Weekly RoundUp July 02, 2020

Financial Services Weekly Roundup: The Supreme Court Strikes Back on Single Director Leadership Structures

Editor's Note

In This Issue. The U.S. Supreme Court struck down the single director leadership structure of the Consumer Financial Protection Bureau (CFPB) in a ruling that could have far-reaching implications for the CFPB and other agencies with single director leadership structures; federal financial regulators finalized a rule modifying the Volcker Rule’s prohibition on banking entities investing in or sponsoring hedge funds or private equity funds; the Federal Deposit Insurance Corporation (FDIC) finalized the so-called “Madden Fix,” affirming long-held understandings and market practices regarding the transferability of interest terms of loans that were valid when made; the Board of Governors of the Federal Reserve System (Federal Reserve) released the results of 2020 stress tests, and restricted share repurchases and capped dividend payments by large banks in the third quarter of 2020; federal financial regulators finalized changes to their swap margin rule to facilitate the implementation of prudent risk management strategies at banks and other entities with significant swap activities; the Securities and Exchange Commission’s (SEC) Office of Compliance Inspections and Examinations (OCIE) issued a Risk Alert providing an overview of certain compliance issues observed in examinations of registered investment advisers that manage private fund advisers; and the staff of the SEC’s Division of Trading and Markets and Division of Investment Management released a statement, in response to the COVID-19 pandemic, regarding the temporary suspension of the requirement to mail certain regulatory communications to specific international jurisdictions. These and other developments are discussed in more detail below.

We also invite you to visit Goodwin’s Coronavirus Knowledge Center and Consumer Financial Services Industry COVID-19 Hub, which are updated regularly, to learn how cross-industry teams at Goodwin are helping clients to fully understand and assess the ramifications of COVID-19, navigate the potential effects of the outbreak on their businesses and evaluate whether and how to safely reopen.

The Roundup will be on hiatus next week due to the July 4 holiday. We will resume publication on July 15.

Editor's Note
Editor's Note
Editor's Note

Regulatory Developments

Financial Regulators Modify Volcker Rule

On June 25, the Federal Reserve, FDIC, Office of the Comptroller of the Currency (OCC), Commodity Futures Trading Commission (CFTC) and SEC adopted a final rule streamlining the covered funds aspects of the Volcker Rule, which is a provision in the Bank Holding Company Act that generally restricts banking entities from engaging in proprietary trading and certain activities related to sponsoring and investing in covered funds. The FDIC also published a fact sheet summarizing the final rule. Among other things, the final rule:

  • Provides exceptions from the definition of “covered fund” for certain venture capital funds and credit funds, which should facilitate investments by banking entities in these types of funds;
  • Provides an exception from the definition of covered funds for customer facilitation vehicles;
  • Provides additional flexibility for foreign public funds, securitization vehicles and small business investment companies;
  • Clarifies the status of funds that make public welfare investments;
  • Limits the extraterritorial application of the Volcker Rule to certain non-U.S. funds;
  • Permits certain covered transactions with covered funds;
  • Clarifies the status of debt interests issued by a covered fund; and
  • Provides helpful guidance to facilitate investments by banking entities in parallel with a covered fund.

The final rule, which is broadly similar to the proposed rule previously covered by the Roundup, will be effective on October 1, 2020. For additional information regarding the amendments to the Volcker Rule, please look for an upcoming Goodwin client alert.

FDIC Finalizes Madden Fix

On June 25, the FDIC issued a final rule (Rule) affirming long-held understandings and market practices regarding the transferability of interest terms of loans that were valid when made, which were shaken by the Second Circuit’s 2015 decision in Madden v. Midland Funding, LLC. The Rule follows closely on the heels of a similar rulemaking finalized by the OCC on May 29. Although Madden relates to loans made by a national bank, Section 27 of the Federal Deposit Insurance Act (FDI Act), which governs loans made by insured state banks, is substantively the same as the relevant provision of the National Bank Act. Additionally, a recent order in Fulford v. Marlette Funding, LLC, Case No. 2017CV30376 (Colo. Dist. Ct. June 9, 2020), informed by Madden, held that an insured state bank cannot export interest on a loan it originated to a nonbank purchaser.

Under the Rule, federal regulations would provide that interest on a loan permissible under Section 27 of the FDI Act would not be affected by changes in state law, changes in the commercial paper rate after the loan was made, or the sale, assignment or other transfer of the loan, in whole or in part. The Rule also clarifies that an insured state bank located in a state whose law denies corporate borrowers the defense of usury may charge a corporate borrower any rate of interest agreed upon by the corporate borrower. The Rule does not purport to address which person is the “true lender” in such cases. It also does not address a state’s ability to opt out of coverage under Section 27 of the FDI Act. 

Because multiple public comments argued that the Rule is inconsistent with the FDIC’s authority under the FDI Act, the Rule may be subject to legal challenge. 

The Rule becomes effective 30 days after publication in the Federal Register

Federal Reserve Releases Stress Test Results, Restricts Stock Repurchases and Caps Dividends for Large Banks

On June 25, the Federal Reserve released its 2020 stress test results and additional sensitivity analyses that it conducted in light of the coronavirus event. In addition to its normal stress test, the Federal Reserve conducted a sensitivity analysis to assess the resiliency of large banks under three hypothetical recessions, or downside scenarios, which could result from the coronavirus event. The scenarios included a V-shaped recession and recovery; a slower, U-shaped recession and recovery; and a W-shaped, double-dip recession. In aggregate, loan losses for the 34 banks ranged from $560 billion to $700 billion in the sensitivity analysis and aggregate capital ratios declined from 12.0% in the fourth quarter of 2019 to between 9.5% and 7.7% under the hypothetical downside scenarios. Under the U- and W-shaped scenarios, most firms remain well-capitalized but several would approach minimum capital levels.

In light of these results, the Federal Reserve took several actions to ensure large banks (defined as banks with $100 million or more in consolidated total assets) remain resilient despite the economic uncertainty from the coronavirus event. Specifically, the Federal Reserve:

  • Prohibited share repurchases during the third quarter of 2020; 
  • Capped third quarter dividend payments at the lesser of (1) the average of the firm’s net income for the four preceding calendar quarters and (2) the dividend amount paid in the second quarter; 
  • Permitted scheduled payments on additional tier one and tier two capital instruments; and
  • Required all large banks to resubmit and update their capital plans later this year to reflect current stresses, which will help firms re-assess their capital needs and maintain strong capital planning practices during this period of uncertainty. The Federal Reserve will conduct additional analysis each quarter to determine if adjustments to this response are appropriate.

The Federal Reserve also released the results of its full stress test designed before the coronavirus. The results from that test are comparable to the V-shaped downside scenario in the sensitivity analysis, in aggregate, and show that all large banks remain strongly capitalized. The Federal Reserve will use the results of this test to set the new stress capital buffer requirement for these firms, which will take effect, as planned, in the fourth quarter of 2020.

Agencies Finalize Amendments to Swap Margin Rules

On June 25, the OCC, Federal Reserve, FDIC, Farm Credit Administration and Federal Housing Finance Agency (FHFA) (Agencies) released their final amendments (Final Amendments) to the uncleared margin swap rules (the Swap Margin Rules). The Swap Margin Rules require, generally, that entities regulated by the Agencies post and collect initial margin (IM) and variable margin (VM) in connection with swaps that are not cleared through a central clearinghouse. The Swap Margin Rules were implemented by the Agencies pursuant to Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Also pursuant to the Dodd-Frank Act, the CFTC implemented its own uncleared swap rules (CFTC Margin Rules). Phase “1” of the Swap Margin Rules became effective on April 1, 2016 for the largest global banks, with a phased-in compliance schedule for the IM and VM requirements. On March 1, 2017, all swap dealers regulated by the Agencies were required to comply with the VM requirements for swaps entered into with other swap dealers and financial end user counterparties. Prior to the Final Amendments, the Swap Margin Rules required swap dealers to comply with the IM requirements (including to have trading documentation in place) for non-cleared swaps with all financial end users that have “material swaps exposure” by September 1, 2020. From September 1, material swap exposure is when the swap dealer (together with the swap dealer’s consolidated affiliates) has more than $8 billion in average daily aggregate notional amount of non-cleared swaps, foreign exchange forwards and foreign exchange swaps with any counterparty (together with the counterparty’s consolidated affiliates) for each business day in March, April and May of the prior year.

