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AIG to NY Regulator: Back Off!

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Recently, the top watchdog in New York's financial regulatory arm announced that it would be reopening a probe into American International Group's (NYSE: AIG  ) handling of its ill-fated credit-default swaps that lead the company to the brink of bankruptcy. But the insurance behemoth is fighting back, stating that the regulators are behind the times and not first in command. The tussle highlights an issue that faces many New York-based firms, which investors should see as a potential long-term hindrance of operations.

The New York Department of Financial Services is the top watchdog for the state, so naturally, it has a heavy caseload with all of the firms on Wall Street. But with the financial crisis highlighting some of the shortcomings of federal oversight, many federal regulators have upped their involvement in the watchdog duties.

This is precisely where the conflict between AIG and NYDFS comes into play. AIG, which was labeled as a Systemically Important Financial Institution this summer for its central role in the financial crisis, contends that the NYDFS will need to accept a back-seat role in regulation of New York companies, especially since the insurer has been working in tandem with the Federal Reserve since its bailout in 2008.

The NYDFS claims that though the insurer was overseen by the Office of Thrift Supervision (a now defunct regulator), it always had full authority to regulate AIG Financial Products, the division that placed risky bets on the housing market through CDS, collateralized debt obligations, and residential mortgage-backed securities. The current probe is looking into the risk management of the remaining portfolio from AIGFP, which was reduced from $1.8 trillion to $116 billion, a 93% reduction.

Since regulators have been ramping up their activity following the financial crisis, a multitude of problems arise when more than one regulator is demanding information or corrections to company risks. In the case of AIG, CEO Robert Benmosche has stated that the company is monitored by the Fed and has eight Fed employees within the company. He's also stated that the insurer has cooperated with all NYDFS inquiries, but that the watchdog may not consider that sufficient.

The problems with multiple regulators vying for the top spot are plentiful. Not only will some of the work necessary to comply with inquiry requests lead to redundancies, but required concessions and corrections from regulators may actually conflict with each other. The problem can lead to increased costs for the companies, as well as interruptions for operations.

While most shareholders would largely agree that a regulator with proper jurisdiction over a company that is found to be acting out of line should be permitted to proceed with an investigation, there is a solid argument for regulators to work together to avoid conflicts. JPMorgan Chase  (NYSE: JPM  ) just demonstrated how regulators can work together through its $920 million settlement with the Office of the Comptroller of the Currency, Securities and Exchange Commission, Federal Reserve, and U.K. Financial Conduct Authority over the London Whale debacle.

Bottom line
Investors should keep an eye out for more developments in regulatory probes and investigations, but as long as there are multiple agencies with authority over the firms, there's no way to know if one settlement or correction will be the end of the story. For AIG investors, it will be interesting to see how the Fed v. NYDFS scenario plays out, especially as new rules are put into place for the firms designated as SIFI. For now, know that the issue is far from being resolved, and expect to see some increases in costs as the company continues to deal with the NYDFS probe.

Getting beyond the scrutiny
With the after-effects of the financial crisis still plaguing the financial firms on Wall Street, it's no surprise that many investors are terrified about investing in big banking stocks. But the sector has one notable stand-out. In a sea of mismanaged and dangerous peers, it rises above as "The Only Big Bank Built to Last." You can uncover the top pick that Warren Buffett loves in The Motley Fool's new report. It's free, so click here to access it now.

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