Here Come the Regulators

The fallout from the subprime and credit crisis continues to highlight imperfections in our banking and finance system. A bright light is now being shined on the patchwork of regulatory bodies, often with overlapping jurisdictions and prerogatives, tasked with overseeing financial and banking entities.

As news stories multiply daily on the crisis and its related investigations by federal, state, and in some instances, city authorities, there is understandable confusion for many board members of public companies. An even greater challenge is realizing whose authority has precedence when an investigation begins. An alphabet soup of regulators, each with its own goals and constituencies and sometimes competitive behavior, has mobilized to address the subprime crisis.

When a major financial scandal begins to make an impact on a significant number of people or a particular industry, as we are now seeing with the subprime meltdown and saw less than a year ago with stock-options backdating, it’s not unusual for multiple regulators to wage independent investigations against the same company.

For example, the FBI’s inquiry into the subprime mortgage crisis is focused on approximately 20 companies suspected of accounting fraud, improperly securing loans, and insider trading. At least three of those 20 companies are also under investigation by the Securities and Exchange Commission, though no one at the SEC could confirm whether its investigations were related to the FBI probes.

Meanwhile, states like New York are getting into the act: Attorney General Andrew Cuomo is investigating the role of a number of Wall Street firms in the crisis.

Even smaller jurisdictions are launching investigations. In January, the city of Cleveland filed lawsuits against 21 banks, according to the Associated Press. The suits claims that the subprime lending practices of these banks have left behind abandoned homes, creating a public nuisance that hurts property values and tax collections.

Feds and Friends

When dealing with multiple authorities that are engaged in parallel investigations, it is important to understand the modus operandi of all the players involved and the overall chain of command.

Federal, state, and local investigatory mechanisms are often pooled together in a common effort to investigate high-priority issues such as the subprime crisis. For instance, a new task force met in May in the Eastern District of New York (Brooklyn), to look into potential crimes, including mortgage fraud and securities, trading, and accounting fraud. Led by federal prosecutors, the task force includes the FBI’s financial institutions fraud unit, the U.S. Postal Inspection Service, the U.S. Secret Service, the New York State Banking Department, the New York City Department of Investigation, and the Federal Deposit Insurance Corp. (FDIC).

The FBI also facilitates multi-agency law enforcement collaboration through its Office of Law Enforcement Coordination. The SEC, Department of Justice (DOJ), and FBI are working as one team to investigate subprime lending practices.

Conversely, the staffs of the New York Attorney General’s office and the enforcement division of the SEC are not known for their close cooperation. In addition to interagency friction, unique challenges that have emerged for those companies facing investigations include having to provide different types of documentation to different regulators, sharing the same documentation multiple times, or undergoing multiple depositions, first by the Attorney General’s office, then by the SEC.

Civil enforcement proceedings can lead to criminal proceedings. The subprime crisis is one of the most emotionally charged situations we have seen in many years. And this is an election year, which raises the stakes for numerous entities. A board faced with an actual or possible encounter with several authorities may need to organize to address the multitude of issues that will be thrown at it. One solution may be for the board to consider organizing a special committee of independent directors to keep abreast of developments. The group may be a separate subcommittee of the audit committee or a temporary panel. SEC: The Market’s Top Cop

The SEC is an independent federal government agency with a mission to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation. The SEC’s approximately 3,800 staff members are located in Washington, D.C., and throughout its 11 regional offices. The SEC, which was established by the Securities Exchange Act of 1934, can bring only civil, not criminal cases. However, the agency often works with law enforcement entities, including the FBI and the DOJ. In wake of the subprime crisis fallout, the SEC is raising questions and investigating the following issues: