Federal and state regulators frequently rely on independent compliance monitors to ensure that corporate wrongdoers follow-through on correcting the conduct that got them into trouble. Southern District of New York Judge Jed Rakoff has referred to a corporate monitor as both a “financial watchdog” and “an overseer who has initiated vast improvements in the company’s internal controls and corporate governance.” Typically installed as part of a settlement agreement between the government and those companies that have had legal and regulatory issues, the monitors assess and report back to the government on violations of the law and on the effectiveness of the corporation’s compliance and ethics programs.
New York’s Department of Financial Services (DFS), under the leadership of Benjamin M. Lawsky, has put a new spin on the use of government-appointed monitors in recent months, pushing for their installation at financial institutions under DFS’s purview regardless of whether the bank has been found to have done anything wrong. Lawsky refers to these pre-settlement monitors as “consultants” who possess an invaluable level of expertise in the types of complex financial matters DFS considers and seems to suggest that the DFS has the authority to order the installation of such monitors at financial institutions even where no investigation has been initiated.
Under DFS’s novel approach, the monitors are to be used to conduct “routine examinations” at some of the almost 2,000 financial institutions regulated by the DFS. Lawsky has told the Wall Street Journal that he views this strategy as a way to prevent bad behavior from occurring in the first place.
The outlines of the DFS’s plan are largely undefined. Lawsky suggests that DFS’s first focus would be on banks participating in “high-risk” international transactions that might raise questions about money laundering or involve countries subject to United States sanctions. Ultimately, he seeks to place DFS “consultants” in the largest international banks.
In addition to using the corporate monitors to conduct routine examinations, Lawsky asserts that these individuals also can provide an extra layer of scrutiny in instances where the evidence suggests significant problems at an institution and an investigation has been initiated, but the agency is not yet ready to bring charges. This approach has been taken in DFS’s investigation of alleged foreign exchange rate manipulation by various international banks. In late 2014, United States and United Kingdom regulators fined six major banks a total of $4.3 billion for failing to stop traders from trying to manipulate the foreign exchange market. DFS declined to participate in those settlements, reportedly finding the deals to be “too weak.”
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Instead, DFS launched its own investigation, in which it reportedly is seeking more severe penalties. Media reports from December 2014 indicate that DFS had been successful in placing monitors at some of the banks it is investigating. As of today, DFS still has not brought charges against these institutions despite months of monitoring.
Some bankers believe that the installation of monitors before a finding of wrongdoing goes too far in an already highly regulated industry. One banker has expressed concern that the outside monitor would “have too much incentive to find and report problems, no matter how small, to justify its fees.”
Although the use of monitors is intrusive and expensive, another concern with the DFS’s plan to install monitors pre-settlement is the potential assault on the attorney-client and attorney work product privileges. This is true especially in those cases in which the institution already is being investigated by the DFS and may be considering building a defense to any charges that may be levied. The idea of having government sponsored supervision and intrusion in an institution’s daily operations before any charges have been brought flies in the face of the traditional role of government and the relationship between counsel for the company and the government. Indeed, in circumstances of on-going negotiations, the installation of a monitor may eliminate a company’s ability to push back or suggest that it would litigate rather than settle.
The DFS’s bold tactics have proven useful in wrestling huge settlements from financial institutions that do business in New York, making it a serious force in the world of international finance. Although the installation of corporate monitors may have been proven to be successful in reining in a wayward corporation, their value must be balanced against the associated costs. The DFS’s plan to rely on monitors pre-settlement to conduct examinations and assist DFS in the discovery of evidence may tip the scales inappropriately in the government’s favor.
From The Insider Blog: White Collar Defense & Securities Enforcement.