In November 2019, in response to industry concerns regarding the preparedness of swap dealers to enter into the documentation required to post and collect IM in time for the September 1, 2020 “Phase 5” deadline, as well as due to other uncertainties, including the cessation of LIBOR, the Agencies proposed to amend the Swap Margin Rules (Proposed Amendments). Based on the Proposed Amendments, commenters supported amendments that would conform the Swap Margin Rules to the CFTC Margin Rules and margin rules adopted non-U.S. regulatory agencies. Other than certain technical adjustments, the Final Amendments are largely consistent with the Proposed Amendments and align the CFTC Margin Rules to the CFTC Rules and foreign margin rules.  Accordingly, the Final Amendments to the Swap Margin Rules will:

  • Help with the transition from LIBOR to SOFR or another alternative reference rate by permitting swaps entered into prior to an applicable compliance date (Legacy Swaps) to retain their legacy status (of not being subject to the IM and VM requirements) in the event that they are amended to replace LIBOR with SOFR or another alternative reference rate;
  • Modify and substantially reduce IM requirements for non-cleared swaps between swap dealers and their own affiliates, provided that inter-affiliate swaps will remain subject to VM requirements, and IM will still be required if a depository institution’s total exposure to all affiliates exceeds 15 percent of its Tier 1 capital;
  • Introduce a new and additional September 1, 2021 Phase “6” compliance date, beyond the September 1, 2020 Phase “5” compliance date, for IM requirements to provide additional time for swap counterparties to enter into the required trading documentation;
  • Clarify that trading documentation, including an IM compliant credit support annex and tri-party custodial agreement, is not required to be in place until the swap dealer has material swap exposure with its swap counterparties;
  • Permit Legacy Swaps to retain their legacy status in the event that they are amended due to technical amendments, notional reductions, or portfolio compression exercises;
  • Make technical changes to relocate the provision within the Swap Margin Rules addressing amendments to Legacy Swaps that are made to comply with the Dodd Frank Act Title I and II “qualified financial contract” rules; and
  • Address a comment letter received in response to the agencies’ publication of the interim final rule dealing with Brexit-related issues. 

While the Final Amendments have been anticipated for some time, swap dealers affiliated with regional commercial banks will be pleased with the extension of the IM trading documentation requirements to September 1, 2021 and all swap dealers will benefit from the relaxation of the IM quantitative requirements as well as the additional flexibility to allocate collateral internally to comply with safety and soundness requirements.

Observations from Examinations of Investment Advisers Managing Private Funds

On June 23, the SEC’s OCIE issued a Risk Alert, titled “Observations from Examinations of Investment Advisers Managing Private Funds” (Risk Alert), highlighting common compliance issues observed by the OCIE staff (Staff) in examinations of registered investment advisers that manage private equity funds or hedge funds (Private Fund Advisers). The Risk Alert identifies three key areas of deficiencies found by the Staff during examinations of Private Fund Advisers: (1) conflicts of interests, (2) fees and expenses and (3) policies and procedures relating to material non-public information (MNPI).

Conflicts of Interest. The Risk Alert describes numerous conflicts of interests that were inadequately disclosed to clients and investors under Section 206 of the Investment Advisers Act of 1940, as amended (the “Advisers Act”) and Advisers Act Rule 206(4)-8, regarding, e.g., (i) the allocation of investment opportunities, (ii) multiple clients investing in the same portfolio company at different levels of the capital structure, (iii) financial relationships between investors or clients and the adviser, (iv) preferential liquidity rights for certain investors in a fund or for certain funds or separately managed accounts that invest alongside a fund, (v) private fund adviser interests in recommended investments, (vi) co-investment allocation processes, (vii) service provider relationships, (viii) fund restructurings and (ix) cross transactions.

