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Tom Day: Regulatory Compliance: Regulatory Capture: A Trip Down Memory Lane
Important post from my good friend Tom Day at SunGard. Tom is former OTS, very smart guy. He should write a book -- Chris
Regulatory Compliance: Regulatory Capture: A Trip Down Memory Lane
Tom Day
http://riskmanagementcommunity.com/community/banking/risk_management/reg...
[The below is a letter I recently found in my "examiner friends" archives that I thought was worth sharing. This was written in 2005 by an anonymous former Federal Reserve examiner. As a former bank supervisor myself, the accuracy should challenge us all to pay more attention to those in the trenches doing the actual work (whether bank supervisors or in your own firm; management by walking around, as Tom Peters used to quip). To say the below is insightful is an understatement. I have always been a strong believer that the "blame" that Dodd-Frank and others try to lay on the regulators is misplaced. The examiners that actually do the work are correct 99% of the time. What happens, often, is that the exminers get "trumped" by "leaders" within the agencies and, then, bad things happen. Unfortunately, it is not the leaders that usually pay the price. A good current example might be Acting Comptroller Walsh who made some quite biased statements to London audience on June 21, 2011. This speech prompted Senator Sherrod Brown of Ohio to write to Geithner asking for Waslh's immediate replacement. What the letter didn't recommend, as it should've, is that he should not only be replaced, but banned from Supervision, as should others that, for example, inappropriately tried to steer TARP funds to troubled banks - yet still remain employed by the regulatory agencies. The letter begins directly below. Give me your thoughts.]
To Congress:
I would like to invoke whistleblower protections and remain anonymous.
The June 22, 2005 article on BSA/AML printed in the American Banker that alleges influence peddling on the part of Wells Fargo, and that accuses the OCC of bending to the will of the large, complex banking organizations that subsidize the OCC’s operations, has motivated me to speak up in defense of the Examiner-In-Charge (EIC) of Wells Fargo as well as for all of the other white-collar professional bank examiners that attempt to do their job with professionalism and honor every day of their lives. My motivation in writing is also girded by a belief that our current financial supervisory system is flawed and needs corrective legislative action by our national lawmakers.
I do not know the EIC of Wells Fargo, but I am in a unique position to recognize clearly the political pressures that are documented in the letter sent to Congress by the anonymous source. While Mr. Garsson of the OCC might deny the accusation that the OCC has been unduly influenced in dishonest and unethical ways by their large bank charges, let me assure you that he is simply wrong. To be fair, let me also note that it is not only the OCC but other financial regulators who are also “captured” by the institutions they are required to supervise. This capturing is similar to the situation faced by public accounting firms that in the past provided consulting services, along with core accounting service, to their clients. This unfortunate and under-publicized situation is a result of the perverse “competitive” incentives that exist within the bank supervision universe, an arcane topic to be sure but one of critical importance to the health and welfare of our financial system. Today’s tacit incentive structure pitches battle between state-bank supervisors, the Federal Reserve System supervisors, and the OCC in ways that encourage lax supervisory programs, rough-shod bank examination work, fear on the part of examiner to “do the right thing”, and the sweeping of issues “under-the-rug”, so to speak. I have participated in bank examinations in which we had 1-week to look at a process, at a $650 billion company, that would take literally 4-6-weeks to perform adequately.
In order to “survive” as a bank regulatory agency, many of these regulatory entities obviously depend on the number of banks that fall under their particular domain. Even where fees are not assessed, as in the case of the Federal Reserve, the number of State Member Banks (SMBs) under its domain remains a critical “head-count” issue and one that can have dramatic impact on how the System operates. For example, with the recent conversion of JP Morgan to a National Charter, the entire FRB System has had to re-think its internal supervisory function and is, at the present time, considering porting all large bank supervision into the NY Federal Reserve Bank, which will then – in theory - directly, but in reality indirectly, report to the Board of Governors. To some this provides evidence that the System “works”. To those that know how the system “really works”, we plainly see that JPM has purchased, through its conversion to a national charter, better access to influence of their examination process, politically and monetarily. While JP Morgan might argue it simply wants access to “national” laws, it is hard not to see this as hypocrisy given that they have been operating as a SMB for decades and that the FRB and NY State Banking Department, along with the Conference of State Bank Supervisors, have done a yeoman’s job dealing with JPM. Something else must be at work, but what? In one word: influence. The real issue facing the bank supervisors is that, given the “slow” adjustment of supervisory overhead but the “immediate” reduction in revenue if and when banks either 1) change supervisors or 2) consolidate, the incentive is to “keep the client happy” – the same issue faced by David Duncan as lead auditor for Anderson during his tenure at Enron.
