On July 6, 2011 the Federal Deposit Insurance Corporation's ("FDIC's") Board of Directors met in open session, voting unanimously to approve a final rule addressing the claims process and other aspects of the FDIC's orderly liquidation authority under Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank").  The Board also discussed the FDIC's progress in preparing final rules with respect to both resolution planning under Dodd-Frank and the FDIC's own proposal, issued prior to the enactment of Dodd-Frank, separately calling for certain large insured depository institutions to file resolution plans.[1]

I.  Final Rule on Orderly Liquidation Authority

The FDIC Board of Directors unanimously approved a final rule amending 12 C.F.R. Part 380, "Orderly Liquidation Authority" under Title II of Dodd-Frank (the "Final Rule").  The approval of the Final Rule followed the FDIC's adoption of an interim final rule in January 2011, (the "Interim Final Rule") on which the FDIC reported receiving 10 public comments, and the FDIC's Notice of Proposed Rules (the "NPR") issued in March 2011, on which the FDIC reported receiving 19 public comments. 

The FDIC Staff commented that the Final Rule is intended to provide the market place, creditors and the public with greater clarity on how the claims process under Orderly Liquidation Authority will work in practice.  The Final Rule addresses the powers provided to the FDIC as receiver as well as the process by which creditors may file claims and seek a judicial determination of claims.  The Staff noted that while an effort had been made to follow bankruptcy practices and rights wherever possible, that in some instances the requirements of Dodd-Frank were contrary to bankruptcy practice and did not permit parallel treatment. 

The Staff noted that the Final Rule is comprised of three subparts.  The first subpart provides definitions of general applicable terms, contains provisions concerning the recoupment of compensation, and clarifies the FDIC's, as receiver, power to avoid fraudulent and preferential transfers.  The second subpart sets forth rules regarding the priority of claims, including those relating to administrative expenses and amounts owed to the United States.  This section also addresses the treatment of similarly situated creditors.  The final subpart concerns the receivership administrative claims process, addresses secured claims, and sets forth rules concerning the manner in which claims will proceed to court for a final judicial determination.

It is also noteworthy that this was Chairman Sheila Bair's final open meeting as Chairman of the FDIC as her term ended as of July 8, 2011.

Several changes were made in the Final Rule from the Interim Final Rule and the NPR, including the following:

Increasing Consistency with Bankruptcy Practice

  • A new sentence was added to the Final Rule providing that contractual subordination agreements will be respected, consistent with bankruptcy practice.
  • The Final Rule also includes changes intended to more fully protect the rights of secured claimants and more closely follow the comparable provisions in the Bankruptcy Code.

Clarification on Priority of Claims

  • The Final Rule revises the definition of "amounts owed to the United States" to clarify that the obligations entitled to the priority afforded to amounts owed to the United States include only amounts advanced to the covered financial company to promote the orderly resolution of the company or to mitigate adverse effects on the financial stability of the United States.  Amounts owed to the United States also include unsecured tax obligations owned to the United States Treasury, which amounts are generally not incurred in connection with the company’s orderly resolution, effectively elevating such claims and making them eligible for inclusion in industry assessments.  This deviates from the treatment of overdue taxes under Chapter 7 of the Bankruptcy Code.
  • The Final Rule revises the provision relating to the priority granted creditors who have lost setoff rights due to the exercise of the receiver's right to sell or transfer assets free of such rights to make clear that the provisions do not affect the provisions of Dodd-Frank relating to rights of netting with respect to qualified financial contracts.  

Clarification of Administrative Claims Process

  • The Final Rule addresses the scope of the receivership administrative claims process by providing that the claims process does not apply to claims against a bridge financial company or involving its assets or liabilities or any extension of credit from a Federal Reserve Bank or the FDIC to a covered financial company.

Contingent Claims

  • A new provision was added to the Final Rule to provide that the FDIC as receiver will estimate the value of all contingent claims no later than 180 days after the claims are filed or any extended period agreed to by the claimant.
  • The Final Rule provides a revision to the exception for late-filed claims that differs from the proposed rule in order to conform it to the provision for contingent claims.

