NY Department of Financial Services emerges as bold new lawman in the financial crime badlands

Financial crimes cases usually do not have the dramatic moments of an old Western movie, when a lawman standing alone appears on a dusty street to confront a gang of villains in a climatic showdown.

When the New York Department of Financial Services (DFS) garnered international attention two months ago by bringing a landmark state enforcement action against Standard Chartered Bank, it felt to many as if a new sheriff, like in the classic movie High Noon, had just arrived in town.

When it brought the case against StanChart, the DFS had existed for less than a year, but it had already made its presence felt in New York. Since its launch in October 2011, the DFS had forced insurance companies to pay more than $100 million in death benefits to surviving family members and imposed strict measures on eight mortgage servicers that had engaged in abusive foreclosure practices.

The first DFS Superintendent, Benjamin Lawsky, had earned a reputation as a tough federal prosecutor in the Southern District of New York, based in Manhattan. Later, he joined then-New York Attorney General Andrew Cuomo as a special assistant.

With a sizeable staff of nearly 1,500, broad powers over diverse financial institutions, including insurance companies, and a leader willing to flex the department’s enforcement muscle, the DFS has emerged as a major force in the national and international financial crime and regulatory arena.

DFS emulates federal regulators in size and regulatory purview

While the StanChart case gave the DFS global name recognition, the department traces its roots to one of the nation’s oldest financial industry regulators. DFS is the product of a merger of the New York Banking Department, which was founded in 1851, and New York Insurance Department, which emerged in 1860.

If “convergence” is the call of the day in the financial sector for the approach to financial crime, the DFS personifies that concept among state regulators. It is the sole New York regulator of banks, insurance companies, real estate agencies, mortgage brokers and money services businesses that are licensed to operate in the state. It supervises 1,700 insurance companies with assets of more than $4 trillion, and 1,900 banks that have assets of $2.1 trillion, according to the DFS 2011 annual report.

The size of the DFS staff and budget rival or exceed those of smaller federal regulators. In late 2011, the DFS had nearly 1,500 employees, including more than 400 bank examiners. Its annual budget was $236 million. For comparison, the National Credit Administration, the federal agency that regulates US credit unions, has a staff of 1,180 and an annual budget of about $234 million.

StanChart case caused financial industry to fret over regulatory aggression

On August 6, the DFS issued an order threatening StanChart with revocation of its New York charter over allegations the bank conducted transactions totaling $250 billion with Iran. StanChart entered into a settlement agreement with DFS and paid $340 million, the largest penalty ever paid to a state regulator in a financial crimes case.

Although the case won DFS and Lawsky plaudits from some enforcement officials and legislators, including Sen. Carl Levin, who praised Lawsky as a “regulator with backbone,” it may also have imperiled its relationships with federal regulators and the New York banking community.

Some compliance professionals and consultants express fears that the financial industry will view the DFS as unduly aggressive and unpredictable. Facing what they perceive as a volatile regulator, they fret banks may balk at seeking or retaining New York state charters.

“Before this, if a bank was choosing between a federal charter from the Office of the Comptroller of the Currency and a New York State charter, it was no question” that the bank would choose the state charter, said a financial institution consultant, who asked for anonymity because he advises banks. He cited the “excellent reputation” of the old NY Banking Department, calling it a “fair and transparent” regulator.

An attorney who advises financial institutions on regulatory issues was more blunt. “If [the DFS] is going to behave like the Atilla the Hun of regulators, they’re going to have to understand there will be consequences,” he said.

DFS emerged from law that also created potent new investigative, enforcement unit

The New York Financial Services Law (FSL) of 2011 created DFS. The legislation was championed by now-Governor Andrew Cuomo, and went beyond merely combining regulatory agencies. It also included measures that increased the enforcement powers of the new state regulator, primarily by creating a new Financial Frauds and Consumer Protection (FFCPU) division that is housed in DFS.

The FFCPU serves as the DFS investigative branch, and may impose monetary penalties or conduct criminal and civil enforcement actions for suspected or actual violations of the Financial Services Law or the New York Banking and Insurance Law.

“The Financial Services Law empowered FFCPD with new investigative and enforcement authority ‘to more thoroughly uncover, investigate and eliminate the myriad financial frauds that may be perpetrated in… New York State,’” Ron Klug, a DFS spokesman, told ACFCS.org.

The FFCPU does not have to wait for bank examiners or other regulatory staff to uncover evidence of potential wrongdoing before commencing an investigation. The DFS Superintendent, under Article 4 of the FSL, may investigate whenever the FFCPU has “has a reasonable suspicion that a person or entity has engaged… in fraud or misconduct with respect to the banking law [or] the insurance law.”

Along with investigative muscle, DFS got greater penalty power

The Financial Services Law also beefed up the monetary penalties DFS may impose for violations it may now impose $5,000 penalties for each fraud,$1,000 for other violations of the FSL, and $1,000 per violation of Insurance Law. The small per-violation amounts can quickly add up to large sums.

DFS has international reach

As the principal financial institution regulator and one of the principal financial centers of the world, the DFS wields a global reach that is unusual for a state regulator. US affiliates of 116 non-United States banks are based in New York. A total of 88 of them hold New York state charters.

In some cases the state-chartered affiliates serve as an institution’s primary point of access to the US financial system. New York Banking Law grants the DFS sole control over state charters of financial institutions, including the power to revoke them for egregious violations.

The authority of DFS over these foreign affiliates produces an international enforcement power that is arguably unmatched by any other state regulator. StanChart is a poster child of that power.

A DFS spokesperson declined to comment on pending enforcement actions, or if the DFS is concentrating its investigations on certain industries or types of violations. Nonetheless, the department has established itself as a new sheriff in the world of financial institution regulation, who is willing to impose remedies for violations of state law even before the federal posse arrives.