For example, Banc of America pays over $30 million to the OCC in assessment fees; however, the on-site supervisory program only costs around $6 million. The additional $24 million subsidizes other OCC work. If, prior to the recent conversion of JP Morgan to a national charter, BAC were to “flip” its charter to State Member Bank (SMB), the OCC wouldn’t have been able to function. This represents a clear and present danger to sound supervision, as the mere threat of taking something “to D.C.” or “flipping a charter” can result in outcomes that are clearly advantageous to the financial institution, while compromising fairness, equitable treatment across organizations, and employee morale. Colonial National in Montgomery, a bank that recently “flipped” to a national charter, is another example wherein a bank tried to influence the exam process through “charter threats”. The only reason it didn’t work is that the FRB is far less sensitive to this “threat” given that they are not dependent on assessments in support of its bank examiner staff. Other examples, which requires some historical knowledge, includes AmSouth’s conversion to a SMB in the early 1990’s. The reason? The OCC was pushing “too hard” on the issue of Fair Lending. As a result, C. Dowd Ritter decided it was time to “change tents”. A similar decision was made at SouthTrust, although in that instance it was purely economic: Wallace Malone, renowned for being “cheap”, simply couldn’t stand paying money to the OCC for what amounted to fairly poor examination work, even though he did hire his ex-CPC under circumstances that should’ve been investigated; however, this was before Riggs, so I guess it was o.k. back then.
Other examples include the OCC’s “over-looking” of Bank of America’s improper booking of mortgage-servicing rights (MSRs) for years and, thus, circumvention of FAS 133 requirements. This issue was raised time and again by FRB Board Staff (in particular Mr. Kerns, now with PNC). That is, BAC didn’t have to comply since everything was allegedly market-to-market, although none of the originated MSRs held were truly marketable and no other financial firm received similar treatment (i.e., they had “special” certificates from FNMA and FHLMC saying the MSRs were “certificated”, an outright lie, regardless of all the attorney opinions you can muster). Additional examples would also include PNCs “Enron-eske” use of special-purpose vehicles (SPVs), an issue that wouldn’t have seen the light of day had it not been for a diligent FRB examiner who, due to the OCC’s unwillingness to investigate issues and allow FRM participation on exams, went about the “problem” through the “back-door”, so to speak.
The on-going battle I am trying to describe has been captured, in part, by some of the recent comments from FDIC Chairman Powell in his June 3rd address before the Annual Conference of State Bank Supervisors, although at much smaller level than the reality that actually exists. That is, it is terribly difficult to express to you, in a reasonable span of time through and via a letter, the level and degree of conflicts of interest that are present within the financial system’s supervisory structure. I realize full well that there are many who would advise that it is not pernicious and that the issues can self-correct, and have self-corrected, over the past decades; however, we live in a much different world today than in the past where financial institutions are not held back by legal entity definitions and restrictions, while the regulators are, in fact, held back by these legal entities, definitions, and restrictions. A good current issue is the unregulated growth and leverage of hedge funds (note: didn’t we learn the last time with LTCM?). It is an un-level playing field to begin with, much more so given our antiquated regulatory and bank supervisory regime(s). These unfortunate incentives have been made more manifest by on-going industry consolidation that is coupled with “fee-based” examinations that constitute the revenue stream of the OCC. The unfortunate reality is that while we have a financial services system and an industry that has modernized, we are still saddled with a regulatory system that was designed in the 1930’s.
As to the EIC of Wells Fargo and the American Banker article, I want to relate a personal experience that I feel has bearing on the conflicts that she was, and is, faced with. While different in some respects, the bottom-line is the same: “superiors” at the regulatory agency cow-towing to the bank’s political pressure and failing to listen to and follow the advice of certified and commissioned bank examiners. My desire is that you hold this in the strictest of confidence.
For reference, I know, as a personal friend, the former Central Point of Contact (CPC) for the Federal Reserve System of a large regional financial company. She worked for the Federal Reserve for around a decade. The bank she supervised possessed management that was considered quite average and the bank was increasing in complexity. The exam program reflected this higher risk. However, the bank felt as though the exam program was “too tough”. Precipitating their complaint, however, had less to do with the scale and scope of the exam program in general and was more the fact that the organization got hit with an informal, non-public Memorandum of Understanding (MOU) for failure to comply with the Bank Secrecy Act and its Anti-money Laundering Provisions, as delineated under the recently issued PATRIOT ACT.
