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Tag: Regulation and compliance

  • SEC’s Gensler directly links crypto and bank failures

    SEC’s Gensler directly links crypto and bank failures

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    Crypto companies “have chosen to be noncompliant and not provide investors with confidence and protections, and it undermines the $100 trillion capital markets,” SEC Chairman Gary Gensler told the House Financial Services Committee on Tuesday.

    Al Drago/Photographer: Al Drago/Bloomberg

    WASHINGTON — Securities and Exchange Commission Chairman Gary Gensler tied together cryptocurrencies and the recent banking crisis as he asked Congress for more resources to police the crypto market. 

    “Silvergate and Signature [banks] were engaged in the crypto business — I mean some would say that they were crypto-backed,” Gensler testified at a House Financial Services Committee hearing Tuesday.

    The loss of deposits linked to cryptocurrency clients are widely believed to have contributed to Silvergate’s decision to close and the failure of Signature. Federal regulators took unusual steps to try to prevent a loss of public confidence in the banking system after the collapse of those two banks and Silicon Valley Bank last month.

    Gensler emphasized that the crisis showed that the regulated banking sector and the less-regulated crypto market have mutual exposures that have to be addressed.

    “Silicon Valley Bank, actually when it failed, you saw the country’s — the world’s — second-leading stablecoin had $3 billion dollars involved there, depegged, so it’s interesting just how this was all part of this crypto narrative as well.” 

    The stablecoin company Circle has confirmed that it held $3.3 billion of its $40 billion USD Coin reserves at Silicon Valley Bank, which failed on March 10. 

    While the SEC has the authority it needs to police crypto market, Gensler says, the agency “could use more resources.” 

    “The dedicated staff of this agency has done remarkable work with limited resources,” Gensler said in his prepared remarks. “In the face of significant growth in registrants, more individual investor involvement in our markets, and increased complexity, the SEC’s headcount actually shrunk from 2016 through last year. With Congress’s help, our headcount this year now is approximately 3% larger than in 2016. I support the President’s FY 2024 request of $2.436 billion, to put us on a better track for the future.” 

    In its budget request, the SEC asked for funding for 5,475 new positions, some of which would increase the agency’s oversight of crypto assets, including policing the market for noncompliant and fraudulent activity. 

    “I think this is a field that, in the main, is built up around noncompliance, and that’s their business model,” Gensler said at the hearing. “They have chosen to be noncompliant and not provide investors with confidence and protections, and it undermines the $100 trillion capital markets.” 

    Gensler’s appearance was his first before the committee since Republicans took control of the House in January. They had little to say on Gensler’s call for more resources.

    But Rep. Patrick McHenry, R-N.C., the chairman of the panel, has said that he intends to scrutinize the SEC and Gensler’s leadership of the agency as part of an aggressive oversight agenda. 

    “As you can see, we’re under new management and a new Congress,” McHenry said. “So please get comfortable.” 

    McHenry suggested he would use the committee’s subpoena power or other methods to get information that Republicans say the SEC has withheld from Congress.

    “If you continue to thwart this institution by ignoring our requests and providing incomplete responses, we will be left with no choice but to pursue all avenues to compel the information or documents we need,” he said. 

    Republicans criticized what they called uncertainty over whether crypto assets should be classified as a security or a commodity, as well as the agency’s proposed rulemaking around climate risk disclosures. The plan would include what’s called a Scope 3 requirement, which might present a challenge for banks if they’re required to report emissions that stem from business-related assets and activities not owned or controlled by firms. For banks, it likely would mean requiring the collection of climate data from all the companies they lend to or invest in.

    Regarding the failed Silicon Valley and Signature banks, Gensler said that the SEC has “initiated discussions” with the other five agencies responsible for finalizing an unfinished part of the Dodd-Frank Act that would give the Federal Deposit Insurance Corp. the ability to claw back some compensation from the executives of failed banks. 

    “I’m committed to getting this done,” Gensler said. 

    Rep. Andy Barr, R-Ky., the chairman of the subcommittee on financial institutions, questioned Gensler on an SEC staff bulletin that he said prevents banks from serving as custodians for crypto assets. Gensler defended the bulletin. 

    “I’m actually quite proud of the staff that put out that staff accounting bulletin, because what they said was public companies, not just banks, needed to put on their balance sheet their customers’ crypto, because what we found in bankruptcy court, Celsius bankruptcy and others, in bankruptcy investors just stand in line,” Gensler said. 

    When Barr asked if bank regulators were consulted beforehand, Gensler said that the agency discussed the issue with them “subsequently.” 

    “There was significant dialogue beforehand with the accounting profession and the big four [accounting firms] and others, because this question kept coming up, but there has been consultation about this with the bank regulators subsequently,” he said. 

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    Claire Williams

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  • Ex-Wells Fargo executive Carrie Tolstedt shows up in court

    Ex-Wells Fargo executive Carrie Tolstedt shows up in court

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    Carrie Tolstedt, the former head of Wells Fargo’s community banking unit, was arraigned in federal district court in Los Angeles on Friday and entered a not guilty plea on charges of obstructing a bank examination.

    Bloomberg News

    LOS ANGELES — Carrie Tolstedt, Wells Fargo’s former head of its community bank, entered a “not guilty” plea at an arraignment hearing on Friday, kicking off a legal battle that could result in prison time for the accused.

    Tolstedt stood before District Court Judge Josephine L. Staton at the federal courthouse in downtown Los Angeles and entered a plea of “not guilty,” to the criminal charge of obstructing a bank examination. If found guilty, Tolstedt would become the highest-ranking executive at Wells Fargo to go to prison for the phony accounts scandal and its ensuing coverup. 

    Prosecutors said Tolstedt failed to disclose to federal bank examiners the number of Wells Fargo employees who had been fired or resigned for opening millions of bank accounts without customer authorization.

    On Friday, Tolstedt, 63, stood before Judge Staton and agreed to waive her right to be indicted by a grand jury, and agreed to the conditions of her release on a $25,000 unsecured bond. The hearing took less than 10 minutes. Tolstedt’s “not guilty” plea starts the administration process that will end in 10 weeks with her sentencing.

    “Ms. Tolstedt, have you read this information,” Judge Staton asked at the hearing, saying: “And I’m not asking you to admit or deny anything right now, but do you understand the contents of what the government is saying that you did?” 

    “Yes,” Tolstedt replied.  

    Last month, Tolstedt entered into a plea agreement with the U.S. Attorney’s Office for the Central District of California, in which she agreed to plead “guilty” to the single obstruction charge in exchange for prosecutors setting an upper limit of prison time. The law for obstruction of a bank examination allows for a broad sentence of up to five years, but the plea deal limits the statutory maximum sentence, or “statmax,” to 16 months, said Ranee A. Katzenstein, a 25-year veteran of the U.S. Attorney’s Office, assistant U.S. attorney and chief of the major frauds section. The guideline range is between 10 to 16 months. 

    The plea agreement has not yet been approved by Judge Staton. The district court will refer Tolstedt’s “not guilty” plea to the U.S. Probation and Pretrial Services System, which prepares a presentence report that will be the subject of the next hearing, prosecutors said. Staton set a status conference for May 19, and a trial date of May 30. 

    Tolstedt is being prosecuted by Assistant U.S. Attorney Alexander B. Schwab. The case’s ultimate resolution is the result of years of work by multiple agencies investigating corporate misconduct, a focus of the Department of Justice under Attorney General Merrick Garland. 

    Meanwhile, Tolstedt spent much of the hearing signing papers and conferring with her attorney Matthew Umhofer, managing partner at Umhofer, Mitchell & King and a former assistant U.S. attorney. 

    The prospect of a high-ranking former banker actually going to prison comes at a particularly inauspicious time for the banking industry. The failures of Silicon Valley Bank and Signature Bank in March — and revelations of stock sales and bonuses of the executives of both banks — have rankled policymakers and the public, giving Republican and Democratic lawmakers the political impetus to craft legislation to claw back compensation. 

    Back in 2016, just months before the first settlement was announced, Wells gave Tolstedt a golden parachute in which she was allowed to retire with $125 million of stock and options, including a $5.5 million incentive bonus the year the scandal broke. Some of it was ultimately clawed back. 

    Last month, Tolstedt agreed to pay a $17 million fine to the Office of the Comptroller of the Currency for her role in the sales misconduct saga that ultimately led to the downfall of two Wells CEOs. Tolstedt also acceded to a ban from the banking industry in order to resolve certain civil charges she was facing. 

    Prosecutors said Tolstedt was aware of sales practices misconduct between 2004 and 2006, when employee firings linked to sales goals began rising. Wells has settled more than $3 billion in fines. The San Francisco bank admitted that employees were pressured for more than a decade to meet unrealistic sales goals leading to thousands of employees falsifying bank records or engaging in identity theft. The Office of the Comptroller of the Currency and L.A. City Attorney’s office announced the first settlement against Wells in September 2016. 

    The obstruction charge that Tolstedt faces stems from a memo that she and other Wells executives prepared for the risk committee of the bank’s board of directors in May 2015. Even though the memo was written for a board committee, Tolstedt knew that it would also be provided to the OCC, according to the plea agreement.

    The scandal was first uncovered by former Los Angeles Times Reporter E. Scott Reckard, whose 2013 article found employees forged signatures, falsified phone numbers and opened customer accounts without their permission, igniting the public investigations.

    Tolstedt was Wells Fargo’s senior executive vice president of community banking and headed the community bank during the time that the aggressive sale practices and firings took place. 

    On Friday, when Tolstedt first entered the nearly-deserted courthouse with her husband, she was stopped by a security guard after a beep went off at the metal detector. The guard ruffled through her belongings and repeatedly sent her wallet through the metal detector. The guard ultimately pulled out a metal credit card that had set off the alarm. 

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    Kate Berry

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  • Bank crisis puts money market funds back in the spotlight

    Bank crisis puts money market funds back in the spotlight

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    The Federal Reserve’s overnight repo facility has been utilized by money market funds to a large extent, and may be contributing to dramatic outflows of deposits from banks since the failure of Silicon Valley Bank and Signature Bank last month.

    Bloomberg News

    Deposit flows after a pair of high-profile bank failures last month have renewed a debate about the Federal Reserve’s support of money market funds and whether that support harms banks.

    Between March 8 and March 22, total commercial bank deposits declined by $300 billion, according to Fed data. During that same period, money market funds ticked up $238 billion. 

    It is unclear how many of those deposits went directly from banks to money market funds, but some in and around the banking sector worry that the Fed’s Overnight Reverse Repurchase Program has made it easier for funds to move in that direction.

    Also known as the ON RRP, the facility allows money market funds and other entities to purchase securities from the Fed and sell them back the next day at a fixed, higher price. Between March 8 and March 22, total ON RRP usage — which includes activity by government-sponsored entities and some banks — only increased by $47 billion. But since March 2021, the facility has swollen from zero to roughly $2.2 trillion per day, and has remained at that level since last June. 

    Some of the sharpest criticism of the facilities growth has come from the Bank Policy Institute, a bank lobbying organization, which accused the Fed last week of “abetting a draining of deposits from banks.”  

    Policy experts outside the banking industry also say the Fed’s engagement with money market funds, through both its ON RRP facility and other actions, have given those funds advantages over banks, ones that do not always benefit the broader economy.

    “The whole [ON RRP] facility should be unwound,” Karen Petrou, managing partner of Federal Financial Analytics, said. “Similarly, the Fed should stop sitting on trillions in bank deposits. It’s a huge distortion.”

    Historically, money market funds have increased the availability of credit by purchasing short term corporate loans — known as commercial paper — and Treasury bills, which are government bonds with maturities of less than one year. Funds still engage in this activity, but their ability to earn interest simply by engaging in these purchase agreements with the Fed diminishes their economic impact, Petrou said.

