Through the Financial Regulation Looking Glass: Avoiding missteps, real or imagined, is no easy task when every move is hawked by a dizzying array of agencies

Financial institutions face tremendous scrutiny from the whole host of regulatory bodies that claim some authority over their services and operations. Jayant W. Tambe, co-head of Jones Day’s Financial Institutions Litigation & Regulation practice, and C. Hunter Wiggins, a former Principal Deputy Enforcement Director at the Consumer Financial Protection Bureau, address how they help clients navigate competing, overlapping and contradictory directives and pursuits from government agencies. Their remarks have been edited for length and style.

MCC: What is the size and scope of Jones Day’s Financial Institutions Litigation and Regulation (FILR) practice?

Tambe: It’s a global coordinated practice, both U.S. and European, covering complex financial products litigation, as well as established and emerging areas of regulation. We have transactional lawyers, litigators, and regulatory enforcement lawyers in our mix. There are 39 lawyers resident in the FILR practice, and an additional 33 lawyers at the firm are part of what we like to call the “FILR and Friends” team. Those additional lawyers don’t devote all of their time to financial institutions representation but are routinely involved in representing financial institutions.

MCC: Describe your backgrounds for our readers.

Wiggins: I’ve been in private practice and in-house at a Fortune 100 company, and I’ve had two stints in federal enforcement agencies, first at the SEC, where I was in the enforcement division, and more recently at the Consumer Financial Protection Bureau (CFPB), where my last role was as the Principal Deputy Enforcement Director, which is the number-two enforcement official in the Bureau.

Tambe: I’m a litigator by training and by practice. I’m primarily involved in both pre-litigation and litigation matters, but the focus is very much on matters that are going to go to court or arbitration. Within that large universe of litigated matters, my practice focuses on complex financial products and derivatives.

MCC: Can you elaborate on your pre-litigation work for clients?

Wiggins: A substantial amount of what I do involves the full range of issues that come up for consumer financial services clients, both bank and non-bank. That includes everything from providing regulatory due diligence on transactions to advising on interpretations of new regulations to handling government examinations or investigations. Much of what I do winds up being pre-litigation, since it tends to involve government activity that occurs pre-filing, but in any engagement involving the government we are always prepared to litigate if appropriate.

Tambe: Since about 2000, litigating over-the-counter derivatives, as well as complex financial products – like CDOs, CLOs and RMBSs – has been a major part of my practice. Most of those are fully litigated matters, and frequently, they pit one large institution against another. Given the complexity of the subject matter and the proceedings themselves, clients are focused on avoiding litigation, and that’s where pre-litigation work comes into play.

In the traditional securities fraud arena, pre-litigation counseling usually accompanies either an internal review or audit, where there’s going to be a restatement of financial information or an update to some prior disclosure. Or there’s been a whistleblower allegation and investigation. We advise the client in terms of updating disclosures, how investigations should be conducted internally and what the outreach to investors should be, and then prepare the client for a strong likelihood of private litigation.

The other area where there is a lot of pre-litigation counseling is around complex financial products involved in a significant market event. For example, the 2007 disruption in the commercial paper market caused many clients to revisit their commercial paper conduits, their relationships with buyers and sellers, and the derivatives contracts that were linked to the commercial paper market. We were counseling those clients on whether they would need to litigate to enforce their own rights as claimants.

MCC: Financial institutions, and corporate America more broadly, have to deal with a multitude of federal regulations and law enforcement agencies, which many would say are intensifying their role. Can you give us the big picture of the government’s interaction with these types of corporations?

Tambe: Financial institutions and corporations today, after the advent of the financial crisis, face challenges in every part of their business and in every geography in which they operate. There are, as you say, a multitude of regulators – some established and familiar, and others that are either brand new or empowered with new authority. Also, within the general public discourse, there is a great deal of animus toward financial institutions and corporations, and suspicion about their motivations, conduct and behavior.

Virtually every action taken by our clients is subject to tremendous scrutiny from a skeptical audience. We need to be familiar with those who are scrutinizing our clients and have a sound understanding of what motivates and empowers them, along with the extent of their authority. Our clients need help navigating what in many instances are competing, overlapping and contradictory directives and pursuits from these agencies.

In addition to the governmental side of things, there’s always the threat of tag-along private litigation and private enforcement actions.

MCC: How do you see the CFPB’s attack on arbitration clauses playing out, and what, if anything, should in-house counsel be doing about it?