Federal Reserve Board Staff in Washington D.C. had been pushing for a public Cease and Desist (C&D) order, similar to the one AmSouth got hit with in 2004; however, the lead-examiner on the BSA exam, a recognized national expert, and my friend as then-acting CPC, believed that 1) given the newness of the PATRIOT ACT and 2) credible and on-going evidence that the bank would be in full compliance with the newer enhanced due-diligence (EDD) provisions of the law within the coming 6-months, we opted for a “wait-and-see” approach that included returning to the organization in 6-months and, if not in compliance, the execution of a formal, public C&D against the firm. This course of action was agreed to by the bank, by the exam team, by the State Bank CPC, by my friend (the FRB’s CPC), and by management of both the regional FRB bank and the management team at the State Bank Supervisory Authority.
FRB Board staff, for reasons they characterized as “…having no tolerance for any actual or perceived weakness in this area due to the political nature of the topic”, decided to pursue an alternative route; Board staff decided to push for a C&D “now” in order to “…make an example…” and set a precedence for their “no tolerance” policy. In hindsight, it is clear that this is precisely what these politicized bureaucrats wanted to do: witness the monumental fine of $50 million paid by AmSouth for failure to comply with portions of the Bank Secrecy Act. In addition to the formal C&D Board staff was REQUIRING (it’s actually in the legal document that was executed) a forensic review of prior CTRs and other accounts to “retro-file” SARs where appropriate. That is, FRB Board staff was asking the organization to reinvent history and send more SARs to FinCEN.
Although Board Staff might deny, the truth is that FRB Board Staff doesn’t “trust” local staff supervision, although certified to conduct examinations by the Chairman of the FRB System and the National head of Supervision, and believes that many CPC’s are “captured” by their assigned institutions. For evidence of this “attitude” of distrust you would simply need to have private and candid conversations with CPCs from around the System. My colleague (and I) vehemently would disagree with Board staff on this point and, rather, we would characterize the situation as Board staff being reactionary, politicized, and not understanding the need to prioritize issues relative to actual, on-the-ground risks. It's not the examiners and on-site bank supervisors that need to be taken to school, it is the politicized leadership of many within our supervisory agencies.
As CPC, my colleague disagreed with the C&D approach given that the bank had committed to full compliance within 6-months and all parties had agreed to a C&D if, in fact, there were still material weaknesses by October of 2003. Moreover, this firm is not well known for international finance or significant money services business, the two highest red-flags for money laundering; if you want to make an example of someone, try to match the profile of the organization with the risks of the actual business, and it helps to actually have violations of law – which it sounds like Wells Fargo actually did have such violations.
Board Staff did lower their recommendation from a public C&D to an informal MOU; however, it was this MOU written and signed in July of 2003 that caused the firm to decide to “make a statement”. That is, the firm believed, and it is something I would agree with them on, that pushing an MOU in July of 2003 rather than giving them 4-months – until October 2003 – to finalize their program and process was unreasonable. At the time, the firm's executives were unaware of the fact that Board Staff wanted to execute a C&D and apply Civil Money Penalities (CMPs) against the organization.
The “statement” that the firm made was the aforementioned “invitation” to William “Bill” Estes to come and visit the company. At this visitation, although non-public and no minutes were kept, the firm presented a case for the “too tough” examination schedule relative to peers. Subsequent to the visit by William Estes, all examination work for the remainder of 2003 was cancelled. Imagine that. All bank supervision work was cancelled due to strong-arm tactics by the bank the FRB was legally obligated to supervise. This would be similar to dismissing your auditors because you didn’t like the fact they gave you a “qualified” opinion. [Update: A subsequent operations review in 2008/2009 found major weaknesses to the FRBA’s supervisory program and William Estes was shown the door, but the damage was done.]
