BPInsights: December 17, 2022

Crypto’s Biggest Flight Risk

The FTX fiasco reached a new pitch this week as Bahamian authorities arrested founder Sam Bankman-Fried. Bankman-Fried also faces substantial charges back home: the U.S. Department of Justice charged him with conspiracy to commit fraud, money laundering and campaign finance violations. Bankman-Fried, who was denied bail, could face years in prison if convicted. He also faces charges from the SEC and CFTC.

  • Tipped off: Ryan Salame, a close Bankman-Fried associate, informed Bahamian securities regulators that FTX had likely used customer funds to cover losses at Alameda Research, according to the Financial Times. Salame alleged that Bankman-Fried and two other FTX executives could be responsible.
  • Secret back door: One focus of the SEC charges is the secret exemption baked into FTX software that enabled Alameda to keep borrowing funds from FTX, including customer funds, regardless of the value of Alameda’s collateral.
  • On the Hill: Meanwhile, the Senate Banking Committee and House Financial Services Committee held hearings examining the crypto exchange’s precipitous downfall. Bankman-Fried was notably absent from both hearings. At the House hearing, new FTX CEO John J. Ray III, who is steering the failed exchange through bankruptcy proceedings, painted a grim picture of a company running rampant without controls and a founder engaged in “old-fashioned embezzlement.” Ray cited commingled assets, undocumented transactions, unreliable books, a dearth of risk management and financial staff and other egregious examples of conduct that brought the firm down. “[N]ever in my career have I seen such an utter failure of corporate controls at every level of an organization, from the lack of financial statements to a complete failure of any internal controls or governance whatsoever,” Ray said in written testimony.

    The FTX failure has reignited interest in crypto legislation in both chambers and both parties, but lawmakers diverge on where to draw the lines. Sen. Chris Van Hollen (D-MD) warned in a Senate hearing of the dangers of giving a “government imprimatur” to the crypto industry by bringing it into the regulated financial system. Banking Committee Ranking Member Pat Toomey (R-PA) called for specific regulations targeting the crypto sector. Sen. Bill Hagerty (R-TN) cautioned against the next potential crypto crash – a failure of Binance, for example, would prove “catastrophic,” he said. Sens. Elizabeth Warren (D-MA) and Roger Marshall (R-KS) introduced a bill this week that would require FinCEN to issue guidance on digital assets, with the goal of subjecting crypto firms to anti-money laundering rules and banning crypto “mixers”.
  • In his own words: Bankman-Fried did not testify at the Capitol Hill hearings, but draft written testimony published by the Wall Street Journal offers a glimpse into what he might have said. While his testimony begins with an apology, it quickly gives way to caveats—for example, that he lacks specific details because he no longer has access to FTX files and that he was pressured to file for bankruptcy. Bankman-Fried also says “[t]o my knowledge, FTX US–a separate, US-based exchange that does accept Americans–is fully solvent, and thus all US customers could and should be made whole immediately.”

Five Key Things

1. Banking Second-Chance Jobs Bill Heads to President’s Desk

The Senate passed legislation to streamline second-chance hiring in the banking sector as part of the must-pass defense package this week. The bill now heads to President Biden’s desk, and he is expected to sign it into law by the end of the year. BPI released a statement in support of the bill’s Senate passage.

  • What it does: This legislative change will give banks the necessary flexibility to offer more jobs to rehabilitated candidates with minor prior criminal offenses. It will broaden access to banking jobs for candidates with minor records by exempting certain applicants from time-consuming regulatory hurdles under Section 19 of the Federal Deposit Insurance Act.
  • Bottom line: The legislation gives candidates with minor records a second chance at economic success and gives banks a chance to invest in an untapped pool of talent.
  • What else is there: In addition to the second-chance hiring update, the NDAA also included provisions to create a new public database to enhance transparency on firms applying for Fed master accounts, and to require Treasury to disclose to Congress any licenses issued to U.S. financial institutions authorizing them to provide services to sanctioned parties. Such licenses are often necessary to support humanitarian aid or food to war zones.
  • What wasn’t included: The defense legislation excluded a provision to create a new “systemically important entities” designation for critical infrastructure, such as financial institutions. This provision would have duplicated current requirements and magnified risk to banks by forcing them to reveal sensitive information that could give hackers a roadmap of their cyber defenses. Also excluded from the NDAA: legislation to make it easier for banks to do business with legal cannabis companies.

2. Misleading Labels, New Appeals Guidelines: What’s New at the FDIC

The FDIC held an open meeting this week, where the agency voted to revise its supervisory appeals guidelines and propose new restrictions on false advertising and misuse of the FDIC’s name and logo.

  • FDIC labels: The agency proposed a new rule targeting misrepresentations of FDIC-insured status. The proposal would require firms, including fintechs, to clarify explicitly to customers that uninsured products are not FDIC-insured and may lose value. The move appears to be a response to crypto and fintech firms, such as FTX and Voyager Digital, falsely suggesting certain accounts and products are covered by FDIC insurance. It gets at the heart of the bank regulatory perimeter – certain services like deposit-taking are cornerstones of regulated banking and come with its protections, while pseudo-banks that offer the same services do not offer that level of safety. The proposal would also require FDIC-insured banks to display a new digital FDIC sign to customers across all online channels, reflecting the rise of digital banking. This is not the first FDIC move against misrepresentations of deposit insurance – the agency sent cease-and-desist letters to several crypto firms earlier this year on the subject, issued a letter to banks in July providing that “in dealings with crypto companies,” banks should monitor those firms to ensure that they do not misrepresent the availability of deposit insurance and clarified in a May rulemaking how it would pursue misrepresentation violations – but this latest move signals the FDIC is continuing to think about how to prevent consumers from being misled by entities providing bank-like services outside of the regulatory perimeter.
  • Worth noting: CFPB Director Rohit Chopra, an FDIC board member, expressed particular concerns about non-insured funds on peer-to-peer payment apps like Venmo and PayPal. “I think we have to think broadly about what would happen if one of those institutions failed,” Chopra said. He expressed that concern at a House Financial Services Committee hearing this week. Chopra also said state attorneys general, the CFPB and other regulators should consider what is necessary to keep deposit-taking nonbanks “upfront and honest.”
  • Appeals changes: The FDIC adopted revised guidelines around supervisory appeals including a modification to the composition of the Supervision Appeals Review Committee (SARC), which is the final level of review in the agency’s appeals process.  The revisions add the FDIC ombudsman to the SARC as a non-voting member in an effort to improve the independence of the process (voting members are a member of the FDIC’s board and two current staff members); direct the ombudsman to monitor the supervision process after a firm submits an appeal in order to call out any indications of examiner retaliation, abuse or retribution; require materials considered by the SARC to be shared with both parties to the appeal in a timely manner; and allow appealing firms to request a stay of a supervisory action while the appeal is pending. The revised guidelines also clarify that decisions on a stay will be provided in writing, including the reasons for the decision. The final revised guidelines reflect some modest but welcome enhancements in transparency and due process.  BPI and a coalition of bank trades submitted comments last month on the proposed guidelines, which left major gaps in transparency and accountability in the appeals process.
  • Nominees: Three nominees to the FDIC Board – Acting Chairman Martin Gruenberg and two Republican nominees, Travis Hill and Jonathan McKernan – were advanced by the Senate Banking Committee to the full Senate this week. They are expected to receive a vote by the full Senate and be confirmed early next week. 

3. FinCEN Unveils Beneficial-Ownership Database Access Proposal

Treasury’s FinCEN this week issued a proposal on access to its legal entity beneficial ownership database being set up for 2024. The database will be a key part of the comprehensive anti-money laundering overhaul enacted in the Anti-Money Laundering Act (AMLA) of 2020. It will contain information about businesses’ beneficial owners to aid law enforcement and financial institutions in their efforts to combat the use of anonymous shell companies to launder money. The proposed rule specifies who will have access to information in the directory; how they may use that information and how they must secure it; and penalties for unauthorized disclosures of that information.

  • Who gets access: Five general types of entities are eligible to access business owner information – U.S. federal, state, local and tribal government agencies requesting it for specific purposes; foreign law enforcement agencies, judges, prosecutors, central authorities and competent authorities; financial institutions using the data to comply with customer due diligence requirements; financial regulators and supervisors evaluating financial institutions for customer due diligence requirements; and Treasury itself.
  • For banks: The proposed rule would allow financial institutions to request beneficial-ownership data only for purposes of complying with customer due diligence requirements. FinCEN anticipates that a bank would submit identifying information specific to a company and receive in return an electronic transcript with that firm’s owner information. The current system prizes bureaucracy over actionable information for law enforcement.
  • Usefulness: The beneficial ownership database will only succeed if it is highly useful is supporting authorized activities that rely on it.  As this proposal takes shape, ensuring the directory’s usefulness and accuracy should be priorities.

