Promontory, by settling, bows to realities of legal challenges against regulators

August 25, 2015

In a swift reversal of its earlier determination to sue the New York State Department of Financial Services, the Promontory Financial Group, a leading consultant to the industry, took what some observers say is the kind of advice it typically offers clients when accused of wrongdoing: settle.

Rather than risk even greater reputational damage during a lengthy court battle – and some speculate that negative fallout from the decision to fight the case could have been a driving force behind the strategy shift — the prominent Washington, D.C.-based firm climbed down from its confrontational strategy on Tuesday, admitting that its actions fell short of the New York regulator’s standards when it investigated possible sanctions violations by Standard Chartered bank.

In addition, Promontory agreed to pay a $15 million fine and accepted a six-month suspension from new consulting projects that require New York state authorization.

“This does show that for firms you can rattle your saber all you want, but you have to settle,” said Peter Henning, professor of law at Wayne State University.

Promontory founder and chief executive Eugene Ludwig showed relief in a statement when the settlement was announced. “We are glad to have resolved this matter,” he said. “We remain committed to quality and integrity in carrying out our work.”

The decision by Promontory to litigate against the New York regulator was at the time viewed by many as a reckless strategy, fraught with considerable risk and little upside benefit.

“What did they gain out of this other than weeks of bad publicity,” said one attorney who requested anonymity. “I think they forgot the lessons they learned when they were regulators: nobody fights the regulator in public.”

What prompted Promontory to back down?

With a roster that includes many former regulators, several of whom had previously worked for the Office of the Comptroller of the Currency – including Ludwig, who once headed the office – the firm would often advise clients who faced enforcement to seek a settlement rather than mount a legal challenge, according to those familiar with the firm’s strategies.

In assessing what caused Promontory to reverse course, several factors might have been at work. First, the public nature of the dispute could have led to a slowdown in new business opportunities. With a choice of consultancies, prospective new clients might have opted against choosing Promontory given its legal troubles. If there was in fact a sharp slowdown in new engagements, experts say that might have prompted a reconsideration of Promontory’s strategy.

Second, Promontory had limited prospects of winning in court.

“I doubt very much they would have won, because what they were quibbling over was a report by the DFS which called into question some of their behavior,” said another legal advisor. “If you really think through the odds of winning, you might think twice. Losing the case would have been devastating.”

Lastly, even if Promontory had won, its relationship with the New York regulator would have been severely damaged, and would likely affect future engagements with clients. Some observers said any bank wishing to use Promontory as an advisor would find the New York regulator refusing to work with them, further damaging their business prospects.

Regulatory intermediary versus client advocate

Some also questioned whether Promontory’s rather unique business model might be reconsidered. The episode highlights the difficult role faced by consultants in performing dual roles: on the one hand they are hired and paid by the client to help them deal with a difficult regulatory problem while at the same time tasked with providing independent and impartial information to a regulator to help determine whether the client is in compliance.

“A message has been delivered to Promontory and any others in this business: if you are going to represent yourselves to regulators as independent then you have to actually be so,” said Roy Smith, a professor at New York University’s Stern School of Business.

“Maybe that will mean they discontinue the role of independently assuring regulators about what their client actually did in preference for an advisory and advocacy role with client banks. More likely they will continue doing what they have been doing, but trying harder to maintain the independence that is expected of them,” he added.

Others agreed that Promontory’s business model was unique and so attractive that the firm would likely maintain its course.

More broadly, the event also illustrates the difficulties for any financial firm in contemplating a legal challenge with a regulator.

“You have to come up with a strategy to fight without it appearing you are fighting and then settle it,” said Henning of Wayne State University. “This is what white collar defense lawyers do and this is what they sell. They can get into the door and talk the agency out of your worst case scenario,” adding that in the end it seemed that both Promontory and the DFS gave some ground in reaching a compromise.

(This article was produced by Thomson Reuters Regulatory Intelligence. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @RiskMgment)

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