[Senate Hearing 116-25]
[From the U.S. Government Publishing Office]




                                                         S. Hrg. 116-25

 
  GUIDANCE, SUPERVISORY EXPECTATIONS, AND THE RULE OF LAW: HOW DO THE 
         BANKING AGENCIES REGULATE AND SUPERVISE INSTITUTIONS?

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                     ONE HUNDRED SIXTEENTH CONGRESS

                             FIRST SESSION

                                   ON

    EXAMINING HOW BANKING AGENCIES SUPERVISE AND REGULATE FINANCIAL 
     INSTITUTIONS, HOW REGULATED INSTITUTIONS INTERACT WITH THEIR 
   REGULATORS, AND THE CONGRESSIONAL REVIEW ACT AND THE SCOPE OF ITS 
              APPLICABILITY TO AGENCY STATEMENTS OF POLICY

                               __________

                             APRIL 30, 2019

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban Affairs
  
  
  
  
                                
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]




                Available at: https: //www.govinfo.gov /
                
                
                             ______

             U.S. GOVERNMENT PUBLISHING OFFICE 
 35-540 PDF            WASHINGTON : 2019
               
                


            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                      MIKE CRAPO, Idaho, Chairman

RICHARD C. SHELBY, Alabama           SHERROD BROWN, Ohio
PATRICK J. TOOMEY, Pennsylvania      JACK REED, Rhode Island
TIM SCOTT, South Carolina            ROBERT MENENDEZ, New Jersey
BEN SASSE, Nebraska                  JON TESTER, Montana
TOM COTTON, Arkansas                 MARK R. WARNER, Virginia
MIKE ROUNDS, South Dakota            ELIZABETH WARREN, Massachusetts
DAVID PERDUE, Georgia                BRIAN SCHATZ, Hawaii
THOM TILLIS, North Carolina          CHRIS VAN HOLLEN, Maryland
JOHN KENNEDY, Louisiana              CATHERINE CORTEZ MASTO, Nevada
MARTHA MCSALLY, Arizona              DOUG JONES, Alabama
JERRY MORAN, Kansas                  TINA SMITH, Minnesota
KEVIN CRAMER, North Dakota           KYRSTEN SINEMA, Arizona

                     Gregg Richard, Staff Director

                      Joe Carapiet, Chief Counsel

               Catherine Fuchs, Professional Staff Member

            Laura Swanson, Democratic Deputy Staff Director

                 Elisha Tuku, Democratic Chief Counsel

                Corey Frayer, Professional Staff Member

                      Cameron Ricker, Chief Clerk

                      Shelvin Simmons, IT Director

                    Charles J. Moffat, Hearing Clerk

                          Jim Crowell, Editor

                                  (ii)
                                  


                            C O N T E N T S

                              ----------                              

                        TUESDAY, APRIL 30, 2019

                                                                   Page

Opening statement of Chairman Crapo..............................     1
    Prepared statement...........................................    23

Opening statements, comments, or prepared statements of:
    Senator Brown................................................     3
        Prepared statement.......................................    24

                               WITNESSES

Greg Baer, President and Chief Executive Officer, Bank Policy 
  Institute......................................................     5
    Prepared statement...........................................    25
    Responses to written questions of:
        Senator Brown............................................    58
        Senator Cortez Masto.....................................    59
Margaret E. Tahyar, Partner, Davis Polk and Wardwell LLP.........     6
    Prepared statement...........................................    36
    Responses to written questions of:
        Senator Cortez Masto.....................................    59
        Senator Sinema...........................................    60
Patricia A. McCoy, Professor of Law, Boston College Law School...     8
    Prepared statement...........................................    48
    Responses to written questions of:
        Senator Warren...........................................    61
        Senator Cortez Masto.....................................    64

              Additional Material Supplied for the Record

Letter submitted by CBA..........................................    68
Letter submitted by CUNA.........................................    70

                                 (iii)


  GUIDANCE, SUPERVISORY EXPECTATIONS, AND THE RULE OF LAW: HOW DO THE 
         BANKING AGENCIES REGULATE AND SUPERVISE INSTITUTIONS?

                              ----------                              


                        TUESDAY, APRIL 30, 2019

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:01 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Mike Crapo, Chairman of the 
Committee, presiding.

            OPENING STATEMENT OF CHAIRMAN MIKE CRAPO

    Chairman Crapo. The Committee will come to order.
    Today the Committee will turn its focus to guidance, 
supervisory expectations, the rule of law, and how banking 
agencies regulate and supervise institutions.
    Banks receive significant forms of Government support and 
benefits, including deposit insurance and access to the Fed's 
discount window.
    In exchange for these benefits, which ensure that American 
consumers have stable access to their deposits, banking 
agencies supervise banks and in return expect them to operate 
in a safe and sound manner.
    The nature of the supervisory process and the need for 
trust between the supervisor and the supervised institution 
means that sometimes supervisory expectations are communicated 
in an informal and confidential manner between the supervisor 
and the supervised institution, which can be appropriate in 
certain circumstances, especially when protecting confidential 
supervisory information.
    With that being said, there appears to be a number of 
situations where the banking agencies have enacted guidance or 
other policy statements that are being enforced as rules and 
therefore do not comply with notice-and-comment rulemaking 
processes and do not comply with the Congressional Review Act.
    In addition, there are a number of situations where 
supervisors make verbal ``recommendations'' to banks that are 
inappropriate given the tremendous power supervisors have over 
banks.
    All rulemaking authority at the banking agencies derives 
from authority delegated to the banking agencies by Congress, 
which means Congress has the authority to disapprove any rule a 
banking agency enacts.
    In addition to the absolute authority Congress has to 
disapprove any agency action, Congress enacted the CRA in 1996 
to provide Congress with an expedited process to disapprove 
agency rules.
    Under the CRA, before a rule can take effect, agencies must 
submit it to Congress for review.
    Congress then has 60 days to disapprove the rule with a 
majority vote.
    A rule is defined, with a few exceptions, as ``the whole or 
a part of an agency statement of general or particular 
applicability and future effect designed to implement, 
interpret, or prescribe law or policy or describing the 
organization, procedure, or practice requirements of an 
agency.''
    That is a very broad definition.
    The CRA applies to more than just notice-and-comment rules. 
It encompasses a wide range of other regulatory actions, 
including, among others, guidance documents, general statements 
of policy, and interpretive rules.
    Even though the text itself is clear about the broad scope 
of what constitutes a rule, during the floor debates leading up 
to the passage of the CRA, then-Senator Reid reinforced this 
point and said: ``[t]he authors are concerned that some 
agencies have attempted to circumvent notice-and-comment 
requirements by trying to give legal effect to general 
statements of policy, guidelines,' and agency policy and 
procedure manuals. The authors admonish the agencies that the 
APA's broad definition of rule' was adopted by the authors of 
this legislation to discourage circumvention of the 
requirements'' of it.
    Too often we see banking regulators implementing policy 
through guidance and other informal means without following the 
requirements in the CRA.
    For instance, some in the agencies may argue that guidance 
is not binding, but as a practical matter, supervised 
institutions and supervisors know that informal guidance and 
other communications between supervised institutions and 
supervisors change behaviors within institutions.
    Legal departments at the banking agencies often assert that 
guidance is nonbinding, but the language the supervisors at the 
agencies use often suggest that supervisors treat guidance as 
binding and expect supervised institutions to treat it as 
binding.
    Actions like this within agencies are problematic and 
require congressional oversight, including by ensuring banking 
agencies comply with the CRA.
    Recognizing the importance of agencies complying with the 
CRA, Acting Director of the Office of Management and Budget 
Russell Vought issued a memorandum recently, which ``reinforces 
the obligations of Federal agencies under the CRA in order to 
ensure more consistent compliance with its requirements across 
the executive branch and sets forth guidelines for analysis 
that the Office of Information and Regulatory Affairs will use 
to properly classify regulatory actions for purposes of the 
CRA.''
    This memorandum is a step in the right direction.
    The abuse of Government and agency power should not be a 
partisan issue, and no Administration or agency should be able 
to use their powers to influence the private market wrongly.
    I continue to encourage the regulators to follow the CRA 
and to submit all rules to Congress, even if they have not gone 
through a formal notice-and-comment rulemaking.
    In addition, I encourage the banking regulators to provide 
more clarity about the applicability of guidance and ensure 
that supervisors throughout the agencies--especially outside of 
Washington, DC--know about how guidance should be treated and 
do not inappropriately use their significant discretion.
    As a final note, during the Obama administration, I fought 
against Operation Choke Point, an initiative in which Federal 
agencies pressured banks to ``choke off'' politically 
disfavored industries' access to payment systems and banking 
services.
    Operation Choke Point initially began in the supervisory 
process. Operation Choke Point was inappropriate and 
demonstrates why supervisory staff at the agencies need to be 
transparent and accountable.
    I look forward to hearing from each of our witnesses on 
their views as to what can be done to ensure that there is 
greater transparency and accountability in the supervisory 
process.
    Senator Brown.

           OPENING STATEMENT OF SENATOR SHERROD BROWN

    Senator Brown. Thank you, Mr. Chairman.
    This is a hearing to talk about guidance, the nonbinding 
advice from Federal agencies that is supposed to make it easier 
for the banking industry to follow the rules.
    There is a reason we have lots of banking laws. It is a 
complicated industry that affects everyone's lives with a great 
deal of potential for special interests to do a whole lot of 
harm. It takes a lot of oversight to prevent terrorist 
financing and to protect consumers and to stop discrimination 
in lending and to keep Wall Street from taking down the economy 
again.
    Banks need guidance to help them comply with those laws. In 
fact, industry begs for guidance all the time, so why this 
hearing? Why hold this hearing at all? The same reason we 
always seem to have hearings in this town: to make things a 
little bit easier for Wall Street.
    We know that this hearing is not actually about making it 
easier for big banks to follow the rules, that it is really 
about making it easier for big banks to get around the rules. 
It is about what kind of guidance the industry wants and the 
kind of guidance it does not want.
    Big banks love guidance that makes it easier to trade 
derivatives with big foreign banks. Big banks love guidance 
that tells them how to track their capital or how to prepare 
for stress tests. I hear that all the time. Big banks love 
guidance that makes sure they can keep lending when a town is 
hit by floods or wildfires.
    The guidance that big banks hate, though, the guidance we 
are actually talking about at this hearing today, is the kind 
that makes it easier for them to skirt the laws or take 
advantage of their consumers. And as usual, Wall Street has 
plenty of Senators lining up to help them every single time. 
Big banks hate guidance that explains how regulators are going 
to enforce the laws, the laws that say you cannot discriminate 
against people of color. They hated that one so much they 
persuaded darn near every Republican to help them repeal it. 
Guidance had never been repealed before, as we know, but 
Republicans used the Congressional Review Act to repeal 
instructions from the consumer protection agency that would 
have made it harder for auto dealers to charge people of color 
more for car loans.
    Big banks also hate guidance that says they should be 
cautious about risky leveraged loans that might crash the 
economy. They hate it because it cuts into the huge fees they 
were getting for making these types of loans to corporations. 
And they really hate guidance that explains how the regulators 
are going to keep tabs on Wall Street.
    Last week, Senator Tillis, a Member of this Committee, sent 
a letter to the GAO to start the process of having Congress 
step in and tell regulators to take it easy on the largest 
banks in the country.
    Two weeks ago, the Office of Management and Budget 
announced they want the President to have direct influence over 
the guidance that independent banking agencies put out. That 
means the President can lean over to his Acting--or maybe he is 
not acting anymore--Chief of Staff Mick Mulvaney, who is also 
the head of the OMB, who also, as we know, is head of the CFPB, 
and in some sense still is, and tell independent agencies--the 
President can lean over and tell Mulvaney and tell independent 
agencies what we do--what they should do, and they saw how Mick 
Mulvaney ran the CFPB.
    These agencies are supposed to be independent for a reason. 
We know how corporate special interests spread their influence 
around in this town. The agencies policing Wall Street are 
supposed to be independent to guard against that influence. But 
now the same President, whose Cabinet looks like a Wall Street 
executive retreat, wants to meddle--although ``meddle'' is 
probably an understatement. Remember S. 2155, the bill that 
gutted many of the rules for the biggest banks in the country 
and the foreign megabanks. Right in that bill, in Section 109, 
the bill that Chairman Crapo wrote and skillfully shepherded to 
the floor, that President Trump signed into law, Congress 
instructed the CFPB to give guidance on filling out mortgage 
forms. Republicans demanded, they insisted, they fought for 
language instructing agencies to give more guidance. This is 
the kind of guidance they pretend to be opposed to today. This 
hearing is not about guidance. It is about getting rid of the 
rules that Wall Street does not want to follow, and as everyone 
knows, everyone except Republicans on the Senate Banking 
Committee, as everyone knows, the whole country will end up 
paying for it.
    Thank you, Mr. Chairman.
    Chairman Crapo. Thank you, Senator Brown.
    Today our witnesses are Greg Baer, president and CEO of the 
Bank Policy Institute; Margaret Tahyar, partner at Davis Polk 
and Wardwell; and Patricia McCoy, professor of law at Boston 
College Law School.
    I would like to inform our witnesses that their written 
testimony has been included in the record. I encourage you to 
follow the 5-minute guideline so we can have time for our 
questions and your oral remarks, and we will proceed in the 
order I introduced you. Mr. Baer, you may proceed.

STATEMENT OF GREG BAER, PRESIDENT AND CHIEF EXECUTIVE OFFICER, 
                     BANK POLICY INSTITUTE

    Mr. Baer. Chairman Crapo, Ranking Member Brown, my name is 
Greg Baer, and I am CEO of the Bank Policy Institute. I am here 
to testify today about how legal process has broken down in the 
regulation and examination of banks. I will not focus on the 
substance of postcrisis requirements but, rather, on a process 
that has prevented the public--not only banks but also their 
customers, academics, and even Members of Congress--from 
learning what many of those requirements are and having a say 
in their content.
    The breakdown has three parts:
    First, examination reports have effectively turned into 
enforcement actions, as their mandates--specifically, Matters 
Requiring Attention, or MRAs--are treated as binding orders. By 
law, an examination report is not binding. Make no mistake, 
however. The banking agencies take the position that MRAs must 
be remediated. So, too, do bank compliance teams. This is 
significant because the volume of MRAs is extreme. Between the 
OCC and the Fed, at any given time over the past 10 years, 
there have been between 8,000 and 20,000 MRAs outstanding. Each 
could be viewed as a quasi-enforcement order. Each under agency 
rules is also secret, and bankers are subject to criminal 
penalties for discussing or complaining about them publicly. 
Notably, many of these, if not most of these MRAs, have not 
focused on capital and liquidity, the core rules that protect 
taxpayers. They are, rather, on matters such as how banks 
manage their vendors, update models or spread sheets, structure 
reporting lines, or monitor transactions.
    Second, the basis for those MRAs frequently has not been a 
violation of law but, rather, of guidance or unwritten rules. 
Postcrisis the agencies have generally avoided notice-and-
comment rulemaking in favor of a massive volume of guidance in 
the form of supervisory letters, bulletins, and circulars. 
Guidance also includes examination handbooks and even 
enforcement actions, which are read to bind all banks.
    In other cases, MRAs are not even based on guidance but 
simply examiner preference. Asked for the legal basis for such 
actions, examiners generally cite ``safety and soundness.'' 
Indeed, they do so increasingly, as the law has recently become 
clearer that guidance is, in fact, not binding.
    But ``safety and soundness'' must be shorthand for an 
``unsafe and unsound banking practice,'' which is defined in 
the case law as referring only to ``practices that threaten the 
financial integrity of the institution.'' That is a high bar. 
The vast majority of MRAs likely fail to meet that standard.
    Third, these examination mandates must nonetheless be 
obeyed because a shadow enforcement regime has grown up 
postcrisis whereby a firm with unresolved MRAs is potentially 
subject to limitations on its growth, limitations never 
authorized by Congress. That is why banks have diverted 
extraordinary resources to comply with mandates that are often 
immaterial to their safety and soundness and against their 
better judgment.
    For a perspective on how odd this new enforcement regime 
is, consider that we routinely see compliance violations across 
American industries. Those companies are appropriately required 
to pay fines and remediate their practices, but no one suggests 
that they should be stopped from opening new franchises, 
building new plants, developing new drugs, designing new cars, 
or launching new apps. Yet in banking, regulators often 
prohibit any type of expansion by the bank as a reaction to a 
compliance failure.
    How could this be improved?
    First, the banking agencies should grant the petition filed 
by the Bank Policy Institute and the ABA and confirm what they 
have already said in a recent statement: that guidance is not 
binding and that only a violation of law (including an unsafe 
and unsound practice) can be the basis for an MRA. This step is 
necessary because by numerous accounts their earlier statement 
has been ineffective.
    Second, more broadly, the agencies should seek public 
comment on what an MRA is.
    Third, a zero-based review of the application process 
should be undertaken to clarify what factors are relevant.
    Fourth, the CAMELS rating system should be rethought 
entirely. The Federal Reserve has recently adopted a thoughtful 
revision of holding company ratings which could serve as a 
model.
    In closing, Congress did not enact the Administrative 
Procedure Act as a sop to regulated entities or a blow to the 
independence of agencies but, rather, out of a genuine and 
well-founded belief that rules are better made when they are 
informed by an open process and not as well made when they are 
made in secret, without fear of public scrutiny or challenge. 
That spirit should be reinjected into the bank examination 
process.
    Many thanks for the opportunity today.
    Chairman Crapo. Thank you, Mr. Baer.
    Ms. Tahyar.

   STATEMENT OF MARGARET E. TAHYAR, PARTNER, DAVIS POLK AND 
                          WARDWELL LLP

    Ms. Tahyar. Thank you very much for inviting me here today.
    Many sectors of the economy today are regulated, but only 
the banking sector is also supervised. The legal framework 
governing the banking sector is open and public. You might 
agree or disagree with the policy choices, but they are open to 
all. Supervision happens behind closed doors and involves 
discretionary actions. The secrecy has traditionally been 
justified by financial stability or safety and soundness. There 
has long been an uneasy truce between the transparency required 
by the rule of law and the secrecy of supervision.
    That uneasy truce has become untenable. One canary in the 
coal mine is the increase in leaks of confidential supervisory 
information. The canary is warning us about changed social 
expectations around transparency.
    I know that the supervisory staff is made up of men and 
women of good faith doing a tough job, but it matters that 
confidential supervision can be a shield that makes it more 
difficult to hold the supervisors accountable. The public, 
congressional oversight committees, scholars, and others have 
limited information about the work of the supervisors. Should 
they be praised or criticized? Nobody knows. The public debate 
and academic scholarship is critically underinformed.
    As Minsky noted, ``Perfection is out of the question, but 
better is possible.'' So I have three suggestions. I hope, I 
dare to hope, they might be bipartisan.
    First, the regulations governing confidential supervisory 
information should be updated. They were put in place in the 
1960s. That is a long time ago. They are not fit for the 
digital age. It should be narrowed to the minimum necessary for 
financial stability. There should be a serious reexamination 
from first principles of the relationship between the zone of 
secrecy and the securities laws.
    One thing is certain. Whatever changes are made should be 
done on a systemic basis. Right now the practical reality is we 
have a system where some banks sometimes are subject to leaks 
and disclosures and others are not.
    Second, there has been an expansion, a vast expansion in 
the zone of secrecy and discretion. Social and economic policy 
choices that affect jobs and credit are being made in a shadow 
regulatory system. These include moral suasion, MRAs, and 
horizontal reviews. The concept of secret law in a democracy is 
on shaky ground. We have recently seen strong steps in the 
right direction from Vice Chair Quarles and Chairman 
McWilliams. These steps should be supported.
    Third, Congress and the banking agencies should rethink the 
training of supervisory staff. The rise in compliance with law 
exams, the focus on governance, and the increase in violation 
of law MRAs all mean that staff are making more judgments that 
are legally infused. And yet as the zone of secrecy and 
discretion has widened, it has increasingly become delinked 
from the legal framework. I recommend that training for the 
supervisory staff should be expanded to include core modules on 
the Constitution, the separation of powers, congressional 
oversight, the rule of law, and due process--essentially the 
legal framework that governs the regulatory State.
    I believe that the time has come for a rebalancing in favor 
of more transparency, accountability, and observance of the 
rule of law, and I believe that regardless of the policy 
choice, regardless of whether you are thinking about Wall 
Street banks or consumers. I believe it content neutral.
    We need to get this balance right now because we are moving 
to a digital age, and if the legal framework, due process, and 
the rule of law are not in the supervisory culture, they won't 
make it into the technology and the algorithms. Cultural change 
is hard. I suspect that both banks and supervisors might be a 
little uncomfortable with what I am saying today, but if, 
however, the changes I recommend are made and there is a little 
discomfort on both sides, I think the balance might be moving 
in the right direction.
    We should not jettison confidential supervision, but we 
ought to reform it for the 21st century digital age. Thank you 
very much.
    Chairman Crapo. Thank you, Ms. Tahyar.
    Ms. McCoy.

   STATEMENT OF PATRICIA A. MCCOY, PROFESSOR OF LAW, BOSTON 
                       COLLEGE LAW SCHOOL

    Ms. McCoy. Chairman Crapo, Ranking Member Brown, and 
Members of the Committee, thank you for inviting me here today 
to talk about guidances and supervision.
    My colleagues have argued that banking regulation needs 
more transparency. They have singled out guidances as an 
offender in that regard. In the interest of transparency, 
proposals are on the table to put guidance through notice and 
comment and routine congressional act review. Today I argue 
that that would backfire and result in less transparency, not 
more.
    In fact, Federal bank regulators issue guidances because 
they want to provide transparency, not because they have to. 
Guidances help financial institutions navigate the thicket of 
Federal banking statutes and rules. Firms find guidances 
valuable because they shed light on agencies' supervisory 
perspectives, priorities, and concerns. Guidances make agency 
decisions more predictable and reduce compliance risk. For 
these reasons, financial providers want guidance, and they 
vocally request it. I have cited in my testimony quotations 
from financial trade associations to that effect.
    Despite the benefits of guidances, agencies are sometimes 
criticized for penalizing third parties for failure to comply 
with them. How often this occurs is unclear. Normally, agencies 
base adverse actions on violations of statutes, notice-and-
comment rules, unsafe or unsound practices, or UDAP laws, not 
on guidances. However, if financial institutions are ever 
penalized for violating guidances, they already have ample 
recourse. They can sue to invalidate binding guidances for 
failure to provide notice and comment under the APA. They can 
and do meet privately with Federal bank regulators to lodge 
complaints. They can ask the agency ombudsman to help resolve 
any problem. They can formally appeal adverse examination 
findings. And they have the right to judicial review to contest 
enforcement actions based on guidance violations.
    The question is, more specifically, should agency guidance 
go through notice and comment and Congressional Review Act 
oversight? Let me cut to the chase. Imposing higher hurdles on 
the adoption of agency guidance would badly hurt financial 
institutions and the financial system. Normally, fast-track 
notice and comment takes 2 years, and many rulemakings take 
longer. CRA review prolongs this process further.
    Agencies might respond by turning nonbinding guidances into 
binding rules. That would just increase companies' legal risk. 
Alternatively, agencies might stop issuing guidances 
altogether. They would be under strong internal pressure to do 
so given the daunting staffing and budgetary challenges of a 
vast increase in notice-and-comment requirements.
    Is this what companies really want? Federal bank regulators 
have statutory responsibility to enforce the statutes and rules 
under their jurisdiction. If agencies stopped issuing 
guidances, they would still be responsible for enforcing those 
statutes and rules, and firms would still have to comply with 
them. But in the meantime, companies would lack guidance about 
agency interpretations or about how to comply. This would 
result in less transparency, not more. This would leave 
financial firms to fend for themselves and might well produce 
the ``regulation by enforcement'' that they intensely dislike.
    Moreover, companies would not be able to get quick 
responses to their implementation questions due to onerous 
notice-and-comment requirements. The result, unfortunately, 
might be less compliance with banking laws. We went down this 
road before pre-2008. It is not a risk that we can ever take 
again. Moreover, GAO has repeatedly criticized Federal bank 
regulators for not citing violations and for failing to require 
their remediation.
    Thank you.
    Chairman Crapo. Thank you very much, Ms. McCoy.
    I will start my questioning with you, Mr. Baer. Your 
association, along with the ABA, recently petitioned the 
banking agencies to engage in a rulemaking clarifying the role 
of supervisory guidance, to codify, to ask the agencies to 
codify their recent interagency statement clarifying the role 
of supervisory guidance, and in that process to clarify that 
MRAs, MRIAs, and other supervisory action should be based on a 
violation of statute or regulation, not on a failure to comply 
with a supervisory guidance.
    Can you explain why a rulemaking will help provide clarity 
in the regulated institutions?
    Mr. Baer. Yes, Mr. Chairman. We commend the banking agency 
for the statement that they did issue. They stated in their 
statement that guidance was not binding, could not form the 
basis for an MRA, and, furthermore, that an MRA needs to be--
well, that a citation by an examiner needs to be based on a 
violation of law. I think that was all very good.
    It turns out, though, that I think there has been a lot of 
confusion about that statement. Some have read citation to mean 
MRA; some have not. There are, I think, numerous reports that 
it is not really being observed in the field. And so really all 
we have asked the agencies to do is to formalize in regulation 
what we believe they have already said in a statement, which, 
of course, is guidance and, therefore, nonbinding itself. But 
all we have asked them to do is put into regulation what they 
have already said through guidance.
    Chairman Crapo. All right. Thank you. And for Ms. Tahyar, 
picking up on the topic of transparency, there is concern that 
the use of guidance is really just a substitute or a work-
around for the notice-and-comment rulemaking standard set in 
statute. The lack of transparency around regulators' 
supervisory activities makes it difficult to decipher when 
regulators use the threat of supervisory actions that 
constitute confidential supervisory information against 
institutions punitively and when they use it for legitimate 
safety and soundness purposes.
    For instance, as I mentioned in my introductory comments, 
in Operation Choke Point Federal regulators used informal 
communications to express concerns about services to industries 
engaged in what they called ``high-risk activities'' to 
pressure banks to cutoff services to lawful businesses engaged 
in politically disfavored industries, and they openly admitted 
that that was exactly what they were doing.
    The question I have is: In this regard, can you discuss 
your concern around the concept of reputational risk and the 
use of this concept to deter financial institutions from 
lending to certain markets as displayed during Operation Choke 
Point?
    Ms. Tahyar. Reputational risk, like supervision, isn't in 
any statute anywhere. I think the concerns that arise when 
supervisors within the confidential exam process express 
examiner preferences either around banking services to a sector 
or their own concerns--and these concerns may be done in the 
field and not in Washington, so there may not be consistency--
around how supposed violations of law or other economic choices 
take place. All of this is happening behind closed doors, and 
all of it is happening--you know, some guidance is subject to 
notice and comment. Much guidance is public. Some guidance is 
major and some isn't. And, of course, the banking sector likes 
guidance. But it is the closed-door aspect of the economic 
choices that are being made, and in my view, these need to come 
out into the open.
    I hope I have answered your question.
    Chairman Crapo. Thank you.
    Ms. McCoy, could you respond to the same question? The 
general issue is the utilization of non-rulemaking or non-
statutory standards for enforcement actions or supervisory 
actions.
    Ms. McCoy. Yes, in my experience, there are multiple layers 
of review of enforcement decisions; for example, at the CFPB, 
enforcement decisions are reviewed all the way up to the 
Director's office. And I have information that enforcement 
decisions similarly at the prudential banking regulators 
undergo many layers of review.
    The agencies are very careful--many of these enforcement 
actions are public, and that is a very good thing. I encourage 
that. They are very careful to ground those enforcement actions 
on violations of statutes, legislative rules, unsafe or unsound 
practices, or in the case of the CFPB, UDAP violations. And so 
I am not seeing the evidence that enforcement is being brought 
based on guidances in isolation.
    Chairman Crapo. Thank you.
    Senator Brown.
    Senator Brown. Thank you, Mr. Chairman.
    Mr. Baer, the BPI, the Bank Policy Institute, represents 
some of the biggest, most powerful banks on Wall Street. You 
are its CEO, correct?
    Mr. Baer. Correct.
    Senator Brown. Those banks talk a lot about their diversity 
initiatives and their antidiscrimination policies. I applaud 
that. I assume you do.
    Mr. Baer. I do.
    Senator Brown. We have a President of the United States who 
said there are good people on both sides in Charlottesville, 
who has made disparaging comments about immigrants, who has 
publicly insulted my friend and colleague, the Chair of the 
House Financial Services Committee, Maxine Waters. The 
President's racism I assume is offensive to many of your 
executives and many of the employees of your member banks. Do 
you think the President is a racist?
    Mr. Baer. Senator Brown, I do not know the President.
    Senator Brown. I do not know his heart either, but do you--
well, I will ask it this way: Do you think his words and his 
actions are racist?
    Mr. Baer. Again, I do not think it is my position to 
characterize at a hearing on bank process what is in the heart 
of our President.
    Senator Brown. Well, I think it is. I am disappointed, but 
let me shift to another question.
    Has the BPI or the Clearing House Association of the 
Financial Services Roundtable, which merged to create you, I 
guess, ever asked regulators to provide guidance?
    Mr. Baer. I would say that is unusual. Generally, we are in 
the position of asking them to engage in notice-and-comment 
rulemaking around things that really matter.
    Senator Brown. But you have supported some guidance as BPI, 
correct?
    Mr. Baer. I am actually trying to recall an occasion when 
we have done so, and I do not recall----
    Senator Brown. Well, let me give you a larger historical 
context, a wider time period. So as either the Financial 
Services Roundtable, the Clearing House Association, either of 
them, or you as the BPI now, you have asked regulators to 
provide guidance in the past?
    Mr. Baer. Senator, we may well have. I just cannot recall 
an instance. In every recollection that I have, we have been 
asking them to use notice-and-comment rulemaking more, not 
less.
    Senator Brown. Did you have a position on Congress' repeal 
of the CFPB guidance, either you or your two predecessors that 
merged, that instructed banks on how to avoid making 
discriminatory car loans? Did you have a position on that 
repeal?
    Mr. Baer. I do not think we engaged on that issue--of the 
two initiatives on the CRA. We were more focused on the 
leveraged lending one.
    Senator Brown. So you did not take a position or do any 
lobbying on that guidance, that rule?
    Mr. Baer. I know we strongly supported review of--well, 
submission of the leveraged lending guidance and congressional 
review of that. I do not recall our taking a position on the 
CFPB auto.
    Senator Brown. Professor McCoy, Congress repealed--we have 
talked about a number of times now the CFPB's guidance on 
discriminatory auto lending.
    Ms. McCoy. Yes.
    Senator Brown. Did that make CFPB's plans for enforcing the 
Equal Credit Opportunity Act more or less clear for industry?
    Ms. McCoy. It certainly made it murkier. I want to stress 
here that before the CFPB was ever enacted, there is 
substantial Federal case law that established that disparate 
impact theory applies to auto lending by indirect auto lenders. 
The CFPB in that guidance was observing decided Federal case 
law that predated its existence. The CFPB remains statutorily 
responsible for enforcing ECOA, and firms have to comply with 
that.
    What it means then to disapprove that guidance in the face 
of the still existing statute, which has not been repealed or 
amended, and the decided case law is really unclear. What does 
disapproval mean? If I were industry, I would not know.
    Senator Brown. That is helpful. This is for you again, 
Professor McCoy. The financial crisis took many Wall Street 
insiders by surprise. Consumer advocates and community 
activists were less surprised, were sounding the alarm about a 
foreclosure crisis, urging regulators to take action before the 
crisis. I wonder about the collective amnesia in this body 
about what happened a decade ago, but I am still hopeful that 
we have learned something.
    If OIRA has the ability to block independent regulators' 
actions, do you think our financial system will be more or less 
safe?
    Ms. McCoy. I am very concerned about what I view as a power 
grab by OIRA. It is a direct attempt to abridge Federal banking 
regulators' statutory independence. Congress clothed the 
Federal banking regulators with independence for a very 
important reason. It is for the stability of the banking 
system. It is to make sure that the executive branch and the 
White House do not improperly interfere with neutral expert 
bank regulatory decisions for short-term political advantage.
    The result of Federal bank regulator independence is to 
reside oversight of Federal banking regulators where it 
belongs, which is here in Congress. So I view OIRA's memo as 
actually not only a power grab vis-a-vis the Federal bank 
regulators, but an attempt to wrest control away from Congress 
and consolidate it in the White House.
    Senator Brown. Thank you.
    Chairman Crapo. Senator Toomey.
    Senator Toomey. Thank you very much, Mr. Chairman.
    Two years ago, I sent two letters to the GAO. I asked the 
GAO to review the CFPB's indirect auto lending bulletin, their 
indirect auto bulletin, and let me be clear, this was an ill-
considered bulletin. It was really aimed at auto dealers 
despite the fact that that industry was explicitly excluded 
from the CFPB's jurisdiction. It was based on extremely dubious 
and speculative statistical analysis, and it ultimately would 
have made offering dealer discounts more difficult. In other 
words, it would have raised the cost of buying cars.
    If Congress intended for dealers to have a harder time 
providing discounts and to raise the cost of buying cars for 
our constituents, in my view, we should pass a law to do that.
    In any case, the second letter was regarding leveraged 
lending, and I specifically asked the GAO to determine if these 
two guidances, bulletins, met the CRA's definition of a rule, 
which the CRA defines in part as ``the whole or part of an 
agency statement of general or particular applicability and 
future effect designed to implement, interpret, or prescribe 
law or policy.''
    In both cases, GAO concluded that the agency actions did 
meet the definition of a rule, despite the fact that they did 
not go through the Administrative Procedures Act. This is not a 
surprise. It is not unheard of for agencies to intentionally 
circumvent the transparent rulemaking process and instead 
implement its will through these tools such as guidance. In 
fact, the authors of CRA, including Senator Reid, acknowledged 
this reality, and the Chairman quoted from his remarks.
    So I want to say I am glad to see the Committee is taking 
this up. I appreciate that, Mr. Chairman, and I would remind 
agencies of their obligations under the Congressional Review 
Act.
    Now, the banking regulators have published a statement 
making it clear that they understand the law and that they do 
not believe that their guidance has the binding force of law or 
of a rule. I think that is widely acknowledged, at least at a 
theoretical level. My question for you, Mr. Baer: In your 
experience with banks as they interact with the regulators and 
supervisors, do supervisors treat guidance as binding even 
though the heads of the regulatory agencies have said that they 
are not supposed to be?
    Mr. Baer. Thank you, Senator. I have to start with an 
important caveat. As noted, and I think as Meg Tahyar noted, 
the examination process is secret, and the communications 
between the examiners and the banks, therefore, are considered 
confidential supervisory information, and it is actually a 
crime for them to discuss that with me or you. So I think my 
knowledge here is quite limited. I think the Committee may have 
a better opportunity to find out what is really going on than 
I. But I can certainly tell you that I have heard from multiple 
banks, and I think in some cases even from supervisors, that 
there is confusion about what that statement means, 
particularly whether a citation means a MRA, whether guidance 
that was previously the basis of an MRA is somehow 
grandfathered. And so, again, it seems to us to be a very low 
cost and quite potentially beneficial move for the agencies to 
clarify and formalize that in a regulation.
    Senator Toomey. What about the argument that if a bank 
feels that their examination or their rating is not accurate or 
is not done properly or is not fair or somehow is inconsistent 
with the rules, they can just appeal it? Is that an effective 
mechanism for regulated institutions?
    Mr. Baer. Sure, Senator, I will confess, I think as a young 
man at the Federal Reserve, I actually at one point drafted the 
appeal rule there and did so in all sincerity and with the 
hopes that it would be used. There has been some terrific 
academic work on this by Professor Julie Anderson Hill who 
actually has documented the effectiveness of that regime. 
Again, consider as backdrop that we are talking about tens of 
thousands of MRAs. I think interagency appeals, the OCC has 
been averaging about nine per year, and----
    Senator Toomey. Can I interrupt for a quick clarification? 
With respect to the MRAs, if I as a Member of this Committee 
wished to examine the MRAs so that I could determine whether or 
not the enforcement--whether they were being used properly in 
accordance with the law, how many would I be able to read 
through?
    Mr. Baer. I think it would depend on the law and your 
relationship with the relevant agency. Certainly I am not 
allowed to read any of them.
    Senator Toomey. You are not allowed to read any of them?
    Mr. Baer. No.
    Senator Toomey. They are not public?
    Mr. Baer. Correct. And, again, given the numbers involved, 
the fact that you are only seeing between two and nine appeals 
per year is an indication that that is not really a live option 
for institutions.
    Senator Toomey. Ms. Tahyar, are you aware of the extent to 
which these MRAs are available to Members of Congress for 
review?
    Ms. Tahyar. Well, the confidential supervisory privilege 
belongs to the agencies, and they could waive it if they chose 
to do so.
    Senator Toomey. And if they chose not to?
    Ms. Tahyar. That is also totally in their discretion.
    Senator Toomey. And there are thousands of these each year.
    Ms. Tahyar. There are thousands of these each year.
    Senator Toomey. There is a lot happening that never sees 
the light of day.
    Ms. Tahyar. That is exactly right, Senator. My 
recommendation would be on MRAs that the agencies continue the 
process that the Fed did in its supervisory report. Let's get 
more information out, more in the aggregate, more granular, 
taking out the names of banks. Let's see what the trends are. 
Scholarship is critically uninformed, and the congressional 
oversight committees are critically underinformed.
    Senator Toomey. Thank you, Mr. Chairman.
    Chairman Crapo. Thank you.
    Senator Cortez Masto.
    Senator Cortez Masto. Thank you.
    Let me just get some clarification because I am kind of 
confused with what I am hearing. Are you telling me that the 
banks want these confidential supervisory examinations to be 
public, Mr. Baer.
    Mr. Baer. I think that is certainly something to be 
considered. I do not----
    Senator Cortez Masto. So the banks are not concerned about 
information that may become public, so the banks are open to 
any type of examination, a supervisory examination, being 
public and people being aware? That is what I am hearing you 
say.
    Mr. Baer. I have not surveyed our members, and I do not 
know that there is one consensus view among the banks.
    Senator Cortez Masto. I would be curious to know that 
because I would think just the opposite. I think from what I am 
seeing, and somebody who has enforced the laws and has dealt 
with regulation, that sometimes there is a need for secrecy for 
purposes of the banking industry, and they request that.
    Now, let me ask you this: With respect to matters requiring 
attention, are you here telling me today that there are some 
enforcement actions taken against banks that were enforced 
because of a violation of an MRA that is not based in a 
violation of law?
    Mr. Baer. I think we can say with great confidence, given 
the numbers and some background knowledge, that most MRAs are 
not based on a violation of law.
    Senator Cortez Masto. So you are telling me that what I 
heard you say is that there is some violations that have been 
implemented that were violations just based on an MRA and that 
MRA was not based in law?
    Mr. Baer. The way I would put it is MRAs frequently, I 
believe, are not based on a violation of law or an unsafe and 
unsound banking practice.
    Senator Cortez Masto. But what I heard you just say is that 
there were some violations based on an MRA. Is that correct?
    Mr. Baer. I do not think that is correct.
    Senator Cortez Masto. So no MRA--what I am understanding is 
that there are MRAs have been out there and that no bank has 
been issued a violation based on an MRA?
    Mr. Baer. Well, an unremediated MRA would probably lead to 
an MRIA, immediate attention, and then if it were unremediated, 
the agency would take formal enforcement action.
    Senator Cortez Masto. Action based on a violation of law, 
correct?
    Mr. Baer. At that point they would need a violation of law 
to take a formal enforcement action, for example, an order----
    Senator Cortez Masto. So any enforcement action is based on 
a violation of law?
    Mr. Baer. Correct.
    Senator Cortez Masto. OK. So there is not a misuse of the 
MRAs or MRIAs from what I heard you say earlier. So I am just 
trying to clarify. Let me jump, because I only have so much--so 
many minutes to ask a question here. And, Ms. McCoy, let me ask 
you this: I am concerned from what I am seeing and what I have 
just heard that OMB's decision that they have authority to 
review independent bank regulatory--or regulators' actions, in 
essence what you have put in your writings, you basically say 
the OMB memo improperly treads on Federal bank regulators' 
independence and violates Executive Order 12866, particularly 
when it comes to the cost-benefit analysis. Can you talk a 
little bit about that and why you think that is a violation?
    Ms. McCoy. Yes. The Congressional Review Act only requires 
Congressional Review Act review in Congress of major rules. So 
somebody has to decide what is a major rule. Congress entrusted 
OIRA with that decision.
    Agencies submit financial information about the effect of 
proposed rules, of final rules, to OIRA. What OIRA is doing in 
the memo is specifying the methodology that the agencies must 
use when they submit this financial information assessing the 
impact. That is totally improper under Executive Order 12866.
    OMB and OIRA have no statutory authority to tell the 
Federal bank regulators how to conduct their cost-benefit 
analysis. In fact, they are barred from doing so.
    Senator Cortez Masto. Because that treads on the 
independence and the province of the banking regulators, 
correct, under the law.
    Ms. McCoy. Exactly.
    Senator Cortez Masto. And that is the whole intent why 
there is that independence, so the White House cannot come in 
and try to usurp that for their own short-term gain or long-
term gain, whatever that is, correct?
    Ms. McCoy. Totally.
    Senator Cortez Masto. OK. Thank you.
    Let me just say one thing. I get that we have to find 
balance, and I think, Ms. Tahyar, you are trying to find a 
balance between the two. And I get that that needs to be there. 
What I heard earlier, that to the extent that my colleagues 
have issued requests to the GAO to determine whether there is a 
rule or not and action is taken, at least we still have that 
authority to take that action and the process was followed. But 
with this new guidance, that changes the game. This is the 
White House now coming in and making a determination and 
usurping the independence of the financial regulators for their 
own short-term gain over the banking industry. That concerns 
me. We should all be concerned about that. I get that bank 
examiners have discretion, and sometimes that discretion--they 