    “The Fed is supporting funds flowing out of the banking system, where they support macroeconomic activities, into the funds sector, then looping them back into the Fed where they support the Fed’s portfolio and government borrowing,” she said. “That’s a really altered state that nobody’s quite focused on.”

    Fed officials, including Gov. Christopher Waller, have described increased use of the ON RRP facility — which has primarily been driven by money market funds — as excess liquidity in the financial system. Because of this, he said, the $2 trillion regularly tied up in that facility could be shed from the Fed’s balance sheet with little consequence. 

    However, some economists worry what the growth of that facility will mean for bank funding, especially if economic conditions worsen. To this, Waller has said it will be up to the banks to attract depositors back from funds by paying higher interest rates.

    “At some point, as reserves are draining out, it’ll come out of the banks and then the banks, if they need reserves, it’s sitting over there on this ON RRP being handed over by money market mutual funds,” he said during a public appearance in January. “You’re going to have to go compete to get those funds back.”

    But doing so may be easier said than done, given how many bank balance sheets are weighed down by long-duration legacy assets — loans and securities — that are paying low fixed rates. If banks start paying more to depositors, they diminish the net interest margins that support their profitability. 

    This could be especially problematic for banks that see outflows of current depositors who are being paid minimal interest on their deposits, said Michael Redmond, an economist with Medley Advisors who previously worked at Federal Reserve Bank of Kansas City and the U.S. Treasury.

    “There’s a limit on how much banks can adjust their deposit rates higher if their existing deposit base does turnover, and that’s why a lot of economists think there is going to be credit contraction,” Redmond said. “Rather than only adjusting on the liability side of their balance sheet, banks might also try to curtail some of the activity on the asset side of their balance sheets as well.”

    Money market funds tend to pay significantly higher interest rates than banks. This happens for a few key reasons. 

    The fund model is simpler than that of a bank. Funds profit off fees charged to investors who, in turn, are paid using proceeds from the fund’s investments. Banks, meanwhile, largely profit from the difference between the interest they collected from their assets and the amount paid out to depositors, also known as their net interest margin.

    Instead of conducting maturity transformation — using short-term deposits to create long-term loans — money market funds use investor money to buy public or private debt. Because these funds invest in short-term instruments, investors are generally able to redeem their deposits at any time.

    However, that redemption is not technically guaranteed. Money market funds are less tightly regulated than banks and they do not have to carry insurance for their deposits. This results in lower operating costs for funds relative to banks, but also increases the risk associated with their model. Investors, in theory, are paid a premium for taking on that additional risk.

    But whether investments in money market funds are actually at risk is debatable, said Aaron Klein, a senior fellow at the Brookings Institution and a Treasury official during the Obama administration.

    “For an institution run by economists, the Fed seems to struggle with the concept that greater return implies greater risk,” Klein said.

    Following the collapse of the investment bank Lehman Brothers in 2008 and the onset of the COVID-19 pandemic in 2020, the Fed and the Treasury Department guaranteed money market investors that they would be made whole. The actions were taken under systemic risk declarations by the agencies to prevent a run by depositors.

    Klein said these actions have signaled to market participants that money market funds will have the implicit backing of the federal government in times of distress. For uninsured depositors — such as those who fled Silicon Valley Bank last month — that not only made funds a more lucrative option, but also a potentially safer one, he said.

    “Ask yourself today what is more implicitly guaranteed by the Federal Reserve: money market mutual funds or uninsured bank deposits? If you can’t find a difference in the level of implicit guarantee, that’s quite telling,” Klein said. “The Federal Reserve’s repeated bailouts of money market mutual funds, which are owned by the wealthy, makes our financial system less stable and, in the long run, our economy more unequal.”

    The Fed created the ON RRP facility in 2013. The idea behind it was to create a channel through which the central bank could convey its monetary policy to market participants other than banks. It was conceived as the Fed was preparing to raise interest rates from their lower bound, where they had been since 2008. 

    Money market funds were not the intended beneficiary of the program, but they have taken advantage of it more than almost any other type of counterparty. 

    As a tool for implementing monetary policy, the facility has been effective, said Bill English, a finance professor at the Yale School of Management and a former monetary official at the Fed. But the program looks quite a bit different than when it was initially introduced. 

    Instead of setting the rate for the facility a quarter percentage point below the federal funds rate, the Fed now pays about 10 basis points less for its repurchases, English said. It also lifted the $300 billion cap that the program first featured and now offers unlimited use. 

    Like others, English says the facility could benefit from some revisions, such as a reducing the rate paid to counterparties. Doing so, he added, could be beneficial to the Fed’s monetary goals by allowing it to shrink its balance sheet more swiftly. 

    Ultimately, he said, banks should not count on changes to the Fed’s ON RRP facility changing the competitive landscape for deposits. 

    “Banks may have to get used to the idea that the safe, stable, low-cost funding that they get from their retail deposit franchise is just less than was the case 20 years ago,”English said. “And this interest rate cycle is showing that.”

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    Kyle Campbell

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  • Fed: management, poor business model contributed to Custodia rejection

    Fed: management, poor business model contributed to Custodia rejection

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    The Federal Reserve disclosed more details on its decision to deny Custodia Bank’s application for membership.

    Bloomberg

    The Federal Reserve said Custodia Bank has insufficient management experience, a non-viable business model and an over-reliance on the “speculation and sentiment”-driven crypto sector, and those factors contributed to its decision to deny the digital asset bank’s application to join the Fed system.

    The Fed released the full 86-page order — albeit with some redactions — on Friday afternoon, explaining why the Cheyenne, Wyo.-based depository presented a safety and soundness risk too great to be permitted into the traditional banking system. It first announced the rejection nearly two months ago.

    Among the litany of concerns outlined in the rejection summary were Custodia’s lack of federal deposit insurance, its liquidity risk management practices and its failure — in the eyes of the Fed — to meet necessary standards for implementing anti-money laundering and Bank Secrecy Act requirements. 

    The Fed expressed skepticism that the resolution requirements under Wyoming’s Special Purpose Depository Institutions were as robust as what is required by the Federal Deposit Insurance Corp. Wyoming is the first — and, so far, only — state with a licensing regime for digital asset banks.

    The Fed’s order also detailed its many concerns with the digital asset sector, which it described as being not only volatile and highly interconnected, but also a hotbed for fraud, theft, money laundering and illicit finance. It described cryptocurrencies as being “not anchored to a clear economic use case.”

    In a response statement issued on Friday afternoon, Custodia spokesman Nathan Miller pushed back against many of the facts cited in the Fed’s decision. He also suggested that, had Custodia been permitted to serve as a regulated bridge between the crypto space and traditional financial markets, recent turmoil in the banking sector could have been avoided.

    “The recently released Fed order is the result of numerous procedural abnormalities, factual inaccuracies that the Fed refused to correct, and general bias against digital assets,” Miller said. “Rather than choosing to work with a bank utilizing a low-risk, fully-reserved business model, the Fed instead demonstrated its shortsightedness and inability to adapt to changing markets. Perhaps more attention to areas of real risk would have prevented the bank closures that Custodia was created to avoid.”

    Miller said the bank engaged with its primary regulator, the Wyoming Division of Banking, as well as an independent compliance consultant last fall, both of which gave its risk management practices and controls a clean bill of health. 

    He also said Custodia would not need deposit insurance because it planned to hold more than a dollar in liquidity for every dollar deposited by a customer. He argued that doing so served as a better protection against deposit runs than insurance.

    “Historic bank runs in the last two weeks underscore the dire need for fully solvent banks that are equipped to serve fast-changing industries in an era of rapidly improving technology,” Miller said. “That is the exact model proposed by Custodia Bank – to hold $1.08 in cash to back every dollar deposited by customers.”

    One of the stipulations of the Wyoming SPDI charter is that banks cannot make loans using customer deposits. Typically, banks create loans for far greater amounts than they bring in through deposits, a concept known as fractional-reserve banking. Rather than profit off interest charged on loans or returns from investments, Custodia intended for its revenue to be entirely fee-based.

    Yet, the Fed took issue with this business model. In its denial, it argued that such a reliance on fees would inextricably link Custodia to the broader health of the crypto ecosystem, which has proven to be volatile and unpredictable.

    “The institutional clients and individual customers that Custodia is targeting will only need the bank’s services if crypto-assets are perceived as an attractive investment,” the Fed’s order notes. “Moreover, given the importance of fee income from planned crypto-asset-related activities to Custodia’s overall business plan and the concentration and interconnectedness of the crypto-asset industry, potential run-related risks with respect to assets under custody could impact the viability of Custodia via a significant and sudden reduction in fee-based revenue. For that reason, Custodia’s fortunes are tied directly to those of the crypto-asset markets.”

    Custodia’s proposed business model includes providing custody, core banking and payment services to businesses and, eventually, wealthy individuals who use digital assets. In 2020, it sought to become the first bank of its kind to gain access to the Fed’s payments system by applying for a master account with the Federal Reserve Bank of Kansas City.

    It later applied to become a state-chartered member bank, which would have made the Fed its primary regulator. Based on guidelines established last year, being federally supervised streamlines the application process for uninsured depositories to obtain master accounts.

    Custodia’s bids for a master account and Fed membership were shot down on Jan. 27. 

    Custodia is suing both the Fed’s Board of Governors in Washington, D.C. and the Kansas City Fed over the decisions. It argues that, as a state-chartered depository, it is entitled to a master account under the Monetary Control Act of 1980.

    After its twin rejections in January, Custodia withdrew its initial lawsuit, which sought to compel the Fed to make a decision about its applications. It has since amended its complaint, arguing that the Board of Governors and the Kansas City Fed coordinated with other government agencies to block it and other digital asset-focused firms from the banking system.

    “It is a shame that Custodia must turn to the courts to vindicate its rights and compel the Fed to comply with the law,” Miller said.

    Custodia’s claims are poised to be put on trial later this year, a rarity for Fed-related legal challenges.

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    Kyle Campbell

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  • Deal to put ex-Wells Fargo executive behind bars sends tough message

    Deal to put ex-Wells Fargo executive behind bars sends tough message

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    Carrie Tolstedt, who left Wells Fargo in 2016, is scheduled to make her initial appearance in federal court in Los Angeles on April 7. Her plea agreement with federal prosecutors has yet to be approved by U.S. District Judge Josephine Staton.

    LOUIS LANZANO/Bloomberg

    For six years, federal prosecutors investigated the Wells Fargo phony-accounts scandal amid a drumbeat of criticism. No big-bank executives went to prison following the 2008 financial crisis, and it didn’t appear that pattern would change anytime soon.

    But last week, the U.S. Attorney’s Office in Los Angeles made an unexpected announcement. Carrie Tolstedt, Wells Fargo’s longtime former head of retail banking, agreed to plead guilty to a single felony charge of obstructing a bank examination. The deal calls for a 16-month prison term.

    The plea agreement was a victory for Attorney General Merrick Garland and Deputy Attorney General Lisa Monaco, who have emphasized the principle of individual accountability in corporate enforcement cases. It was also a win for bank regulators, signaling to industry executives that there can be severe consequences for misleading bank regulators.

    “This is a stern, stern warning to every senior bank person who could be producing material that the examiners eventually rely on,” said a former Wells Fargo executive who spoke on condition of anonymity.

    The criminal case against Tolstedt is part of a coordinated set of actions by multiple federal agencies in response to the fake-accounts scandal.

    The Office of the Comptroller of the Currency announced last week that Tolstedt agreed to pay a $17 million fine and accepted a ban from the banking industry in order to resolve civil charges. And the Securities and Exchange Commission said that it has reached a tentative settlement with Tolstedt on separate civil charges.

