iLast week the New York State Legislature passed and the Governor signed into law, the 2011-2012 State budget. Included in the budget was legislation (Part A of S.2812-C/A.4012-C codified as Chapter 62 of the Laws of 2011) establishing the Financial Services Law (FSL), that consolidates the New York Insurance and Banking Departments into a new single entity, the Department of Financial Services.
The concept of merging the two departments was raised in the recent past by the New York State Assembly, only to be rejected because the consolidation would not result in any significant taxpayer savings. This year, however, the concept of consolidating these diverse departments, which was discussed by the Governor during his election campaign and then mentioned in his State of the State Address, surprisingly garnered little direct opposition from the insurance or banking industries, or Legislature. Instead, the financial services industry’s focus was largely confined to the original proposal’s granting of additional regulatory and investigative powers to the new department, along with greatly increased fines. As is discussed below, most of these provisions ultimately were not included in the final bill.
The enacted bill, as it concerns the insurance and banking industries, largely represents an almost streamlined combination of the two departments, mainly keeping in place the existing powers of the two agencies. The new department does have expanded jurisdiction over a limited universe of previously unregulated entities, and the ability to investigate and penalize any illegal conduct by these groups but, beyond this narrow area, it is unlikely to lead to substantial new enforcement actions.
If there is any true impact of the new agency, it will come in the proclaimed re-evaluation of existing regulations. The Governor’s staff has explained that the consolidation was phase one of a two-step plan. Phase one, which has been achieved through this bill, was intended to structurally combine the entities into a single unit. Phase two, however, is envisioned as a six to nine month evaluation of how the two agencies conduct their business, with an eye towards eliminating or modifying regulation and practices which are unnecessary, overly costly, or simply inefficient.
The original bill had the consolidation slated to be merged on April 1. At the last minute, this was delayed until October 3. It appears this change was intended to allow “phase two” to occur in the intervening time period and for the new regulations and internal changes to, at least partially, begin immediately when the consolidation takes effect. In the interim, the new law requires the Governor to appoint a working group to examine ways to improve the efficiency and effectiveness of regulations, requiring a report by the beginning of the new year. The seriousness of the Governor in tackling this reorganization can be seen in the resources that he has put towards it and the involvement of top Executive staff.
The question to be watched is whether they will succeed where other governors and superintendents have failed. It should be noted that almost every superintendent and governor have pledged to reduce regulations and make New York a more friendly place for business. Most recently, Governor Spitzer, through one of his top aides, then-Superintendent of Insurance Eric Dinallo, launched a blue ribbon commission on financial services regulatory reform to examine these same issues. Multiple meetings were held with industry and consumer groups, speeches were made in large forums, and draft recommendations were formulated. But then, with the fall of the markets, and Governor Spitzer, the commission quietly disbanded with no tangible results. Thus, although this year’s passage of the consolidation bill may have been a significant achievement, the real test is still to come.
The Financial Services Law
As noted above, the FSL contains a number of new powers and some enhanced powers, which will augment the new organizations ability to bring investigations and extend its reach to new areas.
Financial Fraud and Consumer Protection Unit
Rather than have separate investigatory units, the law creates a single Financial Frauds and Consumer Protection Unit (FFCPU) which has all of the investigatory and prosecutorial powers of the previous Banking and Insurance Departments, and is empowered to prosecute frauds involving financial products. Although at first blush this would appear to be a large expansion of power, it is tempered by the very limited definition of what constitutes a financial product. Under the law, the term “financial product or service” encompasses any financial product or service “offered or provided by any person regulated or required to be regulated” under the Insurance Law or the Banking Law, as well as any financial product or service otherwise offered or sold to consumers. Excluded from this term, however, are financial products or services that are (i) regulated “under the exclusive jurisdiction of a federal agency or authority;” (ii) subject to state regulation “for the purpose of consumer or investor protection by any other state agency, state department or state public authority” (e.g., securities, commodities and real property); or (iii) subject to preemptive federal regulation. FSL § 104(a)(2). Thus, unlike previous versions of this unit, which as discussed in our last alert would have represented a large expansion of power, it is now hard to envision many products that currently exist that will be subject to this expanded authority. Nevertheless, the creation of the FFCPU may prove to be a paradigm shift from focusing exclusively on traditional insurance and banking fraud cases, to now investigating categories of financial fraud outside of the banking and insurance industries.
Penalties
Similarly, although the law provides a series of new penalties, many of them will have no effect on any insurance or banking companies which are covered by existing law. As such, this also represents a significant cutback from prior proposed versions of the law. Although the law provides for a $5,000 penalty per violation for financial fraud, unlike the initial version of the bill, the law makes clear that this does not apply to those regulated under the current Insurance and Banking Laws. This limitation is further reinforced by a specific prohibition on the Superintendent imposing any additional penalty or fine for the same act that is imposed under the Insurance or Banking Laws. As a consequence, it is again only for the limited products that fall outside of the current Banking and Insurance areas that this would apply.
The law does impose new fines of $1,000 for violations of the FSL (which do not fall under the existing law) and regulations issued thereunder and does double the amount for a general violation of the Insurance Law under Section 109(c)(1) from $500 to $1,000 per violation. In addition, the amendment to Section 109 (c)(1) by deleting the word “such” codifies existing Department practice that a single insurer transaction may be subject to number of fines for violations of the Insurance Law. The final version of the FSL also deleted express statutory authority for restitution as an available remedy to the new Department. However, even without the express statutory authority, it is unlikely that the Department will abandon the existing practice of asking for restitution in certain instances.
Expansion of the Superintendent’s Rulemaking Authority
The greatest unknown under the new law is that the Superintendent now has authority to adopt regulations and issue guidance governing financial products and services. This extensive statutory language gives the Superintendent the authority to regulate previously unregulated financial products, services, and entities, so long as such regulations are not inconsistent with the new law, the Insurance Law, or the Banking Law. The extent to which these regulations are promulgated and existing products are attempted to be brought under the agencies jurisdiction, will determine the full extent of this new entity.
Conclusion
The full impact of the consolidation of the Banking and Insurance Departments into the Department of Financial Services will take place over the next year as the “phase two” integration is designed and implemented by the Governor’s office. Governor Cuomo’s goal of turning the Department of Financial Service into a model financial services regulator for the federal government and all of the states to emulate, poses significant opportunities and challenges for the financial services sector. A proactive approach of constructive engagement with the new entity would be recommended even before the Department of Financial Services becomes fully operational in October.
