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Making Bank Consultants More Accountable to Regulators

In the aftermath of the 2008 financial crisis, banks and regulators have increasingly hired outside consultants to help comply with regulations and to implement new actions. ((Outsourcing Accountability? Examining the Role of Indep. Consultants: Hearing on S. Hrg. 113-34 Before the Subcomm. on Fin. Inst. & Consumer Prot. of the Comm. on Banking, Hous., & Urban Affairs, 113th Cong. 1 (2013) (statement of Sen. Sherrod Brown, Chairman, S. Subcomm. on Fin. Inst. & Consumer Prot.).)) The limited resources available to regulators and the high cost of hiring a permanent compliance staff have contributed to this trend. ((Evan Weinberger, Banks Must Police Consultant Conflicts Under OCC Guides, LAW360 (November 15, 2013, 7:41 AM), Consultants are usually brought in after regulators have determined that a financial institution has violated a regulation and is unable to remedy the problem. ((Id.)) The consultants are expected to investigate and report their findings to the regulators. As a consequence, there is a symbiotic relationship between consultants and regulators; regulators rely on consultants to investigate ((Id. (noting that bank consultants are often called “shadow regulators”).)) while consultants rely on regulators to generate revenue. ((Hearings, supra note 1, at 1 (“charges have been as much as $1,500 an hour).)) Consulting firms are also often staffed by former regulators. ((Id.))

One area of serious concern resulting from the intertwined relationship between consultants and regulators is the lack of accountability. Consulting firms are often private, with little oversight or transparency in how they operate. ((Id.)) It is difficult to assess the financial incentives that a firm may have. There have been reports of firms “[missing] serious problems or [giving] the banks a free pass” after being hired by regulators “to find and to fix illegal activity.” ((Id.)) Such reports raise doubts as to whether consultants can effectively fulfill their responsibilities. The lack of oversight and transparency increases the potential for a conflict of interest to exist. Rules and regulations increasing accountability should therefore be implemented.

Firms not only generate revenue from regulators, but also from banks, which hire firms to help them in the regulatory process. ((See Ben Protess & Jessica Silver-Greenberg, Promontory Financial Settles With New York Regulator, THE NEW YORK TIMES (August 18, 2015), business/dealbook/promontory-financial-settles-with-new-york-regulator.html.))  Considering that firms must attract clients to generate revenue, firms often have financial incentives to attract repeat business. ((Hearings, supra note 1, at 5.)) The incentives can lead a firm to treat its client favorably. For example, when the Department of Financial Services in New York found that Standard Chartered Bank had violated financial regulations, it required the bank to hire consultants to review and report the violations. ((Protess & Silver-Greenberg, supra note 9.)) Standard Chartered hired the consulting firm Promontory Financial Group to perform the work. ((Id.)) In effect, the consultants had to review the violations and report their findings to regulators on the bank that was paying them to do the work; the bank got to choose its own investigator without oversight. Promontory eventually settled after paying a $20 million fine and agreeing to suspend certain consulting services. ((Id.))

Many consulting firms have financially benefitted from the lack of accountability. During the foreclosure review process, seven consulting firms made about $2 billion from consulting fees alone. ((Evan Weinberger, OCC, Fed Grilled on Use of Independent Bank Consultants, LAW360 (April 11, 2013, 2:26 PM), Although initially, the estimated cost provided by the firms was $5 million to $8 million each, the final cost ballooned. ((Id.)) For example, PricewaterhouseCoopers LLP received $425 million from three banks. ((Id.))

In reality, there remains the need for consultants to act as quasi-regulators on behalf of the regulatory agencies. Regulators are simply unable to do all the work without the help of outside consultants. ((Id. (quoting Daniel P. Stipano, the deputy general counsel of the OCC, “The problem with having the OCC do the work itself is it is just beyond the means of every federal banker regulator to do this”).)) The Office of the Comptroller and Currency claimed that it would need to either quadruple its staff or to shut down its regular bank examination program in order to meet its regulatory responsibilities without the use of consultants. ((Id.)) Furthermore, regulators may not have the special training or expertise that a consultant might have for very specialized issues. ((See Hearings, supra note 1.))

In addition, financial institutions also need the help of outside, presumably independent, consultants. Although the current issue of consultants not being independent is clear, it is nevertheless important that financial institutions hire outside investigators. This is not much different from accounting firms auditing companies. The issue, then, is making sure that the consulting firms are indeed independent and free from the financial pressures of their client banks.

As mentioned, despite the problems associated with consulting firms acting on behalf of regulators, it is nevertheless necessary for firms take on some responsibilities, albeit in a controlled process. Rules and regulations can be implemented to curb the possibility of a conflict of interest so that consulting firms can investigate and report on violations without outside pressure.

The financial institution that violates a regulation cannot be allowed to choose its own inspector (i.e. consulting firm). The current allowance for banks to choose their independent consultants is the result of regulators trying to pass on costs to the banks. ((Weinberger, supra note 14.)) Otherwise, if the regulators were to hire the consultants, the regulators would have to foot the bill. ((Id.)) To address this issue, the regulators should be allowed to choose the consultants while passing the fees onto the banks as a part of the fines for noncompliance. By eliminating the power that banks have in awarding repeat business, consulting firms will not have an incentive to treat the banks favorably.

Although some may promote a competitive bidding process, which is the norm for government contracting due to federal mandate, it will be inadequate. Assuming that regulators can choose the investigators while passing on the cost to the banks, regulators would not have to submit to a competitive bidding process. This opens the possibility for a consulting firm to be chosen on the basis of how independent it can be rather than how inexpensively they can get the work done, if they even can get it done within budget. ((See id.))

Consulting firms should thus be evaluated carefully under a transparent and well-defined process before being selected. In addition, it is crucial that the firms are themselves supervised and made answerable to the regulators. By making firms attest under oath for the objectivity of their work, they will be less likely to give preferential treatment to the banks. It would also have the effect of preventing banks from shopping around for consultants.