    “The case filed by the Justice Department — as well as the related administrative action by the OCC and the pending civil lawsuit by the SEC — should put bank executives on notice that obstruction and fraudulent conduct very well may result in a criminal prosecution,” Thom Mrozek, a spokesperson for the U.S. Attorney’s Office in Los Angeles, said in an email.

    When asked why the case has taken six years to investigate, Mrozek said: “This was an extremely complex investigation, and the plea agreement is the result of extensive negotiations between the parties.”

    Tolstedt, who left Wells Fargo in 2016, is scheduled to make her initial appearance in federal court in Los Angeles on April 7. Her lawyer, Enu Mainigi, did not respond to a request for comment.

    The plea agreement has yet to be approved by U.S. District Judge Josephine Staton. She could impose a sentence that is either shorter or longer than the agreed-upon 16 months, though in the latter scenario Tolstedt could withdraw from the plea agreement, according to Mrozek. The federal sentencing guidelines call for a range of 10-16 months behind bars.

    The obstruction charge that Tolstedt faces stems from a memo that she and other Wells Fargo executives prepared for the risk committee of the bank’s board of directors in May 2015. Even though the memo was written for a board committee, Tolstedt knew that it would also be provided to the OCC, according to the plea agreement.

    Just two weeks earlier, the Los Angeles City Attorney’s Office had sued the San Francisco bank, alleging that Wells employees engaged in fraudulent conduct in order to meet unrealistic sales quotas.

    The May 2015 memo failed to disclose that an average of at least 1,000 employees per year were either fired or resigned pending investigation in connection with sales abuses, according to the plea agreement. It also omitted the fact that only a very small percentage of the employees whose activity constituted potential sales misconduct were investigated under the bank’s monitoring standard, the plea agreement states.

    Previously filed documents in civil litigation brought by the OCC provide more detail about the contents of the May 2015 memo. For example, the memo failed to state that 1% of employees were terminated annually, even though that figure was contained in prior drafts, according to a report by an OCC examiner in 2020.

    And the May 2015 memo misleadingly stated that there had been a “dramatic reduction in inappropriate practices in the past year” — without noting that assertion stemmed from a time when Wells Fargo paused monitoring for at least seven months — according to the same OCC report.

    Former Wells Fargo CEO John Stumpf has testified that the memo was misleading. In 2020, Stumpf agreed to pay a $17.5 million fine and a ban from the banking industry in connection with his own role in the fake-accounts scandal.

    Samuel Buell, a Duke University law professor who focuses on corporate crime, said that prosecutors often bring obstruction charges when they are unable to establish that the underlying conduct was criminal.

    But he also said that the type of obstruction to which Tolstedt has agreed to plead guilty — involving efforts to obscure misconduct before a criminal investigation gets opened — is considered more serious than obstruction at a later stage.

    “It sounds like someone who had an awareness that there was a serious underlying problem before there was law enforcement scrutiny and tried to cover it up,” Buell said.

    Obstructing a bank examination is a rarely filed charge, which carries a statutory maximum of five years in prison.

    When the charge has been brought in the past, the defendant has typically been a senior executive at a community bank, according to David Weber, a former enforcement official at the OCC, the SEC and the Federal Deposit Insurance Corp.

    Weber speculated that there may be a specific document or witness that made Tolstedt’s lawyer feel that accepting 16 months in prison was preferable to the risk of taking the case to trial.

    If the case had gone to trial, prosecutors would have had to prove beyond a reasonable doubt that Tolstedt acted “corruptly” in obstructing the examination, which is a high bar for the prosecution to meet.

    Weber said that prosecutors might have been able to charge Tolstedt with making a false entry in the books of a bank, which carries a statutory maximum of 30 years in prison, for the same underlying conduct. That possibility could have motivated Tolstedt to plead guilty to a charge that carries a lesser maximum sentence, he said.

    “My Occam’s razor theory is that they were afraid of a maximum 30-year sentence,” said Weber, who is currently a professor teaching forensic accounting at Salisbury University’s Perdue School of Business.

    Weber said that while Tolstedt would not have been sentenced to 30 years in prison if convicted for making a false entry in the books of a book, the sentence likely would have been more than 16 months.

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    Kevin Wack

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  • Midsize US banks ask FDIC to insure deposits for two years

    Midsize US banks ask FDIC to insure deposits for two years

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    A coalition of midsize US banks asked federal regulators to extend FDIC insurance to all deposits for the next two years, arguing the guarantee is needed to avoid a wider run on the banks.

    “Doing so will immediately halt the exodus of deposits from smaller banks, stabilize the banking sector and greatly reduce chances of more bank failures,” the Mid-Size Bank Coalition of America said in a letter to regulators seen by Bloomberg News.

    The collapse this month of Silicon Valley Bank and Signature Bank prompted a flood of deposits out of regional lenders and into the nation’s largest banks, including JPMorgan Chase and Bank of America. Customers spooked by the bank failures were taking refuge in firms seen as too big to fail.

    “Notwithstanding the overall health and safety of the banking industry, confidence has been eroded in all but the largest banks,” the group said in the letter. “Confidence in our banking system as a whole must be immediately restored,” it said, adding that the deposit flight would accelerate should another bank fail.

    The group cited remarks by Treasury Secretary Janet Yellen that the backstops put in place so far will protect uninsured deposits only if regulators found it “necessary to protect the financial system.” That’s a category unlikely to include the smaller banks represented by the MBCA.

    The expanded insurance program should be paid for by the banks themselves by increasing the deposit-insurance assessment on lenders that choose to participate in increased coverage, the group proposed.

    The letter was sent to Yellen, the Federal Deposit Insurance Corp., the Comptroller of the Currency and the Federal Reserve. 

    Treasury spokesman Michael Gwin declined to comment, as did representatives for the FDIC, Fed and OCC.

    ‘Modestly reverse’

    Deputy US Treasury Secretary Wally Adeyemo said Friday that, based on discussions regulators have had with banking executives, deposits at small- and medium-sized banks across the country had begun to stabilize and in some cases “modestly reverse.”

    Brent Tjarks, a representative for MBCA, declined to comment on the letter. His group includes banks with assets of as much as $100 billion, and there are at least 110 members of the coalition. The organization was one of the groups that lobbied in favor of reducing some of the burdens the Dodd-Frank Act imposed on smaller lenders.

    “It is imperative we restore confidence among depositors before another bank fails, avoiding panic and a further crisis,” MBCA wrote in the letter. “While the cost of deposit insurance is not insignificant, the likelihood of it being needed is much, much smaller should all deposits be temporarily insured.”

    —With assistance from Christopher Condon and Max Reyes.

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  • Fed, FDIC officials to testify before Congress on bank failures

    Fed, FDIC officials to testify before Congress on bank failures

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    Rep. Maxine Waters, a California Democrat who is ranking member of the House Financial Services Committee, left, speaks with Rep. Patrick McHenry, a North Carolina Republican who chairs the committee, during a Feb. 7, 2023, hearing.

    Ting Shen/Bloomberg

    Representatives from the Federal Reserve and Federal Deposit Insurance Corporation are set to testify before Congress later this month at a hearing about the failures of Silicon Valley Bank and Signature Bank.

    FDIC Chairman Martin Gruenberg and Federal Reserve Vice Chair for Supervision Michael Barr are scheduled to attend the March 29 hearing as witnesses and answer questions about the banks’ collapses. 

    The bipartisan hearing is expected to be the first of multiple hearings on the issue, according to House Financial Service Committee Chairman Patrick McHenry, R-N.C., and California Rep. Maxine Waters, the committee’s top Democrat.

    “This hearing will allow us to begin to get to the bottom of why these banks failed,” McHenry and Waters said Friday in a joint statement.

    Additional witnesses may be added as the hearing date approaches, McHenry and Waters said.

    The Federal Reserve and FDIC did not immediately respond to requests for comment Friday afternoon.

    The Fed said Monday that Barr will lead a review of Silicon Valley’s failure. The findings of that report are expected to be publicly available by May 1, the agency said.

    The Senate Banking Committee has yet to schedule a hearing into the matter. Chairman Sherrod Brown, D-Ohio, this week urged regulators to review the circumstances around the failures of both Silicon Valley and Signature.

    On Thursday, Treasury Secretary Janet Yellen became the first high-level administration official to testify before Congress after the failures set off a maelstrom across the banking industry. Yellen defended the federal government’s decision to step in and provide systemic-risk exceptions to both Silicon Valley and Signature, and maintained that not all deposits at other banks are guaranteed.

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    Orla McCaffrey

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  • Silicon Valley and Signature fallout will raise DIF fees. Who’s paying?

    Silicon Valley and Signature fallout will raise DIF fees. Who’s paying?

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    The Federal Deposit Insurance Corp. will likely have to raise its Deposit Insurance Fund fees in the event that it is reduced due to the failures of Silicon Valley Bank and Signature Bank. Smaller banks are unhappy about paying more fees for what they see as larger banks’ mismanagement.

    Andrew Harrer/Bloomberg

    Many in the banking industry fear that Sunday’s intervention to shore up Silicon Valley Bank and Signature Bank could compel the Federal Deposit Insurance Corp. to hike assessments on all banks to replenish its Deposit Insurance Fund, and some smaller banks are particularly unhappy about paying to make up for larger banks’ failures.

    FDIC’s Deposit insurance guarantees up to $250,000 of depositors funds will be repaid even if the bank fails. Member banks pay deposit insurance premiums, known as assessments, to fund the DIF, which stood at 128.2 billion as of December 31, 2022. 

    The FDIC has made clear banks — not taxpayers — will pay for the rescue of Silicon Valley Bank and Signature Bank’s uninsured deposits.

    “Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law,” the agency wrote in a release detailing their response to the failures.

    While there is no doubt that the FDIC will raise fees, how they raise fees and from whom remains to be seen. Arthur Wilmarth, professor emeritus at George Washington University Law School, thinks the increasing regularity of the systemic risk exception should be factored into banks’ future assessments.

    “We’ve essentially protected all bank deposits twice — during the financial crisis of 2008-09 and again this time,” Wilmarth wrote in an email. “If we’re going to protect all deposits during a crisis, banks should pay for that privilege on an ongoing basis. I’ve argued that the same should be true for money market funds, which we bailed out in 2008 and 2020.”

    Smaller community banks were initially alarmed by regulators’ announcement, which didn’t specify which banks would pay for this special assessment. 

    To be sure, small community and regional banks stand to benefit greatly from the FDIC’s bailout largely because the system is staving off a run on small banks, but small banks also do not receive the kinds of interventions that Silicon Valley Bank and Signature Bank’s customers benefitted from. Wilmarth thinks lessons from Silvergate’s recent demise reveal which institutions regulators are willing to take extraordinary measures to save. He says community banks dislike the idea of paying for a problem they didn’t cause, and a remedy they will not benefit from. 

    “As we saw with Silvergate, it is very unlikely that a bank smaller than $25 billion would have received treatment similar to SVB and Signature,” Wilmarth wrote in an email.

    Jill Castilla, president and CEO of $345.7 million-asset Citizens Bank of Edmond, said she thinks the FDIC should tailor the special assessment to big banks.

    “I’m not necessarily happy to bear that cost,” Castilla said. “But if it’s a price that we have to pay in order to ensure stability in the U.S. banking system, I will, knowing that it’s for the broader good.”

    Castilla said she was rethinking the concept of the special assessment on banks after seeing a Twitter post from Sen. Bernie Sanders, I-Vt., who admonished the bailout of venture capitalists. Sanders said in a tweet and press release: “If there is a bailout of Silicon Valley Bank, it must be 100 percent financed by Wall Street and large financial institutions.”

    Indeed, bankers that said they have long stuck to prudent asset liability management practices — sometimes at great expense — are voicing opposition to funding depositors of banks that failed due to bad management.

