Financial Agencies Release Joint Statement on Innovative Efforts to Combat Money Laundering and Terrorist Financing

On December 3, 2018, the Board of Governors of the Federal Reserve System (“Federal Reserve), the Federal Deposit Insurance Corporation (“FDIC”), the Financial Crimes Enforcement Network (“FinCEN”), the National Credit Union Administration (“NCUA”), and the Office of the Comptroller of the Currency (“OCC”) (collectively, “agencies”) released a joint statement on innovative efforts to combat money laundering and terrorist financing.

In the joint statement, the agencies encouraged banks to consider and, if appropriate, responsibly implement innovative approaches with respect to their anti-money laundering (“AML”) and Bank Secrecy Act (“BSA”) compliance obligations. In particular, the agencies discussed innovative internal financial intelligence units that may be tasked with “identifying complex and strategic illicit finance vulnerability and threats.” The agencies also discussed artificial intelligence and digital identity technologies and recognized the value of these innovative approaches in strengthening banks’ BSA/AML compliance programs, as well as potentially reducing compliance costs.

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OCC Risk Report Trumpets Strong Bank Performance, But Warns of Emerging Risks

On December 3, 2018, the National Risk Committee (“NRC”) of the Office of the Comptroller of the Currency (“OCC”) released its Semiannual Risk Perspective for Fall 2018. The report analyzes the condition of the federal banking system using data reported by national banks and federal savings associations as of June 30, 2018. The analysis covers five main areas: banks’ operating environment, bank performance, emerging risks, trends related to key risks, and supervisory actions. In addition to these usual areas, the Fall 2018 report included a special supplement discussing risks related to the easing of credit underwriting standards. A brief summary of each of these areas follows.

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FTC Solicits Public Comment on Identity Theft Detection Rules

On December 4, 2018, the Federal Trade Commission (“FTC”) announced that it is accepting public comments regarding its Identity Theft Detection Rules, 16 C.F.R. Part 681 (the “Rules”), as part of a systematic review of the Commission’s regulations and guidelines. The review of the Rules is particularly noteworthy because identity theft is among the top consumer complaints to the FTC, and has been an enforcement priority for the FTC’s Bureau of Consumer Protection.

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Intellectual Property Issues in Blockchain and FinTech

FinTech and blockchain technologies are rapidly developing. With the emergence of so many new ideas and technologies comes the need for action, to protect both current and future innovations. Given the pace at which technology continues to disrupt the industry, securing IP assets—especially patents—should be a primary consideration for companies in this space. As the FinTech landscape continues to evolve into areas such as artificial intelligence and machine learning, quantum computing, and big data, counsel with specialized knowledge become increasingly valuable when devising IP strategies. The IP team at Covington understands the disruptive technologies and legal issues that are pertinent to the financial services industry. In this alert, the team detail some of the IP issues companies should consider in relation to blockchain technologies, discussing patents, trade secrets, and the use of open source software. The full alert is available at this link.

 

Federal Reserve Requests Public Comment on New Application Form for Savings and Loan Holding Companies

On November 30, 2018, the Federal Reserve requested comments on a new application form—the FR LL-10(e)—for savings and loan holding companies (“SLHCs”). The new form would replace Form H-(e), which was inherited from the Office of Thrift Supervision when the Dodd-Frank Wall Street Reform and Consumer Protection Act transferred supervisory authority for SHLCs to the Federal Reserve in July 2011.

Existing SLHCs and related individuals would use the form to acquire control of all or substantially all the assets of a savings association or an SLHC, and to engage in acquisitions that cause a savings association to become a subsidiary of an SLHC. In addition, applicants would use the form to become an SLHC.

The instructions for the proposed FR LL-10(e) largely track the structure of the Federal Reserve’s instructions for the FR Y-3, an application form for bank holding companies to be used in similar circumstances. The FR LL-10(e) would replace, revise, and clarify a significant number of questions in the prior Form H-(e), including questions related to regulatory filings, managerial resources, the Community Reinvestment Act, and the competitive factors of the transaction. The revised form would also delete certain requested items from Form H-(e), including requests for certain securities filings, information about previous acquisitions, and information about commitments that the applicant or target has with community organizations. The instructions for FR LL-10(e) are less than half the length of the instructions for Form H-(e).

Comments on the proposed FR LL-10(e) are required to be submitted on or before January 29, 2019.

