In this Issue. The Federal Deposit Insurance Corporation (FDIC) released a report detailing the supervision of the former First Republic Bank; the Securities and Exchange Commission (SEC) Division of Examinations published a risk alert to detail its investment adviser examination selection and scope process; the Board of Governors of the Federal Reserve System (Federal Reserve), the FDIC and the Office of the Comptroller of the Currency (OCC) invited public comment on a proposed rule to require large banks to maintain long-term debt; and California's Department of Financial Protection and Innovation's (DFPI) issued new regulations under the California Consumer Financial Protection Law (CCFPL). These and other developments are below.
Regulatory Developments
FDIC Releases Report Revising the Supervision of Former First Republic Bank
On September 8, the FDIC released its report evaluating the agency's supervision of First Republic Bank from 2018 until the bank's failure in May 2023. The report noted that while the FDIC reviewed First Republic Bank under a continuous examination process, the FDIC could have (1) been more forward-looking in assessing how the increasing interest rates could negatively impact First Republic Bank and (2) done more to effectively challenge and encourage First Republic Bank's management to implement strategies or changes to mitigate the interest rate risk.
"[T]he banking industry still faces significant challenges from the effects of inflation, rising market interest rates, and geopolitical uncertainty. These risks, combined with concerns about commercial real estate fundamentals, especially in office markets, as well as pressure on funding levels and net interest margins, will be matters of continued supervisory attention by the FDIC."
- FDIC Chairman Martin Gruenberg on the Second Quarter 2023 Quarterly Banking Profile
Agencies Request Comment on Proposed Rule to Require Large Banks to Maintain Long-Term Debt
On August 29, the Federal Reserve, FDIC, and OCC issued a notice of proposed rulemaking (NPR) inviting public comment on a proposal that would require certain large insured depository institutions and large U.S. holding companies with $100 billion or more in consolidated assets that are not U.S. global systemically important banking institutions to issue and maintain outstanding a minimum amount of long-term debt and, at the holding company level, establish "clean holding company" requirements restricting their ability to engage in certain activities that could complicate resolution. As the agencies explained, the proposed requirement is intended to improve the resolvability of these institutions by giving the agencies additional resources, reduce costs to the Deposit Insurance Fund in the event of a failure, and mitigate contagion and reduce financial stability risks by reducing the risk of loss to uninsured depositors and fostering depositor confidence. The NPR follows an advance notice of proposed rulemaking issued by the Board and the FDIC in October 2022 that considered possible approaches to promote orderly resolutions, including a long-term debt requirement, and, as the agencies noted in an accompanying Fact Sheet, the failure of three large banks in the spring of 2023 underscored the importance of supplementary, loss absorbing resources that regulators can use to resolve banks in a way that reduces the attendant costs and disruptions to the banking system resulting from bank failures. The long-term debt proposed under the NPR would be used in the event of a bank's failure and be available to absorb losses and increase options to resolve the failed bank. Top-tier large banking organizations (LBOs) would be required to issue the long-term debt externally. A bank that is a subsidiary of an LBO, and that has either at least $100 billion in total assets or is affiliated with an insured depository institution that does, would generally be required to issue long-term debt internally to a consolidated parent. The long-term debt requirement would be equal to the largest of 6 percent of risk-weighted assets, 2.5 percent of total leverage exposure (as defined under the supplementary leverage ratio (SLR) rule) for banks subject to the SLR, and 3.5 percent of average total consolidated assets (the denominator of the Tier 1 leverage ratio). Generally, qualifying long-term debt securities would need to be unsecured, governed by U.S. law, contractually subordinated, and have an outstanding maturity of greater than one year. The NPR would also apply a "stringent capital treatment" to certain large U.S. banking organizations holding long-term debt issued by other large banking organizations. The NPR includes a three-year phased-in transition period. Comments are due by November 30, 2023.
Investment Advisers: Assessing Risks, Scoping Examinations, and Requesting Documents
On September 6, the SEC Division of Examinations (the "Division") published a risk alert to elaborate on its investment adviser examination selection and scope process. The Division emphasized that the process is dynamic, adapting to changes in market conditions, industry practices, and investor preferences. The Division looks at a variety of factors when selecting candidates for examination and the scope of the examination, such as (1) the adviser's risk characteristics based on the Division's published annual priorities; (2) a tip, complaint, or referral; (3) recidivist conduct; and (4) significant fee- and expense-related issues.