Predominantly Engaged in Financial Activities

  • While the proposed rule included criteria for determining whether a company is predominantly engaged in activities that are financial in nature, the Final Rule reserves this provision for future consideration in order to coordinate with the Federal Reserve Board staff, which is considering a similar rule.

Civil Actions

  • The Final Rule provides that the FDIC may seek recoupment in any civil action for the benefit of the FDIC as receiver.

Claw-Back Provision

  • The Final Rule authorizes the FDIC to recover pay from senior executives and directors "substantially responsible" for the failure of the company for the two-year period preceding the FDIC's appointment as receiver.
  • The Final Rule changes the provision set forth in the proposed rule to clarify that an executive or director would be considered "substantially responsible" if there was a failure to conduct their responsibilities "with the degree of skill and care an ordinarily prudent person in a like position would exercise under similar circumstances".  The FDIC has explained in commentary to the Final Rule that this language is intended to clarify that the standard of care that will trigger the claw-back provision is a negligence standard and that a higher standard, such as gross negligence, is not required.  
  • In comments the Staff advised that the provision is only intended to apply to the most senior officers of the company, including the President, CEO and Chairman of the Board and that there would be an opportunity for any such officer or director to rebut the negligence claim.  

Purpose and Intention

Chairman Bair stated during the meeting that the goal of the Final Rule is to ensure that the market understands how key components of the orderly liquidation authority will be implemented. Chairman Bair stated "The rule is designed to provide a road map for creditors to better understand their substantive and procedural rights under Title II [of  Dodd-Frank] and this allows for increased certainty in the planning of transactions and the conduct of business under this new regime". Chairman Bair also acknowledged that the intention of the Final Rule is to directly impact market interactions.

Chairman Bair also commented on the intended impact of the Final Rule on investor and market behavior.  She said that "[T]he paramount goal of orderly liquidation authority is to convince investors in large financial institutions that their money is at risk if the institution fails."

Chairman Bair suggested that the rule will give investors an incentive to exercise greater market discipline on the institution's management and risk taking.  She stated that "[w]e need shareholders and creditors out there conducting their own due diligence and asking the tough questions of executives and management".

II.  Resolution Planning (Living Wills) and Credit Exposure Reports

The FDIC Staff also briefed the FDIC board on the status of its preparation of final resolution planning and credit exposure report rules.  The Staff noted that Dodd-Frank requires the Federal Reserve Board and the FDIC to jointly issue final rules implementing Dodd-Frank section 165(d) no later than January 21, 2012.

Timing

Chairman Bair commented that final rules governing the resolution of large banks and non-bank financial companies in the event of their failure should be completed before the end of August, 2011.  Chairman Bair stated: "I have talked to Ben Bernanke and he has every expectation it will be done before the end of August and everyone will be in alignment and it's important to get this very important rule right."  FDIC General Counsel Michael Krimminger appeared to confirm the potential for a near term rule issuance, commenting that "[w]e have had several meetings since the comment period ended with the Federal Reserve Board and at this point we have no difference in approach or philosophy on how to proceed and we are very close to finalizing the language and we expect to bring this case to the board for final resolution in the very near future."

Resolution Plan -- Orderly Liquidation Authority Link

Comments from some FDIC Board members suggested recognition of the link between resolution planning and the FDIC's Orderly Liquidation Authority.  For example, Vice Chairman Martin Gruenberg noted that "I think we understand these resolution plans are really the essential information and foundation for the effective exercise of orderly liquidation authority under Title II". 

International Coordination -- U.S. Leadership

During the meeting the FDIC Staff acknowledged that "there is a very close relationship between this rule making and some of the developments at the international stage" and expressed the belief that "the United States and the United Kingdom… have been leaders in promoting the importance of resolution planning".  The FDIC Staff also took the position that the United States should continue in its role as the global leader in the resolution planning effort and that it "encourage and push other countries to engage in very robust resolution planning as well".  Chairman Bair agreed with this position, stating that "I'm very proud of the efforts and leadership we have shown in the international front to move the bar forward on resolution authority and resolution planning".

