Financial Services Regulation in a Biden Administration: Personnel Is Policy

Given that the Senate will be closely divided between Republicans and Democrats, legislative reform may be difficult and time consuming to advance. However, as per the old Washington adage that “personnel is policy,” Biden appointees for key regulatory positions will have a large impact on the financial services policy agenda.

It is likely that those appointed to key financial regulatory positions will share the Democrats’ prevailing views in favor of stronger regulations governing consumer protection, robust prudential oversight, and support for smaller financial institutions rather than larger ones. In an early move, President-elect Biden appointed Gary Gensler, a former investment banker with significant credibility among progressives based on his work challenging banks as Commodity Futures Trading Commission chairman, as the leader of the transition team for the Federal Reserve, Banking and Securities Regulators. Chairman Gensler’s work during the Obama Administration signifies that a so-called “Wall Street litmus test” favored by progressives might actually deprive them of their financial services policy goals. Other transition team members addressing financial services issues come from diverse backgrounds that include academics and consumer rights activities, as well as those with prior regulatory and industry experience.

The Trump Legacy on Financial Services Regulations

The financial services sector enjoyed moderate success persuading the Trump Administration and congressional Republicans to reduce perceived regulatory burdens emanating from the Dodd-Frank Wall Street Reform and Consumer Protection Act and other legacy financial services laws. In the legislative arena, in 2018 Congress enacted the seminal Trump era financial regulatory reform bill known as the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Act”), which provided sought-after relief to many small and midsize banks by lowering the asset threshold for enhanced supervision of financial institutions and easing capital and liquidity requirements. The law also simplified the Volcker Rule, expanding the types of proprietary positions permitted by banks and loosening requirements for setting aside capital for derivative trades. However, that law was almost as notable for what it did not include: unlike the much more partisan legislation earlier passed by the then-GOP-controlled House, the Act focused almost entirely on reducing regulatory burden on smaller financial institutions and largely refrained from modifying the structure or the authorities of the Consumer Financial Protection Bureau (CFPB), an item long on the wish list of congressional conservatives. As a result of these compromises, the law was able to enjoy some bipartisan support, particularly in the Senate. And since the law was passed—and the subsequent split in party control resulting from the 2018 elections—Congress has done little in the way of legislating on financial services.

While Congress has not been highly active on financial regulatory reform legislation, the federal financial regulators were quite busy attempting to modernize and ease existing regulations, developing new policies aimed at promoting financial services innovation, modernizing community investment obligations, and bringing greater certainty to supervisory expectations.

Looking ahead: Federal Financial Technology/Innovation Regulation

Most of the federal financial regulators have well established offices of innovation that serve as each agency’s “tip of the spear” for interacting with financial technology (fintech) companies, as well as traditional financial services providers pursuing new innovations. The CFPB, Office of the Comptroller of the Currency (OCC) and the FDIC have all been particularly active under Trump-appointed leadership in promoting financial innovation. The federal financial regulators have worked together on guidance and rulemaking to support innovation, for example in 2018 publishing joint guidance to encourage all financial institutions to consider innovative technology approaches to meeting their Bank-Secrecy Act/anti-money laundering obligations. Similarly, in 2019 the federal financial regulators worked together to issue guidance on the use of alternative and innovative data for credit underwriting decisions. The development of fintech has been supported by both parties and the financial industry is likely to be encouraged to continue to innovate, though perhaps with different emphasis and oversight. Numerous members of the Biden transition’s agency review teams for financial services agencies and the CFPB have significant expertise on fintech issues, and President-elect Biden’s campaign had substantial support and involvement from Silicon Valley and the technology community. The new administration is likely to be supportive of the fintech community and innovation while aiming to ensure that innovative financial products and services serve the unbanked and underbanked communities and increase access to financial services. Fintech companies that are developing products that meet those priorities are likely to gain greater acceptance from legislators and regulators.