Fees and Expenses. The Risk Alert describes the following deficiencies under Section 206 or Rule 206(4)-8 related to fees and expenses issues that potentially cause investors to overpay, including, e.g., (i) inaccurate allocation of fees and expenses, (ii) inadequate disclosure of the role of “operating partners”, (iii) improper calculation of valuation and (iv) failure to apply or accurately calculate management fee offsets.

MNPI and Code of Ethics. The Risk Alert describes deficiencies under Section 204A of the Advisers Act relating to policies and procedures designed to prevent the misuse of MNPI by the adviser or any of its associated persons. The Staff found that Private Fund Advisers failed to address risks posed by employees interacting with, e.g., (i) insiders of publicly-traded companies, (ii) “expert network” firms or (iii) “value added investors” to assess whether MNPI could have been exchanged. The Staff also found that Private Fund Advisers failed to address risks posed by employees who could obtain MNPI through access to office space or systems of the adviser or its affiliates and did not address risks related to employees who periodically had access to MNPI about issues of public securities in connection with a private investment in public equity.

The Risk Alert also describes deficiencies in Private Fund Advisers’ code of ethics under Advisers Act Rule 204A-1, including, e.g., (i) failure to enforce trading restrictions on securities that had been placed on the adviser’s “restricted list”, (ii) failure to enforce requirements relating to employees’ receipt of gifts and entertainment from third parties, (iii) inadequate administration of personal trading policies and procedures and (iv) failure to properly identify “access persons” for personal securities transaction reviews.  

Staff Statement Regarding Temporary International Mail Service Suspensions to Certain Jurisdictions Related to the COVID-19 Pandemic

On June 24, the staff of the SEC’s Division of Trading and Markets and the Division of Investment Management provided a statement responding to inquiries regarding federal securities law requirements to mail certain regulatory communications to shareholders, clients and customers who (1) have mailing addresses located in international jurisdictions where the United States Postal Service, other common carrier, or public or private foreign postal operator has temporarily suspended international mail service due to impacts related to the coronavirus disease, and (2) have not consented to electronic delivery of these regulatory communications. This statement is temporary and expires on the date, as applicable to each specific Affected Jurisdiction, that Common Carriers resume mail delivery of Impacted International Mailings to such Affected Jurisdiction. Recognizing that circumstances related to coronavirus may evolve, Division staff is committed to working with market participants to help them respond to operational and other challenges raised by the pandemic.

Accordingly, the Division staff advises that enforcement action will not be recommended against a Delivering Entity for failure to deliver Impacted International Mailings to Affected Recipients in Affected Jurisdictions if certain actions are taken by the Delivery Entity. These actions may include sending a notification to Division staff of Impacted International Mailings that the Delivering Entity will hold temporarily due to mail service suspensions, publishing notification information to the Delivering Entity’s public website, regularly monitoring relevant Common Carrier websites for updates regarding the status of mail delivery to Affected jurisdictions, maintaining contemporaneous records reflecting completion of the Division staff’s recommended actions and promptly resuming service once suspensions are lifted. With respect to written confirmations or alternative periodic reporting required by Exchange Act Rule 10b-10 and written statements with respect to free credit balances required pursuant to Exchange Act Rule 15c3-3(j)(1), actions may also include using reasonable best efforts to notify Affected Recipients by telephone, email, text message or other means that their documents are being held due to mail service suspensions in Affected Jurisdictions and that Affected Recipients may consent to electronic delivery, using reasonable best efforts to obtain such consent, and, absent such consent, holding documents until resumption of mail service while providing Affected Recipients with a reasonable period of time to respond as needed. For other Impacted International, such actions may include using reasonable best efforts to obtain current contact information for Affected Recipients and making electronic deliveries using such information.