Wiggins: The CFPB’s proposed rule has two pieces to it: First, it would prohibit a company from using an arbitration provision to prevent a consumer from participating in a class action lawsuit; and second, it would require companies that continue to use the arbitration process to provide information regarding the results of those arbitrations to the Bureau. Under Dodd-Frank, the Bureau is permitted to create a new rule only if it “is in the public interest and for the protection of consumers.” And any new rule has to be consistent with the results of the arbitration study that the CFPB completed last year. I expect there will be challenges based on whether the Bureau’s arbitration study was done correctly and whether the results of the study support the rule’s proposed requirements. Additional challenges are going to range from the existential question of whether the Bureau has the constitutional authority to create this kind of rule to whether the Bureau’s data collection requirement is pulling an end run around the Paperwork Reduction Act, which limits the government’s right to demand large amounts of data from the public. It’s fairly clear that once this rule is finalized, you will see very quick and numerous challenges.

In-house counsel in institutions that are considering adopting arbitration clauses with class action bans should do so promptly since the Bureau’s rule, even if it withstands the challenges we’ve discussed, will not apply retroactively. But for companies that currently have class action bans in their arbitration provisions, now may be a time to at least examine whether you want to retain that element going forward. You can see some companies and industries moving away from mandatory arbitration, so this might be the time to identify the costs and benefits of retaining such a clause. Ask if there is a competitive advantage, with consumers, regulators or from an economic standpoint, in removing certain elements from arbitration clauses and moving forward in the world that the CFPB is proposing. The rule doesn’t remove all ability to use arbitration, but it does remove one of the core protections that companies have relied on for a while.

Tambe: An important consideration here is that the proposed rule on arbitration clauses is a rule, as opposed to legislation. It’s illustrative of the concerns that we have about the extent to which regulatory agencies, through the passage of such rules, are upending decades of jurisprudence, which itself is based on legislation, such as the Federal Arbitration Act, and often on Supreme Court decisions. It’s one thing to have legislatures and Congress enact laws that might supercede court decisions; it’s quite another thing to leave that up to regulators, who may be motivated by a political agenda and not quite as responsive to, or as directly responsive or answerable to, the public or the legitimate interests of the industry. That is a remarkable shift that has occurred gradually over many administrations.

MCC: Alleged government misuse of big data is a growing phenomenon. Can you tell us about the issue of statistics in agency lawmaking?

Wiggins: There are two issues here. First, is data being collected and secured in a proper manner? The CFPB in particular represents itself as a data-driven agency, which means that it’s going to regularly demand substantial amounts of data from market participants. However, there has been criticism at times of the tools that the Bureau has used to demand data and the burden associated with those requests. Perhaps more importantly, Congress has repeatedly raised questions about whether the data that the CFPB has been collecting, which includes personal information about millions of consumers, is secure. Second, has an agency like the Bureau shown that it has enough data and has used proper methodology in doing its analysis to make the big decisions that it’s making, especially in areas where there has previously been little data available? There is a perception in industry that data is used selectively to support policy positions that have already been determined rather than driving the analysis of the right policy result.

Tambe: Here is another perspective. The Supreme Court set the bar for the use of the scientific method in either establishing liability or measuring damages. That’s the Daubert test. It’s been widely applied and serves an important gatekeeping function on what is good science and what is junk science. Applied properly, the Daubert test is a critical check on the misuse of big data in a courtroom setting.

But now you have data sampling by regulatory agencies, which doesn’t necessarily have to comply with Daubert’s standard of reliability. Has the analysis met a rigorous test? Has the methodology been peer-reviewed? Has there been enough analysis so that a court can be comfortable in establishing causation, liability or damages? When regulatory agencies start collecting and analyzing data to drive decisions, either for proposed rules or potential fines or damages, they seek to bypass those safeguards, and we are left with divergent standards that apply to financial institutions and corporations. In court, they are empowered to battle junk science; in regulatory dealings, they have no such protection

MCC: What about the CFPB’s and DOJ’s use of the power of the press release? Are they using publicity to overstate their findings and actions? What can be done about it?

Wiggins: Having come quite recently from one of these regulators, I understand that enforcement agencies have a limited number of arrows in their quiver and therefore feel the need to make sure that actions are well-publicized. In an effort to increase their impact, however, agencies have at times sensationalized press releases and described the conduct of companies in a more lurid way than is reflected in the negotiated settlement. That’s a real issue, in terms of the agency’s credibility and in communicating effectively to the market, since when an agency uses inflammatory rhetoric to inflate small matters to make them more interesting to the press, it damages the agency’s ability to properly message its view of the relative seriousness of the alleged violations in the matter.

Then you have situations where an agency steps over the line and actually makes allegations or claims in a press release that are different or more severe than the ones contained in what is often a highly negotiated and hotly contested settlement document. At the CFPB, that issue has been raised several times to the Bureau’s ombudsman and has been mentioned repeatedly in the press. Inaccurately describing a settling party’s conduct hurts everyone: It unfairly punishes target companies; it erodes the credibility of an agency’s enforcement process; and it also creates a disincentive for companies to settle if they reasonably fear being treated unfairly in how a settlement matter is publicly described.

