Despite Pressure to Police Consultants, Regulators Face Obstacles

Federal regulators are facing pressure on Capitol Hill to rein in a multi-billion dollar consulting industry after the firms stumbled during a recent review of foreclosure abuses. But the efforts could be stymied, given regulators’ cozy ties to consultants and limited legal authority to penalize them.

The early signs are discouraging, lawmakers say. After concerns surfaced that one consulting firm was bungling the broad review of foreclosures, regulators sent the firm a letter complaining about the conduct but stopped short of firing the consultant, according to Congressional officials with knowledge of the matter.

The use of consultants, which are paid by the same banks they are expected to help reform, will come under the microscope at a Senate Banking Committee hearing on Thursday. Senator Sherrod Brown, the Ohio Democrat leading the hearing, is examining whether regulators inappropriately “outsource” oversight to consultants like Deloitte & Touche and Promontory Financial Group, concerns that stem from the recent review of home loans.

Since the review was scuttled earlier this year, some government officials have been exploring new ways to constrain the use of the firms and penalize them when they err, according to prepared testimony for the Senate hearing.

“While the use of independent consultants can be an effective supervisory tool, there are certainly lessons to be learned from our experience, and we believe we can improve the process going forward,” Daniel P. Stipano, a senior official at Office of the Comptroller of the Currency, said in the testimony. He added that the agency plans to “enhance our oversight of the consultants when they are utilized.”

But challenges remain.

Mr. Stipano is expected to cite legal limitations that undercut the regulator’s authority over consultants. That constraint stems from 2006 when the Comptroller’s office levied a $300,000 against Grant Thornton, a firm that audited the books of First National Bank of Keystone, which collapsed in 1999. Grant Thornton, the Comptroller found, ignored “unequivocal, written evidence” that showed the bank didn’t account for much of its assets, a major discrepancy that the consultant didn’t flag.

When the firm challenged the fine, a federal appeals court in Washington overruled the Comptroller. The court said that the regulator had “exceeded his statutory authority.”

At the hearing on Thursday, Mr. Stipano is expected to petition lawmakers for greater authority. In the prepared testimony, he said the Comptroller’s office “would welcome a legislative change in this area that would facilitate our ability to take enforcement actions directly against independent contractors that engage in wrongdoing.”

Even if regulators gain new powers to curb the use of consultants, their relationships with the firms may prove difficult to disentangle. Since the financial crisis, the Comptroller has ordered banks to hire consultants in more than 130 enforcement actions, or roughly 15 percent of the cases, an analysis of government records shows.

Further complicating the relationships, consultants like Promontory have forged close ties to the regulators, routinely poaching from the government ranks. Promontory was founded by Eugene A. Ludwig, a former Comptroller of the Currency. Last week, the consultant announced the hire of Mary L. Schapiro, who led the Securities and Exchange Commission until late last year.

Alongside Deloitte and PricewaterhouseCoopers employees, a Promontory executive, Konrad Alt, will testify at the Senate hearing on Thursday. Mr. Stipano, of the Comptroller, will be joined by Richard Ashton, a top official at the Federal Reserve.

The hearing comes a week after the Government Accountability Office issued a scathing report faulting regulators for the flawed foreclosure review. The regulators, the report found, failed to properly coordinate a review of foreclosed loans and potentially allowed some errors to go undetected.

Adding to the scrutiny, Senator Elizabeth Warren, Democrat of Massachusetts, and Representative Elijah Cummings, Democrat of Maryland, are pushing regulators to explain what went wrong with the foreclosure review. Regulators halted the review in January after consultants scrutinized only 114,000 of the more than 800,000 troubled loans they were expected to review, according to the lawmakers.

But when the lawmakers pressed for greater detail on the problems, regulators balked. The regulators, for example, refused to provide the name of the consultant that was admonished â€" but not expelled â€" for shoddy work.

In a letter to the regulators on Wednesday, the lawmakers slammed the Fed and the Comptroller’s office for the resistance. “Your staff would not elaborate” even after finding the consultant’s work was “so poor that you issued a letter faulting the company and directing it to cure its deficiencies,” according to a copy of the letter reviewed by The New York Times.

The letter also took aim at the regulators for shielding the banks. When asked to detail the number of illegal foreclosures at each bank, the regulators declined, arguing that the information amounted to “trade secrets.”

Lawmakers excoriated the argument, declaring in their letter that “breaking the law is not a corporate trade secret.”

The dispute, officials note, came about because regulators are hesitant to provide granular information derived from their supervision of banks. Such documents are typically confidential.

The Comptroller’s office and the Fed declined to comment.

Representative Maxine Waters, Democrat of California, is also taking aim at the regulators’ reliance on consultants. While regulators must grapple with finite resources, forcing them to hire outsiders for certain responsibilities, Ms. Waters argues that federal authorities should adopt stricter oversight measures. On Wednesday, Ms. Waters is expected to introduce legislation that would impose a range of conditions on the use of consultants, including regular progress reports and detailed estimates of costs.

“The situation clearly requires a legislative remedy,” Ms. Waters said on Wednesday. “This is not independence - it is work for hire.”