Banks in the Crosshairs & Finding the Best Leaders for Banking’s Next Phase

Banks in the Crosshairs

While banks have had to deal with increasing regulations over the years, they now face a new round of challenges. State attorneys general have been making their voices heard on issues ranging from deceptive lending practices to loan modification to credit card and overdraft fees, marking perhaps the beginning of what some legal experts liken to the “next tobacco,” a reference to the landmark case between states and tobacco companies in the 1990s.

Several forces have conspired to create the rising tide of anti-bank sentiment among attorneys general. The subprime crisis has led to a spike in foreclosures nationwide, with consumers flooding regulatory agencies with complaints. The foreclosure debacle has also begotten new problems, such as fraudulent operators who bill themselves as debt reduction services. National banks are also under fire for boosting credit card interest rates and fees, in addition to their practice of bombarding debit card users with overdraft charges.

Meanwhile, there have been political and legal shifts. The Obama administration is cooperating with states on investigating alleged wrongdoings. States also got a big break last summer with the Supreme Court ruling Cuomo vs. Clearing House Association, which held states officials are not precluded from regulating and enforcing banking activities governed by the National Bank Act and the Office of the Comptroller of the Currency. Much like the tobacco companies had to face attorneys general, banks may undergo a similar battle down the road.

“There’s a very strong tradition cutting across party lines, geographic boundaries, and other differences that unites the states and combines forces to protect consumers,” says Richard Blumenthal, attorney general for Connecticut. There “seems to be some opportunity for us to act in areas that were preempted before.”

In essence, the Cuomo decision opens the door for attorneys general to file lawsuits under their existing laws that restrict unfair and deceptive trade practices and statues that mandate consumer protection. A host of states have sued fraudulent mortgage-scam operators, and now they are setting their sights on banks with other issues.

For example, Illinois’ attorney general, Lisa Madigan, sued $1.2 trillion-asset Wells Fargo last summer, claiming the San Francisco-based bank discriminated against African-American and Latino homeowners by doling out high-cost subprime mortgages while white borrowers with similar incomes were given lower-cost loans.

Meanwhile, attorneys general from several states formed a task force in August to investigate businesses that deceive or discriminate. Connecticut has pressured banks to reverse recent hikes in credit card interest rates and fees. And overdraft fees, where some financial institutions charge customers multiple times for overdrawn accounts, now are on state radar screens.

For bank chief executives and their directors, “one has to accept that this is now reality,” says Frank Emory, an attorney at Hunton & Williams in Charlotte, North Carolina. “States feel emboldened and empowered to bring these cases.”

Still, states are also using their leverage to get concessions from financial institutions. Tom Miller, Iowa’s attorney general, is pressuring mortgage servicers to lower principal on loans. “If can be done, it saves the homeowners,” he says. “Banks and investors can realize more money in the reduction of payment than they can in foreclosing.”

One area of focus for Washington State has been mortgage loans that reset, such as pay-option loans, resulting in monthly payments that jump as much as two to three times the original cost. The attorney general’s office is looking into loan structure and the marketing practices of companies that sold them. The loans are “starting to recast and present problems to our consumers,” says David Huey, assistant attorney general for Washington. “That is an area of substantial interest.”

Many banks might figure they have done the right thing, but even seemingly compliant banks could find themselves in hot water in the new environment, attorneys say. Mortgage scammers, who have preyed on foreclosure victims, have precipitated a rash of lawsuits by states nationwide. That means more negative press for all financial companies, a sort of guilt-by-association phenomenon for banks.

“The challenge for banks is they figure, ‘Well, that is not my problem, clearly those aren’t connected to me,’” Emory says. “But as a political matter, it’s all of one piece.” And state attorneys general could lump all companies into their lawsuits. Warns Emory: “That is a nightmare scenario.”

