March 30, 2023
As the banking industry continues its efforts to return to business as usual following a hectic and complicated three weeks, we are now seeing the early stages of the process to determine what went wrong, who was responsible and what can be done in the future to prevent a recurrence.
That closer look began earlier this week with Congressional hearings involving some of the nation's top banking regulators, and it is pretty obvious that this is only the beginning of an industry-wide introspection period. This should be very enlightening, and it is something that we will follow carefully in the weeks and months to come.
We also continue to follow the ongoing judicial matters around CFPB funding, with another important development last week addressed here by my colleague, Rachel Rodman.
Lots more to read and discuss this week, so please reach out here if there’s anything on your mind.
Daniel Meade
Partner and Editor, Cabinet News and Views
Both the Senate Banking Committee and House Financial Services Committee held hearings this week on the federal regulatory response to the failures of Silicon Valley Bank (“SVB”) and Signature Bank. Witnesses at both hearings were Federal Reserve Board (“FRB”) Vice Chair of Supervision Michael Barr, Federal Deposit Insurance Corporation (“FDIC”) Chairman Martin Gruenberg, and Treasury Department Under Secretary for Domestic Finance Nellie Liang.
In Vice Chair Barr’s testimony, he stated: “SVB’s failure is a textbook case of mismanagement,” noting poor interest rate risk management. However, he also noted that the Federal Reserve will be conducting a review on how appropriate the supervisory approach to SVB was and what lessons can be learned. In response to questions, Vice Chair Barr noted that he intends to conduct such review “humbly.”
One striking thing to note, in both Vice Chair Barr’s prepared testimony and during the questions from members of the respective committees, was the highly unusual inclusion of public discussion of confidential supervisory information (“CSI”). In his testimony, Vice Chair Barr noted some of the ratings of SVB and SVB Holdings, along with some supervisory findings, such as matters requiring attention (“MRAs”), and the fact that SVB Holdings was subject to an agreement under section 4(m) of the Bank Holding Company Act due to it being rated as not well managed. Regulators normally strictly guard CSI in similar fashion to how other parts of the government might guard classified information. However, one of the main reasons to keep CSI confidential is to prevent a bank run, and the thinking must have been that the reasons for keeping CSI related to SVB were now moot.
Chair Gruenberg’s testimony was similar to Vice Chair Barr’s in that he noted bank management failures, and that FDIC would be conducting a review of both banks, but noted FDIC was the primary Federal supervisor for Signature Bank. Chair Gruenberg also provided some details on the resolutions and ultimate sale of a substantial portion of the assets and deposits of both banks to buyers.
Under Secretary Liang’s testimony focused on the Department of Treasury’s role in the systemic risk exceptions that enabled the FRB to invoke section 13(3) of the Bank Holding Company Act to provide the Bank Term Funding Program (which we discussed last week) and the FDIC to provide insurance for all deposits and establish bridge banks for SVB and Signature.
There were partisan themes to the questions the regulators received from the members of the respective committees. While there was at least some bipartisan agreement that management at the failed banks bear responsibility, Republicans did seem to want to pin at least equal responsibility on the regulators. Republicans also questioned the FDIC’s bid process, and suggested the FDIC was too slow in ultimately reaching purchase and assumption agreements for both banks.
While this is the first Congressional hearing on SVB and Signature, it is unlikely to be the last. The FRB’s and FDIC’s internal reviews are due out in May, and are very likely to generate another round of hearings.
On March 23, the U.S. Court of Appeals for the Second Circuit ruled that the CFPB’s funding mechanism is constitutional.[1] The case, CFPB v. Law Offices of Crystal Moroney, is significant for two reasons. First, the Second Circuit expressly declined to follow the Fifth Circuit’s recent ruling in CFPB v. Community Financial Services Association of America that the CFPB’s funding mechanism violates the Appropriations Clause of Article I of the Constitution.[2] Second, the Second Circuit issued its ruling after the Supreme Court granted certiorari in Community Financial − weighing in on a controversial issue that the Supreme Court has already agreed to address.