Senate Testimony Highlights Tensions in BSA/AML Reform Efforts as Lawmakers Consider Bipartisan Legislation

Representatives of the Office of the Comptroller of the Currency (“OCC”), the Financial Crimes Enforcement Network (“FinCEN”), and the Federal Bureau of Investigation (“FBI”) testified on Thursday, November 29 before the Senate Committee on Banking, Housing, and Urban Affairs (“Banking Committee”) on anti-money laundering (“AML”) issues.

The testimony highlighted some tensions between the views of the different regulators, with the OCC appearing to be supportive of providing some regulatory relief to financial institutions, while FinCEN continues to see the value of the current requirements under the Bank Secrecy Act (“BSA”). Coming on the heels of reports that a bipartisan group of Senators are working on BSA reform legislation, the testimony revealed that FinCEN at least may prove reluctant to support some of the proposed reforms.

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CFTC Issues Primer on Smart Contracts

The CFTC’s LabCFTC recently released “A Primer on Smart Contracts” as part of LabCFTC’s initiative to engage with stakeholders on FinTech topics. The primer explains smart contracts, and explores their potential benefits — with a particular focus on the financial sector — and challenges. The CFTC has an interest in smart contracts because, as the primer suggests, smart contracts could easily be commodities or derivatives, depending upon their structure. As the primer notes, there are a range of potential benefits for smart contracts. There is potential for the code/execution of agreements to become more standardized, for better security and speed, and for new products, business models and regulatory innovation. Whereas existing paper contracts may include provisions that require the parties to undertake specific compliance and reporting obligations, smart contracts might potentially execute on those obligations. Though the CFTC’s primer emphasizes that responsible innovation is market-enhancing, it also forewarns of potential risks. The CFTC highlighted the potential for smart contracts to unlawfully circumvent rules and protections, reduce transparency and accountability, impair market integrity, and introduce operational, technical and cyber security risks, as well as potential susceptibility to fraud/manipulation.

Even if smart contracts themselves are properly coded/secure, the primer points out that there is a risk that other informational inputs (e.g., reference prices or events) upon which the contracts rely may be subject to errors or manipulation.

The CFTC has been very active in the FinTech space by providing primers on Bitcoin and consumer advisories on digital assets (e.g., here). Covington’s Futures and Derivatives Practice advises digital asset companies on compliance with CFTC regulation and guidance and will continue to follow these and other CFTC developments.

FDIC Previews Changes to Resolution Plan Requirements

On November 28, 2018, Federal Deposit Insurance Corporation (“FDIC”) Chairman Jelena McWilliams delivered keynote remarks regarding resolution planning requirements at the 2018 Annual Conference of The Clearing House and Bank Policy Institute.  Chairman McWilliams repeatedly emphasized that the failure of a financial institution should be dealt with through bankruptcy.  She stated that she strongly supports legislation that would establish a more tailored, transparent process for large financial firms under the Bankruptcy Code.  According to McWilliams, “[t]he FDIC stands ready to work with Congress and hopes to see such a measure signed into law.”  Additionally, the FDIC is considering refinements to the Orderly Liquidation Authority (the process created in the Dodd-Frank Act as an alternative to bankruptcy for large financial institutions), including recommendations from the Treasury Department published earlier this year.

Notably, Chairman McWilliams described two rulemaking that are expected in the coming months regarding resolution plans required by:

  • Section 165(d) of the Dodd-Frank Act for bank holding companies (“BHCs”) with $50 billion or more in total consolidated assets (“165(d) resolution plans”); and
  • The FDIC rule for insured depository institutions (“IDIs”) with $50 billion or more in total consolidated assets (“IDI resolution plans”).

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Capital Planning Framework to Continue its Evolution

In a November 9, 2018 speech, Federal Reserve Vice Chairman for Supervision Randal K. Quarles outlined potential adjustments to the revisions to the capital planning regime that the Federal Reserve proposed in April 2018.  Governor Quarles also said he will ask the Federal Reserve to exempt banks with less than $250 billion in assets from the Comprehensive Capital Analysis and Review (“CCAR”) quantitative assessment and supervisory stress testing in 2019 in order to facilitate capital planning moving to a biennial exercise for such banks.

Governor Quarles emphasized that the adjustments “are not intended to alter materially the overall level of capital in the system or the stringency of the regime.”  However, the cumulative impact of the changes outlined in his speech would be to ease the implementation of the SCB and streamline CCAR and capital planning.

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