A Step Toward A Limited-Purpose Fintech Charter
Law360, New York (October 4, 2016, 1:23 PM EDT) -- On Sept. 13, 2016, the Office of the Comptroller of the Currency released its notice of proposed rulemaking addressing the conduct of receiverships for national banks that are not insured by the Federal Deposit Insurance Corp. and for which the FDIC would not be appointed as receiver. The proposed rule would implement the provisions of the National Bank Act that provide the legal framework for receiverships of uninsured banks. The OCC will accept public comments on the proposal until Nov. 14, 2016.
The proposal is significant for many reasons, including that it continues to pave the way for the OCC's rollout of a limited-purpose financial technology banking charter, a project strongly supported by the OCC's comptroller, Thomas Curry. It is also of interest to existing trust banks, which the proposal's terms capture, and international banks with uninsured federal branches and agencies, which the proposal's terms exclude.
This article details the various sections of the proposal and highlights select considerations for various parties with exposure to the proposed rule, including trust banks and fintech firms seeking a limited-purpose fintech charter, as well as their respective sponsors, investors and creditor counterparties.
With limited exceptions, bank and trust company insolvencies are not administered under the federal Bankruptcy Code. Since the beginning of the national banking system in 1863, the OCC has played a key role in the resolution of national banks, and the NBA contains provisions on national bank resolutions and receiverships. The establishment of the FDIC in 1933 and the enactment in the Banking Act of 1933 of a detailed FDIC receivership program for all insured banks, however, limited somewhat the OCC's role in the resolution process. After various legislative amendments in response to waves of bank failures, contemporary banking law has resulted in a regime in which the FDIC does not act as receiver of uninsured banks and trust companies. Rather, the comptroller is given discretion with respect to whom to appoint as receiver of uninsured national banks under a set of statutory provisions and pre-1933 case law on receiverships that do not meet the needs of the current complex financial environment. State bank commissioners appoint the receivers of uninsured state banks and uninsured state-licensed branches of non-U.S. banks.
For more than a decade, the OCC has been reluctant to charter new nondepository national banks and trust companies that are not subsidiaries of FDIC-insured national banks because the OCC did not feel it had the experience and rules to handle a receivership without the FDIC.
Competent handling of receiverships of failing financial institutions is seen by many policymakers as a key protection against transmission of systemic risks across the financial system. Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act contains provisions for the FDIC to serve as receiver of systemically important nonbank financial services firms. Earlier this year, the FDIC and the U.S. Securities and Exchange Commission proposed regulations for FDIC administration of receiverships of systemically important securities broker-dealer firms. These new FDIC powers, however, are not applicable to uninsured banks and trust companies that are not designated as systemically important under Title II of Dodd-Frank.
As part of the OCC's efforts to enhance the conditions under which financial innovation can take place within the national banking system, the OCC released the recent proposal, which sets forth an essential aspect of the cradle-to-grave supervisory framework that a limited-purpose fintech charter would exist within – namely, the resolution mechanism that a national bank would proceed through in the event of its failure and the appointment of a receiver for it by the OCC.
The NBA sets forth the basic framework for the resolution of a national bank. The proposal, however, fleshes out the practical application of the NBA's basic framework in greater detail with respect to uninsured banks and is discussed below.
Purpose and Scope. The proposal would apply to uninsured banks but would not apply to receiverships for uninsured federal branches or uninsured federal agencies. This is a particularly important point as it reveals the continuing difficulties that the banking agencies face as they try to optimize an international resolution framework that intertwines bank resolution and bankruptcy concepts of various jurisdictions.
Appointment of Receiver. The OCC has the authority to appoint a receiver for an uninsured bank which, as the proposal clarifies, could be the OCC itself. An uninsured bank would have, however, the ability to seek judicial review of the appointment.
In what is perhaps a revelation of the OCC's intention to appoint itself as the receiver for failed uninsured banks, the proposal details carefully the separate-capacities construct that has been developed over time by the FDIC. Specifically, the OCC would maintain its capacity as a regulatory agency through the course of a receivership, but it would also take on a separate capacity as the party responsible for appointing a receiver. With this construct, the OCC seeks to act in two separate and distinct capacities, each with a separate legal status and functional role.
Notice of Appointment of Receiver. Pursuant to the proposal, the OCC would provide notice to the public of a receivership that will include instructions for creditors and other claimants seeking to submit claims with the receiver of the uninsured bank.
Claims. Pursuant to the proposal, the OCC would set a claims bar date not less than 30 days after the end of the three-month notice period. Claims would be submitted to the OCC, and the OCC would determine the validity and approve or deny the amounts of such claims, considering security, preference, setoff and priority. Importantly, claimants could present their claims to a court of competent jurisdiction and any final judgment could be submitted to the OCC, and that claimant may participate in ratable dividends along with other proved claims. The proposed rule is somewhat ambiguous, however, as to whether the 30-day claims bar date applies to final judgments obtained from a court but, presumably, would only apply to claims brought to the OCC for determination.
The claims process, which would allow a claimant to submit its claim for judicial review, in addition to, or as an alternative to, filing a claim with the OCC, differs from the claims process of the bankruptcy provisions of the U.S. Bankruptcy Code and the receivership provisions of the Federal Deposit Insurance Act. Under those other regimes, creditors and claimants must generally submit their claims to the bankruptcy or receivership estate for centralized administration and disposition. In comparison, the NBA provides claimants optionality to resolve claims via the administrative claims process or a judicial resolution against the uninsured bank in receivership.
Order of Priorities. Per the proposal, the OCC would pay receivership expenses and proved claims against the uninsured bank in receivership in the following order of priority:
1. administrative expenses of the receiver;
2. unsecured creditors of the uninsured bank, including secured creditors to the extent their claim exceeds their valid and enforceable security interest;
3. creditors of the uninsured bank, if any, whose claims are subordinated to general creditor claims; and
4. shareholders of the uninsured bank.
Administrative Expenses of Receiver. Administrative expenses of the receiver would be paid out of the assets of the uninsured bank in receivership before payment of claims against the receivership. Administrative expenses would include those expenses incurred by the receiver in maintaining banking operations during the receivership, to preserve assets of the uninsured bank, while liquidating or otherwise resolving the affairs of the uninsured bank. The proposal clarifies that these expenses would include both pre-receivership and post-receivership obligations that the receiver determines are necessary and appropriate to facilitate the orderly liquidation or other resolution of the uninsured bank in receivership.
Powers and Duties of Receiver, Disposition of Fiduciary and Custodial Accounts. The receiver for an uninsured bank would be able to exercise the rights, privileges and powers authorized for receivers of national banks under the NBA and the common law of receiverships as applied by the courts to receiverships of national banks conducted under the NBA. The receiver would marshal assets of the uninsured bank as follows:
1. take possession of the books, records, and other property and assets of the uninsured bank, including the value of collateral pledged by the uninsured bank to the extent it exceeds valid and enforceable security interests of a claimant;
2. collect all debts, dues and claims belonging to the uninsured bank, including claims remaining after setoff;
3. sell or compromise all bad or doubtful debts, subject to approval by a court of competent jurisdiction;
4. sell the real and personal property of the uninsured bank, subject to approval by a court of competent jurisdiction, on such terms as the court shall direct; and
5. deposit all receivership funds collected from the liquidation of the uninsured bank in an account designated by the OCC.
Fiduciary and custodial appointments and accounts would be closed or transferred in whole or in part to successor fiduciaries and custodians, a feature of the resolution process that may provide acquisition opportunities for acquisitive trust banks or other fintech firms.
