On May 9, 2023, the New York Department of Financial Services (“NYDFS”) issued proposed guidance that would, if finalized, require New York-regulated banking institutions and non-depository financial institutions licensed or chartered by the NYDFS to perform continuing assessments of the character and fitness of their key personnel. If the proposed guidance is finalized, the NYDFS will begin examining supervised entities’ policies, procedures, and processes to conduct character and fitness assessments as part of the examination process.
Below, we discuss some of the key points of the proposed guidance so that entities subject to supervision by the NYDFS can decide whether to submit comments on the proposal. The NYDFS has encouraged supervised entities to comment on the proposal by the June 30, 2023, comment deadline.
Who Does the Guidance Apply To?
The proposed guidance applies to “covered institutions,” which includes New York-chartered or regulated banking institutions and non-depository financial institutions which are licensed or chartered by the NYDFS, such as New York state-chartered banks, licensed mortgage bankers, licensed consumer lenders, sales finance companies, and other similar licensed providers of financial services. The proposed guidance also applies to “designated persons,” which collectively include each member of a covered institution’s board of directors, board of trustees, and/or board of managers, as applicable, and each senior officer of a covered institution. A “senior officer” includes every officer who participates or has authority to participate in major policy-making functions of a covered institution, regardless of their title. A covered institution’s chief executive officer, chief financial officer, chief operations officer, chief compliance officer, chief legal officer, chief risk officer, president, senior executive vice president, executive vice president, secretary of the board, or treasurer are presumed to be a senior officer, in the absence of a board resolution or bylaw that excludes that person from participation in major policy-making function, and the person does not in fact participate in major policy-making functions.
Why is the NYDFS Issuing the Guidance?
In its proposal, the NYDFS explained that ensuring that key personnel have the requisite character and fitness to serve as designated persons serves to protect the safety and soundness of a regulated financial institution. The NYDFS explained in its proposal that, while covered institutions subject to supervision by the NYDFS typically investigate a designated person’s background as part of the hiring or appointment process, the NYDFS believes that covered institutions’ standards and resources for background checks of their designated persons may be outdated and in need of modernization. As an example, the NYDFS noted that a covered institution may screen a proposed designated person for criminal convictions, but the background check may not be designed to discover possible conflicts of interest or other forms of misconduct that did not result in a criminal conviction.
The NYDFS also noted that it believes covered institutions should not only assess the character and fitness of designated persons at an initial stage, but should also have a “robust” process designed to confirm that there have been no “intervening circumstances that would make continuation as a Designated Person inappropriate or improper.”
What Do Covered Institutions Need to Do?
The proposed guidance would require covered institutions to maintain policies and procedures that require a “robust assessment” of designated persons’ character and fitness at onboarding and on a regular, ongoing basis.
The NYDFS proposal also extends this expectation to transactions involving a change in control, merger, acquisition, or other arrangement where a person who serves as a designated person of one covered institution joins the surviving or acquiring covered institution, and also serves as a designated person of that institution. The NYDFS noted that, in such an instance, the surviving or acquiring covered institution should not rely solely on any previous due diligence or background screening performed with respect to the designated person’s service at another entity, but should instead perform its own due diligence of that person, on an initial and ongoing periodic basis.
The proposal also provides that covered institutions should review materials generated during character and fitness reviews, and report any findings to its board of directors (or any equivalent body) and the covered institution’s chief compliance officer.
How Must Character and Fitness Be Assessed?
Under the proposed guidance, a covered institution’s review of designated persons’ character and fitness must be “robust.” That said, the proposal does allow for a covered institution’s policies and procedures for conducting character and fitness reviews to be “risk-based,” “proportionate,” and tailored to the scope, complexity, and risk profile of the covered institution. The NYDFS proposal includes a list of suggested due diligence questions that covered institutions can use to assess the character and fitness of their designated persons, with appropriate tailoring to the specific business needs, operations, and risks of the covered institution.
The NYDFS noted that a covered institution should also define sensitive issues, “warning signs,” and other indicators that “warrant additional scrutiny before the individual is onboarded and permitted to commence services as a Designated Person or permitted to remain in their position.” As an example, the NYDFS noted that if a covered institution where a person served as a designated person has become subject to an enforcement or other regulatory action, then that person should be subject to an “enhanced” review prior to being allowed to join a new covered institution, in order to ensure that the person “did not play a significant role or otherwise contribute in a meaningful way to the conduct that led to such regulatory action or proceeding.”
Finally, the guidance sets forth an expectation for covered institutions to impose a continuing obligation on designated persons to update and amend answers to due diligence questionnaires in the event that an earlier answer becomes inaccurate or any information has materially changed. A covered institution must also promptly notify the NYDFS if the covered institution removes a designated person from their position, transfers them to a different position or group, or modifies their functions as a result of an adverse character and fitness finding during a periodic review.
The above summary makes clear that, if adopted as proposed, the NYDFS’s proposal would impose sweeping new requirements on covered institutions and their senior executives. Interested parties who are doing business in New York, or considering entering into transactions with entities that would be covered by the proposal, should review the proposal closely and consider providing comments.