Regulatory Crackdown on Deposit Insurance Misrepresentation

Federal banking regulators have recently given clear warnings to banks and fintechs about customer disclosures and the significant risk of customer confusion when it comes to customers’ deposit insurance status.

On July 28, 2022, the Federal Deposit Insurance Corporation and the Federal Reserve issued a joint letter to the crypto brokerage firm Voyager Digital, demanding that it cease and desist from making false and misleading statements about Voyager’s deposit insurance status, in violation of the Federal Deposit Insurance Act, and demanded immediate corrective action.

The letter stated that Voyager made false and misleading statements online, including its website, mobile app and social media accounts. These statements said or suggested that: Voyager is FDIC-insured, customers who invested with the Voyager cryptocurrency platform would receive FDIC insurance coverage for all funds provided to, and held by, Voyager, and the FDIC would insure customers against the failure of Voyager itself.

Contemporaneously with the letter, the FDIC issued an advisory to insured depository institutions regarding deposit insurance and dealings with crypto companies. The advisory addressed the following concerns:

  1. Risk of consumer confusion or harm arising from crypto assets offered by, through or in connection with insured banks. This risk is elevated when a nonbank entity offers crypto assets to the nonbank’s customers, while offering an insured bank’s deposit products.
  2. Inaccurate representations about deposit insurance by nonbanks, including crypto companies, may confuse the nonbank’s customers and cause them to mistakenly believe they are protected against any type of loss.
  3. Customers can be confused about when FDIC insurance applies and what products are covered by FDIC insurance.
  4. Legal risk of insured banks if a crypto company or other third-party partner of the bank makes misrepresentations about the nature and scope of deposit insurance.
  5. Potential liquidity risks to insured banks if customers move funds due to misrepresentations and customer confusion.

The advisory also includes the following risk management and governance considerations for insured banks:

  1. Assess, manage and control risks arising from all third-party relationships, including those with crypto companies.
  2. Measure and control the risks to the insured bank, it should confirm and monitor that these crypto companies do not misrepresent the availability of deposit insurance and should take appropriate action to address any such misrepresentations.
  3. Communications on deposit insurance must be clear and conspicuous.
  4. Insured banks can reduce customer confusion and harm by reviewing and regularly monitoring the nonbank’s marketing material and related disclosures for accuracy and clarity.
  5. Insured banks should have appropriate risk management policies and procedures to ensure that any services provided by, or deposits received from, any third-party, including a crypto company, effectively manage risks and comply with all laws and regulations.
  6. The FDIC’s rules and regulations can apply to nonbanks, such as crypto companies.

At a time when crypto companies are increasingly criticized for courting perceived excessive risk and insufficient transparency in their business practices, the FDIC and other banking agencies are moving to ensure that these companies’ practices do not threaten the banking industry or its customers. On Aug. 19, the FDIC issued letters demanding that five crypto companies cease and desist from making false and misleading statements about their FDIC deposit insurance status and take immediate corrective action.

In addition to the FDIC’s suggestions in its advisory, we suggest both banks and fintech vendors consider the following measures to protect against regulatory criticism or enforcement:

  1. Banks should build the right to review and approve all communications to bank customers into their vendor contracts and joint venture agreements with fintechs and should revisit existing contracts to determine if any adjustments are needed.
  2. Banks should consult with legal counsel as to current and expected regulatory requirements and examination attitudes with respect to banking as a service arrangements.
  3. Fintechs should engage with experienced bank regulatory counsel about the risks inherent in their business and contractual arrangements with insured banks by which the services of the fintech is offered to bank customers.
  4. Banks should conduct appropriate diligence as to their fintech partners’ compliance framework and record.

Additionally, should a bank’s fintech partner go bankrupt, the bank should obtain clarity — to the extent that it’s unclear — as to whether funds on deposit at the bank are property of the bankruptcy estate or property of a non-debtor person or entity; in this case, the fintech’s customers. If funds on deposit are property of non-debtor parties, the bank should be prepared to address such party’s claims, including by obtaining bankruptcy court approval regarding the disposition of such funds on deposit. Additionally, the bank may have claims against the bankrupt fintech entity, including claims for indemnity, and should understand the priority and any setoff rights related to such claims.

