be doing this on the other side? It’s not like regulators can say, ‘Deloitte, you must do this engagement.'”

And while clawbacks for shoddy work sound good in theory, in practice consultants would simply charge more if there was a chance of facing tough regulatory penalties if their work had to meet proscribed standards, Rostan added.

What Lawsky and other regulators should look to do instead is limit banks’ reliance on consultants, Trendacosta said.

Right now, many banks simply take whatever report they get from a consultant and do little to no review, she said. What will really change the industry is if banks that are forced to pay fines and face other penalties because of shoddy consultant work, like Standard Chartered, take matters into their own hands and sue their consultants, Trendacosta said.

“[Lawsky’s] proposal tends to be protective of his institutions rather than placing any responsibility on the constituent banks to understand and review the scope and nature of the projects for which these consultants have been hired,” she said.