United States: Bank Regulatory Relief Legislation: What It Does And Does Not Accomplish

Recently President Bush signed into law the Financial Services Regulatory Relief Act of 2006 (the "Act"), Public Law 109-351. The legislation was the result of a review of voluminous regulations as well as extensive Congressional negotiations, and its primary purpose was to redraft or repeal obsolete or overly burdensome laws affecting the financial services industry. The Act, which contains provisions affecting commercial banks, thrifts, and credit unions, addresses a number of issues that the financial services industry and federal regulators have been debating for years. The Act cannot be regarded as uniformly pro-industry, however, as a number of provisions are intended to enhance the enforcement authority of the federal regulators with regard to insured depository institutions and their institution-affiliated parties (such as officers, directors and principal shareholders). Additionally, some banking industry trade associations, while generally supportive of the Act, have expressed the view that the Act does not go far enough in repealing or amending outdated and unnecessary regulatory burdens or restrictions.

An analysis of some of the Act’s more salient provisions is set forth below, followed by a discussion of some of the issues that ultimately were not addressed by the Act but that continue to be goals of many in the financial services industry.

The Act appears to provide a resolution of what had become a multi-year tug-of-war between the SEC, on the one hand, and the banking industry and federal banking regulators on the other with regard to the proper interpretation and implementation of the securities brokerage "push-out" requirement of the Gramm-Leach- Bliley Act of 1999 ("GLB Act"). The GLB Act amended the Securities Exchange Act of 1934 to eliminate the long-standing exclusions of banks from the statutory definitions of "broker" and "dealer," which has the effect of requiring banks to "push out" their securities brokerage and dealing activities to SEC-registered brokerdealer affiliates or unaffiliated broker-dealers unless the activities fall within certain exceptions specified in the GLB Act. The implementation of the dealing push-out requirement was relatively non-controversial, and final SEC regulations have been in place since 2003. The implementation of the brokerage push-out requirement – with its exceptions for, e.g., trust and fiduciary activities of banks – has been anything but non-controversial, however, and both the SEC’s "interim final rules" from 2001 and its proposed Regulation B from 2004 have generated extensive negative comments and criticism from banking industry groups and the federal banking regulators. As a result, the SEC has issued a number of orders extending the compliance deadline for banks with the brokerage push-out requirement, and seven years after the enactment of the GLB Act that requirement is still not in effect.

Congress has now revisited the matter by providing in the Act for the joint issuance by the SEC and the Federal Reserve Board of a single set of regulations interpreting and implementing the brokerage push-out requirement. The joint regulations, which are required to be in place within 180 days of the enactment of the Act on October 13, will supersede any prior regulations issued by the SEC in this area. In drafting the regulations, the SEC and the Federal Reserve Board are required to consult with and seek the concurrence of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Office of Thrift Supervision. Proposed rules are currently expected to be issued by the end of 2006, with final rules to follow by late spring 2007. Although the specific content of those regulations cannot be known at this time, the decision by Congress to remove sole rulemaking authority from the SEC in this area and to substitute therefor joint Federal Reserve Board-SEC rulemaking can be regarded as a victory for the banking industry and the federal banking regulators and should result in final regulations more sensitive to the concerns of the banking industry.

The Act authorizes Federal Reserve Banks, starting on October 1, 2011, to pay interest on balances maintained by banks for reserve requirement purposes at their local Reserve Bank. While the Federal Reserve Board reportedly lobbied Congress to provide it with the capacity to pay interest on required reserve balances, contractual balances and excess reserve balances, the exercise of this authority is not mandatory. If such interest payments are to be made, the Act provides that they be paid at least quarterly and at a rate not to exceed the general level of short-term interest rates. This provision will be helpful for some depository institutions, but a great many institutions satisfy their reserve requirements with vault cash.

In addition, the Act permits the Federal Reserve Board, effective October 1, 2011, to modify the reserve ratio for banks’ transaction accounts, allowing a zero reserve ratio if appropriate.

Several sections of the Act enhance the enforcement authority of the federal bank regulatory agencies and help their enforcement actions withstand legal challenge. Specifically, the Act clarifies the discretionary authority of the federal bank regulatory agencies to enforce (i) any condition imposed in writing in connection with any action on an application, notice or other request, and (ii) any written agreement between the agency and an institution-affiliated party such as an officer or director, particularly those in which the institution-affiliated party agrees to provide capital to the depository institution, without the previously-applicable requirements that the agency have to prove unjust enrichment by the institution-affiliated party and that the recovery be limited to five percent of the depository institution’s assets at the time it became undercapitalized. The Act also clarifies existing FDIC authority as receiver or conservator to enforce written conditions or agreements. These provisions have raised some concern within the banking industry that bank officers and directors may find themselves with personal exposure in regulatory enforcement actions if the bank with which they are affiliated becomes the subject of regulatory scrutiny or enforcement.

The Act also provides that a federal bank regulatory agency may suspend or prohibit individuals charged with certain crimes from participation in the affairs of any depository institution and not solely the insured depository institution with which the individual is or was associated. Additionally, the Act provides that an individual convicted of a criminal offense involving dishonesty, a breach of trust or money laundering, who prior to the enactment of the Act would have been prohibited from participating in the affairs of an insured depository institution, is henceforth also barred from participating in the affairs of a bank holding company, an Edge or Agreement Corporation or a savings and loan holding company or any of its non-thrift subsidiaries without the consent of the Federal Reserve Board or the Office of Thrift Supervision, as applicable. Other enforcement-related changes made by the Act include, among other things, an amendment to the Federal Deposit Insurance Act providing all of the federal bank regulatory agencies, and not merely the FDIC, with express authority to enforce conditions imposed in writing in connection with the approval of an institution’s application for deposit insurance.

The Act provides that the submission by a depository institution of any information to a federal bank regulatory agency, a state bank supervisor or a foreign banking authority in the course of the supervisory or regulatory process is not to be construed as waiving any privilege that the institution may claim with respect to such information under federal or state law. This provision was included to resolve a conflict between competing court decisions. It is a two-edged sword, in that it provides the regulatory agency with more ammunition to encourage a banking organization to submit otherwise privileged information.

In a related area, the Act provides that a federal bank regulatory agency cannot be compelled to disclose information received from a foreign regulatory authority (i) if such disclosure would violate the laws applicable to that authority, and (ii) the federal bank regulatory agency obtained the information in connection with the administration or enforcement of federal banking laws or pursuant to a memorandum of understanding or similar arrangement with the foreign regulatory authority. The Act further provides that such information would generally be exempt from disclosure under the federal Freedom of Information Act.

Neither of the above provisions of the Act would prevent the turning over of privileged information by a federal bank regulatory agency to a Senate or House committee.

The Act also extends to all federal bank regulatory agencies the discretionary information-sharing authority previously granted to the Federal Reserve Board under the GLB Act. The Act provides that a federal bank regulatory agency may, in its discretion, furnish a report of examination or other confidential supervisory information concerning a depository institution or other examined entity to any other federal or state supervisory or regulatory agency with authority over the institution or entity, to any officer, director or receiver of such depository institution or entity, or to any other person that the federal bank regulatory agency determines to be appropriate.

Prior to the enactment of the Act, a depository institution subsidiary of a financial holding company ("FHC") was prohibited from marketing or offering any product or service of a portfolio company owned by the FHC under the merchant banking authority of the GLB Act, and the portfolio company was prohibited from marketing or offering any product or service of the FHC’s depository institution subsidiary. The Act replaces those provisions with the cross-marketing provisions applicable to insurance company portfolio investments under the GLB Act, which permit cross-marketing of products or services through account statement inserts or internet websites if the arrangement does not violate the anti-tying restrictions under federal law and the Federal Reserve Board determines that the arrangement is in the public interest, does not undermine the separation of banking and commerce, and is consistent with the safety and soundness of depository institutions.

Other changes made by the Act include the following (among others):

• Providing that federal savings associations are exempt from registration as investment advisers under the Investment Advisers Act of 1940 and from registration as broker-dealers under the Securities Exchange Act of 1934 to the same extent as banks;

• Directing the federal bank regulatory agencies to propose a uniform and simplified model privacy notice to comply with the financial privacy notice provisions of the GLB Act, and providing that the use by a depository institution of that model form will constitute compliance with those notice provisions;

• Clarifying the division of authority between home state and host state regulators regarding the supervision of interstate branches;

• Simplifying dividend calculations for national banks and state member banks;

• Permitting a Federal Reserve member bank to maintain required reserves on a pass-through basis with another member bank, which should enhance correspondent relationships;

• Increasing the limit for national banks and state member banks making community development investments from 10 percent of capital to 15 percent of capital;

• Authorizing the Federal Reserve Board in appropriate circumstances to waive the attribution rule of section 2(g)(2) of the Bank Holding Company Act (under which a company is deemed to own or control any shares that are held by a trust for the benefit of the company or its shareholders or employees);

• Extending to insured savings associations the authority previously accorded solely to banks of investing in bank service corporations (thrifts were not granted the increased community development investment authority granted to banks, however);

• Increasing the threshold for community banks that qualify for an 18-month examination cycle from $250 million in assets to $500 million (with larger banks remaining subject to a 12-month examination cycle);

• Exempting from the Fair Debt Collection Practices Act bad check offender programs as well as certain communications (such as, e.g., GLB Act privacy notices) and collection activities, subject to certain requirements;

• Streamlining application requirements under the Bank Merger Act and eliminating post-approval waiting periods for mergers of affiliated institutions;

• Amending federal law to give the Office of Thrift Supervision equal representation on the Basle Supervisors Committee along with the other federal bank regulatory agencies. The OTS is the supervisor for several thrifts and thrift holding companies that are financial and/or non-financial conglomerates with international operations; and

• Eliminating certain regulatory reporting requirements, including reports of loans to insiders of depository institutions.

The Act also requires the federal bank regulatory agencies to review the call report requirements with a view toward eliminating unnecessary reporting requirements. The Act also directs the Comptroller General (the head of the U.S. Government Accountability Office) to prepare a study on the volume of currency transaction reports filed by depository institutions with the Treasury Department along with any recommendations for changes to the filing requirement. The Comptroller General is also directed to study the costs and effectiveness of the overall regulatory regime for the financial services industry and to evaluate the potential benefits of consolidating financial regulators as well as charter simplification and homogenization.

Various regulatory changes embodied in earlier versions of the bill did not make their way into the Act despite pressure from banking groups urging their adoption. These included provisions allowing for the payment of interest by banks on demand deposits and business checking accounts, an exemption from filing of currency transaction reports by banks with regard to their seasoned business customers, the removal of state law restrictions on interstate branching by out-of-state banks, an exemption from the annual privacy notice requirement for banks that do not share customer information with affiliates, increased authority for thrifts to engage in commercial lending, and restrictions on industrial loan entities. Although banking trade associations have expressed an intention to press the next Congress to include many of these provisions in a subsequent round of regulatory relief legislation, the results of the recent mid-term elections – in which Democrats gained control of both Houses of Congress – suggest that Congress may have more pressing legislative priorities for the financial services industry than additional regulatory relief.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.