Moroney concerned a challenge by a law firm to a civil investigative demand issued by the CFPB. The law firm argued, among other things, that the CID was invalid because the CFPB’s funding mechanism is unconstitutional. Under the Consumer Financial Protection Act, the CFPB does not receive funds through annual appropriations from the Treasury Department but is authorized to request a capped amount of funds from the Federal Reserve System. The law firm argued that this arrangement violates the Appropriations Clause because it uniquely insulates the CFPB from the appropriations process.
Importantly, the Fifth Circuit recently adopted this same argument in Community Financial. There, the Fifth Circuit held that funding the CFPB outside of the annual appropriations process means that the CFPB has powers of the “purse” and the enforcement “sword” in violation of the Constitution’s separation-of-powers doctrine. As a remedy, the Fifth Circuit vacated the CFPB’s Payday Lending Rule because it was finalized while the CFPB was unlawfully funded. The Fifth Circuit recognized that its ruling contradicted the decision of “every court to consider” the CFPB’s funding structure. In February, the Supreme Court granted the CFPB’s petition for certiorari in Community Financial. The case is expected to be argued this fall.
In Moroney, however, the Second Circuit rejected the argument that the CFPB’s funding mechanism is unconstitutional. The Second Circuit held that the Appropriations Clause simply requires that “the payment of money from the Treasury must be authorized by a statute.”[3] The Court ruled that “[h]ere, Congress expressly appropriated the CFPB’s funding by enacting the CFPA.”[4] Next, the Second Circuit addressed the Fifth Circuit’s ruling, holding that it could not find “any support” for the Fifth Circuit’s conclusion in Supreme Court precedent, the Constitution’s text, or the history of the Appropriations Clause.[5]
The Second Circuit’s ruling in Moroney deepens the divide between the Fifth Circuit and every other court to address the constitutionality of the CFPB’s funding mechanism. Moroney is also likely to be a factor as federal courts across the country weigh whether to allow cases involving the CFPB to proceed while Community Financial is pending with the Supreme Court. We expect Community Financial and Moroney to continue to reverberate across cases involving both the CFPB and other federal financial agencies that are funded outside the annual appropriations process.
[1] See CFPB v. Law Offices of Crystal Moroney, Slip Op. (Dkt. No. 151-1), No. 20-3471 (2d Cir. March 23, 2023).
[2] CFPB v. Cmty. Fin. Servs. Ass’n of Am., No. 22-448 (Feb. 27, 2023), available at https://www.supremecourt.gov/docket/docketfiles/html/public/22-448.html.
[3] Moroney, Slip Op. at 13.
[4] Id.
[5] Id. at 14–19.
Earlier this month, the CFPB issued a press release and a Request for Information (“RFI”) that is focused upon whether the CFPB should promulgate additional rules implementing the Fair Credit Reporting Act.
The Fair Credit Reporting Act is landmark privacy legislation that was passed by Congress in 1970 and requires lenders, credit bureaus and even employers to provide consumers with information regarding the use of the information in their credit reports and provides rights for consumers to challenge items on their credit reports and to be able to view their credit reports. The RFI explains that its purpose is fueled by, “in addition to supervision of consumer reporting agencies, including the three largest nationwide consumer reporting agencies, the CFPB endeavors to gain insight into the full scope of the data broker industry. The data broker industry is growing and expanding its reach into new spheres of consumers’ personal lives, as more sophisticated computerization has increased the power of these companies to track and predict consumer behavior. Yet, many people lack an understanding of the scope and breadth of data brokers’ business practices and the impact of those practices on the marketplace and peoples’ daily lives.”
The public may provide comments responsive to the RFI through June 13, 2023. Interestingly, the CFPB solicits input from both data brokers and financial industry participants, as well as from consumers themselves. The specific questions from the CFPB for data brokers focus upon collecting general information such as, “What types of data do data brokers collect, aggregate, sell, resell, license, derive marketable insights from, or otherwise share?” and “What specific types of information do data brokers receive from financial institutions?”, as well as more specific information regarding whether financial institutions place restrictions on the data they provide to data brokers, and whether consumers are able to avoid collection of their data. The questions for consumers delve into a variety of categories, including obtaining information regarding whether consumers have attempted to remove data from a specific data broker and how that process worked, as well as their viewpoints on the benefits and harms of collection of their information by data brokers.