    “It will be a travesty if the FDIC fund is used to guarantee deposits in excess of FDIC insurance thresholds,” said Steven M. Gonzalo, president and CEO of $1.2 billion-asset American Commercial Bank & Trust, a 10-branch bank on the outskirts of Chicago that was founded in 1865.

    Sticking small banks with the failures of larger ones is nothing new, said Gonzalo. During the financial crisis in 2008, Gonzalo said, the bank’s FDIC premiums jumped 10-fold to $300,000 a year, from $30,000 a year.

    “We were forced to prepay three years of premiums to bail out the very banks that created the problem,” he said.

    Former FDIC lawyer Todd Phillips thinks small banks shouldn’t be too worried, even if Congress is considering raising total insured deposits, big banks and systemically important institutions will pay for mitigating the risk.

    “Unless Congress changes the law around the deposit insurance ceiling, I don’t expect banks to pay higher insurance premiums. The statutory minimum is still the same,” Phillips wrote in an email. “To the extent the FDIC decides to increase the size of the DIF as a result of this weekend, increased premiums will come from the largest institutions, not community banks.”

    Many small community bankers said they also were shocked that the failed banks did not maximize FDIC insurance by using tools for reciprocal deposit arrangements.

    Both Signature and Silicon Valley Bank were members of IntraFi, a privately-held firm in Arlington, Va., that allows deposit swapping, whereby a customer has a single relationship with a bank but can spread deposits among other FDIC-insured institutions, thus helping to maximize deposit insurance coverage. Intrafi was created more than two decades ago by former regulators at the Federal Reserve, FDIC and Office of the Comptroller of the Currency.

    Silicon Valley Bank had just $469 million in reciprocal deposits on its balance sheet at year end; Signature had $228.4 million, according to call report data from the Federal Financial Institutions Examination Council.

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    Ebrima Santos Sanneh

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  • Brown calls for scrutiny of branch closures that spark local concern

    Brown calls for scrutiny of branch closures that spark local concern

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    “Banks serve a unique role in the functioning of our financial system and economy,” Sen. Sherrod Brown, D-Ohio, wrote in a letter to regulators about branch closures. “That is why they must serve the needs of all members of their community, and all communities across the country.”

    Joshua A. Bickel/Bloomberg

    After community activists expressed opposition to a bank branch closure in a low-income section of Toledo, Ohio, Senate Banking Committee Chairman Sherrod Brown urged regulators to scrutinize branch closures that spark local concern.

    Brown, an Ohio Democrat, wants the Office of the Comptroller of the Currency to hold public meetings on branch closures in situations where community members request them. He also says the OCC should require banks to meet all legal requirements before they’re allowed to close branches.

    “Banks serve a unique role in the functioning of our financial system and economy,” Brown wrote in a March 2 letter to acting Comptroller Michael Hsu. “That is why they must serve the needs of all members of their community, and all communities across the country.”

    Brown’s letter referenced the situation in Toledo, where the nonprofit Fair Housing Center recently asked the OCC to hold a public meeting on Fifth Third Bancorp’s plan to close a branch in the Englewood neighborhood. Brown wrote that he supports the OCC holding a public meeting.

    The Fair Housing Center wrote in a Feb. 16 letter to the OCC that the branch closure will deprive the surrounding neighborhoods of banking services and credit opportunities that local residents need.

    “The neighborhood where this bank branch is located is an area that was historically redlined and has remained segregated by race due to the lasting effects of those policies,” the group wrote.

    In a Feb. 23 response to the Fair Housing Center, the OCC said that it will consider the group’s comments in its next Community Reinvestment Act evaluation of Fifth Third. But it did not commit to holding a public meeting.

    “The bank’s decision to close the branch office is a business decision that does not require the approval of the OCC,” wrote Jason Almonte, the OCC’s director for large bank licensing.

    When asked Monday about the OCC’s view on whether, and under what circumstances, public meetings on branch closures should be held, an agency spokesperson had no immediate comment.

    A Fifth Third spokesperson said that the Cincinnati-based bank is continuously evaluating its branch network, and that it takes into account consumer preferences.

    Fifth Third will keep an ATM at the site of the shuttered branch in Toledo, and customers will be able to use online and mobile banking services, in addition to visiting other Fifth Third branches, according to the spokesperson. 

    “Although we have one location closing in Toledo, we have two additional financial centers within the same zip code to serve customers. Our team has been welcoming and working with those customers as they transition,” the Fifth Third spokesperson said in an email.

    The spokesperson also noted that the OCC gave Fifth Third an ”outstanding” rating on its most recent Community Reinvestment Act examination, which covered 2017 to 2021. Fifth Third said in January that it was planning to close 23 branches in 2023, mainly in the Midwest.

    George Thomas, CEO and general counsel of the Fair Housing Center, said in an interview that Fifth Third’s notices to customers about the branch closure in Toledo did not note that people could submit comments to the OCC about the branch shutdown.

    A provision of federal law states that when an interstate bank proposes to close a branch in a low- or moderate-income area, the notice to customers “shall contain the mailing address of the appropriate federal banking agency and a statement that comments on the proposed closing of such branch may be mailed to such agency.”

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    Kevin Wack

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  • Senate Banking Republicans warn Fed not to go too far in capital review

    Senate Banking Republicans warn Fed not to go too far in capital review

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    Republicans on the Senate Banking Committee are keeping a watchful eye on the Federal Reserve’s ongoing review of bank capital requirements.

    Sen. Tim Scott, R-S.C., the ranking member on the committee, sent a letter to Fed Chair Jerome Powell on Friday afternoon, urging him to make sure any changes to capital requirements are tailored to each bank’s specific activities, risks and complexities.

    Should the review fail to adequately tailor capital requirements, the letter warns, the Fed’s actions could have a “chilling effect on market making activities and availability of financial services.” 

    The letter also noted that the committee expected to be kept fully informed with “robust analysis” from the Fed as it conducted its review and adjusted policies accordingly. A Federal Reserve spokesperson said Friday afternoon that the central bank has “received the letter and [plans] to respond.”

    Sens. Mike Crapo, R-Idaho, Mike Rounds, R-S.D., Thom Tillis, R-N.C., John Kennedy, R-La., Bill Hagerty, R-Tenn., Cynthia Lummis, R-Wyo., Katie Britt, R-Ala., Kevin Cramer, R-N.D., and Steve Daines, R-Mont., co-signed the letter.

    The senators also argued that the banking sector’s ability to withstand the shock of the COVID-19 pandemic and ensuing liquidity crunch in spring of 2020 without widespread failures serves as evidence that they are already sufficiently capitalized.

    The missive is in response to the “holistic” capital review being led by Fed Vice Chair for Supervision Michael Barr. The effort is poised to encompass all of the central bank’s various capital standards and assess how they work with one another and independently to address safety and soundness concerns within the banking system.

    Among the policies to be considered are the Fed’s supplementary leverage ratio, the stress capital buffer — and the stress testing regime that determines it — and the final implementation of capital requirements related to Basel III, known as the Basel III endgame.

    Barr, who has made the holistic capital review his first signature act as the Fed’s top regulatory official, has not taken an official stance on whether capital requirements should be higher or lower. However, in a December speech at the American Enterprise Institute, Barr stated that “current U.S. requirements are toward the low end of the range described in most of the research literature.”

    In their letter, the Senate Banking Republicans pointed to the 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act’s provisions on tailoring requirements. The law narrowed portions of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, which established new principles for bank regulation in the wake of the subprime mortgage collapse in 2008.

    “As the Vice Chair of Supervision, Mr. Barr should adhere to the letter and spirit of the tailoring provisions as enacted by Congress,” the senators wrote. “Reports of regulators’ efforts to unwind those tailoring reforms are concerning and do not comply with the law.”

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    Kyle Campbell

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  • Fed’s Bowman: Regulators should monitor Treasuries market function

    Fed’s Bowman: Regulators should monitor Treasuries market function

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    The functioning of the U.S. government debt market remains a concern for the Federal Reserve. 

    In brief remarks delivered at an event hosted by the University of Chicago’s Booth School of Business, FedGov. Michelle Bowman said it was important for the central bank to continue working with other regulators to review Treasuries markets to make sure they are appropriately supervised and resilient.

    “Doing so can increase the ability of private markets and institutions to function during times of stress and reduce the likelihood of future market interventions by the central bank,” she said. “In this regard, it is important for the Federal Reserve to engage along with the other agencies in a thoughtful consideration of possible regulatory adjustments and structural reforms to increase the resiliency of the Treasury markets and reduce the likelihood of future market dysfunction.”

    Financial regulators in Washington have been studying the impacts of the COVID-19 era actions on Treasury markets. The Interagency Working Group for Treasury Market Surveillance, which consists of the Fed Board of Governors, the Federal Reserve Bank of New York, the Securities and Exchange Commission, the Treasury Department and the Commodity Futures Trading Commission, has issued two reports on the matter during the past two years.

    Last fall, SEC Chair Gary Gensler and Treasury Under Secretary for Domestic Finance Nellie Liang called for more transparency, more competition and more regulation in the government bond space.

    During the Friday afternoon event, Bowman moderated a panel discussion on “Design Issues for Central Bank Facilities in the Future.” In her opening remarks, she detailed how the Fed’s various interventions helped support the U.S. economy in the early stages of the COVID-19 pandemic, including creating lending facilities and buying assets.

    The Fed’s actions, she said, were integral to preserving the flow of credit in the financial system. But, she noted, some of the various tools the central bank used saw differing levels of use by market participants.

    “Significant asset purchases and take-up of the Fed’s repo operations were required to restore smooth functioning in Treasury markets because of the liquidity needs of a wide swath of investors,” she said. “By comparison, many of the 13(3) lending facilities saw relatively limited take-up, but they helped support market functioning and the supply of credit in the targeted markets by offering a backstop and bolstering investor confidence.”

    Bowman said the lending programs proved effective because they offered funding at a penalty rate, because it served as a backstop for banks without expanding the Fed’s footprint too greatly in any particular market. 

    Bowman said targeted purchasing was an appropriate response for the Treasuries market, given the severe liquidity shortage in the spring of 2020. But, she said, such programs raise issues that must be addressed by central banks, including how to “clearly distinguish asset purchases from the central bank’s monetary policy actions.”

    Other considerations include how to minimize the Fed’s footprint in the market and how to “construct and communicate an exit strategy to reduce the enlarged balance sheet over time.”

    The Fed stopped purchasing Treasuries and mortgage-backed securities in March 2022 and then began allowing assets to roll off its balance sheet last June.

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    Kyle Campbell

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  • CFPB is ‘not holding back’ despite cloud of uncertainty from Supreme Court

    CFPB is ‘not holding back’ despite cloud of uncertainty from Supreme Court

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    WASHINGTON — The Consumer Financial Protection Bureau is plowing ahead with a busy enforcement agenda despite a cloud of uncertainty hanging over it from the Supreme Court’s decision to take a case challenging the bureau’s funding. 

    The CFPB said it was “pleased” that the Supreme Court had decided on Monday to take a case about the constitutionality of its funding mechanism. CFPB Director Rohit Chopra weighed in on the case for the first time, saying a decision could have massive repercussions for financial institutions, the agency and others.

    “We don’t want a situation where there are financial institutions all over the country getting sued because of a lack of clarity on the validity of actions,” Chopra said at the Credit Union National Association’s Governmental Affairs Conference in Washington, D.C., on Monday. “I’m hopeful that this is the next step to create that clarity, and we’ll let the process go forward.”

    The CFPB had petitioned the high court to review a decision in October by a three-judge panel of the U.S. Court of Appeals for the 5th Circuit. The three judges, all appointees of former President Donald Trump, found that the bureau’s funding through the Federal Reserve Board violates the Constitution’s appropriations clause. 