The examination will then typically include reviewing advisers' operations, disclosures, conflicts of interest, and compliance with areas such as fees and expenses and custody and safekeeping of client assets. The risk alert also provided a sample list of documentation that the Division requests during an examination, including organization information, disclosures and filings, and compliance policies and procedures. Read more about this risk alert in our client alert here.
California's DFPI Issues New Regulations Under CCFPL
On August 2, the Office of Administrative Law approved the DFPI's proposed adoption of regulations under the CCFPL related to the offering and provision of commercial financing and other financial products and services to small businesses, nonprofits, and family farms. The new regulations (1) define and prohibit unfair, deceptive, and abusive acts and practices in the offering or provision of commercial financing to small businesses, nonprofits, and family farms and (2) establish data collection and reporting requirements. This action becomes effective on October 1, 2023. The first annual report required to be filed under these regulations will cover activity during 2024 and will be due no later than March 15, 2025.
SEC Adopts Expansive (Albeit Slightly Softened) Private Funds Rules
On August 23, the SEC has adopted the much anticipated so-called "Private Funds Rules" under the Investment Advisers Act of 1940. The Private Funds Rules will impact not just SEC-registered investment advisers but also exempt reporting advisers, state-registered investment advisers and other unregistered investment advisers. The Private Funds Rules represent a substantial expansion of the SEC's regulation of private fund advisers that will likely have a significant impact on future SEC examination and enforcement activities. However, the SEC did soften the Private Funds Rules from the proposed version in certain important ways, although certain of the prohibitions have been replaced with reporting and consent requirements that in certain circumstances may be onerous.
Read more about these expansive private funds rules in a recent client alert.
The new rules include restrictions on preferential treatment of investors, which the EU Alternative Investment Fund Managers Directive (AIFMD) also addresses. Noting that there are various instances that could bring an EU AIFM within the scope of the new SEC rules, Goodwin's Private Investment Funds team examines how the new obligations under the SEC rules compare with those that AIFMs are subject to under EU member state laws (and UK law and regulation) implementing the AIFMD in another recent client alert.
Fintech Flash - The Fintech Deal Long Pole: License Change of Controls
From a legal perspective, there is a lot that goes into buying or making a significant investment in a fintech company. Beyond the purchase agreement, there's governance, IP, employment, contract, compliance, privacy, tax, real estate and ESG issues. What is the most important issue of the lot for a fintech target with state financial services licenses? Well, the Flash staff posits that it is one of the least glitzy ones - the one that is the long pole to closing and can cause delays: license change of control approvals by state regulators.
In this Flash, Goodwin's fintech team shares a primer on change of controls and point up important things you should know about them.
Litigation and Enforcement Developments
SEC Announces the First Enforcement Action under the New Marketing Rule
On August 21, the SEC announced that it has settled with a Fintech registered investment adviser (Adviser) that offers multiple investment strategies, including a crypto strategy, through its mobile app, for more than $1 million to resolve allegations that it, among other things, advertised misleading hypothetical performance projections in its marketing materials. Beginning June 2021, the Adviser elected to comply with the new marketing rule, which became effective on May 4, 2021, but had a compliance date of November 4, 2022. The Adviser's advertisements, which were directed at retail investors and available on its website, were found to be misleading because they lacked material information and "painted a misleading picture of certain of its strategies." The SEC also found that the Adviser failed to adopt and implement policies and procedures regarding hypothetical performance that are required under the rule. This settlement is the first enforcement action alleging violations of the SEC's recently amended marketing rule.
Read more about this settlement in a recent client alert.
CFPB Analyzes Mobile Device Tap-To-Pay Market as Possible Precursor to New Regulation
On September 7, the Consumer Financial Protection Bureau (CFPB) published its analysis of how smartphone companies are affecting consumers' use of so-called "tap-to-pay" technology - the wireless transfer of data over very short distances, used in financial transactions conducted at the point of sale. Concluding that "tech companies are playing a powerful role in determining consumers' payment options" via tap-to-pay on mobile devices, it promised that the CFPB would "take appropriate steps to ensure that Big Tech companies do not impede the development of open ecosystems for digital payments."
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
FIRST REPUBLIC BANK 