Ex-Fed Lawyer on 'Faulty' Compliance at Banks
Too many bank lawyers today sport an unhealthy mindset bent on finding loopholes in rules rather than on supporting the spirit of the law. Thats the opinion of one expert, law professor Cornelius Hurley, director of the Boston University Center for Finance, Law, and Policy.
This week Hurleywho served as general counsel of Shawmut National Corporation, a New England banking company, and as an assistant general counsel for the Board of Governors of the Federal Reserve System in Washington, D.C.went one-on-one with CorpCounsel.com in a wide-ranging interview about financial institutions and the law. Below is an edited version of that conversation:
CorpCousel.com: We have seen in the past year a continuous line of banks and financial institutions getting in deep trouble with the Department of Justice and federal regulators. Is this trend growing worse?
Cornelius Hurley: We saw some of the behavior that the [2008 economic] crisis revealed was just so outrageous, the gross misrepresentation of mortgage securities, the criminal activities in reporting international borrowing rates . . . The old standby money laundering has been going on forever, but the grievousness of the offenses combined with the consequences seem to be getting worse. Yes, Id say its a worsening trend.
CC: Why is this happening?
CH: There are more mistakes and misconduct. And weve learned that large financial institutions can bring down the entire economy. It causes people to be nervous. I think we realize now that these financial institutions that we used to trust are actually threats to our financial system and our economy. So the stakes are that much higher. Then theres the old issue everyone is familiar withno persons are really getting punished. Dividing [JPMorgan Chase & Co. CEO] Jamie Dimons salary in half from $20 million to $10 million is hardly the kind of punishment the public is asking for.
But at the same time we are discovering that the compliance mechanisms are faulty, and the incentive systems are misaligned with the public interest. And unfortunately our response to the financial crisis was to create a massive amount of regulations and demand more compliance, creating even more of a problem for the system.
CC: How do more regulations create more problems for the system?
CH: A good example is the proposed Volker Rule, which seeks to separate banks from proprietary trading. First of all the Feds are a long way from finalizing the regulations. Every indication I have is that the [bank] lawyers will skate right up to the edge to what is permissible, and in so doing will inevitably go over the line from time to time.
CC: In the past, you have said that bank lawyers help their clients arbitrage the system. Can you elaborate on what you mean by that?
CH: Regulatory arbitrage in my mind means avoiding regulations by choosing a different way of doing business or a different regulator. So, for example, regulators in the United Kingdom are becoming more aggressive. So theres been much discussion among some banks there about moving their headquarters from the U.K. to places like Hong Kong. Thats an example of regulatory arbitragemoving your headquarters or changing your charter to come under more lenient regulations.
Take the Volker Rule. Just about any comment you read in the file of the Feds proposed regulation youll see the banks saying, If you do this, all this business will move overseas. They are trying to shake the regulation by threatening arbitrage.
CC: So whos to blamethe regulators, the banks, or the banks general counsel?
CH: All of the above. We have really lost our way when it comes to regulation and compliance, and its become an adversarial process. You can certainly, or I do, fault the legal community for not taking a more compliant approach to their practice, and for taking a discover-the-loopholes approach. They are helping clients avoid regulation rather than complying with the spirit of it. Its an unhealthy mindset. [To make his point, Hurley shows a New Yorker cartoon of two men talking in an office; one says to the other: These new regulations will fundamentally change the way we get around them.]
At the same time I fault our political leaders. Our response to the crisis was not just to fill the gaps but to create a mountain of regulations that few people understand, including the regulators themselves.
CC: How did we get to this point?
CH: Financial services lawyers cut their teeth on three major regulations: the ban on interstate banking, the regulations limiting payment of interest, and the Glass Steagall Act. And I have to claim as much guilt as anybody else. Lawyers spent millions of hours coming up with ways to avoid those rules, and in the end they were victorious.
But the residual effect of all those decades of fighting against regulation is that the same mindset resides in lawyers today. They dont come to it as, How can we make this regulation work so millions of people dont lose their homes? They come with the attitude of, How can we help our clients game this system?
So in that sense, nothing was learned. Given what horrible harm has been done by the financial crisis, I think lawyers as officers of the court have a higher duty than just to enhance shareholder value.
CC: A number of financial institutions have hired former high-ranking employees from the Securities and Exchange Commission or other regulatory agencies. Do you see any problem with ex-regulators going to work for the very institutions they once regulated?
CH: The problem I see is with the gross disparities in our reward system. The reason people are leaving government to join the private sector is that they can make five or six times their salaries, and they take with them the knowledge of the agencies they leave so they can help their clients game the system.
There is a sharing of information. If the attitude of private industry was compliance in the public interest, then that sharing would be a good thing. But its not. After I left the Fed, I never went back and practiced before the Fed. It gets awkward when someones former supervisor comes back petitioning for a client.
CC: Federal regulators prefer that compliance chiefs report to an executive who is not in the legal department. To whom do you think a chief compliance officer should report, and why?
CH: I think generally if a general counsel is giving legal advice, it seems a bit of a conflict for the compliance person to then check whether that legal advice has been adhered to in all cases. At one time, I was both general counsel and the chief compliance officer in a relatively small institution with limited resources. And that is often the case. In a larger, more complex institution, compliance takes on more of a risk management and auditing role than a legal role. So the larger and more complex the institution, the stronger the case can be made to separate the two functions.
CC: Anything youd like to add?
CH: [chuckling] Do you think I need a bodyguard now?