Since that time, various “threats” have been made by the firm to switch charters, most recently subsequent to a recent acquisition. However, the exam program has been scaled back in order to appease the organization; in fact, the current CPC [note: recall, this is 2005] now lives in Detroit and the local exam staff in Atlanta. As a result of all of the pressure, virtually all of the original exam team was re-assigned, The former CPC moved on to another role, the AVP in charge of supervision was re-assigned (i.e., demoted), and other “shake-ups” occurred. While some of the change was justified, the one person that really needed to be “re-assigned” still continues to hold his post (William Estes) [See above] Moreover, the message communicated to staff was that financial organizations can and do have access to internal staff issues at the Federal Reserve and that “D.C”, not local expertise, rules the day. Tensions mounted with the State Banking authorities and, around this same time, Colonial switched charters, for reasons similar to the above (i.e., exam work that was “too tough”). Colonial will fail at some point. Its internal control is weak beyond compare and its CEO arrogant without measure. [note: emphasis added. Colonial did in fact fail in 2009]
While true the FRB Board has delegated exam authority, the truth is they have delegated with recourse, even when the recourse sought has less to do with risk and much more to do with DC politics. For its part, the Atlanta FRB has been “captured” by the banks as their exam strategies continue to be weak and banks continue to ply their craft of influence peddling, and the watchwords are "consult" and "bring best-practice advice to the firms".
There is no easy solution to the problems that plague our financial supervisory system. A partial and relatively easy solution to this problem is to remove assessments paid by national banks and publicly fund the OCC. A perhaps better and more long-term solution to the many issues confronted by the “system” would be to cut through the regulatory special-interest groups and finally create a unified approach to supervision of financial conglomerates, similar to structures such as the FSA in England. Such an approach would require folding the FRB, OCC, FDIC, OTS, state banking examiners, and state insurance examiners into one Agency. Obviously the transition would be longer-term, but authority needs to be centralized. It is a myth that our system is truly “dependent” on a dual-banking structure. Coincident with such a move would be the need to fully reconsider our existing regulatory reporting systems and processes, better align SEC, NASD, and PCAOB objectives with this new agency, and undertake a major re-haul of information technology systems and market discipline and monitoring techniques.
I hope this note is, if nothing else, informative and assists in illuminating some of the challenges faced by our supervisory system. It is interesting that with all of the talk and action on reform in public accounting, there has been no discussion of the reforms needed within those agencies that perform a like function for the public welfare. To the degree that these agencies are compromised and/or conflicted, it is unavoidable that at some point in the future a crisis of confidence will present itself, most likely in the form of one of the largest banks in the United States (or a number of hedge funds that “use” these banks), or in the world for that matter, imploding due to bank supervisors at the wheel who have been asleep, or at least been blinded, and have not acted on what was clearly recognized by exam staff in the field. For this reason, I feel certain that the EIC of Wells Fargo had better intuition than the “D.C.” powers and that formal action should’ve been taken against the company. I trust those that actually understand the work, do the work, and bleed the blood more than those that sip a Cappuccino while winking and nodding at bank CEOs, presidents, and Chairman.
==
This is the end of the archived letter that was sent to me back in 2005. Re-reading this left me aghast that such communication - candid and accurate - occurred in 2005 – as the most critical extremes of the mortgage bubble were getting underway – and that no one bothered to act, respond, or acknowledge this correspondence. I know this because prior to posting this message I called my long-lost supervisory friend. According to her, this letter was sent to all leaders of the House and Senate banking committees. The questions - as a taxpayer, risk-manager and a citizen - to ask are:
Why was nothing done?
Has anything really changed?
»
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smart guys dont write books, politicians do..
smart guys make money .. and keep secrets..
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om is former OTS, very smart guy. He should write a book -- Chris
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alx
While well meaning, the writer does not even fully realize how much he himself has been "captured".
One great insight- The "Regulators" openly consider the banks they regulate to be "Clients".
And they are, since they can take their business and money elsewhere ie. shift regulators. System was Built to be corrupted.
Sour Grapes, he simply could not get along with co-workers.
Exhibited spells of depression and meloncolia.
Dude does not get it.
And finding fault with the Agency is like a treasonable offense.
Let's Get The Party Started, Obama in '12
Great article
There is one simple fast solution to all this corruption.. remove the monopoly authority system that is being corrupted.. that monopoly (of authority) system is called "democratic Government"
it's actually the exact same system of Govt as a Totalitarian State.. they're both a monopoly (got it?) single structure. There is no difference, only in the tons of liberal window dressing (BS) around it. A democratic Govt just has 'more PC' little Hitlers sitting behind desks pretending they're following the will of the people when in fact they're just dishing out their own ignorant view of the world and telling other adults how to behave
The inherent weakness of a monopoly system versus a competitive system is parasites, viruses and cancers have one big fat easy bloated target to infest (ask Microshite, their monopoly software is a sack of shit and easily taken down as all users have experienced)
So the answer to constant corruption is to redesign the system, from a monopoly authority system in society to a free competitive system where power is distributed throughout society, not hoarded and centralised. Instead of little Hitlers behind every Govt Dept desk with monopoly authority you allow freedom and the free market to prevail giving decision making to millions (it's called 'democracy').
