Statement of CFPB Director Rohit Chopra, Member, FDIC Board of Directors, on Reviewing Investments in and Takeovers of Banks

April 25, 2024 / Source: CFPB

Thank you, Mr. Chairman, for holding this meeting today. It is particularly timely. This is our first board meeting since Sam Bankman-Fried was sentenced to twenty-five years in prison. Bankman-Fried was convicted on seven counts of fraud and conspiracy in a multibillion-dollar scheme involving FTX and an investment fund known as Alameda Research. During the sentencing process, the court heard compelling stories from victims who suffered enormous losses. It’s critical we make sure we truly understand the implications for the FDIC from this massive fraud and take appropriate action.

First, I want to highlight the curious case of Farmington State Bank in the Sam Bankman-Fried saga. Second, I want to explain how the takeover of Farmington State Bank was able to evade FDIC oversight. Third, I want to offer a proposed change to FDIC rules to ensure that fewer suspicious changes in bank control can escape our review.

The Curious Case of Farmington State Bank

As Americans suddenly realized they could not withdraw their funds from Sam Bankman-Fried’s FTX in November 2022, they wondered whether they would ever get their money back. In FTX’s bankruptcy filing was an unusual item: a deposit account held by FTX worth roughly $50 million at Farmington State Bank.

Farmington State Bank was founded in 1887 and served a rural community in the State of Washington near the Idaho border. As a state-chartered bank, Farmington was supervised by state regulators and the FDIC. Its parent company, Farmington Bancorp, was organized as a bank holding company and regulated by the Federal Reserve, with Farmington State Bank as its primary asset.

In January 2020, the Federal Reserve Board of Governors voted on new rules that purported to provide transparency on how it would evaluate when an entity gains control of a bank holding company.¹ In reality, the rule changes reduced the scrutiny of investments in, and takeovers of, banks. It sent a clear message that the Federal Reserve would be lenient when it came to enforcing Congressional prohibitions and limitations on ownership of banks more broadly.

Then, in September 2020, the Federal Reserve Bank of San Francisco granted approval to a Maryland shell corporation, which was established by the owner of a Bahamas-based financial firm, to take over Farmington Bancorp, and therefore control Farmington State Bank.² It was certainly odd that the owner of a Bahamian financial firm, which was tied to the stablecoin Tether, wanted to take over a tiny rural U.S. bank. Then Farmington made another change. In June 2021, the Federal Reserve Bank of San Francisco approved an application for Farmington State Bank to become a member of the Federal Reserve System. The following year, Bankman-Fried’s Alameda Research took a supposed “9.9%” stake in Farmington’s bank holding company by investing $11.5 million.³ In an obvious red flag, the “9.9%” stake valued the bank at $115 million, even though the bank had only $18 million in assets and $6 million in equity at the end of 2021.

Behind the scenes, investors were reshaping Farmington’s business model away from its rural banking roots and towards speculative crypto asset activities. Law enforcement would later seize tens of millions of dollars at the bank held by entities tied to Bankman-Fried.⁴ So many individuals continue to feel the pain of the financial fraud associated with FTX.

Evading FDIC Oversight

The Farmington State Bank fiasco and other developments in the market have provided a number of lessons for the FDIC and bank regulators about the efficacy of bank takeover policies. While some of these lessons suggest that statutory exemptions can be exploited, it’s also clear that many of our discretionary rules just don’t make sense. Bankman-Fried, FTX, and Alameda Research were able to evade the FDIC in several ways.

Farmington State Bank engaged in charter shopping.⁵ After the shell corporation won takeover approval from the Federal Reserve Bank of San Francisco over Farmington’s bank holding company, it was also able to kick the FDIC out as its supervisor by joining as a member of the Federal Reserve System. Charter-flipping has long been a concern and one that the regulators need to constantly watch.