Emory compares the current groundswell to the tobacco lawsuit by the states. In the mid-1990s, state attorneys general banded together and sued the tobacco companies on the argument that decades of deceptive and fraudulent sales practices led to health problems across the population, which in turn increased state Medicare and Medicaid costs. The battle culminated in a landmark settlement 1998, where the tobacco companies agreed to pay 46 state attorneys general $206 billion over 25 years in return for freedom from class-action lawsuits and a capping of litigation costs.

With the efforts by Congress to create a consumer financial protection agency, banks are certain to face even more scrutiny, and some bankers say new compliance rules will put a damper on loan growth and product innovation. Says Frank Sorrentino, chairman and chief executive officer of North Jersey Community Bank, a $500 million bank in Englewood Cliffs, New Jersey: “There comes a point where you can’t legislate against liquidity. That is going to put a severe constraint on the types of lending that are going to take place.”

Banks should get a jumpstart and talk with their regulators and state attorneys general, Blumenthal says. He likens banks’ conduct to the bumbling Schultz, the sergeant-of-the-guard on the old television show Hogan’s Heroes. “‘Hear nothing, see nothing’ won’t work anymore,” Blumenthal says. “There is real opportunity for banks to become heroes rather than villains if they raise the bar for themselves and hold themselves accountable.”

Banks also need to invest more in technology to handle the new scrutiny. “You automate compliance by embedding in your technology compliance tools that capture data and formulate your disclosures,” says Joseph Lynyak, a partner at law firm Venable in Los Angeles. “It is going to be a whole new level of compliance that is technology driven.”

To be sure, it’s in everyone’s interest to reach a deal on consumer issues rather than go to trial, says one official. “States traditionally have favored negotiated settlements,” Huey says. “Long bouts of litigation don’t serve anyone’s interest.”

Finding the Best Leaders for Banking’s Next Phase

“The financial crisis wiped out entire levels of executive leadership at banks, and 2010 will see a restructuring of the talent pool to drive organizations into recovery mode,” says S. John Kim, global head of the financial services practice at search and leadership advisory firm Heidrick & Struggles. Kim is the author of a new white paper, “Rising from the Ashes: Finding the Best Leaders for the Next Phase in Banking.”

The paper makes several cogent points about the evolving need for bank leadership in the coming decade. Among them:

The need to shift away from “supermarket” strategies-Only a very few of the big financial supermarkets will remain, and even as Wall Street results improve, the days of trying to be all things to all people are over. Instead, Kim argues, “many will thrive by tightly focusing on what they do best or on a core market. Thus, different skill sets will be needed as financial services institutions refocus on core strengths.

A hybrid type of leadership will be most effective-Prior to the economic meltdown, says Kim, the top leaders of financial institutions often fell into one of two types. “The first was the charismatic personality who motivated, inspired, or in some cases dictated through the force of his or her own presence, and the second type was a hands-on, detail-oriented operator who drove performance through results and significant attention to detail. Today’s renewed focus at banks now requires leaders who are a combination of both types.

An understanding of risk management will be paramount-Whereas the markets were flush with liquidity by the government and spreads were wide due to the dislocation in 2009, there will be more challenging times in 2010 asu2002the markets continue to move toward normalcy. “A strong manager with vision and a risk control focus will be in demand,” Kim states.

Skill sets will need revamping-There are many bankers who played in higher risk areas who simply won’t fit into the new architecture of banking. But on the other hand, there will be opportunities as well. According to Kim, “People who can evolve from a jack-of-all-trades role to flex a more specialized, sophisticated skill set are in hot demand. And we are also seeing a lot of crossover in the talent pool-people from big banks are moving to boutiques, those on the sell side are going to the buy side and vice versa, and global bankers are moving to the regionals.”

In general, the white paper takes a position that companies with bold leadership will become the employers of choice. “Talent will instinctively follow bold leaders, and it is those companies who are emerging first as the next decade’s key players.” And while there may be little agreement about precisely where we stand in terms of economic recovery generally or financial services recovery specifically, the paper makes clear that when the inevitable recovery gets into full swing, the financial services firms that already have in place the skills and the teams to take advantage of it will far outdistance their competitors.