overstep their discretion. And I think what we are trying to do 
is find a balance here.
    But let me ask you this, Mr. Baer: Are you saying that 
there should be no supervision?
    Mr. Baer. To the contrary, Senator.
    Senator Cortez Masto. So let me ask you this: Are you 
saying there should be no guidance with that supervision?
    Mr. Baer. What I am saying, Senator, is that if the 
agencies are going to treat guidance as a binding requirement, 
which is effectively what MRAs have become, even without resort 
to consent orders or an order----
    Senator Cortez Masto. So I guess I am still trying to 
understand that. Maybe I need to see some of these, and I know 
they are confidential. But if I am an enforcement agency and I 
am trying to give you the benefit of the doubt without taking 
enforcement to guide you, to give you that opportunity to clean 
it up, clear it up, before enforcement action is taken, and you 
have not done it, then I am going to enforce it based on a 
violation of the law. So the only time enforcement is going to 
happen is if there is a violation of law. But I am going to 
give you the benefit of the doubt, and I am going to let you 
try to take--cure it before you do.
    Mr. Baer. Right.
    Senator Cortez Masto. So what I am hearing is that is not 
happening?
    Mr. Baer. Here is, I think, the crucial distinction. The 
situation you are describing I think describes agencies that 
use only enforcement as a way to impose their wishes, so 
basically anybody but banking agencies. Banking agencies are 
unique in that they are resident at these institutions. They 
are always with them, and they are telling them a lot of things 
that would never rise to the level of an enforcement action, 
you know, how to minute your meetings, how to structure your 
reporting lines, how to review your models. Those are things 
that would never end up becoming a violation of law or even an 
unsafe and unsound banking practice.
    So really the question is--there has always been an 
informal give-and-take between bank and regulator about, you 
know, ``We would like your report line to look like this,'' 
``No, we like it the way it is,'' and you have that discussion. 
That has gone on for a century.
    What has changed over the last 10 years is that that has 
become a much more one-sided conversation, and the notion is 
that if the agency wants you to do something and you do not do 
it, well, then you are subject to, you know, nonpublic 
sanctions, particularly around your growth. ``You do not want 
to do it our way, we are going to give you a 3 for management, 
we are not going to let you open any branches for a year.''
    And all of that, to the extent it is happening behind the 
scenes, I think that is what you hear us objecting to.
    Senator Cortez Masto. Thank you. I appreciate that.
    I know I went over my time. Thank you for the indulgence, 
Mr. Chairman.
    Chairman Crapo. Thank you.
    Senator Moran.
    Senator Moran. Chairman Crapo, thank you.
    Before we turn to the specific topic of today's hearing, we 
are on the topic of accountability, and I want to restate, once 
again indicate my concern with the lack of accountability at 
Financial Accounting Standards Board and its requiring banks to 
forecast and book current and expected losses over the life of 
loans at the time the loan is made. Those actions are not 
subject to review, and I do not think we ought to be allowing a 
self-governing body to, in effect, set national economic policy 
without congressional input and Federal regulators should 
acknowledge.
    On the topic of today's accountability, let me start with 
Mr. Baer, but I am fine to have comments from any of you. 
Effective supervision and regulation of financial institutions 
require accountability of the regulators. That is what some of 
you--maybe all of you--have been saying. One of the most 
important components of accountability is the thread of 
legitimate appeal process, and Senator Toomey raised this topic 
a moment ago.
    As mentioned in the testimony, the ultimate arbitrator of 
an examination appeal is made by the same agency that made the 
original decision. I think it is a difficult argument to make 
that this does not have an effect on the impartiality of the 
appeals.
    In addition to reining in the shadow enforcement regime 
that was discussed in the testimony, would establishing an 
independent ombudsman within the regulators be one of the most 
effective legislative items this Committee could take up to 
address the examination appeals process that is currently in 
effect? Mr. Baer.
    Mr. Baer. Senator, thank you. I think that would certainly 
be of help. I think there are really two things that drive the 
fact that banks generally do not appeal supervisory ratings or 
loan classifications. The first, as you note, is they are 
effectively appealing to the agency that made the decision, so 
you are unlikely to succeed.
    I think the bigger factor, though, is really--and this gets 
to my conversation with Senator Cortez Masto, which was that 
you have to continue to live with those examiners.
    Senator Moran. All the other things they regulate or can 
do.
    Mr. Baer. Right. I liken it to you can file for divorce and 
continue to live with your spouse, but you need to sleep with 
one eye open. And I think the notion that you can be contesting 
an appeal with regard to the examiner you are seeing every day 
and maintain the relationship you have--and this is not of 
recent vintage. This goes back forever. Examiners have long 
memories, and they will tell you that. And so, you know, I 
think it is very difficult, even to the extent that the 
agencies are well meaning--and I think they are. They recently 
actually just put out a request for how can we do more to 
prevent retaliation and make the system work better. I think 
they genuinely wish to make the system work better. But I think 
just as it is structured currently, it is very difficult to 
make progress on that.
    Senator Moran. I was surprised a number of years ago at the 
number of bankers in Kansas who had a particular complaint 
about a particular regulator, and I invited the regulator to my 
office and invited my Kansas bankers to come meet with the 
regulator. Not one was interested in doing that. Instead, they 
sent the president of the Bankers Association on their behalf, 
again, highlighting what I was surprised to learn was the fear 
of retaliation if they were complaining about something at 
least they thought was legitimate enough to complain to me over 
a long period of time in numerous occasions.
    Either of you have a thought about an ombudsman?
    Ms. Tahyar. I think an ombudsman with real power, acting 
independently, would be a helpful step. But, ultimately, the 
appeals process from examinations is a limited way forward 
because I think ultimately the balance of power is such that, 
as you experienced in Kansas, banks will be reluctant to come 
forward. That is why some system of more transparency is 
needed. I am not necessarily suggesting that suddenly 
everything comes out. I think change is hard, and it would have 
to be done in an appropriate and systemic way. But more 
information, trends in aggregate of MRAs, MRIAs, more 
information coming out I think would make a lot of difference.
    Senator Moran. Thank you.
    Professor.
    Ms. McCoy. Yes, and, Senator, I am a fellow Kansan. It is 
wonderful to meet you finally in person.
    Senator Moran. Thank you so much.
    Ms. McCoy. Yes. I think it is really important that we 
focus on improving the MRA and MRIA process. The current 
regulators are really starting to focus on that to reduce the 
number. I totally agree with Ms. Tahyar that it is imperative 
to do a better job of training examiners--we have a lot; we 
have over 10,000 examiners in the United States--on the proper 
use of MRAs and MRIAs. But if I can look at Mr. Baer's 
proposal, let us say that a particular regulator wants to adopt 
an MRA with respect to one bank on a particular safety and 
soundness issue. Do I understand him to say that the agency 
would be required to publish that in the Federal Register, 
naming the bank, naming the alleged unsafe and unsound 
practice, seek public comment, and then decide whether to make 
it final? Putting aside the time that that would take, I very 
much doubt that banks want to be put through that ordeal. So 
that suggestion does not seem to be at all practical to me. But 
an empowered ombudsman is a very good idea.
    Ms. Tahyar. I think there is no suggestion that individual 
MRAs be put through notice and comment. I will turn to Greg to 
see where he is.
    Mr. Baer. No. Again, it depends on what an MRA is. It would 
never be a notice-and-comment rulemaking would be de facto in 
order, which under the rules, if you are issuing a capital 
directive or an order, there is a notice and process appeal 
right to the institution. And if it is going to have an effect 
on your ability to establish branches and grow, then perhaps 
you should have a formal appeal process akin to what you would 
have with an order or capital directive or a prompt corrective 
action directive. But, you know, again, most MRAs are not 
anywhere near that level, and if they were truly treated as 
nonbinding orders, there would be no need for that appeal 
process.
    Senator Moran. Thank you all three.
    Thank you, Mr. Chairman.
    Chairman Crapo. Senator Tillis.
    Senator Tillis. Thank you, Mr. Chairman. Thank you all for 
being here.
    I think it was said by the Ranking Member that I dislike 
guidance. What I dislike--it has nothing to do with guidance. 
Guidance has a place in the regulatory process. What I dislike 
is the inappropriate use of guidance for things that should 
give rise to a rule, which is why we have already utilized the 
CRA and the GAO process on three, and we have got a long, long 
list of other actions that regulatory agencies have taken that 
we are saying, look, maybe this does relate to safety and 
soundness of the banking industry. Just do your homework and go 
through the rulemaking process and then determine whether or 
not you have got a rule that is sustainable, that regulates the 
risk, that gives appropriate insight into the risk, but not so 
burdensome that we just layer more and more and more on the 
banking industry. And I believe based on some of the actions 
they just want to de facto nationalize the industry through a 
combination of rules that sometimes overreach and guidances and 
speeches and policy memos and a number of agency actions that I 
think are inappropriate.
    Look, that would be like the Congress deciding, well, you 
know, we are going to pass laws when we think we can and when 
we have, you know, the time to do it. But, otherwise, we are 
going to start passing guidances that, unless the President 
vetoes them, they are just in place. That is an absurd concept, 
and I think it is also equally absurd for administrative 
agencies to go down the same path.
    I want to go back to the MRA. Why couldn't we, instead of 
all-or-nothing scenario that Senator Cortez Masto is 
suggesting, why couldn't we simply say that for financial 
institutions who simply want to have the MRA review, they can 
actually have a redacted version of it reviewed so that people 
like me and other third parties, an IG, could take a look at it 
and see if it was an appropriate supervisory examination 
process? Why wouldn't that work? I do not know necessarily the 
rules, if that runs afoul of the rules, but why couldn't they 
do that, almost like a whistleblower, like this was an 
inappropriate set of behaviors and instructions between a 
supervisor and an examiner, and we actually want this to see 
the light of day? What would be wrong with a concept like that, 
Mr. Baer?
    Mr. Baer. I think this gets to sort of what Senator Moran 
was saying. You could certainly envision an appeals process 
around MRAs where you could have a more neutral arbiter and 
perhaps better assurance that there would not be future 
retaliation. Again, I am a little dubious on that second point. 
I think, you know, institutions that were in the habit of 
appealing their MRAs would, again, if that is a public appeal--
and we have not even talked about this component--you would 
have the reputation as someone who could not get along with 
your regulator, which from an investor relations perspective is 
not a good thing. And I think that is also a factor here.
    Senator Tillis. That is a great point. What we are really 
trying to do, if you talk about 10,000 people in the mix on 
this, then obviously you know there are some number who, 
through their personality or personal preferences, are probably 
abusing their authority. So my goal is to try and figure out 
how you actually weed out the minority, significant minority of 
people doing this every single day, so that we are just not 
shifting our focus away from having a safe and sound financial 
services industry. That is all I care about.
    And, incidentally, industries that are regulated to the 
appropriate level but not regulated to death have more 
resources to provide loans, to provide housing, to do the kinds 
of things they want to do ultimately for consumers. We talk 
about more and more regulation here, but we do not talk about 
at the end of the day that it has to be paid for. It is not 
paid for by the bank. It is paid for by the people who take 
loans, who get credit cards, and who need financial services to 
make ends meet.
    I want to talk about maybe a couple of other ones that I 
should take a look at, Mr. Baer, in terms of my list of other 
actions that I may take through the GAO and the CRA. I think 
one--well, actually, I am not going to talk about this one. I 
had one on the list. Oh, yeah, the SR letter, 1402, bank 
expansion, are you familiar with that one?
    Mr. Baer. Yes.
    Senator Tillis. What do you think? Is that something that I 
should take a look at and get a consultation with the GAO to 
see if that was something that should have been done through 
rulemaking?
    Mr. Baer. Senator, I could certainly see that being 
appropriate. I would hope--and it is not really clear what the 
status of that is. I mean, I think the Federal Reserve 
recently, to their credit, has been indicating that they are 
more inclined to stick to the statutory factors for reviewing 
applications.
    Senator Tillis. That is awfully good of them.
    Now, I would also say I think Chair McWilliams has done a 
good job of rescinding a number of guidances over in the FDIC. 
Do you think there is equal opportunities to do that in OCC and 
with the Federal Reserve?
    Mr. Baer. Yes, Senator, again, this sort of gets to the 
core of what we are seeking through our petition for 
rulemaking, along with the ABA, which is simply, you know, a 
clarification that if you are going to have an MRA, it is going 
to be based on a violation of law or an unsafe and unsound 
practice, not guidance. And that cures a lot of ills because at 
that point guidance is, as I think some here have described it, 
nonbinding as an indication of the priorities or concerns of 
the agency but not a rule.
    Senator Tillis. Yeah, and when used in that spirit, it can 
be helpful. When abused, it can be harmful.
    Mr. Baer. Absolutely.
    Senator Tillis. And people should do their jobs and go 
through the right processes.
    I know I am over time. I almost never go over time, but the 
Chair and Ranking Member are talking, so I am going to try and 
get one more question in.
    [Laughter.]
    Senator Tillis. I wanted to go back because I had one that 
was actually my--I have got two banking institutions who have 
decided that they are going through the merger process, 
SunTrust and BB&T. I personally think it would be good for the 
country. After we implemented S. 2155, I think those are two 
banks that are right in that middle ground that actually give 
them the scale to be able to deal with what larger banks have 
to do with respect to footprint and banking operations, 
regulatory burden.
    Should I be worried as we go through this review process 
that we could get caught up in things that are not necessarily 
things that they should be subjected to to get approval for 
this bank merger?
    Mr. Baer. Senator, I think----
    Senator Tillis. And do you think we will ever know the 
specifics of the negotiations that occur?
    Mr. Baer. I would just say, I mean, fortunately, when 
evaluating bank mergers, the Federal Reserve looks at an 
objective measure of that, the Justice Department measure, the 
HHI, or Herfindahl-Hirschman Index, which I think shows--and we 
have looked at this particular merger and published on it--
shows banking to be an unconcentrated industry, both as an 
absolute matter and relative to other industries. I think the 
numbers show that this merger would not materially add to the 
concentration of that industry.
    Senator Tillis. Just intuitively, can you imagine why it 
would take a year or more to review this and make a decision on 
this merger? It seems to me it should be something that should 
be done in a matter of months. I think that the Federal Reserve 
is trying to greatly compress the length of time for doing 
these reviews. But can you imagine any scenario why it should 
be next year before we get a decision on this merger in your 
professional opinion?
    Mr. Baer. That is kind. I do not know if there are any 
complications around the merger of which I am unaware. I would 
think in the ordinary course it would not take that long.
    Senator Tillis. Well, I do not think that there are, so I 
am looking forward to a quick decision on the part of the 
regulators so that we can move forward. Thank you all.
    This is the first time I have gone over my time, Mr. Chair, 
and I appreciate your indulgence.
    Chairman Crapo. Thank you. You are welcome.
    Senator Brown.
    Senator Brown. First time Senator Tillis went over this 
week.
    [Laughter.]
    Senator Brown. Thank you.
    Chairman Crapo. He has been really good.
    Senator Brown. Thanks. My staff--a question to Mr. Baer. We 
are going to follow up with written questions. We found several 
instances in which the Financial Services Roundtable took a 
position on indirect auto lending, so we would like to get some 
clarification. We will send you a letter, if you would respond 
as quickly as possible, Mr. Baer.
    Mr. Baer. Thank you, Senator. As I said, my statement was 
based on my recollection. I actually never worked at the 
Financial Services Roundtable, so I take your word for that.
    Senator Brown. Thank you.
    Chairman Crapo. All right. Thank you, and that concludes 
our questioning for today's hearing. I again thank our 
witnesses for your time and for your expertise and for coming 
here and participating in this hearing.
    For Senators who wish to submit questions for the record, 
those questions are due to the Committee by Tuesday, May 7th, 
and I ask the witnesses to respond to those questions as 
promptly as you can once you receive them.
    Again, we thank you for being here, and this hearing is 
adjourned.
    [Whereupon, at 11:06 a.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
               PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO
    Today, the Committee will turn its focus to guidance, supervisory 
expectations, the rule of law, and how banking agencies regulate and 
supervise institutions.
    Banks receive significant forms of Government support and benefits, 
including deposit insurance and access to the Fed's discount window.
    In exchange for these benefits, which ensure that American 
consumers have stable access to their deposits, banking agencies 
supervise banks and in return expect them to operate in a safe and 
sound manner.
    The nature of the supervisory process and the need for trust 
between supervisor and supervised institution means that sometimes 
supervisory expectations are communicated in an informal and 
confidential manner between supervisor and supervised institution, 
which can be appropriate in certain circumstances, especially when 
protecting Confidential Supervisory Information.
    With that being said, there appears to be a number of situations 
where the banking agencies have enacted guidance or other policy 
statements that are being enforced as rules and therefore do not comply 
with notice-and-comment rulemaking processes and do not comply with the 
Congressional Review Act (CRA).
    In addition, there are a number of situations where supervisors 
make verbal ``recommendations'' to banks that are inappropriate given 
the tremendous power supervisors have over banks.
    All rulemaking authority at the banking agencies derives from 
authority delegated to the banking agencies by Congress, which means 
Congress has the authority to disapprove any rule a banking agency 
enacts.
    In addition to the absolute authority Congress has to disapprove 
any agency action, Congress enacted the CRA in 1996 to provide Congress 
with an expedited process to disapprove agency rules.
    Under the CRA, before a rule can take effect, agencies must submit 
it to Congress for review.
    Congress then has 60 days to disapprove the rule with a majority 
vote.
    A rule is defined, with a few exceptions, as ``the whole or a part 
of an agency statement of general or particular applicability and 
future effect designed to implement, interpret, or prescribe law or 
policy or describing the organization, procedure, or practice 
requirements of an agency.''
    That is a very broad definition.
    The CRA applies to more than just notice-and-comment rules. It 
encompasses a wide range of other regulatory actions, including, among 
others, guidance documents, general statements of policy, and 
interpretative rules.
    Even though the text itself is clear about the broad scope of what 
constitutes a rule, during the floor debates leading up to the passage 
of the CRA, then-Senator Reid reinforced this point and said: ``[t]he 
authors are concerned that some agencies have attempted to circumvent 
notice-and-comment requirements by trying to give legal effect to 
general statements of policy, `guidelines,' and agency policy and 
procedure manuals. The authors admonish the agencies that the APA's 
broad definition of `rule' was adopted by the authors of this 
legislation to discourage circumvention of the requirements'' of it.
    Too often, we see banking regulators implementing policy through 
guidance and other informal means without following the requirements in 
the CRA.
    For instance, some in the agencies may argue that guidance is not 
binding, but as a practical matter, supervised institutions and 
supervisors know that informal guidance and other communications 
between supervised institutions and supervisors change behaviors within 
institutions.
    Legal departments at the banking agencies often assert that 
guidance is nonbinding, but the language the supervisors at the 
agencies use often suggest that supervisors treat guidance as binding 
and expect supervised institutions to treat it as binding.
    Actions like this within agencies are problematic and require 
Congressional oversight, including by ensuring banking agencies comply 
with the CRA.
    Recognizing the importance of agencies complying with the CRA, 
Acting Director of the Office of Management and Budget (OMB) Russell 
Vought issued a memorandum recently, which ``reinforces the obligations 
of Federal agencies under the CRA in order to ensure more consistent 
compliance with its requirements across the Executive Branch and sets 
forth guidelines for analysis that the Office of Information and 
Regulatory Affairs (OIRA) will use to properly classify regulatory 
actions for purposes of the CRA.''
    This memorandum is a step in the right direction.
    The abuse of Government and agency power should not be a partisan 
issue and no Administration or agency should be able to use their 
powers to influence the private market.
    I continue to encourage the regulators to follow the CRA and submit 
all rules to Congress, even if they have not gone through a formal 
notice and comment rulemaking.
    In addition, I encourage the banking regulators to provide more 
clarity about the applicability of guidance and ensure that supervisors 
throughout the agencies (especially outside of Washington, DC) know 
about how guidance should be treated and do not inappropriately use 
their significant discretion.
    As a final note, during the Obama administration, I fought against 
Operation Choke Point, an initiative in which Federal agencies 
pressured banks to ``choke-off'' politically disfavored industries' 
access to payment systems and banking services.
    Operation Choke Point initially began in the supervisory process.
    Operation Choke Point was inappropriate, and demonstrates why 
supervisory staff at the agencies need to be transparent and 
accountable.
    I look forward to hearing from each of you on your views of what 
can be done to ensure that there is greater transparency and 
accountability in the regulatory and supervisory process.
                                 ______
                                 