    Chopra made clear that the agency is continuing its enforcement. The bureau in 2010 faced a similar period of limbo when the Supreme Court accepted a constitutional challenge to the protections its single director had from being fired by the president; that case threatened to hamper the CFPB, but it went on with its work as before. 

    “I will be very clear that we are not holding back when it comes to our enforcement program,” Chopra said. “We do know that many repeat offenders [and] bad actors want to use this to escape liability and accountability, and we are not holding back on that front.”

    But the CFPB also faces significant litigation risks if the high court finds that the bureau’s funding is unconstitutional. Financial firms that have paid billions in settlements may ask the CFPB to return their money, lawyers said. Even some attorneys that have been highly critical of the CFPB said that situation would be chaotic.

    Joe Lynyak, a partner at Dorsey & Whitney LLP, said the Supreme Court will have a hard time finding that the CFPB’s funding is unconstitutional because doing so would automatically mean financial firms that have paid roughly $14.9 billion to the CFPB in past settlements may sue to get their money back. 

    “If the CFPB is declared to be unconstitutional then all its actions from the past 10 years are void, and from a practical perspective, courts do not favor this result,” Lynyak said. “It would open up a whole new can of worms, including the enforceability of any payments made to injured consumers.”

    Isaac Boltansky, managing director and director of policy research at the investment bank BTIG, listed nearly a dozen companies that stand to benefit from a ruling against the CFPB because they currently face enforcement actions or pressure from CFPB regulations. 

    “From a practical perspective, this means that the cloud of uncertainty will remain over the Bureau’s rulemaking and enforcement actions,” Boltansky wrote in a research note.

    He thinks the CFPB faces even more litigation because of the court case. The bureau will likely be sued once it finalizes its proposal to regulate credit card late fees, he said. 

    “The CFPB will still push to finalize its credit card late-fee rule this year, but that would likely be challenged on its own grounds and could be overshadowed by the funding mechanism review,” Boltansky said. 

    Roughly a dozen CFPB enforcement cases have been stayed since the 5th Circuit’s ruling in October. Boltansky said that the CFPB may end up partnering with state attorneys general “to provide more legal staying power” to its enforcement actions, Boltansky said. 

    Richard Hunt, a senior advisor to Boston Consulting Group, said that if the Supreme Court decides that the bureau’s funding is unconstitutional, the core issue will be how the high court “defines a remedy.” Many experts think a Supreme Court decision against the CFPB could require bipartisan legislation by a closely divided Congress just months before a presidential election.

    “Fast-forward a year from now, and the Supreme Court could rule in June or July 2024,” said Hunt, a former CEO of the Consumer Bankers Association. “A decision could come out just before an election year that changes the whole bailiwick.”

    Hunt said he is concerned about the time period between a high court ruling and when Congress would have to act on the bureau’s funding even as he acknowledged that there are more questions than can be answered about how Congress might respond if the CFPB loses.

    “There are probably 20 questions that are unanswerable right now. Is there a remedy for past actions? Will Congress compromise to keep the agency afloat?” he said. “If Jan. 2, 2025, comes around and Congress has not passed any funding for the CFPB, does it exist or not?”

    Consumer advocacy groups also are raising a flurry of concerns about what could happen if Congress ties the CFPB’s funding to congressional appropriations. 

    “If the CFPB has to rely on congressional funding, the banking industry could try to influence members of Congress to withhold funding from regulators unless they do their bidding,” said Mike Litt, consumer campaign director at U.S. PIRG. “Making the CFPB the only banking regulator subject to congressional appropriations would put the most pro-consumer federal agency at risk of being starved of the funding it needs to protect consumers.”

    Financial firms also face larger questions about whether they would have to jettison compliance and risk management programs that were created around the CFPB’s rules.

    “To unwind the large compliance and risk management structures that companies have already built over many years on reliance of these expectations would be itself a huge undertaking that would ironically detract from the goal of efficient regulation,” said Jenny Lee, a partner at Reed Smith LLP and a former CFPB enforcement attorney. Lee said that any remedy in the Supreme Court could require a congressional solution “which is not an easy lift in today’s environment.”

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    Kate Berry

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  • Supreme Court has not decided yet to take the CFPB constitutionality case

    Supreme Court has not decided yet to take the CFPB constitutionality case

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    The Supreme Court has not yet agreed to hear a challenge to the funding structure of the Consumer Financial Protection Bureau, though the high court could still take the case this term or next.

    The Supreme Court on Tuesday did not list the case — Community Financial Services Association of America v. CFPB — among the cases it intended to hear in the current session, but the high court may still take the case next week or at any time, experts said. The court regularly releases a list of cases each Monday. But the court also may issue individual “miscellaneous” orders at any time. The CFPB case is being closely watched for its impact on not only its own funding structure but those of other regulatory agencies as well. The case also threatens to undo all of the bureau’s past actions and rules, depending on how sweeping the Supreme Court’s decision on the case ultimately is.

    In November, the CFPB petitioned the high court to review an appellate decision that the bureau’s funding through the Federal Reserve Board violates the appropriations clause. A three-judge panel of the U.S. Court of Appeals for the Fifth Circuit had ruled in October that the CFPB’s funding contravenes the Constitution’s separation of powers. The three judges, all appointees of President Donald J. Trump, found that Congress had ceded its own “power of the purse” by funding the CFPB outside congressional appropriations, even if the funding was authorized by statute.

    The CFPB was created by the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010, which structured the bureau as an independent agency within the Federal Reserve. The CFPB’s budget is drawn from the Federal Reserve and capped at up to 12% of the central bank’s operating expenses. In 2022, the agency’s maximum budget was $734 million.

    Few experts think the high court will abolish the CFPB outright. But the Fifth Circuit’s ruling opened the door for the bureau’s 12-year history of rules and enforcement actions to be challenged. Many experts think any Supreme Court decision will lead to a fight in Congress over the CFPB’s future funding. Though some banks and financial institutions want the CFPB to be abolished outright, many others are hoping for a ruling that would force Democratic lawmakers to bow to reforms, including funding the agency through congressional appropriations and adopting a commission structure. 

    The CFPB argued in its petition that many agencies including the Post Office and National Mint are funded from sources other than annual appropriations. Prudential regulators — including the Office of Comptroller of the Currency and Federal Deposit Insurance Corp. — are funded through fees or assessments imposed on financial firms, while the Federal Reserve Board is funded through its own open market operations. When the Dodd Frank Act was being written, financial firms objected to the CFPB being funded through fees or assessments, experts said.

    “No other court has ever held that Congress violated the Appropriations Clause by passing a statute authorizing spending,” the CFPB said in its petition. The bureau is being represented by U.S. Solicitor General Elizabeth B. Prelogar. The CFPB also said a ruling against it “threatens to inflict immense legal and practical harms on the CFPB, consumers and the nation’s financial sector.”

    The Supreme Court already ruled on the CFPB’s constitutionality once. In a split 5-4 decision written by Chief Justice John Roberts, the high court in 2020 ruled that the CFPB’s single director could not be shielded from being fired by the president and could be fired without cause. The practical effect of that ruling was limited. The court simply struck down the words “for cause” removal in a provision of the Dodd-Frank Act and the bureau continued to operate as it had before. 

    The implications of the current case are less clear, experts say. The Supreme Court has become highly skeptical of administrative agencies and increasingly has sought to assert its power over the other two branches of government, research shows. 

    Republican lawmakers have long pushed for the bureau to be reconstituted as a commission. Republicans have proposed more than 70 bills in the past decade — all without success — seeking to limit the CFPB’s authority. The bureau has become so politicized that it is unclear if Democrats would support a commission structure or if Republicans would provide funding through appropriations, experts said, potentially leaving the agency in limbo. 

    The Fifth Circuit’s ruling last year struck down the CFPB’s 2017 payday lending rule, which many experts think will never go into effect. Two payday trade groups had sued the CFPB in 2018 claiming various arguments including that the CFPB”s funding violated the appropriations clause. 

    The CFPB continues to face legal challenges citing its funding as unconstitutional. Last year, bank trade groups and the U.S. Chamber of Commerce filed a 116-page lawsuit challenging the bureau’s authority to adopt a policy that for the first time claimed discrimination on the basis of age, race or sex — regardless of intent — violates the federal prohibition on “unfair, deceptive or abusive acts or practices,” or UDAAP. 

    “The CFPB relies on this unconstitutional funding scheme to carry out its overly expansive UDAAP authority to Plaintiffs’ detriment,” the groups said.  

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    Kate Berry

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  • Fed’s Barr aims to ‘eradicate’ racial discrimination in banking

    Fed’s Barr aims to ‘eradicate’ racial discrimination in banking

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    The Federal Reserve’s top regulator wants to “eradicate discrimination” from the financial services sector and he’s ready to use all the tools at his disposal to do so.

    Fed Vice Chair for Supervision Michael Barr delivered a speech on financial inclusion Tuesday afternoon at Jackson State University, a historically black research university in Mississippi. In it, he said the central bank would incorporate screening for discriminatory practices into all of its supervision practices, including evaluating applications for mergers and acquisitions.

    “Congress provided regulators with supervisory and enforcement tools to help ensure that supervised firms resolve consumer protection weaknesses as well as the more pervasive risk management issues that often lead to those weaknesses,” Barr said. “We have a close working relationship with the Consumer Financial Protection Bureau and other regulators and integrate other regulators’ consumer-focused reviews—such as examinations for unfair, deceptive, or abusive acts or practices, as well as fair lending—into our assessments of bank holding companies, including in the context of applications for mergers and acquisitions.”

    Michael Barr, vice chair for supervision at the Federal Reserve, said Tuesday that the central bank and other regulators are working to further bridge the racial wealth gap and “eradicate” discrimination in lending.

    Bloomberg News

    During his prepared remarks, Barr highlighted racial wealth gaps, the difficulties Black-owned small businesses have in obtaining credit and the fact that Black households are nearly six times as likely to be unbanked as their white counterparts. He said many of these issues are part of the “long shadow” of past discriminatory practices at banks and policies set by the U.S. government.

    “For most of our country’s history, the United States government and many state and local governments, as well as many private individuals, corporations, and organizations, did not merely fail to protect minorities from discrimination, they actively reinforced segregation, entrenched inequality, and enforced unequal policies,” he said, “including through brutal violence.”

    Barr pointed to auto and small business lending as areas of top concern for bank regulators, noting the Black borrowers have faced higher interest rates and more restricted access to these products than their white peers. 

    He also expressed concerns around mortgage lending, singling out residential appraisals as an area of keen focus for the Fed and other regulators, picking up on a subject that has been a top priority for the Biden administration in its effort to root out systemic racial inequity. 

    Barr nodded to the Fed’s participation in a hearing on appraisal bias held by the Federal Financial Institutions Examination Council’s Appraisal Subcommittee last month, saying: “I look forward to working with my fellow regulators to help ensure that individuals are treated equally in the appraisal process regardless of race or the racial composition of neighborhoods.” 

    The central bank sits on the council alongside other bank and housing regulatory agencies, including the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, the Federal Housing Finance Agency and the Department of Housing and Urban Development. 

    Barr said the Fed will lean on enhanced data collection to identify discriminatory practices by banks and craft policies accordingly. He noted that under section 1071 of the Dodd-Frank Act, banks should be reporting more data on small business lending. Once this provision is fully implemented, he said, the Fed will have “tangible insights into the availability and pricing of credit” being extended to Black-owned businesses.

    At the same, Barr also encouraged banks to be proactive in identifying discriminatory practices, suggesting that they use “mystery shoppers” tests to evaluate their employee practices. This involves two people who have identical profiles except for a different protected class, such as race, both applying for similar loans. The idea is to test whether individuals receive different credit offerings based solely on their race, gender or personal attributes.