Proposed Revisions to Interagency Questions and Answers Regarding Flood Insurance

On June 26, the FDIC, OCC, Federal Reserve, National Credit Union Administration and Farm Credit Administration (Agencies) issued a proposed revised Interagency Questions and Answers Regarding Flood Insurance (Proposed Q&A). Topics addressed in the Proposed Q&A include the effect of major amendments to flood insurance laws with regard to the escrow of flood insurance premiums, the detached structure exemption and force-placement procedures. The Proposed Q&A has been reorganized to make it easier to find information related to technical flood insurance topics, including introducing a new numbering system. The Agencies are also currently drafting revisions related to the 2019 private flood insurance final rule and will propose these revisions at a later date. Public comments to the Proposed Q&A are due on or before 60 days after publication in the Federal Register.

FinCEN Issues Guidance on Hemp-Related Businesses

On June 29, the Financial Crimes Enforcement Network (FinCEN) issued guidance on how financial institutions should conduct due diligence on hemp-related business in compliance with the Bank Secrecy Act (BSA), emphasizing that hemp-related business should be treated in a manner similar to all other customers. In the guidance, FinCEN instructed financial institutions to obtain basic identifying information about hemp-related businesses through the application of the financial institutions’ customer identification programs and risk-based customer due diligence processes, including beneficial ownership collection and verification, “as they would for all customers.” For customers who are hemp growers, financial institutions may confirm the hemp grower’s compliance with state, tribal government, or the USDA licensing requirements, as applicable, by either obtaining (1) a written attestation by the hemp grower that they are validly licensed or (2) a copy of such license. The extent to which a financial institution will seek additional information beyond the steps outlined above will depend on the financial institution’s assessment of the level of risk posed by each customer. As with any customer, FinCEN expects financial institutions to tailor their BSA/anti-money laundering programs to reflect the risks associated with the customer’s particular risk profile and file reports required under the BSA.

The guidance also reiterated previous guidance indicating that, because hemp is no longer a Schedule I controlled substance under the Controlled Substances Act, financial institutions are not required to file a Suspicious Activity Report (SAR) on customers solely because they are engaged in the growth or cultivation of hemp in accordance with applicable laws and regulations, but rather should follow standard SAR procedures and file a SAR if the financial institution becomes aware, in the normal course of business, of suspicious activity. Similarly, financial institutions must report currency transactions in connection with hemp-related businesses in the same manner they would for any other customers (i.e., report all currency transactions above $10,000 in aggregate on a single business day).

FHFA Provides Tenant Protections

On June 29, the FHFA announced that Fannie Mae and Freddie Mac (the Enterprises) are allowing servicers to extend forbearance agreements for multifamily property owners with existing forbearance agreements for up to three months, for a total forbearance of up to six months. While the properties are in forbearance, the landlord must suspend all evictions for renters unable to pay rent. The forbearance extension is available for qualified properties with an Enterprise-backed multifamily mortgage experiencing a financial hardship due to the coronavirus national emergency.  If a forbearance is extended, once the forbearance period concludes the borrower may qualify for up to 24 months to repay the missed payments. Additionally, if the forbearance is extended, the repayment schedule is modified, or a new forbearance agreement is executed, the borrower is required to provide the following tenant protections during the repayment period:

  • Give the tenant at least a 30-day notice to vacate;
  • Not charge the tenant late fees or penalties for nonpayment of rent; and
  • Allow the tenant flexibility to repay back rent over time and not in a lump sum.

SEC Issues Additional COVID-19 Disclosure Guidance

Further guidance on disclosure considerations regarding business operations, liquidity and capital resources resulting from business and market disruptions related to COVID-19 has been issued by the SEC’s Division of Corporation Finance (Division). The Division’s guidance, Coronavirus (COVID-19) — Disclosure Considerations Regarding Operations, Liquidity, and Capital Resources (CF Disclosure Guidance: Topic No. 9A), supplements the Division’s earlier guidance, Coronavirus (COVID-19)  (CF Disclosure Guidance: Topic No. 9), published on March 25, 2020, which we summarized in a recent Goodwin alert. Read this client alert to learn more about the guidance and what questions companies should consider around their liquidity positions and capital resources.

