Federal authorities are scrutinizing private consultants hired to clean up financial misdeeds like money laundering and foreclosure abuses, taking aim at an industry that is paid billions of dollars by the same banks it is expected to police.
The consultants operate with scant supervision and produce mixed results, according to government documents and interviews with prosecutors and regulators. In one case, the consulting firms enabled the wrongdoing. The deficiencies, officials say, can leave consumers vulnerable and allow tainted money to flow through the financial system.
"How can you be independent if you're hired by the entity you're reviewing?" Senator Jack Reed, Democrat of Rhode Island, who sits on the Senate Banking Committee, said.
The pitfalls were exposed last month when federal regulators halted a broad effort to help millions of homeowners in foreclosure. The regulators reached an $8.5 billion settlement with banks, scuttling a flawed foreclosure review run by eight consulting firms. In the end, borrowers hurt by shoddy practices are likely to receive less money than they deserve, regulators said.
(Read More: Ten Banks Settle Foreclosure Suit for $8.5 Billion)
On Thursday, Senator Elizabeth Warren, Democrat of Massachusetts, and Representative Elijah Cummings, Democrat of Maryland, announced that they would open an investigation into the foreclosure review, seeking "additional information about the scope of the harms found."
Critics concede that regulators have little choice but to hire outsiders for certain responsibilities. after they find problems at the banks. The government does not have the resources to ensure that banks follow the rules. Still, consultants like Deloitte & Touche and the Promontory Financial Group can add to regulators' headaches, the government documents and interviews indicate. Some banks that work with consultants continue to run afoul of the law. At other times, consultants underestimate the extent of the misdeeds or facilitate them, preventing regulators from holding institutions accountable.
Now, regulators and lawmakers are rethinking their relationship with the consultants. Officials at the Federal Reserve, which oversees many large banks, are questioning the prudence of relying on consultants so heavily, said two people with direct knowledge of the matter.
When the Office of the Comptroller of the Currency penalized JPMorgan Chase last month for breakdowns in money-laundering controls, it imposed stricter requirements, ordering the bank to hire a consultant with "specialized experience" in money laundering and to ensure that the firm "not be subject to any conflict of interest." In a separate action against the bank related to a $6 billion trading loss last year, the agency opted not to mandate an outside consultant at all.
(Read More: JPMorgan bet Against Itself in 'Whale' Trade)
While the comptroller's office will continue requiring consultants in certain cases, some agency officials are worried about the quality of the work, as well as the consultants' independence, according to three government officials briefed on the matter.
Since the financial crisis, regulators have increasingly relied on consultants. The comptroller's office ordered banks to hire consultants in more than 130 enforcement actions since 2008, or nearly 15 percent of the cases.
It can be a lucrative business. In 2011, regulators mandated that 14 banks employ consultants to determine whether homeowners were wrongfully evicted. Over 14 months, the consultants collected about $2 billion in fees, according to regulators and bank officials.
Those fees amounted to more than half of what homeowners will receive under the $8.5 billion settlement that ended the review. As part of the deal, officials will disburse $3.3 billion to 3.8 million borrowers in foreclosure.
According to consultants and regulators, the broad review was plagued with inefficiencies. For example, Promontory initially instructed employees to calculate lawyers' fees for each loan, to assess if borrowers were overcharged. Later, it scrapped the original procedure, only to reverse the policy again two weeks later, according to two reviewers who worked for Promontory.
"From Day 1, Promontory strove to conduct its review work as thoroughly and independently as possible," a spokesman for the firm, Christopher Winans, said in a statement. "Our overarching concern at all times was to serve the best interests of borrowers."
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Some lawmakers question whether a consultant's regulatory connections helped it secure contracts. PricewaterhouseCoopers, which has a stable of former Securities and Exchange Commission officials, won much of the foreclosure review work, signing deals with four banks, including Citigroup. Promontory, the firm examining loans for Wells Fargo, Bank of America and PNC, was founded in 2000 by the former head of the comptroller's office, Eugene A. Ludwig.
When the contracts were initially awarded, some housing advocates complained that consulting firms could not objectively evaluate banks with which they had pre-existing business relationships. The comptroller's office said it vetted the firms to spot such potential conflicts, and argued that the process provided swifter relief for homeowners than if the government had hired the companies directly through a lengthy contracting process.
But concerns persisted. Deloitte, which won the contract to review JPMorgan's loans, had previously audited Washington Mutual and Bear Stearns, two firms JPMorgan acquired during the financial crisis. In May, the comptroller's office replaced Allonhill, the consultant for Aurora Bank, after the firm disclosed that it had already reviewed some "of the same pool of loans" as part of an earlier contract.
"It's clear from the foreclosure settlement that oversight over consultants was inadequate and the review process was deeply flawed," said Representative Carolyn B. Maloney, Democrat of New York, who recently pressed regulators to detail how consultants were paid. People close to the review say consultants relied on a process that the comptroller's office designed in 2011, under previous leadership.
"This was a very complex process," a spokesman for the comptroller said. "Throughout the process, regulators provided continuous oversight, guidance and were available to discuss issues." The agency also performs spot checks on the consultants.
Still, the foreclosure review highlighted broader concerns about the role consultants play.
Since the financial crisis, the comptroller's office has issued nearly 20 enforcement actions against banks that had already hired consultants to help iron out problems, according to government documents. While consultants cannot be expected to remedy every last issue at the banks, the actions raise questions about the effectiveness of their work.
When HSBC, the British bank, was sanctioned in 2003 over porous money-laundering controls, the bank turned to Deloitte to review its compliance, an official briefed on the matter said. Deloitte also worked for HSBC from 2006 to 2008, the person said, building a system to monitor money flows more effectively. But the bank ran into trouble in 2010 over similar issues, as highlighted in a recent scathing report by the Senate's Permanent Subcommittee on Investigations.
As part of a regulatory order, HSBC again hired Deloitte, this time to assess the number of times the bank failed to report suspicious transactions. Deloitte, three officials said, generously bundled hundreds of missed transfers into a single report. That helped save the bank from some government fines.
Despite the undercounting, HSBC still paid a record $1.9 billion last year to settle accusations that it enabled drug cartels to move money through its American subsidiaries.
In a statement, a spokesman for the firm said, "Deloitte fully stands behind the quality and integrity of its work on behalf of regulatory authorities."
Deloitte has also been suspected of helping institutions cloak illicit transfers of money to rogue nations around the globe. In August, New York's top banking regulator, Benjamin M. Lawsky, accused Deloitte of helping the British bank Standard Chartered flout American sanctions.
The consulting firm was hired to flag suspicious transfers routed through Standard Chartered's New York branches. Instead, it instructed bankers on how to escape regulatory scrutiny, according to state court documents.
Deloitte turned over "highly confidential information" from which the bank gleaned insight into "regulators' concerns and strategies," the court documents said. The firm later doctored its report to regulators, Mr. Lawsky said, deliberately removing some illegal transfers on behalf of Iranian clients. In an e-mail, a Deloitte partner admitted that a report on the transactions was a "watered-down version."
The authorities never took legal action against Deloitte, and federal officials noted in a separate settlement agreement that Standard Chartered employees withheld critical information from the consulting firm.
Despite these concerns, regulators are turning to a familiar source to help Standard Chartered. As part of a $327 million settlement last year, the bank is required to hire "an independent consultant."