CFPB Sandboxes and Innovation Policies

The CFPB has been quite aggressive in updating and promoting financial sandbox and innovation policies. The CFPB innovation policies have recently been updated to ease the requirements and expand their potential applicability, including:

• Easing the requirements in the CFPB compliance assistance sandbox policy, which provides a legal safe harbor for financial firms to test innovative products and services for a limited time while sharing data with the CFPB;
• Expanding the CFPB policy that permits a company to seek a No-Action Letter to clarify uncertainty or ambiguity regarding the application of an identified statutory/regulatory provision to a particular product or service; and
• Providing an updated Trial Disclosure Sandbox Program policy that permits companies, under legal safe harbor, to test new disclosures that could improve consumer understanding regarding a product or service.

A key requirement of these policies is that they require a customer benefit and the CFPB has stated that these policies are intended to promote a consumer benefit. Additionally, each of these policies permits a service provider or trade association to apply for a “template” relating to the policy that can be used for other industry members after an expedited review.

It is likely that the CFPB will continue to use these policies going forward, though a Biden appointee to replace current Director Kathy Kraninger may change the focus and priorities, for example, putting a greater emphasis on the consumer benefit requirement. At the same time, Congress may attempt to exert pressure on the Bureau to change these policies; for example, House Financial Services Committee Chairwoman Maxine Waters (D-CA) has called for the CFPB to rescind them. Although rescission is unlikely, fintech companies and traditional financial institutions would be well advised to closely analyze whether the policies evolve, either in form or in practice.

OCC and Fintech

The OCC has actively promoted a “responsible innovation” agenda through various administrations. Under its current leadership, the OCC has been especially focused on these initiatives, and has adopted several significant new proposals aimed at innovating the financial sector, including in particular increasing the acceptance of virtual currency and blockchain technology at federally chartered financial institutions. The OCC has also been pushing forward on the Special Purpose National Bank (SPNB) Charters, known popularly as “fintech charters,” for non-bank financial services providers to engage in certain lending and payment activities under a federal banking charter and thereby pre-empt state money transmitter or lending licenses. The OCC is currently mired in litigation with both the Conference of State Bank Supervisors and the New York Department of Financial Services regarding its authority under the National Bank Act to issue any charter for a non-depository institution. The OCC is enjoined from issuing any such charters pending appeal.

It is likely that the OCC will continue its responsible innovation agenda under a new leadership. It has prioritized innovation in banking technology, products and services for many years, and those efforts will continue. A Biden-appointed Comptroller is likely to prioritize efforts to use technology that will increase access to traditional banking products and serve the unbanked and underbanked population.

FDIC Standards Setting Initiative for Fintechs/Regtechs

The FDIC has also started to make its own mark this summer on financial innovation policy by seeking public input regarding whether a standard-setting and voluntary-certification program could be established to support financial institutions’ efforts to conduct due diligence of third-party providers of technology and other services. This proposal could have a significant influence on how banks and fintech or regtech companies both work together and compete with one another. The FDIC has not yet issued a proposed rule to formally establish the standard-setting and voluntary certification program; as such, whether FDIC Chair Jelena McWilliams—who is currently halfway through her five-year tenure—continues to pursue such a policy as the FDIC Board evolves to include Biden appointees, remains to be seen.  

Fair Lending and Discrimination Policies

The President-elect has been particularly critical of the Trump Administration on two key policies—reform of the Community Reinvestment Act and adoption of a CFPB rule governing short-term, small dollar (payday) loans. Both are likely to be continuing hot topics during the Biden Administration—in Congress, at the agencies, and, perhaps, in the courts.