It is now impossible for the parasites to attack this disparate and diverse system, there are too many targets and it's too much hard work to corrupt so many
Regulators will never work and have never worked. Both are patent facts. The above article details the corruption inherent in Regulatory (monopoly authority) systems. The parasites (like JP Morgan) infiltrate them easily. JP Morgan would not last 3 months if the financial markets were competitive. These bloated corrupt parasites cannot compete against 100's of smaller firms sniping away at them, innovating faster, cutting costs faster, providing greater productivity
If i didn't know any better i'd say the Big Banking Cartels set up the Regulatory systems using taxpayer money to fund their protection racket to strangle competitiors, tap into the information Regulators gather on competitiors and drown small business in red tape to control their cartel.. just a thought!
Send this letter to Simon Johnson at MIT. Upom reading it, I'm not sure if he'd laugh or cry.
I would tend to agree.
Put yourself in this guys place as a regulator.
You'd think twice about blowing the whistle on anybody once your tit got pulled through this wringer.
http://www.youtube.com/watch?v=_MGT_cSi7Rs
Figures. Next we'll hear about the under-the-table payments and revolving door policy for agency heads into nice cushy jobs for a "job well done" on Wall Street. No nothing dishonest going on here.
Same thing can be said of the MMS (hookers and drugs) in regards to big oil and the FDA in regards to food and pharma.
Reset anyone?
One more piece of evidence to the already large pile, that the financial/politico and military/ industrial complex that exists controls the country. Period. Freedom is just a word. Citizens rights are non existent and are being continually eroded. Trust has been replaced by fear. Fear of the police, IRS, HLS, TSA, etc. In a word - fear of government and those that control it.
The entire complex must be deconstructed and rebuilt around the Constitution, as the Founding Fathers intended the country to be. Without this drastic action - the country is lost.
+ The Parasite Club rule the nation (Mmm wonder what funds them?)
- you want to re-build another Parasite Club (monopoly authority system) around the Constitution (isn't there one already!). Hey there's 1,000 Laws out there also being trampled over, you think words on pieces of paper make any difference?
..instead of moaning about the Parasites running amock why not do something simple, effective and fast about it? Here's a hint: the whole dirty rotten sham is staffed and funded by wages.. if the wages aren't paid the obnoxious staff are unemployed, the parasites are out of money, the music (corruption) stops.
Any idea how? Well you pay your taxes dont you? Who do you think is funding all this corruption? ...yes mate, it's YOU
Stop Paying Your Taxes
Zero Tax = Zero Govt = Zero Corruption
Is that simple enough to do? When you've stopped paying tax then you can gob off... until then stop moaning about it because you are fully endorsing it, you are directly fueling all the corruption, you are funding Govt, its illegal and delusional war machine and all the other stinking abuses clogging up our society ..you're paying for it and doing precisely zero about it
Ultimately we all individually decide if we are going to assume the capacity of taxpayer or not. He who does not deny, admits the presumption.
Same goes for the presumed debts. It's up to the individual to decide if he is going to accept the liability for the trustee's breach of fiduciary duty. Every alleged debt is a trust scenario. They are the ones who reissued your own credit to you in the form of a liability. But so precious few understand the mechanics behind colorable money today.
Also, please advise where I may find your signature upon the contract known as the constitution for the united states...?
Otherwise it is simply one of the most exquisite scams to ever be pimped upon you the people.
One should be aware that their rights come from far greater than a piece of paper.
The vast majority of taxes paid are unavoidable. Employers take out payroll taxes directly, so no opportunity exists to not pay them. Then there's sales taxes, which are slightly avoidable when transactions are private, but for the most part, cannot be negated. For most people, personal property taxes are the only taxes "voluntarily" paid, but of course, many have escrow accounts that manage payments for their largest property, the home. So there is no real widespread opportunity there either.
Which is why there will be no major tax revolt, ever. The closest thing we will see is ballot measures being defeated. Even that though is ineffective in many cases, as the entity can just increase their assessment rate to make up for any shortfall.
As for funding the parasites, well, they have this thing called a Treasury, that does all of the heavy lifting. Taxes meanwhile, hardly fund the interest payments on them.
Great post. At least with banking the corruption is direct - money to buy influence over money
but Nancy Pelosi said this all snuck up on the country out of nowhere - "like upon little cats' feet"
they say its a 300 year flood that no one could have possibly seen coming -
America embracing baksheesh out in the open.
Trust is lost; manipulation prevails.