              PREPARED STATEMENT OF SENATOR SHERROD BROWN
    This is a hearing to talk about guidance--the nonbinding advice 
from Federal agencies that's supposed to make it easier for the banking 
industry to follow the rules.
    There's a reason we have a lot of banking laws--it's a complicated 
industry that affects everyone's lives, and with a great deal of 
potential for special interests to do a whole lot of harm. It takes a 
lot of oversight to prevent terrorist financing and protect consumers 
and stop discrimination in lending and keep Wall Street from taking 
down the economy again.
    And banks need guidance to help them comply with those laws.
    In fact, industry begs for guidance all the time.
    So why hold this hearing at all?
    The same reason we always seem to have hearings in this town--to 
make life a little easier for Wall Street.
    Chair Crapo, I am concerned this hearing isn't actually about 
making it easier for big banks to follow the rules--that it's really 
about making it easier for big banks to get around them.
    It's about what kind of guidance the industry wants, and the kind 
of guidance it doesn't.
    Big banks love guidance that makes it easier to trade derivatives 
with big foreign banks. They love guidance that tells them how to track 
their capital or how to prepare for the stress tests. They love 
guidance that makes sure they can keep lending when a town is hit by 
floods or wildfires.
    The guidance big banks hate--the guidance we're actually talking 
about at this hearing today--is the kind that makes it harder for them 
to skirt the laws or take advantage of their consumers.
    And as usual, Wall Street has plenty of senators lining up to help 
them.
    Big banks hate guidance that explains how regulators are going to 
enforce the laws that say you can't discriminate against people of 
color. They hated that one so much they persuaded Republicans to repeal 
it.
    Guidance had never been repealed before. But Congress used the 
Congressional Review Act to repeal instructions from the Consumer 
Protection agency that would have made it harder for auto dealers to 
charge people of color more for car loans.
    Big banks also hate guidance that says they should be cautious 
about risky leveraged loans that might crash the economy. They hate it 
because it cut into the huge fees they were getting for making these 
types of loans to corporations.
    And they hate guidance that explains how the regulators are going 
to keep tabs on Wall Street. Last week Senator Tillis sent a letter to 
the GAO to start the process of having Congress step in, and tell 
regulators to take it easy on the very largest banks in this country.
    And 2 weeks ago, the Office of Management and Budget announced they 
want the President to have direct influence over the guidance that 
independent banking agencies put out.
    That means the President can lean over to his Chief of Staff Mick 
Mulvaney, who is also the head of OMB, and tell independent agencies 
what to do. And we saw how Mick Mulvaney ran the CFPB.
    These agencies are supposed to be independent for a reason. We know 
how corporate special interests spread their influence around 
Washington.
    The agencies policing Wall Street are supposed to be independent to 
guard against that influence. But now the same president whose cabinet 
looks like a Wall Street executive retreat wants to meddle.
    And remember 2155--the bill that gutted many of the rules for the 
biggest banks in the country, and for foreign megabanks?
    Right in that bill, in section 109 to be exact, the bill that 
Chairman Crapo wrote and skillfully shepherded to the floor and that 
President Trump signed into law, Congress instructed the CFPB to give 
guidance on filling out mortgage forms. Republicans demanded, insisted, 
and fought for language instructing agencies to give more guidance. 
This is the kind of guidance they pretend to be opposed to today.
    This isn't about guidance--it's about getting rid of the rules that 
Wall Street doesn't want to follow.
    And everyone else will end up paying for it.
                                 ______
                                 
                    PREPARED STATEMENT OF GREG BAER
      President and Chief Executive Officer, Bank Policy Institute
                             April 30, 2019
    My name is Greg Baer, and I am president and CEO of the Bank Policy 
Institute. \1\ I am here to testify about how legal process has broken 
down in the regulation and examination of banks. I will not today 
generally discuss the substance of postcrisis requirements imposed by 
the Federal banking agencies; instead, my focus will be on a process 
that has prevented stakeholders in banking policy--not only banks but 
also their customers, academics, and even Members of Congress--from 
learning what many of those requirements are, and having a say in their 
content.
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     \1\ The Bank Policy Institute (BPI) is a nonpartisan public 
policy, research and advocacy group, representing the Nation's leading 
banks. Our members include universal banks, regional banks, and the 
major foreign banks doing business in the United States. Collectively, 
they employ nearly 2 million Americans, make 72 percent of all loans 
and nearly half of the Nation's small business loans and serve as an 
engine for financial innovation and economic growth.
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    In so doing, I bring to bear not only my perspective as CEO of the 
Bank Policy Institute, a trade association representing America's 
leading banks, but also that of a lawyer and sometime law professor. 
Over time, the laws and regulations I learned, teach, and in some cases 
wrote have become decreasingly relevant in practice. The procedural 
rights and protections that those laws provide are generally 
obsolescent, as regulation and examination have become increasingly 
subjective, opaque, and unappealable.
    So, this hearing is a welcome development, and I thank the 
Committee for devoting its valuable time to these issues.
    In my testimony, I will describe the laws enacted by Congress to 
govern the regulatory, examination and enforcement process. I will then 
describe the actual status quo, and how it diverges significantly from 
the laws as written. Finally, I will describe recent actions by the 
Government Accountability Office and some of the financial regulators 
that hold the potential for reform in this area, and some additional 
steps that could be taken to restore the rule of law as enacted by 
Congress.
    My testimony today describes how examination reports have been 
effectively turned into enforcement actions, as their mandates--Matters 
Requiring Attention and Matters Requiring Immediate Attention, or MRAs 
and MRIAs--are treated as binding regulations or orders. Furthermore, 
the basis of those MRAs frequently is not a violation of law but rather 
a ``violation'' of guidance that under the law is actually nonbinding, 
or of other standards that also have neither a legal basis nor an 
evidentiary foundation. Finally, the reason these examination mandates 
are treated as binding regulations or orders is because a shadow 
enforcement regime has grown up postcrisis whereby firms with any 
unresolved MRA are subject to limitations on their growth--limitations 
never authorized by Congress.
    I should note that my testimony generally does not focus on capital 
and liquidity rules. Clearly, these are the most important components 
of banking regulation and universally regarded as the core protection 
for taxpayers and financial stability. And they generally have been 
adopted in accordance with the Administrative Procedure Act, and are 
enforced in a transparent, objective way. \2\ Rather, ironically, it is 
the regulatory requirements that matter the least that are the most 
opaque and come with the fewest checks and balances--requirements about 
how banks manage their vendors, minute their meetings, update 
spreadsheets, structure reporting lines, or monitor transactions. Those 
requirements, not the core capital and liquidity requirements, are what 
have built a vast compliance bureaucracy, and it is those requirements 
that frequently have prevented banks from branching, investing and 
otherwise serving new customers and offering new products postcrisis. 
Over the past few years, many banks that met all of the dozens of 
capital and liquidity requirements to which they are subject have been 
unable to open a branch because of perceived failures in areas that are 
immaterial to their safety and soundness.
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     \2\ One notable exception, however, is the Federal Reserve's 
stress testing regime. See, e.g., Jeremy Newell, The Fed's ``2018 CCAR 
Scenarios: A Look at Process'', Underwritings: The BPI Blog (March 2, 
2018), https://bpi.com/the-feds-2018-ccar-scenarios-a-look-at-process/.
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    If I could stress one theme, though, it would be this: the erosion 
of the rule of law in banking should not be a concern just to lawyers 
and bankers. Decisions made behind the examination curtain 
significantly affect the ability of consumers and businesses to access 
credit and other financial services, and the terms and price of credit 
and services. They have every right to comment on the currently 
nonpublic and sometimes unwritten rules that affect them. So, too, do 
academics and other policy experts whose views would be helpful in 
making those rules better. This, of course, is precisely why Congress 
enacted the Administrative Procedure Act: not as a sop to regulated 
entities, but rather out of a genuine and well-founded belief that 
rules are better made when they are informed by an open and public 
comment process than when they are made in secret, without fear of 
public scrutiny or challenge.
The Law as Written
    Under the law, banks are examined by the Federal banking agencies. 
\3\ By law, an examination report is not an enforcement action, and is 
in no way legally binding. Rather, it is a statement of an examiner's 
views, and the beginning of a dialogue between examiner and banker. To 
be sure, bankers generally accept examiner criticisms, and strive to 
resolve any problems identified. But they sometimes disagree.
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     \3\ See 12 U.S.C. 248(a)(1) (Federal Reserve); 12 U.S.C. 481 
(OCC--national banks); 12 U.S.C. 1463, 1464 (OCC--Federal savings 
associations); and 12 U.S.C. 1820(b) and (c) (FDIC). State-chartered 
banks are also subject to examination by the relevant State banking 
agency.
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    In that case, the law is clear. If the agency wishes the bank to 
conform to its prescriptions, it must initiate an enforcement action. 
Congress has provided multiple legal mechanisms for doing so. For 
example:

    Under section 8 of the Federal Deposit Insurance Act, a 
        Federal banking agency may issue an order to halt, remediate, 
        or penalize a violation of a law, rule, regulation, or final 
        agency order, an ``unsafe or unsound practice,'' or a breach of 
        fiduciary duty. \4\
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     \4\ 12 U.S.C. 1818.

    Under section 39 of the FDI Act, each Federal banking 
        authority has prescribed safety and soundness standards 
        relating to internal controls, loan documentation, credit 
        underwriting, interest rate exposure, asset growth, 
        compensation, and other topics. If an institution fails to meet 
        the applicable standards, the regulator may issue an order 
        compelling remediation. \5\
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     \5\ 12 U.S.C. 1831p-1.

    If the issue relates to capital, under section 38 of the 
        FDI Act, the banking agencies may impose sanctions on a banking 
        institution whose capital levels fall below predefined levels. 
        Alternatively, a Federal banking agency may issue a capital 
        directive to require a bank to maintain a level of capital 
        deemed reasonable by the regulator. \6\
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     \6\ 12 U.S.C. 3907(b); see also 12 CFR 3.601 et seq. (OCC); 12 
CFR 263.83 (Federal Reserve); and 12 CFR 324.5 (FDIC).

    For individual employees and directors who engage in 
        misconduct, the Federal banking regulators have the authority 
        to bar them from a firm (or the industry) and assess monetary 
        penalties. \7\
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     \7\ 12 U.S.C. 1818.

    In each of the above cases, the affected bank or individual has 
clearly delineated procedural rights, which generally include the right 
to be notified of the basis of the order, respond on the merits, and 
ultimately contest it before an Article III court. \8\ Notably, these 
procedural rights incentivize both regulator and regulated to negotiate 
an agreement in lieu of litigation.
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     \8\ See 12 U.S.C. 1818(h).
---------------------------------------------------------------------------
    Another important procedural right was provided by Congress when it 
required each banking agency to establish a process for administrative 
appeal of any material adverse supervisory determination--that is, 
actions for which there was no formal appeal under the law. \9\ This 
might include a CAMELS rating or a loan classification.
---------------------------------------------------------------------------
     \9\ 12 U.S.C. 4806.
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    Finally, all of these procedural rights are supplemented by section 
706 of the Administrative Procedure Act, which governs the rulewriting 
process for all Federal agencies and gives any affected person the 
right to seek judicial review of any final agency action. \10\ It 
serves as the ultimate guarantee that the regulations against which 
banks are being examined are adopted and administered with due process 
of law.
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     \10\ 5 U.S.C. 706.
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The System in Practice
    Unfortunately, the laws that I have just described, and the 
procedural rights that Congress provided in them, have become 
increasingly irrelevant in practice, supplanted by an alternative, 
nonpublic examination and enforcement regime where they are 
unavailable.
The Shift From Regulation to MRAs Based on Guidance and Ad Hoc Mandates
    First, the banking agencies have increasingly avoided notice and 
comment rulemaking, which under the APA requires the agencies to give 
prior notice of the rule they propose to issue, seek public comment on 
that proposal, and explain in any final rule why they have disregarded 
any comment. Instead, they have (i) issued guidance generally without 
opportunity for public comment or Congressional review or (ii) imposed 
mandates through the examination process, and then proceeded to treat 
each examination mandate as binding as a regulation, contrary to law.
    MRAs and MRIAs
    A Matter Requiring Attention, or MRA, is the vernacular by which 
bank examiners communicate criticisms to a bank's management or 
(increasingly) to the board of directors. MRAs and MRIAs have no basis 
in law--there is no reference to them in any statute--and they are 
unenforceable as a legal matter (in contrast to agency orders, which 
are enforceable and subject to due process). In essence, MRAs create a 
to-do list for the bank that comes at the end of examination report.
    Make no mistake, however: the banking agencies take the position 
that MRAs must be remediated. \11\ And ask any banker whether 
remediation of MRAs or MRIAs is optional, and the answer will be no. 
\12\ But you really can't ask any banker, because MRAs and MRIAs are 
included in an examination report, which the banking agencies consider 
Confidential Supervisory Information; therefore, it is a Federal crime 
for a banker to complain publicly about an MRA.
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     \11\ The bank enforcement section of the OCC's ``Policies and 
Procedures Manual'' states that an examination report may contain 
``concerns,'' which are expressed in an MRA. It then states: ``The 
actions that the board and management take or agree to take in response 
to violations and concerns are factors in the OCC's decision to pursue 
a bank enforcement action . . . A bank's board and management must 
correct deficiencies in a timely manner.'' See Office of the 
Comptroller of the Currency, ``Policies and Procedures Manual'', PPM 
5310-3 (Nov. 13, 2018) at 3 (emphasis added), available at https://
www.occ.treas.gov/news-issuances/bulletins/2017/ppm-5310-3.pdf. 
Similarly, in its Supervision and Regulation Report, the Fed states: 
``In the event that holding companies do not address MRAs in a timely 
or complete manner, examiners may determine that the related weaknesses 
represent a significant threat to the safety and soundness of the 
company or its ability to operate in compliance with the law and may 
recommend further action.'' Federal Reserve, Supervision and 
Examination Report (Nov. 9, 2018) at 16, available at https://
www.federalreserve.gov/publications/supervision-and-regulation-
report.htm. The Federal Reserve also states, ``MRIAs are matters of 
significant importance and urgency that the Federal Reserve requires 
banking organizations to address immediately.'' Id. at Appendix A 
(emphasis added).
     \12\ Greg Baer and Jeremy Newell, ``The MRA Is the Core of 
Supervision, But Common Standards and Practices Are MIA'', 
Underwritings: The BPI Blog (Feb. 8, 2018), https://bpi.com/the-mra-is-
the-core-of-supervision-but-common-standards-and-practices-are-mia/.
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    Consider the number of MRAs they are prohibited from talking about:
    
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
    
    Consider, in contrast, the use of the enforcement mandates actually 
prescribed by statute and described above. For the Federal Reserve and 
the OCC over the past 10 years:
---------------------------------------------------------------------------
     \13\ Data taken from the Federal Reserve's ``Supervision and 
Regulation Report'' dated November 2018, available at https://
www.federalreserve.gov/publications/files/201811-supervision-and-
regulation-report.pdf and OCC's 2018 Annual Report, available at 
https://www.occ.gov/annual-report/download-the-full-report/2018-annual-
report.pdf. Federal Reserve data includes MRAs for BHCs, SLHCs, and 
FBOs. Figures for 2018 are as of the end of Q2 2018. OCC data includes 
MRAs for national banks and Federal savings associations. Figures for 
2018 are as of the end of Q3 2018.

    The Federal Reserve has issued 34 safety and soundness 
---------------------------------------------------------------------------
        orders; the OCC has issued zero.

    The Federal Reserve has issued only 20 prompt corrective 
        action orders; the OCC has issued 34.

    The Federal Reserve has issued 211 capital directives; the 
        OCC issued 9.

    The Federal Reserve has issued 75 removal actions against 
        individuals; the OCC issued 246.