    Another focal point for the Fed and other regulators, Barr said, will be the use of artificial intelligence or computer algorithms for determining credit scores or otherwise evaluating loan applications. 

    “[Banks] should review the underlying models, such as their credit scoring and underwriting systems, as well as their marketing and loan servicing activities, just as they should for more traditional models,” he said. 

    The CFPB also expressed skepticism about the ability of AI and algorithmic evaluation models to adhere to fair lending standards.

    Barr said ongoing efforts to update the Fed’s supervision and regulation policies on bank mergers and the Community Reinvestment Act will both prioritize access to financial services for low and moderate income communities. 

    He added that it is also important for regulators to encourage innovations that help banks extend services to traditionally underserved areas, especially as it relates to community development financial institutions and minority deposit institutions, which he said provide services in which traditional banks cannot. 

    “One thing we do is make sure that our examiners understand the CDFI space and the MDI space and the role that CDFIs and MDIs play, and the particular kinds of circumstances that MDIs and CDFIs face such as being able to do small consumer loans and to do character lending and to lend to people without a credit score,” Barr said during a question and answer session following his speech. “Our examiner’s need to know and understand what the offsetting risk mitigation measures that CDFIs and MDIs are using, including knowing the family. It makes a difference.”

    Barr also said the Fed is doing its part to help facilitate better services for low-income and underserved customers, noting specifically its instant payments network, FedNow, which is due to roll out this summer. He said FedNow will enable faster services at lower costs to consumers.

    “We can also make a difference by updating our rules on check clearance, so that consumers and small businesses still receiving checks have access to their funds in a timelier manner,” Barr said. “And of course, we need strong consumer protections in place so that consumers don’t have to worry about making payments in a safe way.”

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    Kyle Campbell

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  • Chapter 3: Heads in the sand

    Chapter 3: Heads in the sand

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    In July 2011, Wells Fargo agreed to pay an $85 million fine to the Federal Reserve — a little-noticed enforcement action that served as a precursor to the fake-accounts scandal. Salespeople at a subsidiary called Wells Fargo Financial had allegedly inflated prospective borrowers’ incomes so that they would qualify for loans.

    Specifically, the employees created and printed false W-2s, according to testimony by James Strother, who was Wells Fargo’s general counsel at the time of the settlement. Employees also put false information into a model that funneled applicants who should have qualified for prime mortgages into higher-cost subprime loans.

    “So there were two sets of conduct there that were dishonest and wrong,” Strother testified. “And we ended up terminating a bunch of people.” The Fed concluded that the cheating was motivated by employees’ desire to meet sales performance standards, qualify for incentive pay and avoid losing their jobs.

    Inside Wells Fargo’s headquarters at 420 Montgomery Street in San Francisco were the 12th-floor offices of CEO John Stumpf, retail banking head Carrie Tolstedt, wholesale banking head Tim Sloan, Chief Administrative Officer Pat Callahan, Human Resources Director Hope Hardison and Chief Risk Officer Mike Loughlin.

    In the aftermath of the settlement with the Fed, Wells Fargo formed a new committee — composed of high-level executives — to address employee misconduct. The Team Member Misconduct Executive Committee was to meet semiannually. Its seven members shared responsibility for the management of employee misconduct and internal fraud.

    They included Strother; Pat Callahan, the chief administrative officer; Hope Hardison, the human resources director; David Julian, the chief auditor; Mike Loughlin, the chief risk officer; and Deputy General Counsel Christine Meuers. The committee’s chair was Michael Bacon, the bank’s chief security officer, who saw an opportunity finally to bring high-level attention to the sales integrity problem.

    “We put this committee together to comply with the consent order,” Bacon said in an interview. “These are the individuals that can make a change.”

    Bacon used numbers in an effort to persuade the committee members to take more forceful action. He presented data on the number of sales integrity cases, the types of cases, the regional distribution of the cases, the number of employees fired, the number of instances of confirmed fraud, and more.

    One problem with the data — and Bacon was aware of this shortcoming at the time — was that the corporate investigations unit could only count the cases that came to its attention. “I made it clear that it was the tip of the iceberg, because we’re so reactive as a company,” Bacon said in an interview.

    The cases that did get investigated often grew out of consumer complaints or calls by employees to the bank’s ethics hotline. “I had even made the comment in several meetings that to me it was a sad statement to say that we’re sitting back for an employee to tell us something’s wrong,” Bacon said. “Or we’re waiting for a customer to tell us something’s wrong, when we have all of the industry-leading information technology.”

    Bacon had been advocating for detection measures to find sales abuses that didn’t get reported, but he was repeatedly rebuffed. For instance, he wanted the bank’s retail unit to run a report that could help identify employees who had set up accounts in the names of friends, relatives or fictitious individuals, using the same address. “Not too difficult. To my knowledge, that report was never run,” Bacon said in a 2018 deposition.

    Alarm bells, arrogance and the crisis at Wells Fargo - organizational chart

    In 2013, Bacon believed that the sales integrity problem was getting worse, and he saw the Team Member Misconduct Executive Committee as the ideal venue to raise the issue to the top echelon of leadership at the bank.

    In late August, Bacon gathered with other committee members in the executive conference room on the 12th floor at Wells Fargo’s San Francisco headquarters. He presented data, but he also spent time educating his colleagues about the motives of employees who cheated. This time, Bacon didn’t get pushback.

    “We talked about it. They all nodded their head. They all, I mean, got it. There was no ‘I don’t understand,’ ” he recalled. “They all knew it’s a problem. They knew it’s gotten worse.”

    Loughlin shared an anecdote that demonstrated his understanding. The chief risk officer was an approachable executive who, like numerous other members of the bank’s operating committee, had an office on the 12th floor of the headquarters building. He had joined Wells Fargo in 1986 and been the risk chief for five years.

    During this meeting, Loughlin said that his wife wouldn’t even go to a local branch anymore because the staffers made such aggressive sales pitches, Bacon recounted in an interview. It was not the first time that Loughlin had raised concerns about his wife’s negative experiences with the bank.

    Earlier in 2013, a Wells Fargo colleague recalled Bacon recapping a similar story from Loughlin. “He mentioned that on a recent call, Mike Loughlin mentioned his wife went into a store to do a transaction and came out with 5 products,” the colleague wrote in an email.

    Alarm bells, arrogance and the crisis at Wells Fargo - Loughlin email

    In a Jan. 3, 2013 email, a colleague of Chief Security Officer Michael Bacon recapped a meeting in which Bacon spoke about Chief Risk Officer Mike Loughlin sharing an anecdote involving sales pressure that Loughlin’s wife experienced at a Wells Fargo branch.

    Loughlin had also told retail banking chief Carrie Tolstedt that his wife received two unauthorized debit cards, according to court papers filed by the government. Tolstedt’s response was to tell Loughlin to stop telling that story, since it reflected poorly on Wells Fargo’s retail banking unit, according to the court filings.

    During the same Aug. 26, 2013, meeting of the Team Member Misconduct Executive Committee, Bacon proposed that Wells Fargo start doing monitoring of its own executives’ accounts for signs of irregularities. Other banks were already doing the same thing, he later testified. It would have required adding just one full-time-equivalent employee, according to Bacon.

    But Callahan, the bank’s chief administrative officer, rejected the idea, Bacon said. “And she stated verbatim: ‘We’re not going to approve it. We’ve got too many investigations and we’re terminating too many team members,’ ” he testified.

    Before the meeting wrapped up, members of the committee agreed that someone needed to discuss the sales integrity situation with Tolstedt, according to Bacon. Callahan volunteered to do so, he said.

    As Bacon left the conference room, he felt a sense of accomplishment. He had escalated the problem to senior executives who were in position to take meaningful action. “I walked out of there with a V for victory,” he recalled. But over the next year, Bacon again became frustrated by the lack of change.

    Loughlin, the former chief risk officer, testified that he did not recall attending the August 2013 meeting. His lawyers did not respond to requests for comment. Likewise, attorneys for several other onetime Wells executives who sat on the Team Member Misconduct Executive Committee either declined to comment or did not respond to requests for comment.

    Alarm bells, arrogance and the crisis at Wells Fargo - Mike Loughlin 2

    Chief Risk Officer Mike Loughlin was a member of both the Team Member Misconduct Executive Committee and the bank’s operating committee.

    Hardison, the former HR director, also testified that she did not recall attending the August 2013 meeting. She declined to comment for this article, but a person familiar with her thinking, who spoke on condition of anonymity, said the data that Bacon presented did not die at the Team Member Misconduct Executive Committee.

    In November 2021, Hardison testified at an administrative law hearing that it was not until 2015 that Wells Fargo executives began to understand that sales abuses were causing financial harm to consumers. “Customer harm, I think, significantly increased the urgency and focus of what we needed to do,” Hardison testified.

    After Bacon left Wells Fargo in 2014, the Team Member Misconduct Executive Committee stopped meeting. The inactivity didn’t sit well with Loretta Sperle, who was then a manager in the unit that included the company’s corporate security and corporate investigations teams.

    Although the Team Member Misconduct Committee was supposed to be replaced with an existing ethics oversight committee, the latter committee did not have as many members from the top echelon of the bank’s leadership, and employee misconduct was to become just one component of its jurisdiction, Sperle said in an interview.

    There was also the fact that the Team Member Misconduct Executive Committee had been formed in response to the 2011 consent order, and it was effectively being disbanded without informing the Fed, according to Sperle.

    She recalled telling senior bank executives, ‘You’ve got to talk to the Federal Reserve,’” arguing that Wells Fargo was not allowed to take this action without first informing its regulator.

    When Wells eventually told the Fed about what had happened, Fed officials required Wells Fargo to write an explanation, Sperle recalled. “They weren’t happy, because the requirement of that consent order was, any changes you need to discuss with them,” she said. A Fed spokesperson declined to comment.

    Looking back on what happened, Sperle sees the decision to suspend the committee as part of a pattern of indifference to regulatory requirements. She chalks it up to arrogance. The prevalent attitude, Sperle said, was: We can do what we want. We’ll resolve it later. We’re not going to let the regulators drive our business.

    Read the other installments in this series:

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    Kevin Wack

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  • CFPB lawsuit seen as warning shot to subprime auto lenders

    CFPB lawsuit seen as warning shot to subprime auto lenders

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    A federal lawsuit against the subprime auto lender Credit Acceptance Corp. is making waves, posing existential questions for the company and potentially upending some corners of the auto finance industry.

    Consumer advocates hope the suit will curtail lending practices they consider predatory. They point to the Consumer Financial Protection Bureau’s allegations that Credit Acceptance deceives subprime borrowers into taking out inflated loans they can’t repay, ultimately leading to their cars being repossessed and harming their already-low credit scores.

    The company is fighting the lawsuit in a case that some observers see as a warning shot to other subprime auto lenders. CFPB critics say the agency’s push to overhaul lending practices could ultimately hurt lower-income consumers by drastically limiting their access to auto loans.

    Credit Acceptance Corp.’s borrowers had median yearly gross incomes of $35,000 and median FICO scores of 546, the Consumer Financial Protection Bureau said in a recent lawsuit.

    Adobe Stock

    The case, which is in its early stages, has captured the attention of some investors, who are evaluating their legal exposure and whether their investments in Credit Acceptance could suffer. But they also worry that heightened regulations — or changes the CFPB is strongly hinting it wants to see in the industry — could force subprime lenders to pull back from making auto loans.

    “That’s really what they’re really concerned about. What does this mean for the future of the industry?” said Joseph Cioffi, a partner at the law firm Davis & Gilbert.