In terms of what a company dealing with one of these agencies can do, you need to anticipate the problem and deal with it head-on. Companies can try to negotiate advance access to the language in a settlement press release to ensure that it’s accurate – but that’s often very difficult. If a company feels like it will be unfairly and publicly vilified by an agency if it settles, that might change the calculus of whether to fight or settle, at least initially. Jones Day excels at making sure that we’ve got a credible threat to litigate where appropriate. When agencies decide that they’re going to pillory you in the settlement, particularly where they might enhance the description of what happened beyond the scope of what’s agreed, it raises the question about whether or not settlement is an appropriate result.

Long term, these agencies are not doing themselves any favors. If an agency develops a reputation for inflammatory or inaccurate press releases, over time that will impede settlements, and the agency is going to find itself litigating more and not being able to handle as many investigations.

Tambe: There has to be a change in the tone at the top, both at a local level and at higher national levels. It should not be considered acceptable practice for important legal issues to be decided and resolved in press conferences. There’s a whole body of case law about the deference afforded to regulatory agencies in interpreting and enforcing their own regulations. I can see that deference being eroded, curtailed or potentially eliminated if the regulatory agencies abuse their discretion. That, ultimately, is a very high price to pay, not just for a particular agency but for regulatory agencies in general.

MCC: What is the CFPB’s position on the rise of nontraditional, tech-influenced lending, or are the agencies still jockeying over who gets to regulate fintech?

Wiggins: The CFPB is always consumer oriented, and they have talked about fintech through that lens. They have said that it could be a valuable platform for consumers and provide more and better access to credit, depending on how the products are developed and sold. Agencies jockeying over who gets to regulate fintech is the real question. Just in the last several months, everyone from the CFPB, to the FTC, to the Department of Treasury, to the OCC, to the DOJ has suggested that they should get involved in regulating fintech.

It’s going to be subject to a great deal of overlapping regulation and a great deal of uncertainty, which is understandable given that it’s a new area. But there’s a real risk that if regulators can’t quickly sort out the regulatory landscape among themselves, innovation will be damaged – not the innovations that are going to get created and maybe get regulated out, but rather the innovation that isn’t going to occur. I’ve been talking to clients in this space, and one of the first questions is, “Who should we be talking to in order to figure out whether these ideas are good or whether they’re going to be looked at with skepticism?” Often the answer is, “You’re probably going to have to talk to many different audiences, and these audiences have different perspectives, too.”

If the regulators can’t decide who among them is going to have responsibility over the space or, if it’s going to be multiple regulators, if they can’t come up with a set of standard expectations that will be applied consistently by all of them, then the benefits of a financial product market with the opportunity for explosive innovation are not going to be realized because of regulatory gridlock.

Tambe: Imagine a federal regulator who decided whether Betamax won or VHS won, or MySpace versus Facebook. Those were competing businesses ideas, each trying to attract consumer interest. Some succeeded, and some failed. Ultimately, the consumers decided what service, product or collection of features that they most greatly valued. A regulatory agency interjecting itself between innovators and consumers is almost guaranteed to slow down the pace of innovation. We’ve already seen that with payment through mobile phone systems and tap-and-go cards, which are further ahead in many parts of the world, including many emerging market countries, in terms of penetration of those emerging technologies.

MCC: The CFPB is a very young agency. Is there any chance that it will be reined in by a new administration?

Wiggins: The Bureau is very young, and it’s very polarizing from a political standpoint. There have been repeated efforts to defund the CFPB. The Democrats are passionate about efforts to defend and protect the Bureau. A new administration could change things, but the real issue is that as long as there’s a single director, then there’s a high likelihood that the Bureau will be reactive to whoever appointed that single director. Currently, the director of the Bureau is appointed to a five-year term; it is not set by the rhythm of whether the presidency has changed political parties. The better question, and one for which there seems to be some support across both sides of the aisle, is whether the Bureau’s structure will change in such a way that the culture of the Bureau changes.

The primary issues from a political standpoint are converting the Bureau from a single-director model to a commission model and placing the Bureau’s budget, which is currently funded through a percentage of the Federal Reserve budget, within the appropriations process, as it is for other agencies. There’s a moderate amount of support on both sides of the aisle for converting the Bureau to a commission. As long as that’s tied to whether the Bureau should be included in the appropriations process, however, it’s likely to be a third rail for Democrats. If there was political will to put forward a bill that changed only the commission structure, you could see a real change in the character of how the Bureau operates.

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