But even if the bank hadn’t flipped regulators, they still could have avoided the FDIC. Alameda Research’s sham “9.9%” investment in Farmington State Bank was at the holding company level, not at the bank level. Under the Change in Bank Control Act, this type of transaction can be reviewed by both the Federal Reserve and the primary banking supervisor. However, many years ago, the FDIC instituted procedural rules that exempt review of transactions at the holding company level and instead defer to the judgment of the Federal Reserve when it reviews the transaction, even though exerting influence and control at the holding company gives the investor influence and control over the bank itself.⁶

Changes Needed to FDIC Rules

Given the critical role banks play in the functioning of our society and economy, Congress has put into place a number of guardrails to ensure that commercial firms and investors cannot unfairly exploit the public benefits that come with being an insured bank. I am concerned that the FDIC’s rules rely solely on the Federal Reserve for certain transactions and therefore violate our statutory responsibility to ensure that banks we supervise are operated in a safe and sound way. In many respects, it makes more sense for the FDIC to be the lead reviewer when an FDIC-supervised bank is the sole or primary asset of the bank holding company.

These issues related to control do not only extend to takeovers of small banks by overseas hedge funds and trading firms. Director McKernan has also highlighted how very large asset managers are growing their stakes in banks as their index funds continue to accumulate investor assets at a rapid rate. Two asset management giants, BlackRock and Vanguard, collectively control over $17 trillion in assets. They now own large enough shares in many banks across the sector to trigger statutory guardrails and limitations. These firms, though, claim they are “passive” and do not actually control banks. They can enter into so-called “passivity” agreements with the Federal Reserve when taking stakes in bank holding companies to avoid these regulatory requirements. Under the Federal Reserve’s 2020 rule changes, and some existing passivity agreements, these asset managers can still be considered “passive” even if they take a seat on the board.⁷ Holding a seat on a firm’s board of directors seems to be anything but “passive.”

It makes sense for the FDIC to review the substance of its own passivity agreements, take a more active role to determine whether these agreements are being adhered to, and take action if asset managers are evading our oversight. It’s also critical we make sure that passivity agreements aren’t fake paperwork exercises. We need to understand any harms, distortions, or conflicts of interest posed by this concentration of ownership.

Let me turn to the proposal.

FDIC staff have worked to develop a Notice of Proposed Rulemaking that would make sure the FDIC can spot potential issues, like the ones that occurred at Farmington State Bank, by restoring the agency’s role in reviewing certain changes in control. The proposed rule would simply delete the exemption from the notice requirement for acquisitions of voting securities of a holding company with an FDIC-supervised subsidiary for which the Federal Reserve Board reviews a notice under the Change in Bank Control Act. The proposal also seeks public feedback on a broad range of issues under the Change in Bank Control Act, including the implications of concentrated ownership of banks by large asset managers. We can also use feedback on the proposed rule to refine our approach to these applications, so the process is more efficient.

I’d like to offer this Notice of Proposed Rulemaking for board consideration.

In closing, the bankruptcy of FTX and the conviction of Sam Bankman-Fried reminds us of the devastating impact of financial fraud and abuse. The involvement of Farmington State Bank in this scheme is an important part of the story. While the Federal Reserve Board took an enforcement action last year against Farmington in order to wind it down, it is impossible to ignore the steps taken to evade FDIC oversight.⁸ We need to have the courage to learn from this and to act accordingly.

Footnotes

1. This rulemaking was promulgated under the Bank Holding Company Act and Home Owners’ Loan Act.
2. Under the statute, this transaction did not need approval from the FDIC.
3. FBH Corp. raises $11.5M in private equity funding from Alameda Research Ventures (prnewswire.com) .
4. Feds seize $50 million from Farmington State Bank tied to Bankman-Fried | The Spokesman-Review .
5. The bank did not technically change its charter, as we have often seen in the national bank charter vs. state bank charter context. The intent and outcome of its regulator shopping, though, was similar.
6. 12 CFR § 303.84(a)(8).
7. blackrock-letter-20201203.pdf (federalreserve.gov) .
8. Federal Reserve Board – Federal Reserve Board issues enforcement action with Farmington State Bank, and its holding company, FBH Corporation .