Confidentiality

Acting Director of the Office of Thrift Supervision John Bowman raised the point during the meeting that there are confidentiality issues presented by the kind of aggregation of information that is required in resolution planning, both under the FDIC's proposal regarding resolution planning by insured depositories and under the Dodd-Frank proposal.  The FDIC Staff acknowledged that confidentiality is a concern, stating "[a]s a Federal agency we are subject to the Freedom of Information Act requirements" and that "information of this nature should be subject to protection under the confidential trade secrets and confidential information as well as the exception which deals with bank supervisory information" but pointing out that "the ultimate arbiter of that will be a court and so we are looking at possible ways to address the issue by designating certain parts of this submission as public and certain parts as private and then noting [in the Final Rule] that it is our intent that information be maintained confidentially". 

Securities Law Disclosures

The point was raised at the open meeting that if a covered company filed a resolution plan that was deemed not satisfactory to regulators, that this might require the filing of a Form 8-K by the company under the Federal securities laws.  It was also suggested that as part of the resolution planning process the FDIC consider that there be "something in the nature of a public statement by a particular firm beyond what it might be required to do for securities laws purposes in summarizing what its plan is" with the suggestion that this kind of disclosure would be "an important information source to the public in general".

III.  FDIC Resolution Plans for Large Banks (May 2010 FDIC Proposal)

The FDIC staff also briefed the FDIC board on work being done on a draft rule proposed by the FDIC on May 11, 2010 regarding special reporting analysis and contingent resolution plans at large FDIC-insured banks. The draft rule predates Dodd-Frank and would require insured depository institutions with more than $10 billion in assets that are part of a larger holding company with more than $100 billion in assets to submit in-depth resolution plans.  As proposed by the FDIC, such depository institution plans would enable the FDIC, as receiver, to resolve the institutions in a manner that would ensure depositors receive access to their insured deposits in a bank in an expedited manner, maximize the net present value of assets and minimize the amount of losses realized by creditors.

The FDIC Staff stated at the meeting that "[w]e are coordinating our approach with respect to resolution plans and our rules and we are very close to finalizing that rule as well and we expect to bring that to the board at the same time [as the Dodd-Frank resolution plan rules] in the very near future."  FDIC Director John Walsh commented at the meeting that "I'm very supportive of this idea of having the two [rules issued] in tandem so that it is both clear what is required and also that there is no confusion".  That the FDIC will be issuing resolution plan rules relating to Dodd-Frank and also the earlier FDIC proposal is noteworthy because there had been speculation that the earlier FDIC proposal was rendered moot by the passage of Dodd-Frank.  The FDIC had originally projected that its proposal, applicable to depository institutions with more than $10 billion in assets that are part of a larger holding company with more than $100 billion in assets, would have captured about 40 companies at the time the rule was proposed.

The FDIC proposal, issued on May 11, 2011, differed in important respects from the final Dodd-Frank requirement.  The FDIC proposal anticipated the passage of resolution plan requirements in the broad financial regulatory reform measure then being debated in the U.S. Congress that would become Dodd-Frank but preceded the grant of authority over resolution planning by holding companies and nonbank financial companies that was included in Dodd-Frank.  It would have required the largest insured depository institution subsidiaries of financial holding companies (but not the holding companies themselves) to submit plans showing they could be separated from their parent companies and resolved in an orderly fashion.[2]  The FDIC stated at the time that the proposal would dovetail with resolution plan requirements in what would become Dodd-Frank.

The FDIC's proposal was primarily focused on information gathering.  The rule required detailed disclosure about non-financial parents and "key" affiliates as well as the depositories themselves.  The rule proposal demanded disclosure of the financial relationships among the parent, affiliates and the depositories, analysis of the ability of each affiliate to function on a stand-alone basis, and plans for resolving the insolvency of the parent and key affiliates.  The proposal would have let the FDIC reject plans not meeting requirements.  Although the proposed FDIC rule did not specifically address whether the FDIC could take additional action in the event a company failed to submit a workable plan, the FDIC likely assumed that such a failure would constitute a violation sufficient to trigger the entire scope of its enforcement authority.