PPP Legal Update for Tax-Exempt Organizations

On April 24, the President signed the Paycheck Protection Program and Healthcare Enhancement Act (PPP Enhancement Act), adding an additional $310 billion to the previously exhausted $349 billion in funds allotted for small business entities (including tax-exempt organizations organized under Section 501(c)(3) and Section 501(c)(19) of the Internal Revenue Code) and additional funds to various relief programs under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The passage of this act allows more funds to be available, at least for those who have already applied to the PPP, and are currently waiting in the queue. On June 5, the President signed a further amendment to the PPP, the Paycheck Protection Program Flexibility Act (PPPFA) of 2020, which brings additional changes. Read the client alert for additional detail around this amendment.

U.S. Department of Labor Issues Proposed Regulation on Environmental, Social & Governance Investing

On June 23, the U.S. Department of Labor issued a proposal to regulate the use of environmental, social, and governance (ESG) strategies by investment fiduciaries under ERISA. The proposal, if finalized, would be the first rulemaking since ERISA was passed in 1974 in which the Department has singled out a specific strategy for more rigorous treatment under ERISA’s duties of loyalty and prudence. Read the client alert to learn more about the terms of the proposed regulation.

U.S. SEC Grants Muni Advisors a Temporary, Limited Exemption From Broker-Dealer Registration

On June 16, the SEC granted registered municipal advisors (MAs) a temporary, limited exemption (Exemption) from broker-dealer registration to the extent that they solicit banks and other “Qualified Providers” in "Direct Placements" of securities and receive transaction-based compensation. The Exemption, which is intended to address the financial stresses on municipal issuers caused by the COVID-19 pandemic, is valid through December 31, 2020. Read the client alert for key takeaways from the Exemption.

Enforcement & Litigation

Supreme Court Rules CFPB Structure Unconstitutional but Agency Is Here to Stay

On June 29, the U.S. Supreme Court held that the single director structure of the CFPB, and specifically the “for-cause” removal provision that insulates the Director of the agency from removal by the President, is unconstitutional. Characterizing the President’s removal power as “unrestricted,” the majority opinion, delivered by Chief Justice John Roberts, rejected the limitation enacted by the Dodd-Frank Act that restricts the President’s ability to fire the head of the agency.  In doing so, the Court found the removal restriction is impermissible for a sole directorship such as the CFPB, as it undermines the President’s oversight of the executive branch and violates the separation of powers. But the Court did not go so far to hold that the entire CFPB must be struck in its entirety – instead, it held that the “for-cause” removal provision is severable from the rest of the Dodd-Frank Act and can be fixed by narrowly eliminating that specific provision. The CFPB may therefore continue to operate as long as its Director can be removable by the President at will. The Court’s majority remanded the case, Seila Law LLC v. Consumer Financial Protection Bureau, back to the Ninth Circuit to decide whether the CFPB can still enforce its civil investigative demand—issued by then-director, Cordray, and later ratified by then-acting-director, Mulvaney.

Goodwin News

Madden Fix and True Lender: A Webinar on the OCC’s Final Rule on Permissible Interest on Sold Loans and the True Lender Doctrine

July 16th 2:00 – 3:00 pm ET  

In this webinar, the Goodwin Team will discuss recent OCC and FDIC rules on permissible interest on loans sold by a national bank or insured state bank (a.k.a the “Madden Fix”) and the latest on the true lender doctrine. Goodwin will also cover state usury and interest exportation basics to set a good foundation for the discussion. This webinar is intended for the entire Fintech lending community, including Fintechs and banks in lending partnerships, servicers, credit facility providers and investors. Register for the webinar here.

What’s Next? A Path Forward in Uncertain Times

In light of the recent global pandemic, Goodwin’s interdisciplinary team of lawyers presents various types of financings and investment structures applicable in current market conditions in a new webinar series, “What’s Next? A Path Forward in Uncertain Times”. This multi-part series explores the financing transactions and topics that are most relevant for companies and investors at a time where valuations are uncertain and companies across industries need capital. Visit the website to learn more, register for upcoming webinars and access previous events.

This week’s Roundup contributors: Alex Callen, Kristina Jacobs, Bill McCurdy, Jessica Rabinowitz and Courtney Schrenko.