State Regulators Grab Bigger Role in Finance

With the likelihood of vigorous state enforcement, tailoring compliance solely to the feds courts real disaster.
Mark PetersOctober 1, 2012

Last week the media reported, with more interest and fanfare than usual, that the New York State attorney general had subpoenaed some of the country’s largest private-equity funds to determine their compliance with certain rules for reporting and paying taxes on income.

The interest in the story did not come from the fact that a government agency was looking at tax issues. As George Bernard Shaw once observed, “taxes are the chief business” of government. Rather, the interest came from the fact that it was a state official doing the looking.

The state attorney general’s investigation is only the most recent example of the increasing role taken on by state law enforcement in national economic policy: Earlier this year, President Obama appointed that same state attorney general to head up his mortgage-lending task force. Late last year, the Massachusetts attorney general brought litigation against the national system of recording mortgages and documenting defaults. The drumbeat will continue.

There is little to be gained by arguing about whether the increasing involvement of state attorneys general and other regulators in national economic policy is a good or bad idea. It’s here to stay. Regulators have brought on board sophisticated staffs capable of tackling these issues, they have crafted legal theories to justify their roles, and have seen to it that they can have impact. In a world tightly connected by the Internet, it is easier than ever for a regulator in one state to feel connected to the causes of the country as a whole. The more productive question is how the private sector will (and should) now navigate this new, more complex playing field. Some hints are emerging.

At the outset, it is important to understand that state and federal regulators see the world differently. To begin with, state regulators, such as attorneys general, are popularly elected. Their senior staff members, who manage these matters, are reporting directly to an elected official with constituents and public opinion to consider. Technically, of course, federal regulators also report to an elected official (the President) but much more indirectly. Most of the federal officials working on these matters will never meet the President or will certainly not be briefing him regularly.

This is not to say that federal regulators are less political, nor is it a challenge to either group’s motivations: many popular actions are well-intentioned and most people in public service have a deep commitment to the public good. Rather, it is merely recognition of the different perspectives that exist. There is immediacy to state decisions and how they are perceived that is not as stark in the federal system.

The difference in world view is compounded by the phenomenon of scale. Federal regulatory agencies are vastly larger than any state system. The federal Department of Justice has hundreds of lawyers who can specialize in particular areas of the law and bring the same case over again in different venues.

For state attorneys general, each case is a more unique proposition, with senior lawyers often learning about new subjects as the case progresses. As a former senior regulatory official in New York, I know that it allows a fresh look at a subject (often with new ways of tackling a problem). At the same time, as a lawyer in private practice, I have seen how this can be frustrating to those steeped in the industry. They feel they must now help educate outsiders who have considerable, sometimes newfound, powers.

Finally, there is the inherent competition between state and federal law enforcement: a competition in which each wants to be first and most prominent to a case. While there have been a number of notable attempts at coordination, these remain the exception, and an entity under investigation can still find itself whipsawed between two investigators.

For companies facing these dynamics, the most important first step is to recognize that it is, indeed, a new world. With the likelihood of vigorous state enforcement, tailoring compliance and prospective legal responses solely to a federal enforcement regime courts real disaster.  Several strategies suggest themselves:

  • State attorneys general are not mini-feds and their investigations need to be managed accordingly.
  • The presumption that responding to federal queries  and simply copying state officials  no longer works. Independent investigations require independent responses.
  • Compliance programs, once focused entirely on federal regulations and federal agency interpretations, must be retooled to review state codes.

At the same time, there is a need to be respectfully assertive about coordination between federal and state regulators. Each sovereign is entitled to be treated as distinct, but that does not justify contradictory demands. It is unfair to insist on industry coordination without related government coordination.

There was a time when even federal intervention in the economy was a new phenomenon; indeed, another economically turbulent time ushered in that era. The private sector adjusted then, and it will adjust now. With states flexing their collective muscles, however, companies can no longer pretend that the federal government is the only game in town.

Mark Peters is a partner in the international law firm of Edwards Wildman Palmer. Previously he served as the senior public corruption prosecutor for the New York State Attorney General and as head of the New York Liquidation Bureau, which manages insolvent insurance companies on behalf of the state.