Community Reinvestment Act

Federal banking regulators, members of Congress and the incoming administration have all proposed significant overhauls to the Community Reinvestment Act (CRA). In late 2019, the OCC and FDIC published a joint Notice of Proposed Rulemaking outlining proposed changes, and this past summer, the Federal Reserve—which notably refrained from joining the OCC and the FDIC on its CRA proposed rule—released its own Advance Notice of Proposed Rulemaking seeking public comment on how the CRA’s core goal of financial inclusion for low- and moderate-income individuals can be best achieved. The OCC proceeded with adopting a final rule, with a 2023 effective date, but the FDIC withdrew its support for that final rule. Chairwoman Waters has recently called for repeal of this OCC rule and a new effort by the prudential regulators working together to strengthen and modernize the CRA to eliminate modern-day redlining. President-elect Biden has also criticized the OCC rule that broadens the range of activities qualifying for CRA credit, lessens the connection between CRA assessment areas and location of a bank’s facilities and establishes general performance benchmarks that are less sensitive to local community needs. The President-elect has criticized the proposal, stating it would allow lenders to receive a passing rating even if the lenders exclude many neighborhoods and borrowers. Biden has proposed expanding CRA to apply to mortgage and insurance companies and to add a requirement for financial services institutions and to close perceived “loopholes.” It is likely that this will be an active matter for debate amongst the various financial regulators, the incoming administration and Congress as to what the appropriate rightsizing of CRA should look like. While all parties agree that CRA needs to be reformed, the path forward is likely to be the subject of more debate.

Short-Term Lending Regulation

In 2017, the CFPB promulgated a comprehensive rule governing short-term, small-dollar loans that would have precluded most consumers from debt traps and required that customers have an “ability to repay” their loan as a necessity for underwriting. After two years of reconsideration, the Bureau under its current leadership rescinded the “ability to repay” requirement. The new version of the rule that is now in effect is being challenged in court by both sides: payday lenders want to see the entire rule dismantled, while, in separate litigation, consumer advocates and their Democratic allies in Congress are seeking reinstatement of the “ability to repay” requirement.

Given that the Supreme Court ruled that the CFPB Director effectively serves at the pleasure of the President, it is likely that President-elect Biden will replace current Director Kathy Kraninger with a new Director seen as more consumer friendly. If that occurs, it is possible that the original version of the final short-term lending rule—or something similar to it—could be rejuvenated. Handling this issue will likely be a high priority issue for the CFPB under leadership installed by the Biden Administration.

State Interest Rate Issues

Most states cap the amount of interest a lender can charge for credit, though these caps can be overcome when non-bank lenders, such as online lenders and other fintechs, partner with a bank in another state not subject to such caps and have that bank issue such loans. The OCC and FDIC have finalized rules over the past year permitting these so-called “rent-a-bank” arrangements. State attorneys general are suing the federal regulators to challenge the rules. Congressional Democrats have been highly critical of the OCC and FDIC moves and are already pressing the Biden Administration to withdraw the rules permitting rent-a-bank arrangements.

Approach to Prudential and Consumer Protection Enforcement and Supervision

Fairly or unfairly, there is an impression among the financial services community that federal regulators—and, most notably, the CFPB—has shown greater restraint in pursuing enforcement actions against financial services institutions than they did during the Obama Administration. In some respects, this impression may be unfounded, as CFPB enforcement activity under current Director Kathy Kraninger has accelerated meaningfully—in terms of the number of enforcement actions completed—over the past year. Nevertheless, at a minimum, there has been a clear effort by regulators to clarify supervisory expectations and to identify ways in which “responsible conduct” by companies can mitigate penalties for alleged violations of law. In particular, several federal regulators recently joined to issue a proposed rule that would codify a previous joint statement asserting that supervisory guidance documents (e.g., interagency statements, advisory, bulletins, FAQs, etc.) outline the agencies’ “supervisory expectations or priorities” for a given area, but do “not have the force and effect of law,” and that the agencies should not take enforcement actions based on supervisory guidance. The proposed rule also expresses an intent to limit the use of specific bright-line standards, such as numerical thresholds, in supervisory guidance.