4. The Crypto Ledger

The Federal Reserve will not be subject to full discovery in its legal dispute with crypto bank Custodia over the firm’s master account application, a federal judge ruled this week. The Fed will only need to account for its actions on Custodia’s application for an account with the Kansas City Fed, Judge Scott Skavdahl of the U.S. District Court of Wyoming said in his decision. Here’s what else is new in crypto.

  • DOJ divided on Binance: Divisions between Department of Justice prosecutors present a roadblock to the conclusion of a years-long criminal investigation into Binance, according to Reuters. The probe, which began in 2018, centers on anti-money laundering and sanctions compliance. Some prosecutors involved in the case contend that the evidence justifies filing criminal charges against executives including founder Changpeng Zhao, while others favor a more gradual approach, according to the story. The DOJ offices involved in the investigation include the Money Laundering and Asset Recovery Section, the U.S. Attorney’s Office for the Western District of Washington, and the National Cryptocurrency Enforcement Team.
  • Binance falters: Meanwhile, customers have pulled more than $1 billion from Binance in a flurry of withdrawals, and CEO Zhao sought to calm anxious clients on Twitter.
  • Coinbase and SCOTUS: The Supreme Court agreed to hear an appeal by Coinbase, which is aiming to resolve customer lawsuits by private arbitration. The Supreme Court will consider the issue of whether a party in a lawsuit can be forced to defend the case in proceedings in a federal district court while it seeks to send the dispute to an arbitrator.

5. Chopra on the Hill: Key Takeaways

CFPB Director Rohit Chopra testified this week at Senate Banking Committee and House Financial Services Committee hearings on the semiannual report of the CFPB. Here are some key takeaways.

  • Oversight: Under its new GOP majority, the House Financial Services Committee is preparing for increased oversight of the CFPB, expected incoming Chair Patrick McHenry (R-NC) said at the House hearing. McHenry decried a lack of transparency at the Bureau and a heavy reliance on policymaking channels outside of the notice-and-comment rulemaking process, such as press releases and circulars. “While not legally binding, such clarifications and guidance without time to process the changes foster an environment of uncertainty for the industry,” McHenry said. “That doesn’t make it better for the consumers.” Senate Banking Committee Ranking Member Pat Toomey emphasized the same theme, and Chopra also fielded questions from Republicans about the Fifth Circuit ruling on its funding structure. Toomey expressed concern that the CFPB is unaccountable to Congress.
  • Stablecoins and crypto: Stablecoin runs could put consumers at risk, Chopra said at the House hearing. Fraud protections also need to be in place, he said. “[T]he biggest concern I would have is making sure that the regulators are ready if some of these digital currencies like a stablecoin really scale,” he said at the House hearing. He also noted cases where crypto intersects with consumer financial products and customers are misled about accounts that appear to be safe.
  • Tech: Chopra emphasized the risks of Big Tech’s foothold in financial services, which the CFPB is studying. Such risks include fraud and abuse of customers’ data, he noted at the House hearing. He expressed concern about consumers’ accounts on payment platforms being frozen or suspended “because of their speech or their other activities.” Big Tech firms have “enormous power to elevate or suppress some users over others,” which is “very scary,” Chopra said at the House hearing.
  • Privacy: Chopra called on lawmakers to update the Gramm-Leach-Bliley Act, which contains comprehensive rules on financial firms’ data privacy. Financial privacy is an area McHenry has targeted for legislative action in the House during the next Congress.
  • Small business lending data: The CFPB’s forthcoming small business data collection rule under Section 1071 of Dodd-Frank could raise the cost and decrease access to credit for small businesses that need it most, Rep. Ann Wagner (R-MO) said at the House hearing. Separately at that hearing, Chopra confirmed the agency is on track to meet the March 31, 2023 deadline to finalize the rule.
  • Data sharing: Rep. French Hill (R-AR) questioned why the CFPB’s data-sharing rulemaking under Section 1033 of Dodd-Frank would not apply to nonbanks. Chopra responded that the CFPB is “starting there” with applying the rule to deposit and transaction accounts, but “we’re going to keep going” and expand to more products.

In Case You Missed It

Eleventh Circuit Gives Sharp Rebuke to CFPB Deposition Practices

A three-judge panel at the U.S. Court of Appeals for the Eleventh Circuit sharply criticized the CFPB’s conduct during depositions in a Georgia robocall case. The CFPB had urged the panel to reverse a sanction against it for failing to comply with deposition instructions, but the judges indicated that the sanction was warranted. CFPB deposition behavior included the Bureau’s witness reading from a script for long periods when answering questions and the CFPB’s repeated objections to questions for its witness. “How are these depositions anything more than a document production?” Eleventh Circuit Judge Elizabeth L. Branch asked CFPB counsel. “How were they actually fulfilling what a deposition is supposed to do? I’m not sure the CFPB communicated any meaningful information to the defendants.”