    The case of safety and soundness orders is particularly telling. 
These are orders that specifically relate not to capital or liquidity 
levels but rather exactly to the sorts of issues examiners consider 
during an examination--risk management, credit underwriting, etc. Over 
the past 10 years, the OCC has not issued a single such order, but it 
has issued tens of thousands of MRAs.
    What, then, are the bases for the thousands of MRAs and MRIAs being 
issued to banks?
    ``Guidance''
    Postcrisis, there has been issuance of a massive volume of 
``guidance'' in the form of supervisory letters, bulletins, and 
circulars. Guidance also includes examination handbooks (which 
previously were designed for examiners, not banks) and even enforcement 
actions (where the standards enforced on one bank through a consent 
order have at times been treated as binding on all banks). \14\
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     \14\ This stance is contrary to Supreme Court precedent. United 
States v. Armour and Co., 402 U.S. 673 (1971); Local No. 93, Int'l 
Ass'n of Firefighters v. City of Cleveland, 478 U.S. 501 (1986) 
(holding that settled cases have no precedential effect).
---------------------------------------------------------------------------
    The volume of guidance is in some ways inestimable, as it takes so 
many forms. By one estimate, since 2013, the OCC has issued 330 pieces 
of OCC-only or interagency guidance in the form of bulletins; the 
Federal Reserve has issued 103 pieces of Federal Reserve-only or 
interagency guidance in the form of Supervision and Regulation (SR) 
letters. \15\ But this dramatically understates the volume, because the 
agencies (and therefore bank compliance teams) treat numerous other 
agency statements as binding.
---------------------------------------------------------------------------
     \15\ The Federal Reserve Bank of St. Louis maintains a public 
compendium of these and other agency issues at https://
www.stlouisfed.org/federal-banking-regulations/.
---------------------------------------------------------------------------
    Consider, as an example, vendor management. The OCC in 2013 issued 
a voluminous bulletin, which itself referenced and reinforced over 50 
previous bulletins, advisory letters, and banking circulars, that 
describes how federally chartered banks should deal with their vendors 
and contractors. \16\ It applies to a wide range of vendor--and many 
other types of business relationships (other than customer 
relationships)--everything from key IT vendors to corporate wellness 
vendors--and its expectations are granular and prescriptive. The result 
has been a cottage industry, requiring the retention of large teams of 
people, both internal and consultants, to act as gatekeepers to any 
contract with a third party and to draft policies and procedures for 
practically any interaction with a third party, and to document 
compliance with those policies on an ongoing basis. \17\ 
(Unfortunately, but not surprisingly, one effective means to compliance 
is to concentrate one's most critical vendor relationships with fewer, 
larger firms that are able to handle the associated compliance burdens, 
at the expense of small businesses who cannot.) \18\
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     \16\ OCC Bulletin 2013-29.
     \17\ This consultant-industrial complex frequently includes 
retention of former regulators.
     \18\ In a 2017 ``Semi-Annual Risk Report'', the OCC itself 
observed that ``[c]onsolidation among service providers has increased 
third-party concentration risk, where a limited number of providers 
service large segments of the banking industry for certain products and 
services.'' See https://www.occ.gov/publications/publications-by-type/
semiannual-risk-perspective/pub-semiannual-risk-perspective-spring-
2017.pdf.
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    Banks generally treat all of those utterances as legally binding 
because a ``violation'' of any of them can form the basis for an MRA. 
And these guidance documents not only impose meaningful restrictions on 
banks internal operations but also proscribe or circumscribe specific 
products and offerings (e.g., small-dollar credit or leveraged 
lending).
    To be sure, recent pronouncements by the GAO and statements by the 
agencies have sent a message that guidance is not to be treated as 
binding. One could read a recent interagency statement as stating as 
much, though it does not include a specific reference to MRAs and 
rather refers to agency ``citations,'' which has prompted confusion. 
This area therefore appears to be one where, as suggested later in my 
testimony, clarity is required.
    ``Safety and Soundness''
    In some cases, MRAs are based not on any law, regulation or even 
written guidance, but simply on examiner preference. In some cases, 
they take the form of ``industry MRAs,'' which are identical 
examination mandates issued to multiple banks--basically, an ultra 
vires regulation without the process required by the APA. Increasingly 
those preferences derive from ``horizontal reviews,'' where examiners 
review practices across a variety of banks, decide which one they 
prefer, and then require the remainder to adopt what examiners have 
determined to be best practice. A primary source of many such reviews 
is the Federal Reserve's Large Institution Supervision Coordinating 
Committee (LISCC), a supervisory committee it uses to oversee the 
supervision of large banks. Notwithstanding the LISCC's significance, 
the Federal Reserve has never established a process or meaningful 
criteria for how firms become subject to (or exit from) LISCC 
designation and its requirements. Yet LISCC designation triggers a wide 
range of heightened requirements related to capital adequacy and 
capital planning, liquidity sufficiency, corporate governance, and 
recovery and resolution. (In turn, these significant requirements 
generally flow from guidance, not law or regulation.)
    Asked for the legal basis for such actions, examiners often cite 
``safety and soundness.'' Indeed, they are doing so increasingly, as 
the law has become clearer that guidance is nonbinding and cannot serve 
as the basis for an MRA.
    But ``safety and soundness'' is not a magical phrase. Rather, it is 
shorthand for an ``unsafe and unsound banking practice'' that the 
banking agencies are authorized (after appropriate procedural process) 
to prohibit under 12 U.S.C. 1818. And that phrase has a well-defined 
legal meaning. As explained by the DC Circuit Court of Appeals, an 
unsafe or unsound practice for purposes of section 1818 ``refers only 
to practices that threaten the financial integrity of the 
institution.'' Johnson v. OTS, 81 F.3d 195, 204 (DC Cir. 1996); see 
also Gulf Federal Savings and Loan Association v. Federal Home Loan 
Bank Board, 651 F.2d 259 (5th Cir. 1981) (``The breadth of the `unsafe 
or unsound practice' formula is restricted by its limitation to 
practices with a reasonably direct effect on an association's financial 
soundness.''); Seidman v. Office of Thrift Supervision, 37 F.3d 911 (3d 
Cir. 1994) (``The imprudent act must pose an abnormal risk to the 
financial stability of the banking institution . . . . Contingent, 
remote harms that could ultimately result in `minor financial loss' to 
the institution are insufficient to pose the danger that warrants cease 
and desist proceedings.''); Hoffman v. FDIC, 912 F.2d 1172, 1174 (9th 
Cir. 1990) (requiring ``abnormal risk or loss or damage to an 
institution, its shareholders, or the agencies administering the 
insurance funds''). \19\
---------------------------------------------------------------------------
     \19\ There is a minority of circuits that has a somewhat lower 
standard for what constitutes an unsafe and unsound practice, but even 
there the bar is still extremely high. These circuits primarily endorse 
the so-called Horne standard--named after the Federal Home Loan Bank 
Board Chairman who, in material provided to Congress in 1966 in support 
of the legislation that employed the term, described it as: ``any 
action, or lack of action, which is contrary to generally accepted 
standards of prudent operation, the possible consequences of which, if 
continued, would be abnormal risk or loss or damage to an institution, 
its shareholders, or the agencies administering the insurance funds.'' 
See, e.g., First National Bank of Eden v. Department of the Treasury, 
568 F.2d 610 (8th Cir. 1978). That said, the law of the DC Circuit is 
effectively dispositive, given that the defendant in any action under 
12 U.S.C. 1818 has the option of appealing to the DC Circuit, in 
addition to the relevant circuit for traditional venue purposes. Thus, 
a bank seeking to challenge an action can do no worse than the law of 
the DC Circuit.
---------------------------------------------------------------------------
    Clearly, given the sheer number of MRAs it seems highly unlikely 
that all or even most of them meet that standard. The fact that they 
come at a time when the vast majority of banks are in compliance with 
all relevant capital and liquidity requirements makes it still more 
unlikely. Indeed, I wish that I could provide the Committee examples of 
MRAs that deal with matters that are beyond immateriality to the point 
of irrelevancy. Again, however, the banking agencies take the position 
that doing so is a criminal violation, so I cannot. The Committee 
itself would need to investigate the extent to which banking agency 
MRAs meet this standard--perhaps by requesting a sample of anonymized 
MRAs from exam reports issued over the past 5 years. Furthermore, it is 
deeply unfortunate that, other than reporting the total number, the 
agencies report no aggregate or anonymized data on the subject of those 
MRAs--reporting that no reading of the law would prohibit.
    Examination Versus Supervision
    The breakdown in legal process goes hand in hand with a broader 
trend. By law, the job of the regulatory agencies is to establish ex 
ante regulations, and then to examine the books and records of banks to 
ensure that they are operating in accordance with those regulations and 
that they are not engaged in practices that pose the risk of a 
substantial loss to the firm--that is, losses that could materially 
erode their capital and liquidity position. It is a system of 
regulation and examination.
    Notably, the word supervision does not appear in the authorizing 
statues for the examination process. There is a large difference 
between examining a firm and supervising it. Congress authorized the 
former, but the current system is all about the latter. It is less and 
less about protecting taxpayers--that goal is primarily served through 
capital and liquidity requirements--and more about protecting 
shareholders by attempting to comanage the firm. Thus, we see constant 
references to ``reputational risk''--another term that does not appear 
in law or regulation, but which has become shorthand for a practice 
that is legal and creates no material financial risk but which is 
disfavored by examiners. And as I will now describe, there is now a 
shadow enforcement regime that allows regulators to ``supervise'' 
without due process.
The Shadow Enforcement Regime
    At this point, one should wonder: if all the MRAs are legally 
unenforceable and, moreover, based on unenforceable guidance and vague 
references to safety and soundness, why are they treated as binding 
rules by banks, and particularly their compliance teams? Why are they 
diverting extraordinary resources to comply with mandates that are 
often immaterial to their safety and soundness and in many cases 
against their better judgment?
    The answer is: because a new, shadow enforcement regime has grown 
up postcrisis. It relies on growth and investment restrictions never 
authorized by Congress in place of written agreements, formal orders, 
and capital directives that were so authorized. Those restrictions are 
immediately effective, effectively unreviewable and therefore 
practically uncontestable by the bank. It is why those tens of 
thousands of MRAs should not be viewed as examination findings but 
rather as de facto enforcement actions.
    Shadow Growth Restrictions
    Thus, the Federal Reserve's Supervisory Letter 14-02, issued in 
2014, describes factors the Federal Reserve will consider in acting 
upon bank applications to engage in a wide range of proposed 
transactions, including mergers, acquisitions, asset purchases, 
investments, new activities, and branching. \20\ SR 14-2 states that 
banking organizations that are rated below ``satisfactory'', that are 
subject to any enforcement action, or that have any significant 
consumer compliance issues or other ``outstanding supervisory issues'' 
should not even file an application until they resolve their 
supervisory issues. Although the literal terms of SR 14-2 suggest that 
various of these prohibitory conditions can be overcome, the general 
prohibitions have been virtually absolute in practice. Yet none of them 
is articulated in the relevant governing statutes. And, for good 
measure, SR 14-02 itself was never published for notice and comment or 
submitted for Congressional review under the Congressional Review Act. 
By all accounts, the practices at the other Federal banking agencies 
have generally been similar, though generally not codified in writing. 
\21\
---------------------------------------------------------------------------
     \20\ SR 14-2/CA14-1: ``Enhancing Transparency in the Federal 
Reserve's Applications Process'' (Feb. 24, 2014). Most large 
transactions involve a Federal Reserve review and therefore SR 14-2 may 
well directly affect many bank-level (in addition to bank holding 
company level) applications in that context.
     \21\ Applicable OCC and FDIC guidance--which like SR 14-2 have 
never been subject to public comment--differ from 14-2 in some respects 
and are less detailed. The OCC's Comptroller's Manual, Business 
Combinations (July 2018) states that in the context of MRAs and program 
deficiencies, the OCC assesses the nature and duration of the issues, 
the institution's progress in remediating identified program 
deficiencies, and whether the proposed combination would detract from 
the remediation, exacerbate existing problems, or create new problems 
for the resulting institutions. In the context of an enforcement 
action, the Manual simply states that in these circumstances the bank 
should consult with its supervisory office and Licensing Division 
before pursuing any plans for a transaction. See ``Comptroller's 
Manual'' at 7-8. The FDIC's 1998 ``Statement of Policy on Bank Merger 
Transactions'' simply provides that ``[a]dverse finding may warrant 
correction of identified problems before consent is granted, or the 
imposition of conditions.''
---------------------------------------------------------------------------
    For perspective on how odd this new enforcement regime is, consider 
that we routinely see serious compliance violations across a wide range 
of American industries. Those companies are subjected to enforcement 
proceedings and are required to pay fines and remediate their 
practices, but no one ever suggests that while those proceedings are 
pending they should be stopped from opening new franchises, building 
new plants, developing new drugs, designing new cars, or launching new 
apps. Yet in banking, regulators often prohibit any type of expansion 
by the bank as a reaction to any compliance failure.
    Thus, SR 14-02 states that covered banks seeking to expand must 
``convincingly demonstrat[e] that the proposal would not distract 
management from addressing the existing problems of the organization or 
further exacerbate these problems.'' Again, it is very difficult to 
imagine how senior management could not simultaneously oversee, for 
example, one group of employees mailing reimbursement checks to 
consumers under a consumer compliance settlement and another group of 
employees opening a branch in Philadelphia or buying an asset manager 
in Los Angeles. In other industries, one presumes that a retailer with 
a data breach can still open new stores, or that an auto company with a 
fatal defect in its ignition switch can still open new dealerships. Yet 
over the past 10 years, a contrary illogic has significantly impaired 
the ability of banks to invest and expand to serve their customers 
better.
    The unique reliance on growth restrictions in banking is even more 
remarkable when one realizes that banks already are subject to more 
potential penalties, imposed by more potential regulators, than 
practically any other industry. The inability to open a new branch is 
not necessary as a deterrent.
    Thus, under agency practice, any unresolved consumer compliance 
issue or any unresolved supervisory issue can prevent a bank from 
expanding in any way. There are two results. First, obviously, bank 
expansion and investment in new technologies has been curtailed to an 
unhealthy extent. Second, and more importantly, this arrangement has 
given examiners powers never contemplated by Congress, without any 
procedural check or balance.
    To be clear, Congress has authorized the banking agencies to 
restrict the growth of financial institutions under some circumstances, 
but those circumstances were intended to be quite limited. Under 
section 4(m) of the Bank Holding Company Act and implementing 
regulations, and the Board's Regulation Y, a financial holding company 
which receives either a rating of Deficient-1 or Deficient-2 on any 
component under the LFI rating system or whose subsidiary bank receives 
a CAMELS ``3'' composite or Management rating must receive Federal 
Reserve approval to conduct certain nonbanking activities. \22\ A 
related provision requires the Board to consider a company's 
effectiveness in combatting money laundering activities in connection 
with applications to acquire bank shares or assets. \23\ Similarly, 
under the law governing interstate mergers and branching, for a bank to 
open a branch in any State in which it does not already have a branch, 
the bank must satisfy certain statutory standards and requirements for 
the bank to be ``well capitalized'' and ``well managed.'' \24\
---------------------------------------------------------------------------
     \22\ 12 U.S.C. 1843(m)(3); 12 CFR 225.83(d)(2).
     \23\ 12 U.S.C. 1842(c)(6).
     \24\ 12 U.S.C. 1831u. A similar requirement exists for approval 
of interstate mergers.
---------------------------------------------------------------------------
    These provisions have been extended far beyond their statutory 
intent and become part of the shadow enforcement regime. First, as 
noted above, the requirement to consider anti- money-laundering 
effectiveness in connection with some applications became a bar to any 
expansion by any institution with an outstanding AML consent order, 
regardless of whether the alleged problems were minor or major, or what 
their State of remediation was. \25\ Second, in conditioning certain 
nonbanking activities on a ``3'' rating, Congress understood that 
rating to reflect the management of the overall organization. Indeed, 
by its own terms, the Management rating is intended to reflect ``the 
capability of the board of directors and management, in their 
respective roles, to identify, measure, monitor, and control the risks 
of an institution's activities and to ensure a financial institution's 
safe, sound, and efficient operation in compliance with applicable laws 
and regulations.'' \26\ Postcrisis, however, the Management rating has 
become less about the financial condition of the bank and more about 
compliance with banking agency rules, guidance, and examiner 
preference. This represents a fundamental change.
---------------------------------------------------------------------------
     \25\ According to Federal Reserve SR 13-7, which addresses de novo 
branching by State member banks rated ``3'', ``In all cases, the bank's 
Bank Secrecy Act/Anti- Money-Laundering program needs to be considered 
satisfactory.''
     \26\ Uniform Financial Institutions Rating System, 61 FR 67021, 
67027 (Dec. 19, 1996).
---------------------------------------------------------------------------
    The direct result of this shift (lower ratings) was less important 
than its indirect result: adding an enforcement mechanism for MRAs that 
Congress never considered. Once the Management rating became subjective 
and untethered to financial condition, the threat of a downgrade to a 
``3'' rating became as powerful an enforcement tool as any formal 
order. So, too, did an actual downgrade, with the need for Federal 
Reserve approval to continue conducting nonbanking activities unless 
the bank remediate exactly as instructed.
    Again, though, section 4(m) relates only to nonbanking activities 
conducted by bank affiliates. It has nothing to do with the 
establishment of branches, or even the acquisition of or merger with 
other depository institutions or bank holding companies. Congress has 
never conditioned the opening of a branch on a particular management 
rating of the bank. Yet in practice, the agencies have done that 
themselves. \27\
---------------------------------------------------------------------------
     \27\ See Louisiana Public Service Comm'n v. FCC, 476 U.S. 355, 375 
(1986) (``[A]n agency literally has no power to act . . . unless and 
until Congress confers power upon it . . . . Thus, we simply cannot 
accept an argument that the FCC may nevertheless take action which it 
thinks will best effectuate a Federal policy. An agency may not confer 
power upon itself.'')
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Examination Appeals
    As the banking agencies have avoided statutory enforcement 
mechanisms that come with congressionally established procedural rights 
in favor of informal but equally binding examination mandates, the 
importance of the examination appeals process, and the agency 
ombudsman, has grown significantly.
    Sadly, for both structural and practical reasons, these tools are 
effectively dead letters for banks, and thus almost never used. Between 
1995 and 2012, the OCC issued 157 decisions, and the Federal Reserve 
issued 25. \28\ Consider that against a backdrop of tens of thousands 
of MRAs, and clearly something is very, very wrong.
---------------------------------------------------------------------------
     \28\ Julie Anderson Hill, ``When Bank Examiners Get It Wrong: 
Financial Institution Appeals of Material Supervisory Determinations'', 
92 Wash. U. L. Rev. 1101 (2015). The author notes that data from 1995-
2000 was unavailable for the Federal Reserve.
---------------------------------------------------------------------------
    The reasons for the paucity of appeals are not hard to divine. 
First, every banker and bank counsel is taught that ``examiners have 
long memories,'' such that potential for retaliation is always a 
concern. \29\ Second, appeals are made to the same agency that assigned 
the rating. For example, at the Federal Reserve, the ultimate arbiter 
in an appeal is a designated Federal Reserve Board Governor, while at 
the FDIC, appeals are ultimately decided by the agency's Supervision 
Appeals Review Committee.
---------------------------------------------------------------------------
     \29\ In recognition of this tendency to retaliate, the agencies 
have adopted internal policies criticizing examiner retaliation against 
institutions for pursuing supervisory appeals. One can question their 
effectiveness in practice, however.
---------------------------------------------------------------------------
    To their considerable credit, some of the agencies have recently 
sought public comment on their internal appeals processes. My 
suspicion, though, is that the problem cannot be solved without related 
reforms of the type discussed in this testimony.
Attorney-Client Privilege
    A case study in the examination status quo concerns the attorney-
client privilege. Examiners take the position that they can override 
attorney-client privilege, whether in the course of an ordinary 
examination of a bank or of an enforcement action. Thus, for example, 
in the latter case, the agencies take the position that they can begin 
their investigation by seeking the interview notes of inside and 
outside litigation counsel who have been defending the case. This is 
remarkable. So too is the fact that the SEC and the Department of 
Justice take the opposite position in the enforcement context.
    What is more remarkable is that there is no legal basis for this 
position. Seven of the Nation's leading law firms have done a joint 
opinion that concludes ``There is no valid legal basis for the Agencies 
to demand that supervised institutions disclose privileged material. As 
discussed, all the relevant case law and fundamental legal principles 
compel this conclusion.'' \30\ The American Bar Association in a 2012 
letter to the CFPB agreed that the examination powers of the agencies 
do not allow them to invade the privilege, finding ``the ABA is not 
aware of any reported Federal appellate court case holding the Federal 
Banking regulators--or any other Federal agencies--can require 
production of privileged materials, nor do the Federal banking statutes 
contain such authority.''
---------------------------------------------------------------------------
     \30\ See ``Banking Regulators' Examination Authority Does Not 
Override Attorney-Client Privilege'', Opinion of Cleary Gottlieb Steen 
and Hamilton; Covington and Burling; Davis Polk; Debevoise and 
Plimpton; Simpson Thacher and Bartlett, Sullivan and Cromwell; and 
Wilmer Cutler Pickering Hale and Dorr, available at https://
www.sullcrom.com/siteFiles/Publications/SC-Publication-Banking-
Regulators-Examination-Authority-Does-Not-Override-Attorney-Client-
Privilege.pdf.
---------------------------------------------------------------------------
    Of course, the agencies state that the privilege still holds with 
respect to all other third parties, and that providing privileged 
material to examiners or enforcement lawyers does not constitute a 
waiver of the privilege. While this is true, it is akin to saying that 
only the Government will be reading your email or searching your house, 
not other third parties. The fact that the Government is potentially 
accessing any and all privileged information absolutely vitiates the 
goal of the privilege, which is to ``encourage full and frank 
communication between attorneys and their clients and thereby promote 
broader public interests in the observance of law and administration of 
justice.'' \31\
---------------------------------------------------------------------------
     \31\ Upjohn Co. v. United States, 449 U.S. 383, at 389, citing 
Hunt v. Blackburn, 128 U.S. 464, 470 (1888).
---------------------------------------------------------------------------
    Notably, none of the banking agencies has contested the legal 
merits of the seven-firm memorandum in any venue at any time. Rather, 
they have continued their practice unabated. And banks have almost 
universally complied.
    Why? This question really gets to the heart of the postcrisis 
hidden regime. First, it is unlikely that any bank (or trade 
association) would have standing to bring a declaratory judgment action 
against the agencies. A court's likely response would be that a case or 
controversy would exist only if a bank refused to provide privileged 
material and the agencies served a subpoena for it. But no bank is 
going to take that step, because of concerns about retaliation and 
reputational harm if labeled as uncooperative. For that reason, the 
Department of Justice and SEC affirmatively state that a bank's failure 
to provide a ``voluntary'' waiver will not be considered against it in 
assessing cooperation and penalties. Neither, importantly and 
conversely, will a company be rewarded for a waiver. \32\
---------------------------------------------------------------------------
     \32\ 28710-20; SEC Division of Enforcement Office of Chief 
Counsel, ``Enforcement Manual'' (Oct. 28, 2016).
---------------------------------------------------------------------------
    As a result, banks (and indeed, banks alone) operate without the 
benefit of the candid legal advice that the attorney-client and work 
product privileges have ensured for centuries. Examiner pressure on 
keeping minutes of all management committee meetings and criticizing 
banks when the minutes are not specific enough are another means to 
chill candid conversations within the banking organization itself.
The Results
    The results of this new supervisory regime are significant. Many 
banks of all sizes have been restricted from branching, investing in 
new businesses, or merging for reasons that are neither public nor 
assessable. (Indeed, the Committee might consider asking the banking 
agencies for a list of all banks that have been subject to a nonpublic 
growth restriction over the past 5 years, to be reviewed in camera.) 
Bank technology budgets often are devoted primarily not to innovation 
but to redressing frequently immaterial compliance concerns. Indeed, an 
underrated cause of the rise of FinTech companies over the past 10 
years has been the fact that banks were spending their innovation 
budgets on compliance systems geared towards immaterial issues.
    Board and management time has been diverted from strategy or real 
risk management and instead spent remediating frequently immaterial 
compliance concerns and engaging in frequent meetings with examiners to 
ensure that they are fully satisfied.
    In effect, Congress has said that banks are free to develop 
different and competing practices, so long as they do not rise to the 
level of unsafe or unsound. But ``unsafe and unsound'' is a high bar 
from an evidentiary perspective, and due process can be a bother; thus, 
bank supervision has shifted away from this legal concept to a more 
malleable and supple one--``best practices'' enforced by MRAs (Matters 
Requiring Attention) that are effectively unappealable.
A Way Forward
    Notwithstanding the problems and concerns I have articulated, it is 
important to acknowledge several recent developments that suggest more 
attention is being paid to these issues:

    The General Accountability Office in a series of opinions 
        requested by Members of Congress has ruled that various types 
        of agency action self-described as ``guidance'' are in fact 
        rules under the Congressional Review Act; they are therefore 
        unenforceable until they are submitted for Congressional review 
        and not invalidated. Furthermore, these decisions have served 
        to highlight the fact that rules the agencies have clearly 
        treated as binding \33\ not only were not submitted to Congress 
        but also were never published for public comment, in violation 
        of the Administrative Procedure Act.
---------------------------------------------------------------------------
     \33\ See, e.g., Ryan Tracey, ``Feds Win Fight Over Risky-Looking 
Loans'', Wall Street Journal (Dec. 2, 2015), available at https://
www.wsj.com/articles/feds-win-fight-over-risky-looking-loans-
1449110383.

    Last September, the Federal banking agencies and CFPB 
        issued an ``Interagency Statement Clarifying the Role of 
        Supervisory Guidance'', which reaffirmed that supervisory 
        guidance ``does not have the force and effect of law, and the 
        agencies do not take enforcement actions based on supervisory 
        guidance.'' \34\ This represented an important step forward in 
        ensuring that agency guidance is issued and applied in a manner 
        consistent with the APA and the Congressional Review Act and, 
        more broadly, that formal examination criticisms focus on 
        matters material to the financial condition of a bank. 
        Unfortunately, there are numerous reports that the statement 
        (which is itself nonbinding guidance) is not being followed in 
        practice.
---------------------------------------------------------------------------
     \34\ See, e.g., Federal Reserve Supervisory Letter SR 18-5 / CA 
18-7, Interagency Statement Clarifying the Role of Supervisory Guidance 
(Sept. 12, 2018).

    Also last year, the CFPB issued a bulletin that established 
        two categories of examiner mandates--a step that could serve as 
        a model for the Federal banking agencies. The bulletin notes 
        that the CFPB would continue to use MRAs going forward, but 
        only to address and correct issues that are ``directly related 
        to violations of Federal consumer financial law''; \35\ the 
        bulletin then establishes a separate and distinct category of 
        communication, the ``Supervisory Recommendation'' (SR), which 
        will be used ``to recommend actions for management to consider 
        taking . . . when the Bureau has not identified a violation of 
        Federal consumer financial law, but has observed weaknesses in 
        CMS.'' \36\ Thus, the CFPB statement allows for an important 
        dialogue to continue between examiners and the institution with 
        respect to nonmaterial matters, but without legal sanction. In 
        other words, with respect to matters that do not involve a 
        violation of law, a bank's management is free to design and 
        innovate, while examiners remain free to identify best 
        practices and provide input.
---------------------------------------------------------------------------
     \35\ BCFP Bulletin 2018-01, ``Changes to Types of Supervisory 
Communications'' (Sept. 25, 2018) (emphasis added).
     \36\ Id.

    Last November, the Federal Reserve finalized a new ratings 
        system for large financial institutions that was substantially 
        clearer, more objective, and better focused on core matters of 
        financial condition than its predecessor. Although not perfect, 
        this new framework not only represents a meaningful shift 
        closer to transparency and the rule of law for those 
---------------------------------------------------------------------------
        institutions.

    The FDIC has recently withdrawn hundreds of Financial 
        Institution Letters, its version of regulatory guidance.

    In general, there has been a recent trend towards 
        publishing more regulatory requirements for public comment. As 
        the numbers show, the number of outstanding MRAs has reduced 
        over the past few years. Still, the numbers remain 
        extraordinarily high, particularly given that by every possible 
        objective measure the banking industry is in good health. 
        Furthermore, we cannot know whether those lower numbers reflect 
        a greater focus on material safety and soundness matters by 
        examiners, or simply the fact that banks have spent billions of 
        dollars redressing every possible examiner concern for the past 
        few years.

    More broadly, some banks have reported that examinations have 
recently become more focused on material issues. Others, though, have 
not. But the primary concern remains: when the great majority of 
requirements are imposed in secret, with no process, they can vary 
across banks and across time because there simply are no checks or 
balances. So, this fundamentally is not an issue of tighter regulation 
or looser regulation (deregulation) but an issue of consistent and 
predictable regulation that is consistent with the law.
Potential Next Steps
    How could matters be improved?
    First, the banking agencies should grant the petition for 
rulemaking filed by the Bank Policy Institute and the American Bankers 
Association, follow the example set by the CFPB, and confirm what they 
have already said in a recent statement: that guidance is not binding 
and will not form the basis for an MRA, and that only violations of law 
(including an unsafe and unsound practice) will form the basis for an 
MRA. This step is necessary because by numerous accounts their earlier 
statement is being disregarded in practice.
    Second, more broadly, the agencies should seek public comment on 
what an MRA is. If an MRA is an unenforceable suggestion, with no 
consequences for a company's ability to grow or invest, then they 
should make that clear. If it is a de facto order, then it should be 
issued only when there is a legal basis for it--a violation of law or 
an unsafe or unsound banking practice--and the bank should receive APA-
prescribed process.
    Third, a zero-based review of the application process should be 
undertaken by each banking agency. Pending such a review, the Federal 
Reserve should rescind its SR Letter 14-02 (establishing a series of 
ultra vires rules for bank expansion) and formally return to applying 
statutory standards for branching, merger, and investment applications. 
The OCC, which has acted similarly but without issuing public guidance 
to that effect, should do likewise. Any resulting application process 
should emphasize transparency and accountability. For example, the 
Governors of the Federal Reserve Board, the Comptroller of the 
Currency, and the Directors of the FDIC personally should receive 
regular reports on applications that have been pending for more than a 
given period--say, 75 days--along with the reason for the delay. The 
pendency of an investigation should not constitute grounds for delay 
absent extraordinary circumstances.
    Fourth, the CAMELS rating system should be rethought entirely. \37\ 
The Federal Reserve Board has recently adopted a significant rethinking 
of holding company ratings, and the banking agencies/FFIEC should do 
likewise. Such a review should emphasize the benefits of objective, 
transparent, consistent standards over subjective, opaque, and ad hoc 
standards. In particular, a management component, if retained, should 
not be a highly subjective wild card that can be used to deem a bank 
with solid capital, liquidity, and earnings to be unsafe and unsound, 
and thereby subject to an expansion ban. Any assessment of management 
should focus on financial management. A meaningful appeals process 
should be instituted.
---------------------------------------------------------------------------
     \37\ The expansion of bank supervision is having an impact on the 
economy. See Greg Baer and Jeremy Newell, ``How Bank Supervision Lost 
Its Way'', Underwritings: The BPI Blog (May 25, 2017), https://bpi.com/
how-bank-supervision-lost-its-way/.
---------------------------------------------------------------------------
Conclusion
    Many thanks for the opportunity to appear before you today.
                                 ______
                                 