Payment of Claims and Dividends to Shareholders. Following the payment of administrative expenses, the OCC would make ratable dividends from time to time of available receivership funds in accordance with the proposal's order of priorities based on those claims that have been proved to the OCC's satisfaction or adjudicated in a court of competent jurisdiction. Dividends would exclude assets held by the uninsured bank in a fiduciary or custodial capacity. Any receivership assets remaining would be paid to the uninsured bank's shareholders in proportion to their stock ownership. The proposal invites public comment on the mechanics and timing for how such payments should be made, such as whether full satisfaction of all liabilities should serve as a condition precedent to dividend payments.
Termination of Receivership. If there are assets available for a shareholder distribution, the OCC would call a meeting of the shareholders of the uninsured bank for the shareholders to decide the manner in which the liquidation would continue, which could either be a continued receivership under the direction of the OCC or a liquidation of the receivership estate for the benefit of the shareholders. Unlike with insured deposits of an FDIC-insured institution, creditors' claims against an uninsured bank are not government-guaranteed.
The proposal raises numerous policy and strategic considerations that various parties holding exposure to either fintech firms or the OCC's receivership process ought to be aware of. The following is a list of select considerations.
Investor Exposure. The existence of a limited-purpose fintech charter as a viable corporate form through which to operate provides sponsors and investors of fintech firms a market arbitrage opportunity — that is, to operate their fintech firms as nonbanks or as national banks and, in particular, as uninsured banks. The claims process is one key consideration in that arbitrage analysis and investors should consider how the OCC's claims process differs from the bankruptcy claims process. Specifically, the question becomes under which process would a creditor of a failed fintech firm be better off – the United States Bankruptcy Code or the NBA.
Uninsured Trust Banks. Although the proposal is clearly meant to advance the seemingly eventual establishment of a limited-purpose fintech charter aimed at promoting financial innovation, the 52 uninsured trust banks currently in existence would be wise to closely review the proposal and comment on it as appropriate. Of particular importance will be how the funding mechanism will function. For instance, trust banks might wish to avoid having to subsidize the resolution costs of a new class of bank entrants that operate with a different risk profile than their own.
Limited-Purpose Fintech Charter. The discussion in the proposal for what types of entities might be suitable candidates for a limited-purpose fintech charter raises fundamental questions of competitive equality, charter arbitrage, vertical agency competition, and a host of other practical and philosophical issues. The proposal, for instance, states that a limited-purpose fintech charter could be granted to firms that engage in a core banking function – receiving deposits, paying checks or lending money. Many fintech firms, especially those engaged in payment processing or other applications of virtual currency or the blockchain, might not comfortably fit into one of those core banking function categories. The proposal also does not seem to contemplate the possibility that certain fintech firms, such as virtual currency wallets, would wish to become trust banks. Further, the discussion leaves open the question of what kind of innovation would be acceptable to justify the grant of the limited-purpose fintech charter, a question of keen interest to numerous already-established and emerging specialty finance companies.
It is no coincidence that the OCC has now decided to unveil a regulatory framework to flesh out the receivership provisions of the NBA. The decision is a clear step in the OCC's cautious rollout of a limited-purpose fintech charter that will redefine the future of banking at this historical moment of financial innovation. Nevertheless, uninsured national banks would be wise to critically review the proposal to ensure they are not adversely impacted by these regulatory changes. Fintech firm sponsors, investors and counterparties of various types would also be wise to review the proposal, in light of the differential exposure it creates for them versus what they would experience under the bankruptcy process in the United States Bankruptcy Code.
—By Brian C. McCormally, David F. Freeman Jr., Rosa J. Evergreen and Pratin Vallabhaneni, Arnold & Porter LLP
Brian McCormally is a partner in Arnold & Porter's Washington, D.C., office. He has more than 20 years of experience in senior legal positions in the enforcement and regulatory compliance areas at the Office of the Comptroller of the Currency and the Office of Thrift Supervision.
David Freeman is a Washington-based partner who heads the firm's financial services practice group.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.