    Southfield, Michigan-based Credit Acceptance makes indirect auto loans to consumers through its network of more than 10,000 dealers. It is one of the largest subprime auto lenders in the country, and its annual report says that most of the loans it buys from dealers are to customers who have “impaired or limited credit histories.”

    In its lawsuit, the CFPB said the company’s borrowers had median yearly gross incomes of $35,000 and median FICO scores of 546, numbers that are in “deep subprime” territory.

    Between roughly 2016 and mid-2021, Credit Acceptance made nearly 2 million loans nationally, and a majority of its borrowers became delinquent, according to the lawsuit. The company repossessed over 25% of the vehicles it financed nationally and 44% of those it financed in New York, where the CFPB and the state’s attorney general filed the suit.

    The agencies say the loan defaults are part of a business model that encourages dealers to “sell cars at inflated prices,” resulting in large “hidden finance charges” that set borrowers up for failure. “Over and over, repossession, garnishment, and bankruptcy result,” the lawsuit alleges, adding that “despite the significant human toll borne by consumers,” the company “continues to profit.”

    Credit Acceptance declined to comment for this story, but it said in a statement earlier this month that it “operates with integrity and believes it has complied with applicable laws and regulations.”

    “We believe the complaint filed is without merit and we intend to vigorously defend ourselves in this matter,” the statement read.

    Since the lawsuit was filed on Jan. 4, the company’s stock price has recouped its losses. 

    While investors are attuned to the lawsuit, some are viewing it as a “buying opportunity” since past complaints against Credit Acceptance haven’t dealt a fatal blow, said Vincent Caintic, an analyst at Stephens. In 2021, the company settled a lawsuit with the Massachusetts attorney general’s office for $27 million over similar claims.

    “There’s this skepticism that because this is nothing new, that nothing’s really going to happen,” Caintic said. 

    But if the CFPB wins the case, Credit Acceptance would have to drastically overhaul its business model, since it would be “unprofitable” to operate, Caintic said. He argued that the same would be true for other subprime auto lenders.

    The CFPB declined to comment on potential broader implications of the lawsuit, with an agency spokesperson saying its action is “targeted at the specific illegal practices of this lender.”

    The American Financial Services Association, a trade group whose members include auto lenders, said the lawsuit is a “prime example of regulation by enforcement,” or forcing changes in the industry through lawsuits rather than formal policy proposals. 

    “If creditors changed their practices based on the principles in the lawsuit, that are unmoored to any established law or regulation, it would substantially limit credit availability, and likely eliminate subprime credit,” Celia Winslow, senior vice president at the trade group, said in a written statement.

    Chuck Bell, advocacy program director at Consumer Reports, expressed an opposing view, saying that a “highly predatory” business model that results in severe customer harm should be eliminated. If Credit Acceptance were no longer able to operate, other lenders would step in to “provide safe and sustainable credit,” he said.

    “This type of lending that these companies are doing is really a disaster,” Bell said. “They’re pricing the loans so aggressively. They don’t really care whether the customer can afford it or not because they know they can get the car back and that they can make their money back in other ways by selling the car again.”

    The definition of a “finance charge” figures to feature heavily in the case. The CFPB argues that the money that dealerships get for selling loans to Credit Acceptance is a proxy for what they would have accepted from an all-cash buyer. Any amounts above that level are finance charges, the CFPB alleges, even if they are not explicitly called interest. 

    In New York, Credit Acceptance typically discloses annual interest rates of just below 25%, the maximum rate allowed in the state, according to the lawsuit. But the company’s loans often exceed that cap, the CFPB alleges, thanks to what isn’t explicitly stated as an interest charge: the “inflated” prices that dealers charge so they can get more money from Credit Acceptance.

    That theory is an “incredibly aggressive” approach, said Scott Pearson, a partner at the law firm Manatt. It suggests that the CFPB believes secondary market transactions — the sale of the original loan — need to be taken into account in disclosures to consumers.

    “If they win, then investors in secondary markets are going to have less of an appetite for purchasing loans,” Pearson said. “When that happens, then companies that are making loans in the first place are going to make fewer of them.”

    The CFPB also alleges that Credit Acceptance does not assess borrowers’ “ability to repay” their loans. In its lawsuit, the agency notes that the lender requires proof of income for borrowers, and it generally doesn’t approve loans if monthly payments exceed 25% of the borrowers’ gross monthly income. But it doesn’t consider other debts, rent payments, mortgage payments or other critical expenses like food, healthcare or childcare.

    Specific “ability to repay” requirements are not currently in place for auto lenders — and efforts to implement them for payday lenders have stalled in the face of industry-backed litigation.

    The CFPB doesn’t want auto lenders to just “look at income and FICO and say: ‘OK, that’s good enough,’” said Ed Groshans, an analyst at Compass Point Research & Trading. But rather than writing an ability-to-repay rule for auto lenders, the agency appears to be taking an “iron first” approach toward certain lenders, Groshans said.

    “If there’s a lending model out there where there’s elevated defaults and collections, their view is that is harm to the consumer,” Groshans said.

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    Polo Rocha

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  • Kansas City Fed rejects Custodia’s master account application

    Kansas City Fed rejects Custodia’s master account application

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    The Federal Reserve Bank of Kansas City has denied Custodia Bank’s application for a master account, according to a U.S. district court filing.

    The reserve bank disclosed the rejection in a motion to dismiss filed with the U.S. District Court of Wyoming on Friday afternoon. Custodia is suing both the Kansas City Fed and the Fed Board of Governors over its long-delayed application for a master account, which grants access to the Fed’s various financial services, including its payment system.

    In its filing, the Kansas City Fed and the Board of Governors argue that the ruling should render Custodia’s lawsuit moot. The bank had sought to pressure the Fed to make a decision about its two-year-old application, arguing that it had been subject to an unreasonable delay.

    The Federal Reserve Bank of Kansas City rejected Custodia’s application for a master account Friday afternoon, just hours after the Fed Board of Governors denies the bank’s application to become a state member bank. The moves have dealt a blow to the digital asset bank’s efforts to join the Fed system, though the bank is expected to continue to pursue its case in court.

    Bloomberg News

    The Kansas City Fed’s denial of Custodia’s master account application came just hours after the Board of Governors rejected the Wyoming-based digital asset bank’s bid to become a state member bank. The designation would have made the Fed Custodia’s primary supervisor and — according to the central bank’s recently enacted application review framework — made it easier for the bank to receive a master account.

    Nathan Miller, a spokesman for Custodia, said the bank plans to continue its litigation against the Fed, noting that the bank intends to challenge whether the bank has congressional authority to pick and choose which institutions can have master accounts. Custodia and others argue that any state chartered depository is entitled to master account access.

    In a written statement, Miller accused the Board and the Kansas City Fed of taking “coordinate action against” the bank and said the rationale for the rejections was “misguided and wrong.”

    “It will not protect American consumers, will discourage responsible innovation, and will provide even greater advantages to incumbent banks,” Miller said in a written statement. “Custodia Bank offered a safe, federally regulated, solvent alternative to the reckless speculators and grifters that the Fed has allowed to penetrate the U.S. banking system, with disastrous results for some banks. Custodia actively sought federal regulation, going above and beyond all requirements that apply to traditional banks.”

    The Kansas City Fed’s court filing did not disclose a reason for the denial. The reserve bank declined to comment on the decision Friday afternoon.

    For its rejection decision, the Board of Governors cited safety and soundness concerns related to Custodia’s “untested” business model, which involves providing custody services for crypto assets and calls for the eventual creation of a stablecoin. 

    Custodia filed its lawsuit against the Fed in June, claiming that not only had the Kansas City Fed taken too long to review the matter, but that the Board of Governors had intervened, violating the Fed’s stated policy that regional reserve banks have sole authority over granting master accounts.

    Both the Board and the Kansas City Fed have made multiple attempts to have the case against them dismissed, but the matter has survived to move to trial — a rarity for legal challenges involving the central bank.

    Following a pretrial hearing earlier this month, the parties have begun the discovery process, which involves requesting and disclosing information of material importance to the suit. Disclosures were set to be made this summer, with a tentative trial date set for Nov 6.

    Along with decisions from both the Kansas City Fed and Board of Governors, the Fed also issued a policy statement on Friday, requiring federally supervised state banks without federal deposit insurance to be subject to the same rules around crypto activity as those that are both insured and regulated at the federal level. The move was designed to align the supervision regimes for the Fed and the Office of the Comptroller of the Currency.

    The White House also announced a “roadmap” to mitigating cryptocurrency risks, in which it directs regulatory agencies to “ramp up enforcement” and issue guidance around best practices in dealing with digital assets. It also called on Congress to empower regulators to have greater oversight of the crypto space without greenlighting greater engagement with the sector by mainstream institutions.

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    Kyle Campbell

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  • Auto lending practices draw regulatory scrutiny for USAA

    Auto lending practices draw regulatory scrutiny for USAA

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    USAA Federal Savings Bank is once again in hot water with regulators over discriminatory practices in its auto lending unit.

    The San Antonio-based bank is now the first with more than $100 billion of assets to receive low marks on consecutive Community Reinvestment Act performance exams. And, according to the report from the Office of the Comptroller of the Currency — USAA’s primary regulator — things appear to be heading in the wrong direction.

    In 2019, the OCC downgraded USAA’s CRA rating from “satisfactory” to “needs to improve, ”  the second-lowest grade in the system, after identifying 600 violations of laws aimed at protecting military members. In the 2022 report, the OCC noted 6,477 violations of a different statute and again issued a “needs to improve” rating.

    San Antonio-based USAA Federal Savings Bank has drawn criticism from the Office of the Comptroller of the Currency in its 2022 Community Reinvestment Act examination over Unfair, Deceptive and Abusive Practices in its auto lending unit.

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    “There are only 34 banks with over $100 billion [of assets], we expect all of them to be outstanding,” Kenneth H. Thomas, president of Miami-based consulting group Community Development Fund Advisors LLC, said. Outstanding is the highest grade achievable on the exam. “Satisfactory we’ll accept … but they almost never go below that. Only four banks have done that and each of those times, they’ve upgraded themselves in the next round.”

    The other four large banks that have been given “needs to improve” ratings are Centennial, Colo.-based Countrywide Bank in 2008, Sioux Falls, S.D.-based Wells Fargo National Bank Association in 2012, Cincinnati-based Fifth Third Bank and Birmingham, Ala.-based Regents Bank, both in 2014, according to a digital database maintained by the Federal Financial Institutions Examination Council. 

    No bank that size has ever received the CRA exam’s lowest rating, substantially noncompliant, but Thomas said that might have been warranted for USAA. 

    “If you have the same bad results, you’ll get the same low rating, but they actually got worse. They were 10 times worse. They went from 600 violations to 6,000,” he said. “I don’t know why they did not get substantial noncompliance. That’s the absolute lowest grade and we only get a handful of those each year.”

    USAA declined to comment about its CRA exam results. But in a written statement, a company spokesperson said the bank considers its latest result an improvement over its previous examination — despite its rating remaining unchanged — because it received a “high satisfactory” rating on the lending portion of the performance test, up from “low satisfactory” in 2019.

    “USAA FSB received an overall CRA rating of satisfactory based on CRA performance, consistent with our commitment to the financial security of all members, including those in low-to-moderate income communities,” the spokesperson wrote. “Our overall rating was lowered due to regulatory concerns that have been addressed and were related to a product that USAA discontinued in 2020.”

    The USAA spokesman declined to disclose the name of the since-discontinued product line where the violations originated, citing concerns about disclosing confidential supervisory information. 

    In Feb. 2020, USAA announced that it was ending its digital car buying business and severing its relationship with the online auto pricing website TrueCar, Inc.

    Enacted in 1977, the CRA was designed to encourage bank investment in underserved communities. OCC-regulated banks are subject to CRA exams roughly every three years. During these reviews, the agency inspects the lending activity, investment activity and services provided by a bank to ensure they are meeting performance standards in each category.