                PREPARED STATEMENT OF MARGARET E. TAHYAR
                  Partner, Davis Polk and Wardwell LLP
                             April 30, 2019
    Many sectors of the economy are regulated. Only the banking sector 
is also supervised. The legal framework that governs the banking sector 
and the banking agencies is written and public. Whether you agree or 
disagree with the policy choices, the legal framework is made in full 
sight of all. Supervision happens behind closed doors. It relies upon 
secrecy and involves a system of discretionary actions by supervisory 
staff. This zone of secrecy is traditionally justified for the sake of 
financial stability and bank safety and soundness. There has long been 
an uneasy truce between the transparency and accountability required by 
the rule of law and the secrecy and discretion of supervision.
    That uneasy truce has become untenable. One canary in the coal mine 
is the increase in leaks of confidential supervisory information. The 
melody that canary is singing is changed societal mores about 
transparency. It also matters that confidential supervision can be a 
shield that makes it more difficult to hold the banking supervisors 
accountable. The public, including the Congressional oversight 
committees, scholars and others, has limited information about the work 
of the banking supervisors. Should they be praised or criticized? \1\ 
Nobody knows. The public debate, and academic scholarship, is 
critically underinformed.
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     \1\ Banking supervisors are highly professional men and women 
acting in good faith to carry out an important mission in monitoring 
the banking sector for safety and soundness and compliance with the 
law. The pressures on the supervisory staff during and since the 
Financial Crisis have been enormous. I am convinced that more openness 
will lead to as much praise as criticism.
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    As Hyman Minsky has noted, ``Perfection is out of the question, but 
better is possible.'' \2\ Understanding that some secrecy is necessary 
for bank safety and soundness and candid conversations, I recommend 
beginning with three changes.
---------------------------------------------------------------------------
     \2\ Hyman P. Minsky, ``Financial Instability and APT Bank 
Supervision'', Hyman P. Minsky Archive Paper 470, 24 (1992).
---------------------------------------------------------------------------
    First, the regulations governing confidential supervisory 
information need to be modernized. Their core framework was put in 
place during the late 1960s and only lightly updated in the mid-1990s. 
They no longer match the reality of the digital age. The realm of 
confidential supervisory information should be narrowed to the core 
minimum necessary to protect financial stability or individual bank 
safety and soundness.
    Second, we should recognize that one of the aftereffects of the 
Financial Crisis has been a vast expansion in the nature of supervision 
and its zone of secrecy and discretion. Social and economic policy 
choices are being made within a shadow regulatory system. From ``moral 
suasion'' to the matters requiring attention and matters requiring 
immediate attention that come out of the examination process, as well 
as horizontal reviews, banking organizations are subject to both a 
public and a nonpublic web of guidance and expectations. Sensible 
guardrails are needed so that supervision does not make economic and 
social policy choices that impact credit, jobs and growth in an ad hoc 
manner free from oversight. We should also recognize that secret lore 
\3\ and guidance have a troublesome placement in the legal framework 
since the concept of secret law in a democracy is on shaky ground.
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     \3\ I prefer the term ``secret lore'' to ``secret law'' even 
though many banking lawyers, myself included, will, in conversation 
refer to ``secret law.'' We do well to remind ourselves that, in a 
democratic country, law cannot be secret. And, under the Administrative 
Procedure Act, it is not.
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    Third, Congress and the banking agencies need to think clearly 
about how to create an environment where the supervisory staff are 
given the training, resources and tools that would permit them to do 
their jobs in a way that is more transparent to the world, where there 
is more accountability and where there is more consistency with the 
rule of law. As the zone of secrecy and discretion has widened, it has 
increasingly become delinked from the legal framework of the regulatory 
State. One way to increase those tools and resources, in light of the 
increased complexity of both the legal framework and the banking 
sector, is that training for the supervisory staff should be expanded 
to include core modules on the rule of law in a Constitutional 
democracy and the legal framework that governs the regulatory State.
    The time has come for a rebalancing of how the banking regulators 
supervise banking organizations. The extensive scope of the shadow 
regulatory system, which operates without transparency and with limited 
accountability, has become untenable in the digital age. The 
rebalancing should be in favor of more transparency, accountability and 
observance of the rule of law by the banking supervisors. We need to 
get this balance right as we move toward a more digital world with 
increasing reliance on algorithms. If the norms of the rule of law, 
transparency, and accountability are not part of supervisory culture, 
they will not find their way into new technology.
    We should not jettison confidential supervision but we ought to 
reform it for the 21st Century digital era.
    The need to rethink the theory of supervision and how we might go 
about it are inextricably linked to its history. I therefore begin in 
Part I by describing that history and suggesting principles for how to 
reform the regulators' approach to confidential supervisory 
information. In Part II, I set forth my view that supervisory staff 
have not been trained in the legal framework at a time when their jobs 
have grown tougher and the legal framework itself has become more 
complex.
I. The Need To Reform Confidential Supervisory Information
    The Federal banking regulators have long operated under a cultural 
mindset different from other independent Federal agencies both in the 
financial sector and in the larger regulatory State. \4\ History 
explains why the separate cultural tradition exists. This Part examines 
two regulatory traditions--a tradition of secrecy and discretion unique 
to banking supervision and a New Deal tradition of transparency in the 
regulatory State more broadly.
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     \4\ For the purposes of this testimony, the concept of a banking 
regulator is limited to the Federal Reserve, the OCC and the FDIC. The 
CFPB operates under newer, more transparent cultural norms.
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A. The Tradition of Secrecy and Discretion
    In banking supervision, two regulatory traditions have lived in an 
uneasy truce since the New Deal. The central core and direct ancestor 
of Federal banking supervision is the confidential bank examination, 
which dates back to at least the mid-19th Century. \5\ Many do not 
realize, however, that these traditions of secrecy and discretion 
developed at a time when there was limited Federal regulation of any 
sector, long before Federal deposit insurance, the creation of the 
Federal Reserve as the lender of last resort, the New Deal 
administrative State of the 1930s and the Administrative Procedure Act 
(APA) of 1946. The lack of a solid foundation in Federal law for many 
of the secrecy traditions of the banking regulators will surprise many 
who have accepted them as if they were contained in hallowed texts.
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     \5\ As Professor Conti-Brown has noted, ``the Examination Report 
from the Comptroller of the Currency for each bank remained the same in 
general form from 1865 to 1953--an extraordinarily stable institutional 
arrangement across a long period of economic, political, legal, and 
financial tumult.'' Peter Conti-Brown, ``Stress Tests and the End of 
Bank Supervision'', The Regulatory Review (Apr. 21, 2016), available at 
link.
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    There is another, more recent policy tradition, dating from the New 
Deal, which created Federal securities disclosure laws and put in place 
a legal framework that favors transparency and accountability by 
administrative agencies. Both traditions must abide by the rule of law 
in our Constitutional democracy.
    The truce remained workable when banks were engaged almost 
exclusively in taking demand deposits and making commercial loans. But, 
as market competition and technological change made the banking sector 
more complex, the uneasy and unexamined truce was, counterintuitively, 
sustained by the expansion of both the tradition of secrecy and 
discretion and that of transparency and the rule of law. In today's 
complex times, we have both more secrecy and discretion and more 
transparency. The problem is that we have them randomly and without 
serious thought about how the zone of secret supervision ought to work 
in the 21st Century digital era.
    The bank examination, where an outside person appointed by the 
State examines the books and records of the bank, has a long history. 
The 19th Century bank examiner's job was to look closely at the loans 
and liabilities of each individual bank and to make sure that vault 
cash and reserves really existed. \6\ He, and in the 19th Century it 
was always a he, performed his task in conditions of utmost secrecy. 
\7\ His critically important job was to assess whether the bank was 
safe and sound in an era when rumors could lead to deposit runs and 
bank panics were frequent. \8\ Thus developed the tradition of the 
secret bank examination, the crime of spreading false rumors about a 
bank \9\ and the view that bank supervision was best done inside a cone 
of confidentiality to preserve the stability of the financial system 
and avoid triggering a bank panic.
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     \6\ Simpler times exemplified in ``It's a Wonderful Life'' by Mr. 
Carter, a diligent bank examiner checking whether the Bailey Building 
and Loan had cash in its vault.
     \7\ The first woman bank examiner was Adelia M. Stewart who 
officially become a bank examiner in 1921, after having gone to law 
school at night and having worked as a ``clerk-stenographer'' at the 
OCC since 1892. In 1922, the year after she was the first woman to pass 
the test for national bank examiners, she was promoted to head of the 
examination division. See Office of the Comptroller of the Currency, 
``The Changing Role of Women in the Workplace'', available at link. I 
like to imagine that the first woman examiner understood the tight link 
between the legal framework and supervision.
     \8\ Panics took hold of the American banking sector in 1819, 1837, 
1857, 1873, 1893, 1901, 1907, 1929, and 1933, as well as in 2007-2008.
     \9\ N.Y. Banking Law 671 False Statements or Rumors as to Banking 
Institutions.
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    Central to the concept of a confidential bank examination is the 
need for a free flow of communication in conditions of high trust 
between a bank's management, its board of directors and supervisory 
personnel. Bank examiners and the banking sector feel strongly about 
the need for this candid conversation, which has contributed to the 
creation of a common-law bank examiners' privilege that keeps reports 
out of the public domain and out of the hands of the plaintiff's bar. 
\10\ The other justification for a confidential bank examination report 
has been that it contains private personal information about bank 
customers and unvarnished views about the creditworthiness of 
borrowers. The free flow of information, much of it deliberately and 
appropriately leaning toward the negative and critical, and the 
protection of personal information are policy goals to be taken 
seriously today.
---------------------------------------------------------------------------
     \10\ The need for candid conversations in the supervisory context 
is hotly defended in the courts by banking regulators. By sharp 
contrast, banking regulators frequently take the view that the 
attorney-client privilege should be waived by the banks or limited in 
supervisory communications. So, sometimes candid conversations are 
encouraged and sometimes they are not.
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    The Federal banking regulators used the passage of FOIA in the mid-
1960s, a statute meant to expand the scope of information available to 
the public, to expand their zone of confidentiality beyond the scope of 
the traditional bank examination. There is no Federal statute that 
explicitly prohibits anyone other than bank examiners from disclosing 
the bank examination or parts of it, \11\ such as CAMELS or other 
ratings. \12\ Soon after the passage of FOIA, \13\ each of the Federal 
Reserve, the OCC and the FDIC promulgated stern but ambiguous 
regulations that contain additional constraints on the sharing of 
confidential supervisory information. These regulations also introduced 
the assertion of the Federal banking regulators that bank examinations 
and other supervisory communications are the property of the banking 
regulators.
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     \11\ There is a Federal criminal statute that prohibits bank 
examiners from disclosing the results of an examination. See 18 U.S.C. 
1906. Few are aware, however, that the Comptroller may, if he is not 
satisfied with the response of a national bank, disclose an 
examination. See 12 U.S.C. 481.
     \12\ CAMELS is used in this testimony for simplicity even though 
there are other ratings systems with their own acronyms.
     \13\ The precise words of the FOIA statute's exemption, which were 
originally drafted by the banking regulators, encompass matters 
``contained in or related to examination, operating, or condition 
reports prepared by, on behalf of, or for the use of an agency 
responsible for the regulation or supervision of financial 
institutions'' from disclosure.
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    The authority to treat confidential supervisory information as 
property is less solid than one might think, relying on a general 
Federal statute relating to Federal Government property. One suspects 
that the general Federal property law was pressed into service by the 
Federal banking regulators because no other statutory authority was 
available. The result of viewing bank examinations or other supervisory 
communications as the property of the State is that stealing them or 
misusing them becomes a crime. It is solely from this source that the 
criminal prohibitions on banking organizations revealing bank 
examinations or other supervisory communications derive. With the 
increased scope of confidential supervisory information along with the 
changes in technology and societal mores, it is increasingly 
uncomfortable for banking entities and their personnel to have to worry 
about criminal liability for the ``property'' of the banking 
regulators. \14\
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     \14\ One of the elements of the confidential supervisory 
information regulations that needs updating is the requirement that any 
``property'' of the banking regulators be viewed on bank premises. This 
made sense in the late 1960s, but with the development of email and the 
cloud, it no longer does.
---------------------------------------------------------------------------
    The banking regulators have defined this type of ``property'' very 
broadly in their regulations, the plain text of which could be read to 
encompass a vast amount of information. Tracking the statute, the 
Federal Reserve's definition of confidential supervisory information 
includes any document prepared by a banking organization ``for the use 
of'' the Federal Reserve. \15\ The FDIC's definition is similar. \16\ 
The Federal Reserve's definition excludes documents prepared by the 
banking organization ``for its own business purposes and that are in 
its possession.'' \17\ The FDIC does not have such an explicit 
exclusion. The OCC's definition of confidential supervisory information 
(in OCC parlance, ``nonpublic OCC information'') is broader and 
includes any ``record'' that is ``obtained'' by the OCC in connection 
with the OCC's performance of its duties, including ``supervision.'' 
\18\
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     \15\ 12 CFR 261.2(c)(1)(iii).
     \16\ See 12 CFR 309.5(g)(8).
     \17\ 12 CFR 261.2(c)(2).
     \18\ 12 CFR 4.32(b).
---------------------------------------------------------------------------
    These regulations were put in place before a world of email, 
electronic files, the cloud and PowerPoint and at a time when the data 
and information flow was much smaller. The line between data prepared 
by the banking organization ``for the use'' of the agency or for its 
own ``business purposes'' is a troublesome one in the supervisory 
context today. It cannot be that, by some means of transubstantiation, 
every bit of data or every PowerPoint sent to the regulators becomes 
confidential supervisory information. \19\
---------------------------------------------------------------------------
     \19\ Even if such information were not considered confidential 
supervisory information, other exemptions from FOIA disclosure may 
apply, such as the exception for trade secrets, confidential commercial 
or financial information and personal information.
---------------------------------------------------------------------------
    The Federal Reserve, the FDIC and the OCC all permit sharing of 
confidential supervisory information within the banking organization. 
Under the OCC's regulation, sharing within the banking organization is 
permitted only ``where necessary or appropriate for business 
purposes.'' \20\ The OCC has not defined what would be necessary or 
appropriate for business purposes and criminal liability may hang on 
this ambiguous phrase. These ambiguities will get more intense as we 
enter into more technologically infused RegTech. There is a real 
question whether these vague standards, along with the changes in the 
world since the 1960s, ought to continue to contain the threat of 
criminal liability.
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     \20\ 12 CFR 4.37(b)(2). The Federal Reserve does not have this 
limitation on sharing in the group. The FDIC's regulations require that 
there be an annual board resolution for a bank to share a report of 
examination with its parent, which must contain a number of archaic 
requirements. These requirements include that the resolution 
specifically name the parent holding company and state the snail mail 
address to which the reports are to be sent. See 12 CFR 
309.6(b)(7)(iii)(B).
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B. The Other Tradition of Transparency
    The other regulatory tradition has as its central paradigm that of 
the disinfectant of disclosure. \21\ Created in the New Deal or as an 
immediate reaction to it, the norms of the securities disclosure laws 
and the APA illustrate this cultural mode of transparency. These laws 
take a very different approach to the relationship between the 
Government and the governed.
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     \21\ As Justice Brandeis famously said just before his time on the 
court, ``[s]unlight is said to be the best of disinfectants.'' Louis D. 
Brandeis, ``Other People's Money and How the Bankers Use It'' 93 
(Frederick A. Stokes Company ed. 1914).
---------------------------------------------------------------------------
    The APA is properly viewed as a ``bill of rights for the new 
regulatory State.'' \22\ It demands that regulations be public and 
subject to notice and comment, and has transparency and accountability 
as its central core. The APA was the end product of a decade's worth of 
political wrangling between New Dealers, who fought for the expansion 
of a discretionary administrative State, and those concerned with the 
rule of law and transparency. A compromise was finally reached 
following Truman's assumption of the Presidency, in a post-WWII 
environment more sensitive to authoritarian tendencies. \23\ Public 
choice scholarship since the New Deal has widely shown that the 
regulators also have their own stakeholder interests.
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     \22\ George B. Shepherd, ``Fierce Compromise: The Administrative 
Procedure Act Emerges From New Deal Politics'', 90 NW. U. L. Rev. 1557, 
1558 (1996).
     \23\ See id. at 1683.
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    It was not immediately clear whether or to what extent this new 
approach would apply to banking regulators, at least from the 
perspective of the supervisors accustomed to secrecy and discretion. 
While for many readers the New Deal and the passage of the APA may seem 
like long ago developments, it is important to understand that, by the 
time of their passage, the cultural traditions and institutional path 
dependency of the banking supervisors had already been set. Early 
versions of the bill that became the APA excluded the Federal banking 
agencies from its scope. \24\ The banking regulators might be forgiven, 
in the early years after the APA, for thinking that the APA only 
lightly applied to them. But we are now nearly 85 years since the 
passage of the Securities Exchange Act and 73 years since the passage 
of the APA. The impulse toward secrecy remains strong within the 
banking regulators, even as transparency and accountability have become 
foundational tenets of administrative law. \25\
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     \24\ See id. at 1618.
     \25\ As stated by Professor Gillian Metzger, ``Accountability is 
administrative law's central obsession, which it furthers through 
mechanisms for public participation, congressional oversight, 
centralized White House regulatory review, and judicial review. Fear of 
agency capture is a recurring theme, as is the concern that agencies 
will wield their delegated powers arbitrarily.'' Gillian E. Metzger, 
``Through the Looking Glass to a Shared Reflection: The Evolving 
Relationship Between Administrative Law and Financial Regulation'', 78 
Law and Contemp. Probs. 129, 130 (2015).
---------------------------------------------------------------------------
    A key question is how both of these regulatory traditions--the 
long-standing secrecy of banking regulators and the 20th Century 
paradigm of a transparent administrative State more broadly--have 
managed to coexist in an uneasy truce for so long. One part of the 
answer is counterintuitive: as the banking sector has become more 
complex, both transparency and secrecy have expanded in scope.
    For example, the scope of financial disclosure and its companion 
market discipline has been expanding over the last 50 years vis-a-vis 
banking organizations. \26\ In addition to the constraints of the 
securities laws, Pillar 3 of Basel II, now in full implementation, also 
requires more disclosure. The existence of enhanced capital and 
liquidity requirements, subordinated debt, credit default swaps, and, 
more recently, TLAC debt that might be bailed in, all push towards 
market signaling functions.
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     \26\ The long-standing spat between the banking regulators and the 
SEC on the calculation of allowances for loan losses is an example of 
the transparency and secrecy traditions clashing. See George J. Benston 
and Larry D. Wall, ``How Should Banks Account for Loan Losses?'', 
Federal Reserve Bank of Atlanta (2005), available at link. That clash 
was resolved by an administrative detente in the early 2000s. 
Nonetheless, so-called GAAP/RAAP debates sometimes show up in the 
footnotes to call reports. It remains to be seen how the implementation 
of CECL will impact this dynamic.
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    The public nature of these disclosures has become so embedded in 
our consciousness that many have forgotten that the requirements to 
disclose hundreds of pages of information, whether in periodic reports 
under the securities laws, Pillar 3 or the many public reports filed by 
banking organizations, were once new and shocking in the banking 
sector. Banking-sector requirements for disclosure lagged the 
disclosure norms in other sectors by many years. Call reports were not 
made public by the FDIC until 1972 and even then, it was upon request, 
with a fee for search costs, \27\ bank stocks were not subject to 
periodic reporting until 1964, \28\ the requirements of Guide 3 date 
from 1976 \29\ and audited bank financial statements were not required 
under Federal law until 1991. \30\ When CAMELS ratings were first 
created, they were not even disclosed to bank management. \31\
---------------------------------------------------------------------------
     \27\ See 37 FR 28607, 28608 (Dec. 28, 1972).
     \28\ See Alfred D. Mathewson, ``From Confidential Supervision to 
Market Discipline: The Role of Disclosure in the Regulation of 
Commercial Banks'', 11 J. of Corp. L. 139, 141 (1986).
     \29\ See id. at 161.
     \30\ See Eugene N. White, ``Lessons From the History of Bank 
Examination and Supervision in the United States 1863-2008'', in 
Financial Market Regulation in the Wake of Financial Crisis: The 
Historical Experience Conference 15, 34 (2009), available at link.
     \31\ See Ron Feldman, Julapa Jagtiani, and Jason Schmidt, ``The 
Impact of Supervisory Disclosure on the Supervisory Process: Will Bank 
Supervisors Be Less Likely To Downgrade Banks?'' in Market Discipline 
in Banking: Theory and Evidence, edited by G. Kaufman in Research in 
Financial Services, Elsevier, at 3 (2003), available at link.
---------------------------------------------------------------------------
    The formal and informal punitive actions of the banking regulators 
against banking organizations have also become increasingly more 
public. Banking regulators were not given formal enforcement powers 
until 1966. Before that, moral suasion and ``jawboning'' were the main 
powers of the banking supervisors, backed by the nuclear, and therefore 
not used, threat to revoke a charter or terminate deposit insurance. 
Even after the banking regulators were given the power to remove 
directors and officers, impose civil money penalties and enter into 
informal written memoranda or formal consent or cease and desist 
orders, the tendency was to favor informal--that is, nonpublic--board 
resolutions and memoranda of understanding (MOU). The long litany of 
very public post-Financial Crisis consent orders shows that the old 
custom has definitively changed to be more transparent. As a result, 
there is an increasing tendency to disclose informal and private MOUs 
in securities disclosure documents, with the express consent of the 
banking regulators, when their contents are deemed material to 
investors. \32\
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     \32\ Requirements to raise capital and restrictions on dividends 
are the core examples. Other MOUs remain undisclosed.
---------------------------------------------------------------------------
    Also on the side of transparency, the long-term trend has been 
toward a greater tendency to publish guidance, interpretations, and 
FAQs, and greater disclosure of informal and formal enforcement actions 
against banking organizations. Many interpretive positions, even in the 
form of written letters, were typically kept secret well into the 
1990s. It was long a given that the only way to find out the 
interpretive views of the Federal Reserve was to file a FOIA request 
and hope for the best. \33\ The development of the Internet, which 
brings with it increased expectations of transparency, has meant that 
many, but not all, interpretive positions now find their way onto the 
banking regulators' websites. There is more in the public domain than 
ever before. This trend started even before the Financial Crisis and 
the Dodd-Frank Act, which required 390 new rulemakings by the banking 
agencies. \34\ A prominent pre- Dodd-Frank example is that the long 
history of semipublic interpretations under Section 23A of the Federal 
Reserve Act came to an end with the promulgation of Regulation W in 
2002.
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     \33\ As a young lawyer in the early 1990s, I was frequently given 
the task of crafting a FOIA request to capture a secret interpretive 
letter that was known by the bank regulatory bar to exist but that was 
not public. Letters received under FOIA were carefully tended in paper 
files and shared among banking lawyers. Contrast that cultural mode 
with that of the SEC, which began publishing no-action letters in 1970. 
See Donna M. Nagy, ``Judicial Reliance on Regulatory Interpretations in 
SEC No-Action Letters: Current Problems and a Proposed Framework'', 83 
Cornell L. Rev. 921, 948-49 (1998).
     \34\ See Davis Polk and Wardwell LLP, ``Dodd-Frank Progress 
Report'' (July 19, 2016), available at link.
---------------------------------------------------------------------------
    Yet, all of these advances in transparency and accountability are 
not enough, either for the rule of law or for the norms of the digital 
age. The disparate elements of increased use of the Congressional 
Review Act, the GAO ruling that guidance can be subject to the 
Congressional Review Act, an increased focus on cost-benefit analysis 
in financial regulation and increased attention by the OMB on major 
guidance issued by independent agencies each, in their own way, are 
attempts to answer the call for more transparency and accountability.
C. The Increasing Scope of Secret Guidance and Lore
    Against this recent societal backdrop of increased transparency and 
accountability is the opposite tradition covered by confidential 
supervisory information, secret guidance and secret lore. As a noted 
administrative law scholar has argued:

        The banking agencies of the Federal Government have long 
        maintained systems of secret evidence, secret law, and secret 
        policy. The result has been a degree of unchecked and 
        unstructured discretionary power that is far greater than it 
        should be. Sound principle calls for openness, so that 
        discretion may be checked and structured. To some extent the 
        systems the agencies have been following violate existing legal 
        requirements. The banking agencies can and should make 
        procedural changes that will increase both efficiency and 
        fairness. \35\
---------------------------------------------------------------------------
     \35\ Kenneth Culp Davis, ``Administrative Procedure in the 
Regulation of Banking'', 31 Law and Contemp. Probs. 713 (1966).