BPI and TCH Support Global Blueprint for Digital-Asset Oversight

The Bank Policy Institute and The Clearing House commented this week on two Financial Stability Board (FSB) consultative reports outlining approaches for the oversight and regulation of digital assets and global stablecoin arrangements, respectively. TCH and BPI support the FSB’s 19 recommendations in the consultative reports and its efforts to balance responsible innovation with comprehensive, clear and consistent rules. The frameworks could be further strengthened by 1. explicitly clarifying that the risks in the digital asset ecosystem primarily relate to activities of nonbanks, 2. calling on local authorities to define permissible activities for regulated banks and 3. establishing universal definitions distinguishing among types of digital assets and the risks each may present.

“BPI and TCH support innovation but believe it must be conducted in a manner consistent with the safety and soundness of the financial system, anti-money-laundering and countering-the-financing-of-terrorism standards, and robust consumer and investor protections,” the letter states. Like the FSB, BPI and TCH firmly believe that the same activities posing the same risks should be subject to the same regulation. In this regard, the letter notes, “[The] comprehensive regulatory risk management framework distinguishes banking organizations from nonbanks, protects clients (including consumers) and promotes safety and soundness regardless of the activities in which banking organizations are engaged.”

Some studies indicate that as many as 16% of American adults – approximately 40 million people – have invested in, traded or used cryptocurrencies. Most of this activity has occurred outside of the regulated banking sector, leading to catastrophic losses for consumers and less trust in the financial system, as occurred during the recent FTX collapse. An international framework promoting uniform standards across jurisdictions will help to ensure that:

  • Consumers, investors and businesses fully understand the benefits and risks of digital assets;
  • Nonbanks operate under the same rules as banks, reducing opportunities for regulatory arbitrage and thus reducing risks to consumers, investors and businesses; and
  • Authorities provide banks with the clarity they need to safely meet customer demand for products and services using new technologies, including through the use of distributed ledger and blockchain technologies.

To learn more, click here.

BPI Hires Greg Hopper as Senior Fellow

BPI this week announced the hiring of Greg Hopper as a senior fellow. Greg previously served as a managing director at Goldman Sachs, where he led the Office of New and Emerging Risks and served as Global Head of Enterprise Risk Management. In those roles, Greg oversaw Firmwide Stress Testing, ESG Quantitative Analysis, the Sovereign and Economic Risk Group, Firmwide Risk Identification, Firmwide Limits and Risk Appetite and the Risk Economics Group.

In his new role at BPI, Greg will work on a range of bank capital, climate and digital assets topics.

“Greg brings to BPI extraordinary knowledge of all technical aspects of prudential regulations and extensive experience in both the public and private sectors,” BPI CEO Greg Baer said. “He has a well-earned reputation as a thoughtful and rigorous economist, and we are fortunate that he has agreed to join BPI and are excited to welcome him to the team.”

Bank of England Calls for Stronger LDI Oversight

The Bank of England recommended that UK financial regulators bolster the pensions market after recent bond market ructions. In particular, the central bank called on the pensions regulator and the Financial Conduct Authority to take action to ensure liability-driven investment funds – the vehicles at the heart of the recent pensions turmoil – can withstand higher interest rates. “There is a clear need for urgent and robust measures to fill regulatory and supervisory gaps to reduce risks to UK financial stability,” the BOE said in its Financial Stability Report this week.

Treasury Launches Campaign to Help Consumers Avoid Common Holiday Scams

The U.S. Department of Treasury and The Office of Cybersecurity and Critical Infrastructure Protection kicked off a new campaign this week to help educate American consumers about common holiday scams. The campaign introduces best practices, highlights commonly employed scam tactics and provides victim resources to help consumers remain vigilant and safe. “If you are uncomfortable or feel pressured to send or spend money, STOP!” the campaign asserts. Instead, consumers should take the time to conduct more research or ask for help.

Huntington Launches Tool to Help Neurodiverse People Navigate Banking

Huntington Bank announced a new tool in collaboration with Magnusmode to make the banking experience easier for neurodiverse customers, including those with autism. The step-by-step visual guides help neurodiverse people understand different banking processes, such as depositing a check.

Next Post: BPInsights: April 20, 2024 View Next Post


The views expressed do not necessarily reflect those of the Bank Policy Institute’s member banks, and are not intended to be, and should not be construed as, legal advice of any kind.