More recently, the OCC issued a proposed rule requiring large banks (i.e., those with $100B or more in assets) to ensure that their operations provide access to financial services, based on quantitative, impartial risk-based standards or on a basis that is not tied to individual risk assessment and risk management. The proposed rule aims to restrict banks’ ability to exclude customers that may be politically controversial even though they are lawful, such as family planning organizations or fossil fuel companies. According to the proposal, “a bank’s decision not to serve a particular customer must be based on an individual risk management decision about that individual customer, not on the fact that the customer operates in an industry subject to a broad categorical exclusion created by the bank.” The future of this proposal is unclear, though there is a narrow window for the current administration to finalize it prior to President-elect Biden’s likely replacement of the current Acting Comptroller early in the new Administration.

It remains to be seen whether the federal regulators will intensify supervisory and enforcement activity, particularly in the consumer financial services space, under new leadership. Given the influence of the consumer advocate community in the Democratic Party and on the Biden transition team, it is likely that appointees to lead the regulators will generally be predisposed to strengthen supervisory and enforcement activity, both with respect to the number of supervisory actions taken and the amount of monetary penalties that alleged violators will be required to pay.

Securities Regulation and Enforcement

A Securities and Exchange Commission chaired by a President-elect Biden appointee is likely to change course from the current Commission on both the rulemaking and enforcement fronts. Under Chairman Clayton—who recently announced that he will step down at the end of the year—the Commission focused on expanding capital formation, minimizing the burden of securities regulation on public companies and regulated entities, and streamlining disclosure processes to more effectively convey material information to investors. Chairman Clayton’s enforcement priorities included protecting retail investors, addressing perceived abuses in the cryptocurrency markets, and combating opportunistic misconduct in the wake of COVID-19.

Although the Commission will continue to devote resources to punishing individuals and entities that seek to capitalize on market disruptions caused by the pandemic even after Clayton departs, under a potential Democrat-led Commission, the Enforcement Division is likely to shift its focus to traditional Wall Street misconduct including insider trading, issuer reporting and accounting fraud, and Foreign Corrupt Practices Act violations. Under the Trump-led Commission, the volume of these historically “bread-and-butter” matters dropped significantly, including, most strikingly, the lowest level of insider trading enforcement since the Reagan administration.

A Democratic Commission may also be more inclined to bring enforcement actions to give teeth to recently enacted rules, including the retail investor-focused Regulation Best Interest, which broadly provides that broker-dealers and their registered personnel must act in their customers’ best interest with reasonable diligence, care, and skill when making investment recommendations. Finally, while we do expect a Commission with a Democratic Chair will continue to bring cyber and cryptocurrency enforcement actions, it is reasonable to anticipate that the SEC will be less willing to bring cases regarding failures to comply with the registration provisions of the securities laws in the absence of more egregious violations (e.g., fraud charges).

In addition to shifting enforcement priorities, a Democratic-led Commission may also take other steps that will result in a more aggressive enforcement regime. For example, during the tenure of Chair White (Chairman Clayton’s predecessor), the Commission hired various subject matter experts (e.g., market structure specialists, quantitative analysts, accountants) to assist enforcement attorneys in bringing complex cases. A Biden Commission might also be inclined to recruit additional industry experts, and more generally, is likely to aggressively lobby Congress to allocate substantial funds to the SEC’s enforcement function.

As an overarching matter, rulemaking under a Biden Commission will likely reflect a shift away from the Trump commission priority of minimizing the burden on financial institutions and issuers. For example, the SEC has been grappling with certain recommendations in favor of greater disclosure regarding environmental, social or governance matters. While the current Commission has resisted these recommendations, we would not be surprised if pressure continues to build in the year ahead. Similarly, a Democratic-led Commission might revisit the Commission’s decision to decline to impose a fiduciary standard when it opted for a less investor-friendly standard under Regulation Best Interest.

(Special thanks to Oscar Theblin for his assistance in the preparation of this alert.)