    USAA received passing grades in each of the three performance categories in the 2022 exam but still received the “needs to improve” rating because of its illegal lending practices, the OCC report notes.

    Fair lending and consumer protection advocates see the unprecedented second failing grade as a sign of both the severity of USAA’s malpractice and a growing willingness for regulators to be tougher on banks. 

    “What is encouraging about all this is that we’ve called for the OCC and all the bank regulators to pay more attention when there are consumer protection violations,” said Adam Rust, senior policy advisor at advocacy group National Community Reinvestment Coalition. “Typically that would be the work of other agencies, but for them to consult one another is good.”

    Those in and around the banking sector view the action more skeptically. 

    Alan Wingfield, a partner with the law firm Troutman Pepper who defends banks in consumer protection disputes, said the specific law the OCC accused USAA of violating  — Section 5 of the Federal Trade Commission Act, which relates to Unfair and Deceptive Acts and Practices, or UDAAP — is open to broad interpretation. 

    During the Biden administration, Wingfield said, the Consumer Financial Protection Bureau has used UDAAP provision of the Dodd-Frank Act to expand its reach beyond previously assumed statutory bounds. He sees the OCC and other regulators following suit.

    In USAA’s 2019 CRA report, 546 of the violations cited by the OCC were under the Servicemembers Civil Relief Act, which bars military members from being sued while on active duty overseas, and the rest were under the Military Lending Act, which establishes financial protections for servicemembers. For the 2022 report, all the violations were under UDAAP.

    Wingfield said it was hard to tell how squarely the latest violations fell under UDAAP, because of the limited details disclosed in the CRA report. But he said it was something the industry is on high alert for.

    “The regulators are reaching for that UDAAP power as their magic wand to be able to do whatever they want to do,” he said. “That has definitely been viewed quite negatively in the industry.”

    Still, others see the issuance of a second failing grade to USAA as a sign of the statutory limitations of the CRA.

    “It shows that one of the big problems with CRA is that unless a bank is trying to merge, the CRA doesn’t really have teeth,” said Todd Phillips, an independent consultant and former Federal Depository Insurance Corp. lawyer. “Going from 600 or so violations to more than 6,000 is really, really bad. But unless USAA is trying to buy another bank or open a new branch at a time when most banks are closing branches, it doesn’t really have a lot of impact on the bank’s operations.”

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    Kyle Campbell

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  • California’s AG defends small-business disclosure law opposed by merchant cash advance lenders

    California’s AG defends small-business disclosure law opposed by merchant cash advance lenders

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    California’s Attorney General Rob Bonta is defending the state’s newly enacted small-business disclosure law that requires merchant cash advance lenders, factoring firms and some fintechs to divulge annual percentage rates to borrowers.

    Bonta sent a letter last week to Rohit Chopra, the director of the Consumer Financial Protection Bureau, supporting the agency’s view that California’s law — which went into effect on Dec. 9 — is not preempted by the federal Truth in Lending Act.

    The California law mandates that nonbanks disclose the APR, total interest and fees on financings of $500,000 or less.

    Rob Bonta, California’s attorney general, is defending the state’s lending disclosure law for commercial loans in court.

    Bloomberg News

    Bonta submitted the letter in response to a preliminary determination by the CFPB last month that small- business disclosure laws in four states — California, New York, Utah and Virginia — do not run afoul of TILA, the seminal consumer protection law that created the current consumer disclosure regime. But TILA only governs consumer disclosures; there currently are no federal disclosure requirements for commercial loans.

    State disclosure laws that protect small businesses are a relatively new concept and only California and New York require that lenders calculate and disclose key terms. The issue is further complicated by the proliferation of short-term, high-cost financing options online, made primarily by nonbanks to small-business borrowers with bad credit. As states have become more proactive in seeking to regulate small-business lending, the lenders have filed lawsuits and floated novel legal theories to gut the state laws.

    Bonta wrote in the comment letter to the CFPB that California’s disclosure law “was enacted in 2018 to help small businesses navigate a complicated commercial financing market by mandating uniform disclosures of certain credit terms in a manner similar to TILA’s requirements, but for commercial transactions that are unregulated by TILA.”

    He noted that the law went through four years of public notice-and-comment with extensive input from industry. Nevertheless, last month a trade group group of merchant cash advance firms sued California’s Department of Financial Protection and Innovation in what many see as a Hail Mary pass to gut the new law. The Small Business Finance Association, based in New York, sued California’s DFPI Commissioner Clothilde Hewlett alleging that the disclosure law violates nonbank lenders’ free speech rights by forcing them to describe their products to borrowers “in ways that are false and misleading,” according to the lawsuit. 

    “The reason for the lawsuit is there are a lot of reasons why APR disclosure doesn’t work for commercial finance products,” said Steve Denis, CEO and executive director of the Small Business Finance Association. “What’s confusing to customers is they don’t understand what APR is and with products with shorter terms it skews the calculation.”

    Asset-based lenders and factoring firms allege that calculating an APR is challenging for businesses that pledge receivables for working capital.  They also allege that the state disclosure laws will raise the cost of credit for short-term financing particularly one- or two-week bridge loans for commercial borrowers. Some experts also contend the state are mandating yet another disclosure regime with reams and reams of fine print that borrowers never read.

    Bonta is urging the CFPB to further articulate that state laws that require more disclosures than federal law are not preempted. He also said state law should be preempted only where there is an actual conflict with federal law.

    “It is vital that businesses and entrepreneurs have the information they need to understand the risks and benefits of borrowing and to have the tools available to find the solution that best meets their needs,” Bonta said in a press release.

    California’s DFPI said it tailored the regulations to cover a wide range of financing, from closed-end loans to open-end credit plans, merchant cash advances, asset-based lending, lease financing and factoring transactions. When an offer of commercial financing is made, the funder must disclose the total dollar cost of the financing, and the total cost of the financing expressed as an annualized rate, which means lenders must disclose any finance charge, or estimated finance charge, the annual percentage rate, or estimated APR, depending on the specific commercial financing arrangement.

    Lenders allege the regulations will require that they provide information that does not accurately describe the costs of financing. They also claim that the new law prevents lenders from giving prospective customers additional information without the risk of fines, penalties and further liability. 

    “The disclosures required under the Regulations, far from providing accurate information that would allow businesses to compare the terms and costs of different financing options, actually require providers to give inaccurate disclosures,” the lawsuit states. 

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    Kate Berry

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  • Could credit card late fees drop to $10? CFPB looks to rein in late fees

    Could credit card late fees drop to $10? CFPB looks to rein in late fees

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    Credit card late fees could drop dramatically under a proposal expected to be released soon by the Consumer Financial Protection Bureau. Some analysts are predicting that late fees could be cut in half to as low as $15, while consumer advocates want the CFPB to reduce late fees to as low as $9 or make them proportional to the debt owed by a cardholder.

    CFPB Director Rohit Chopra launched a broad assault last year on so-called “junk fees,” and has said he specifically wants to slash the $12 billion a year in late fees charged by credit card companies. The CFPB is expected to publish a notice of proposed rulemaking this month on late fees but analysts expect the proposal will be released in February.

    “Our expectation is that the CFPB will lower credit card late fees through the rulemaking process to between $15 to $25, though there are some advocates that want fees to go as low as $9,” said Ed Groshans, senior policy and research analyst at Compass Point Research & Trading. 

    The Consumer Financial Protection Bureau may seek to reduce the amount that banks can charge for credit card late fees. The move is the most recent effort by the bureau to set new rules on what CFPB director Rohit Chopra has called “junk fees.”

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    Banks and credit card companies argue that a reduction in late fees would harm subprime and low-income consumers the most. Any reduction in late fees would force credit card issuers to increase fees on other products, reduce credit, raise annual percentage rates on all cardholders, and potentially even slash rewards and cash-back cards, bank trade groups argue. 

    Robert Maddox, a partner at the law firm Bradley Arant Boult Cummings, noted that most large banks cut or eliminated overdraft fees last year under pressure from the CFPB and other regulators. 

    “The fact that banks cut overdraft fees opened up just about every fee that is consumer-related as a possible target,” Maddox said. 

    Currently, banks and credit card issuers can charge $29 for the first late credit card payment and $40 for subsequent late payments within six billing cycles. Some credit card executives have said they are not worried about changes made by the CFPB because nearly all late fees currently are in compliance with the maximum amounts set by the Credit Card Accountability Responsibility and Disclosure Act, known as the CARD Act.

    In its upcoming proposal, the CFPB is expected to re-examine whether Regulation Z — the implementing regulation for the CARD Act and the Truth in Lending Act — should continue to have a safe harbor provision that was created by the Federal Reserve Board in 2010. The safe harbor allows credit card companies to raise late fees annually in line with inflation. It also allows for higher late fees for second violations to deter consumers from paying late. 

    Chopra also has signaled that changes are coming. 

    “The Fed created a set of immunity provisions that has been going up [due to] inflation every year,”  Chopra said at a conference last year. “We are going to be reviewing whether that number makes sense or whether there needs to be a new framework on it.”

    Credit card companies are coming off three years of abnormally low levels of delinquencies and charge-off rates. Even with a recession looming, credit card delinquencies are expected to rise to 2.6% at the end of this year, up from 2.1% last year, according to a forecast released this week from the credit bureau TransUnion. The number of new credit cards opened is at its highest point in 10 years, TransUnion found. 

    “As we face headwinds with a potential recession, and more and more people have a significant amount of debt on their credit cards, the consumer advocates have been pushing for late fees to go down,” Maddox said. 

    Banks and credit card issuers say that late fees must be set at a level to cover costs, and that a penalty fee is not a hidden cost but rather is necessary to reduce the frequency of a consumer making late payments. Dan Smith, executive vice president and head of regulatory affairs at the Consumer Bankers Association, said efforts to reduce credit card late fees are misguided and would harm the very consumers with subprime credit scores that the bureau is trying to help. 

    “Late fees are intended to encourage responsible spending behavior and empower consumers to avoid negative impacts on their credit scores that may arise from defaults and delinquencies,” Smith said. “Eliminating or dramatically reducing the safe harbor threshold will undoubtedly affect consumers’ access to these valued products as credit card issuers would be forced to drastically alter their business models to mitigate the risks associated with increasing instances of missed payments.”

    The CFPB is considering changes to the CARD Act including the safe harbor for penalty fees. Currently, credit card companies cannot impose a late payment penalty unless they have determined that the dollar amount of the fee represents “a reasonable proportion of the total costs,” incurred by the financial institution, the CFPB said in an advance notice of proposed rulemaking in June. 

    Groshans at Compass Point said he thinks the bureau may decide to change the language of the safe harbor to favor consumers rather than financial institutions. 

    “The entire industry has been operating under that safe harbor for over a decade, so don’t think the safe harbor is going away,” Groshans said. “But the risk is that the CFPB tries to change the basis of the safe harbor.

    “Right now the basis [of the safe harbor] is if the fee is reasonable … relative to the cost incurred by the financial institution,” he said. “Do they try to change that to whether the fee is reasonable and proportional to the harm to the consumer? That’s a very different safe harbor and it seems like that could be feasible.” 

    Consumer advocates say credit card late fees disproportionately impact subprime borrowers and serve as a back-end profit center for banks and credit card companies. Advocates want late fees tailored to the amount of the debt owed by a cardholder and suggest that the CFPB include a mandatory waiting period of several days before a late fee can be assessed. 

    “The late fees imposed by card issuers exceed the amounts they incur in costs, especially for accounts with smaller balances and for delinquencies of short periods of time,” said Chi Chi Wu, a staff attorney at the National Consumer Law Center. 

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    Kate Berry

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