Committees Can Foster Innovation: Here’s How

innovation-7-3-15.pngBoston-based Eastern Bank Corp. has quickly ramped up its ability to invest in and deliver innovative products and services. The $9.7 billion asset mutual holding company started changing its culture in 2014, through the creation of its innovation lab. In June, the bank began using voice biometrics in its call center, so customers now can access accounts using just the sound of their voice.

This year, Eastern dedicated $4 million to research & development—1 percent of its annual revenue, says Bob Rivers, Eastern’s president. The additional investment meant that Eastern’s board needed to increase its involvement and oversight, so Eastern created an innovation advisory committee to guide and support the bank’s innovation investment. The committee is staffed by four board members and four members of Eastern’s management team, and meets quarterly to discuss innovation within the company. “It’s really to give the board visibility and oversight with respect to that investment and focus,” says Rivers.

Financial institutions today are increasingly reliant on technology and the delivery of innovative products and services to drive organic growth. Boards must be ready and willing to engage in discussions on innovation and technology. An advisory board can be a great way to drive innovative thinking, but the board may instead focus on innovation within a board-level committee.

Innovation comes from diverse perspectives, ages, experiences and cultures—not just from individuals with a technology background, says Edward Stautberg, managing director at PartnerCom, a New York-based board advisory firm that helps corporations create advisory boards. Advisory boards have their benefits. They can be comprised of businessmen who may not be a good fit for the board but may have the right expertise to advise the bank, and directors and executives can take their input with a grain of salt. Food and beverage conglomerate PepsiCo Inc.’s ethnic advisory boards are tasked to create products for the company’s diverse worldwide customer base. According to Stautberg, one of these boards came up with the idea to add chili and lime flavors to some product lines, such as Lay’s potato chips and Doritos tortilla chips. “That was a direct result of a diversity in thinking,” he says. Digital advisory boards are a growing trend for Fortune 500 companies such as Target Corp. and General Electric Co., reports The Wall Street Journal.

But banks can choose to focus on innovation in a board-level committee, which sends a message throughout the organization that the board is truly dedicated to the issue. “It shows that you’re actively discussing innovation at the board level and that it is something that the board is engaged on,” says Stautberg.

Huntington Bancshares Inc., the $68 billion asset bank holding company headquartered in Columbus, Ohio, founded its board-level technology committee in 2014. Among the many technology-related duties listed in its charter, the committee oversees whether the bank has the technology in place to push innovation, and monitors innovation trends that impact Huntington’s strategic plan. Peter Kight chairs the committee, which he says was created to address two of the board’s biggest concerns: Cybersecurity and digital delivery. “A financial services [company] is an information based business, and information is digital today, which means our business is a digital services business,” he says. “Are we going to be able to innovate fast enough to be able to be one of the survivors, and in fact one of the winners?”

At its most recent board meeting, Huntington’s technology committee brought in a venture capitalist who focuses on financial technology. The discussion provided the board with direction about which startup companies they might want to work with, and helped identify threats in the financial technology marketplace. Trends in digital lending were also discussed.

The technology committee isn’t staffed with technology experts. While Kight has a background in financial technology—he was the founder and chief executive officer of CheckFree, and after its 2007 acquisition by technology services provider FiServ, he served on FiServ’s board for five years—he doesn’t believe a technology background is necessary. “Who’s really driven to want to learn in this space?” says Kight. “What we need are people who understand the need to look for this innovation and drive it within our culture and to drive it within our strategy, both in management and at the board.”

Huntington doesn’t lack for board members committed to innovation. Finding four board members to staff the bank’s technology committee wasn’t a challenge, because every board member wanted to join. Not only did the focus sound “cool,” Kight says, but the board believes innovation is critical to the success of the company. 

“If we keep thinking like bankers, in five years, we won’t be bankers, because banking isn’t going to be done in the same way,” says Kight. “We absolutely cannot continue to run the bank the way we have run it in the past, which means we have to, at a strategic level, drive for innovation.”