    What may come as a surprise is that these statements were made in 
1966. They remain fresh today.
    Indeed, I would posit that as supervision and the banking sector 
have grown more complex, the amount of confidential supervisory 
information shielded from public view has increased vastly not only 
since 1966, but also at an accelerated pace after the Financial Crisis. 
One reason for the expansion of confidential supervisory information is 
that the traditional bank examination has morphed into something much 
wider in scale and scope than its 19th and early 20th Century ancestor. 
A regional banking organization will have up to 50 bank examinations on 
different topics a year; a G-SIB will have hundreds. The annual roll-up 
examination now covers multiple areas, and the number of matters 
requiring attention or immediate attention have expanded into hundreds 
for some banking organizations. It is a fair question, in a time of 
high capital and liquidity, what these matters requiring attention are 
covering and at what level of materiality. It goes without saying that 
there is no sense of cost-benefit or proportionality. The lack of 
public data is disturbing.
    Economic and social policy, affecting financial stability, economic 
growth and jobs, is being fashioned in the shadows of the confidential 
supervisory arena. Some of these economic and social policy choices may 
reflect the right tradeoffs, but, as they are made, Congress and the 
public have no way of knowing. Before regulators act through matters 
requiring attention, horizontal reviews, guidance or lore, we should 
ask why a particular policy choice or regulatory interpretation is 
being made under the rule of discretion rather than the rule of law. In 
an era of increased transparency and accountability, policy choices 
that have an impact on access to deposit services, credit allocation, 
and investment in the banking sector--that is on jobs and growth--
should be open, not secret.
    Today's supervisory culture has moved far away from the core of 
examining the quality of a bank's loans or the amount of cash it has in 
its vault. It is easy to understand how the supervisory theory of the 
traditional bank examination translates into supervision over capital 
and liquidity, including stress testing. The theory of supervision for 
the 21st Century becomes muddled, however, once one leaves the realm of 
qualitative judgements around a quantitative core. How should 
compliance with law examinations be fashioned? What is the purpose 
behind supervisors' focus on the internal governance structure of 
management, the review of the minutes of management's discussions and 
forced changes in reporting lines? \36\ On what basis was the ideology 
of the three lines of defense imposed upon almost all banking 
organizations? \37\ The word supervision, although longstanding, 
appears nowhere in the legal framework governing the banking sector. 
The only public source is the explanations published in agency reports 
and on agency websites. These explanations are not helpful to 
understanding the theory of banking supervision beyond logical 
extensions of the traditional banking examination. \38\ Academic 
scholarship on supervision is almost nonexistent and hard to do given 
that what is happening is kept confidential. Congressional oversight is 
also made more difficult.
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     \36\ Since the Financial Crisis, the banking agencies have 
required that compliance in larger institutions report to risk, not 
legal. These decisions were taken without any public comment or 
discussion, and the evidentiary basis for them was not developed. In 
most smaller and regional banking organizations, compliance remains 
within legal. The collateral consequences of two competing poles of 
legal interpretation and judgement within the organization were not 
considered.
     \37\ The three lines of defense appears in only one place in the 
legal framework in guidelines issued by the OCC in 2014. See 12 CFR pt. 
30 app. D. It is otherwise not a part of the traditional bank 
supervision. There was no cost-benefit analysis around its adoption in 
the OCC's guidelines and it was imported from a position paper of The 
Institute of Internal Auditors. See generally The Institute of Internal 
Auditors, IIA Position Paper: ``The Three Lines of Defense in Effective 
Risk Management and Control'' (January 2013), available at link.
     \38\ The Federal Reserve describes supervision as follows: ``Once 
the rules and regulations are established, supervision--which involves 
monitoring, inspecting, and examining financial institutions--seeks to 
ensure that an institution complies with those rules and regulations, 
and that it operates in a safe and sound manner.'' Board of Governors 
of the Federal Reserve System, The Federal Reserve System: Purposes and 
Functions, at 73 (10th ed., Oct. 2016), available at link. Until 
recently, however, the OCC included the promulgation of regulations in 
its concept of supervision. The OCC's 2017 annual report, for example, 
listed the power to issue regulations as one of its supervisory powers, 
but that was removed from the 2018 report. Compare Office of the 
Comptroller of the Currency, 2017 Annual Report, at 2, available at 
link, with Office of the Comptroller of the Currency, 2018 Annual 
Report, at 1, available at link. The FDIC's 2018 annual report does not 
explicitly distinguish between supervision and regulation under its 
``Supervision'' section. Federal Deposit Insurance Corporation, 2018 
Annual Report, at 14-20, available at link. Moreover, it contains a 
section titled ``Supervision Policy'' that groups together discussions 
of supervision programs, rulemaking, and supervisory guidance. Id. at 
20-26.
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    The bias, for important policy choices affecting economic and 
social conditions, should be toward the rule of law and transparency. 
The realm of lore or secret constraints on banking organizations should 
be narrowed to a core minimum of what is necessary to preserve 
financial stability or the safety and soundness of any one banking 
organization. Part of the challenge is that, a decade ago, the 
supervisory staff, like the rest of us, lived through the Financial 
Crisis and its aftermath on the economy. When the fire is raging, the 
firefighters appropriately use whatever tools are handy, whether it is 
by the stretching of legal texts or the need for tough supervisory 
actions. But, long after the fire, when the house has been rebuilt on a 
better foundation, it is time to leave behind the emergency culture of 
firefighting and think in terms of regular maintenance.
    As those within banking organizations will know, it is only 
possible, because of the constraints of confidential supervisory 
information, to speak about those examples that have randomly become 
public. Those who are at banking organizations or the regulators will 
know that there are many additional examples. This informal nonpublic 
shadow system of regulation is neither transparent nor accountable.
    For example, what became the leveraged lending guidelines, which 
are meant to guard against the next asset bubble, started in the bank 
examination. They were originally sent to banks as confidential 
letters, and banks were not permitted to disclose to their clients such 
letters' existence, or the reasons why banks were not making certain 
loans. From the perspective of the banking regulators, the leveraged 
lending guidelines were an advancement in transparency and disclosure. 
They were, after all, public and had been subject to notice and 
comment. From the perspective of those who have been thinking deeply 
about the administrative law and its march towards transparency and 
accountability, they did not go far enough. Similarly, there have been 
attempts to take legal interpretations on the Volcker Rule in the 
context of bank examinations.
    As one more significant example of important policy being made in 
the shadows, the Federal Reserve's lore on what constitutes a 
``controlling influence'' and the so-called ``tear-down rules'' were 
mostly secret for a long time. These are not ``rules'' at all, but a 
series of oral principles, not made public nor written down, but which 
reflect the views of some legal staff at a moment in time. In a welcome 
development, the Federal Reserve last week announced a move from the 
``Delphic and hermetic process'' for ordaining control to notice and 
comment rulemaking. \39\ In announcing the proposed rulemaking, Vice 
Chair for Supervision Quarles acknowledged that divining whether the 
Board will find control under the existing framework requires 
``supplication to a small handful of people who have spent a long 
apprenticeship in the subtle hermeneutics of Federal Reserve lore, 
receiving the wisdom of their elders through oral tradition in the way 
that gnostic secrets are transmitted from shaman to novice in the 
culture of some tribes of the Orinoco.'' \40\ As the Vice Chair for 
Supervision implies with his colorful metaphor, the oral tradition from 
shaman to novice is not good governance.
---------------------------------------------------------------------------
     \39\ Board of Governors of the Federal Reserve System, ``Federal 
Reserve Board Invites Public Comment on Proposal To Simplify and 
Increase the Transparency of Rules for Determining Control of a Banking 
Organization'', Press Release (Apr. 23, 2019), link (statement of Vice 
Chair for Supervision Quarles).
     \40\ Board of Governors of the Federal Reserve System, 
``Transcript Open Board Meeting on April 23, 2019'', at 2-3, available 
at link.
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    Another example arises because of the ability of the Federal 
Reserve to impose limitations on the conduct and activities of a 
financial holding company. To qualify as a financial holding company, 
an institution and all of its insured depository institution's 
subsidiaries must be both ``well managed'' and ``well capitalized.'' 
Under Section 4(m) of the Bank Holding Company Act, the Federal Reserve 
may impose limitations on the conduct and activities of a financial 
holding company that fails to satisfy either condition, and the 
financial holding company is required to enter into a 4(m) agreement to 
comply with those limitations. Because the Federal Reserve treats the 
failure to be well managed as confidential supervisory information, the 
existence and scope of 4(m) limitations are confidential if based on 
the failure to satisfy the well managed condition. One study, which 
examined the securities disclosures of 60 financial holding companies 
(FHCs) between the years 2005 and 2017, noted that nearly all FHCs 
disclose that they are well capitalized but many do not disclose if 
they are well managed. \41\
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     \41\ ``Ethics Metrics, Analysis of Bank Holding Company 
Disclosures'', comments submitted May 8, 2017, to the SEC on its 
Industry Guide 3, Statistical Disclosure by Bank Holding Companies, 8, 
link.
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    Another example has come about due to the informal ``penalty box'' 
rules of thumb that the banking supervisors have applied to banking 
organizations as a result of CAMELS ratings, especially as to 
Management ratings, BSA/AML compliance reviews and consumer compliance 
reviews. Tacit principles in the evaluation of management include the 
fact that any compliance problem resulting in an enforcement action 
will result in a downgrade of the Management rating and that it is 
often hard for a bank to obtain a Composite rating better than ``3'' if 
it has a Management rating of ``3''. \42\ Bank expansion is not 
possible as long as a consent order is pending, meaning banks of all 
sizes devote board and management time as well as technology resources 
toward even the most immaterial compliance concerns to ensure 
regulators are fully satisfied. \43\ Appeals against adverse ratings 
are rare because appeals must be made to the same agency that issued 
the rating--part of evaluation is the readiness with which management 
responds to regulator criticisms, and banks are warned that ``examiners 
have long memories.'' \44\
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     \42\ See ``Examination of the Federal Financial Regulatory System 
and Opportunities for Reform'': Hearing before the U.S. H. Financial 
Services Subcomm. on Financial Institutions and Consumer Credit, 115th 
Cong. 10 (2017) (statement of Greg Baer, President, The Clearing House 
Association), available at link.
     \43\ See id. at 11.
     \44\ See id. at 12.
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    The evolution of the living wills guidance is also instructive. 
Resolution plans and their guidance started out as largely 
confidential, then morphed into a mix of confidential and public 
feedback--all of which applied--and finally, over the years, regulators 
nudged toward public guidance. The first set of public guidance was 
issued without advance warning or notice and comment and stated that 
all previous guidance, public and private continued to apply. For those 
working on living wills, figuring out which parts of which years' 
private guidance no longer applied--because it was not aligned with the 
public guidance--was a puzzle. More recently, and in a welcome move, 
the Federal Reserve and the FDIC have issued new guidance, subject to 
notice and comment, that makes it clear that all previous guidance has 
now been superseded. The point here is that banking organizations were 
subject to a mix of private and public expectations, many of which were 
not clearly aligned and all of which were perceived as binding.
    The long tradition of regulation by negotiation in the applications 
process is another type of shadow regulatory system. \45\ Conditions, 
sometimes not linked to the pending application, are imposed. 
Regulators strategically use delays and silence to encourage silent, 
nonpublic withdrawals of applications. Some have called this regulation 
by negotiation but it is more akin to regulation by threat or 
intimidation. \46\ An illustrative example, which can be used because 
it is one of the few to become public, comes from applications by 
Citicorp, J.P. Morgan, and Bankers Trust New York Corporation in 1987 
to underwrite and deal in municipal revenue bonds, mortgage related 
securities and commercial paper. \47\ During negotiations with agency 
staff, each applicant ``voluntarily'' consented to market share 
limitations while protesting that they saw no need for them. When 
considered for review by the Federal Reserve Board of Governors, the 
banks admitted that they agreed to the limitations only to ``expedite 
the applications.'' \48\ In this instance, the market share limitations 
were ultimately overturned by the Second Circuit but normally such 
``voluntary'' commitments do not come up in final orders and are 
unlikely to be challenged in court or known to the public. \49\ As a 
result, the staff conducting negotiations during the application 
process wield an immense policymaking power.
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     \45\ See Culp Davis, ``Administrative Procedure in the Regulation 
of Banking'', supra n. 35, at 713 (arguing the OCC practice of making 
decisions regarding charter applications without providing reasoned 
opinions or findings of fact lends itself toward arbitrariness).
     \46\ Daniel Schwarz and David T. Zaring, ``Regulation by Threat: 
Dodd-Frank and the Non-Bank Problem'', 84 U. Chic. L. Rev. 1813, 1817 
(2017).
     \47\ See Alfred C. Aman, Jr., ``Bargaining for Justice: An 
Examination of the Use and Limits of Conditions by the Federal Reserve 
Board'', 74 Iowa L. Rev. 837, 894-95 (1989).
     \48\ See id. at 895.
     \49\ See id.
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    Many have debated whether confidential supervision and its secret 
lore are binding upon banking organizations. The recent ``guidance on 
guidance'' from the banking regulators seeks to settle that debate by 
stating that guidance is not binding unless it impacts safety and 
soundness. In a world where the supervisor can punish the banking 
organization and mold its behavior through these tools, from the 
perspective of those who receive it, the secret guidance and lore may 
as well be binding. Of course, banking organizations frequently seek 
and are happy to receive nonpublic guidance, on a written or oral 
basis, from the supervisory staff. The point is not to eliminate these 
communications but to put more guardrails around them, as the guidance 
on guidance begins to do.
D. Uneasy Truce Is Now Untenable--Tilt Towards Accountability and 
        Transparency
    The uneasy truce between the tradition of secrecy and the tradition 
of accountability has become untenable. The signal that the balance is 
askew is the increase in leaks of confidential supervisory information. 
By my count, there have been 7 leaks of confidential supervisory 
information that have made their way into the media since 2011, some 
but not all of which can be traced to regulators. In addition, in 2016 
one judge released the CAMELS ratings of a bank \50\ and, near the time 
of the Financial Crisis, two exam reports were released by the 
Financial Crisis Inquiry Commission. Before 2011, leaks of confidential 
supervisory information into the public square were virtually unknown. 
So far, each of these releases has been treated as a one-off situation. 
It is time to consider, however, whether they are a signal of the 
pressures felt by humans living in a digital society where there is a 
strong tilt towards transparency.
---------------------------------------------------------------------------
     \50\ See Memorandum Opinion and Order, Builders Bank v. FDIC., No. 
15-cv-06033 (N.D. Ill Apr. 25, 2016), ECF No. 26.
---------------------------------------------------------------------------
    There is also an increase in the officially sanctioned publication 
of confidential supervisory information by the banking supervisors 
themselves. Confidential supervisory information belongs to the 
supervisors who can choose, when they so desire, to disclose it. 
Although the Comptroller has not used his power to disclose examination 
results to the public, that power exists. The New York Department of 
Financial Services in 2017 used its power to release information in the 
public interest to release its otherwise confidential ratings of Bank 
of Tokyo-Mitsubishi as part of its ongoing spat with the bank and the 
Comptroller over who should be the primary regulator of the bank's New 
York branch. \51\ The decision about what is in the public interest and 
its timing is entirely in the hands of the supervisors.
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     \51\ Letter from Shirin Emami, Executive Deputy Superintendent-
Banking, N.Y. State Dept. of Fin. Servs., to Marva V. Cummings, 
Director for District Licensing, OCC (Nov. 13, 2017), available at 
link.
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    Banking organizations, however, are silenced in the public arena 
when the media or Congress make statements that might otherwise be 
corrected but for the rebuttal being considered confidential 
supervisory information, even when that information has been made 
public by the regulatory staff. As one example of the potential 
chilling effect, the OCC issued a bulletin reminding banking 
organizations of their confidentiality responsibilities and potential 
criminal liability just 2 weeks before the CEOs of the Nation's largest 
banks were scheduled to testify before the House Financial Services 
Committee. \52\
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     \52\ See OCC, Bulletin 2019-15: Statement on Confidentiality (Mar. 
25, 2019), available at link; United States House Committee on 
Financial Services, Hearing: ``Holding Megabanks Accountable: A Review 
of Global Systemically Important Banks 10 years after the Financial 
Crisis'' (Apr. 10, 2019), available at link.
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E. What Policy Purpose Is Served by Confidential Supervision and 
        Discretionary Actions?
    The question then becomes how to improve the existing situation by 
narrowing the scope of confidential supervisory information. Following 
in the footsteps of Minsky, we should aim for better, not perfect. We 
are moving into an era where policy making will increasingly be driven 
by data analytics and evidence in a technological environment. Going 
forward, three key questions ought to be asked about confidential 
supervision. Each one of these questions would involve a new way of 
thinking.
    1. Why is this topic being treated confidentially? Banking 
regulators and banking organization should begin to ask themselves why 
a given topic is being treated as confidential. There should be a tight 
link to financial stability and the need for candid conversations. 
There should be a serious reexamination, from first principles, of how 
the obligations of the securities laws and confidential supervision 
interact. It is fair to ask why shouldn't banks have the option to make 
their CAMELS ratings public. After all, since 1990, the results of CRA 
examinations have been made public. \53\ Or, one could ask why the 
banking regulators don't publish examination findings and trends in 
matters requiring attention in anonymous aggregate but with granular 
detail. \54\ One thing is certain, however, and that is that any reform 
of the confidential supervisory information regulations and culture 
needs to be done on a systemic basis that applies equally to all 
banking organizations. Right now, the practical reality is one where 
some institutions sometimes are subject to random leaks or disclosures 
and others are not. There is a deep unfairness in that situation.
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     \53\ See FFIEC Interagency CRA Rating File Specifications, 
Community Reinvestment Act, FFIEC, link (last visited Apr. 22, 2018).
     \54\ The Federal Reserve's recent ``Supervision and Regulation 
Report'' is an excellent start. Board of Governors of the Federal 
Reserve System, ``Supervision and Regulation Report'' (Nov. 2018), 
available at link.
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    2. Who or what is being protected by the confidentiality? Sometimes 
confidentiality shields the supervisors' actions from the public 
scrutiny. How is it that the confidential ``penalty box'' constraints 
on a banking organization's activities can exist for years? \55\ Do 
CAMELS ratings really judge individual institutions or do they follow 
the trends of the business cycle? On what basis are matters requiring 
attention and matters requiring immediate attention issued and what 
patterns exist in them? Some of these examples are areas where the 
supervisor fears that its actions would be controversial to the public 
and so a confidential route is chosen, or sometimes the confidential 
route is traveled just because it is familiar and is done without much 
forethought. If confidentiality is chosen to protect the regulator from 
public scrutiny, it is not appropriate. If, however, it is chosen for 
financial stability, then it is appropriate.
---------------------------------------------------------------------------
     \55\ Transcript of Q&A with Federal Reserve's Randal Quarles, WSJ 
(Nov. 7, 2017), available at link (statement by Greg Baer) [hereinafter 
Quarles Transcript].
---------------------------------------------------------------------------
    3. Why is this policy choice or regulatory interpretation being 
made under the confidential rule of discretion rather than the rule of 
law? Why did the leveraged lending guidelines start as confidential 
letters? What is one to make, for example, of Henry Paulson admitting 
that he privately threatened to remove the management and board of Bank 
of America if it did not complete a merger with Merrill Lynch? He has 
since stated ``[b]y referring to the Federal Reserve's supervisory 
powers, I intended to deliver a strong message.'' \56\ This message was 
not disclosed at the time. The penalty box, and many nonpublic examples 
involve similar threats of confidential supervisory actions. \57\ The 
increasing number of banks requesting to strengthen their ability to 
appeal examination results reflects the sense that confidential 
supervision can look like a weapon when it is shrouded in secrecy. \58\ 
On what basis can new standards be imposed upon banking organizations 
through horizontal reviews by supervisors that are not made transparent 
to the organizations or the public?
---------------------------------------------------------------------------
     \56\ Martin Kady II, ``Paulson Admits To Threatening Lewis'', 
Politico (July 17, 2009), link.
     \57\ Quarles Transcript, supra n. 55 (statement by Greg Baer).
     \58\ Julia Anderson Hill, ``When Bank Examiners Get It Wrong: 
Financial Institution Appeals of Material Supervisory Determinations'', 
92 Wash. U. L. Rev. 1101, 1165-69 (2015).
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    We have recently seen helpful steps in the right direction toward 
transparency and accountability. Vice Chair for Supervision Quarles has 
stated that increases in transparency and a re-think of supervision are 
high on his agenda, noting that ``one of the reasons for transparency . 
. . is just a basic view of the right relationship between the 
Government and the governed . . . I do think we can be much more 
transparent about the regulatory process generally.'' \59\ Chairman 
McWilliams has also focused on increased transparency with her Trust 
through Transparency initiative at the FDIC.
---------------------------------------------------------------------------
     \59\ Quarles Transcript, supra n. 55 (statement by Vice Chair for 
Supervision Randal Quarles).
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II. Training of Supervisory Staff in the Legal Framework of the 
        Regulatory State
    Congress and the banking agencies need to think clearly about how 
to create an environment where the supervisory staff are given the 
training, resources, and tools that would permit them to do their jobs 
in a way that is more transparent to the world, more accountable and 
more consistent with the rule of law. \60\ Given that the legal 
framework governing the banking sector has become much more complex, 
the work of the examination staff has become more legally infused and 
yet the supervisory culture has become increasingly unmoored from the 
legal framework itself. \61\ The rise in compliance with law 
examinations, the focus on risk and board governance and the increasing 
use of matters requiring attention and matters requiring immediate 
attention for violations of law mean that the examination staff are 
increasingly making judgments that are legally infused, either 
involving legal judgments or involving a mixture of facts and law.
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     \60\ One important resource, beyond the scope of this testimony, 
is equipping the supervisors with more advanced technology, known as 
RegTech or SupTech. See Jo Ann Barefoot, ``Regulation Innovation: Using 
Digital Technology to Protect and Benefit Financial Consumers'', 
Harvard Kennedy School Mossavar-Rahmani Center for Business and 
Government Working Paper Series No. 110, at 10-11 (Mar. 2019), 
available at link.
     \61\  Of course, major elements of bank supervision are related to 
credit, interest rate, liquidity, and other market driven elements 
rather than the legal framework.
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    At the same time, the legal departments and legal staff of the 
Federal banking agencies remain quite slim, especially as compared to 
other major agencies. \62\ It is fair to ask whether there is a deep 
enough pool of lawyers at the agencies for the agency lawyers to be 
able to guide the supervisory staff on the more complex legal framework 
and to deal with all of the increased legally infused work that is 
occurring. \63\ It is also fair to ask whether the budget, resources, 
and stature of the agency legal departments is sufficient for the 
increased legal complexity and the coming digital transformation. A 
study should be done on whether increases in the legal staff have kept 
pace with increases in supervisory staff and increases in legally 
infused work by the supervisory staff. \64\
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     \62\ See Rory Van Loo, ``Regulatory Monitors: Policing Firms in 
the Compliance Era'', 119 Columbia Law Review 369, 436-40 (2019)
     \63\ The banking agencies have long been understood to be monitor- 
or examiner-dominated in their personnel. Based on research by an 
academic, some of which is estimated, the Federal Reserve is 95 percent 
monitor staff, the OCC is 93 percent monitor staff and the FDIC is 86 
percent monitor staff. See id. at 438-39. The higher proportion of 
lawyers at the FDIC is likely linked to its work as the deposit insurer 
and bank failures. Just a comparison of the number of lawyers to the 
number of examination staff at each of the agencies tells us that deep 
training on the law, legal interpretation and the legal framework has 
not been possible. A memo published by two former Federal Reserve 
staffers has pointed out that training on the legal framework has been 
delegated to the regional Federal Reserve Banks. Richard K. Kim, 
Patricia A. Robinson, and Amanda K. Allexon, ``Financial Institutions 
Developments: Revamping the Regulatory Examination Process'', Wachtell, 
Lipton, Rosen, and Katz (Nov. 26, 2018). That fact alone brings into 
question the consistency of the training.
     \64\ In the private sector it is well understood that increases in 
the budget, resources and staffing of the in-house legal department 
have not kept pace with the rise of risk management and the separation 
of compliance from the legal function. See Thomas C. Baxter, Jr., ``The 
Rise of Risk Management in Financial Institutions and a Potential 
Unintended Consequence--The Diminution of the Legal Function'', 
American Bar Association Business Law Today (Apr. 2, 2019), link.
---------------------------------------------------------------------------
    Examples that I have seen in my practice, as well as examples that 
have been relayed to me, lead me to believe that the current generation 
of examination and supervisory staff, who are people of goodwill trying 
to do a complex job under difficult circumstances, have not had in-
depth training in the legal framework. Some examiners were confused 
about the fact that the First Amendment protects lobbying activity by 
banking organizations, and attempting to stop such activity or subject 
it to an examination is unconstitutional. \65\ There is confusion about 
the fact that the Constitution and statutes are higher level 
authorities than a regulation, guidance, or handbook. Some supervisory 
staff mistakenly believe that guidance can override a statute. Some 
supervisory staff are confused about what is part of the legal 
framework and what is not. Some supervisory staff mistakenly believe 
that guidance is not governed by the statutes or regulations and that 
they can pick and choose among the applicable guidance or law. Some 
supervisory staff seek to exclude in-house lawyers from meetings or 
tasks.
---------------------------------------------------------------------------
     \65\ See Semi-Annual Testimony on the Federal Reserve's 
Supervision and Regulation of the Financial System, 115 Cong. 86 (2018) 
(Statement of Randal K. Quarles, Vice Chairman for Supervision).
---------------------------------------------------------------------------
    I believe that the training of supervisory staff for compliance 
with law is heavily weighted towards the technical elements of 
individual banking regulations and guidance in areas of subject matter 
expertise. The training has been overfocused on compliance with the 
technical aspects on a regulation-by-regulation basis and has 
underweighted fundamental principles such as the rule of law in a 
Constitutional democracy and the legal framework that governs the 
regulatory State. The training has also not focused on basic grounding 
statutes such as the APA or the Congressional Review Act. \66\ The 
supervisory staff are also not trained in major case law that affects 
their work. There is a large difference in what the supervisory staff 
believe to be their authority under safety and soundness and the case 
law that defines the term.
---------------------------------------------------------------------------
     \66\ It is safe to say that none of the banking regulators, and 
certainly not the banking bar, noticed or were aware of the passage of 
the Congressional Review Act in 1996. In hindsight, the GAO ruling that 
the leveraged lending guidelines are a ``rule'' under the APA is 
completely obvious. See 5 U.S.C. 551(4) (defining ``rule''). Thinking 
of guidance as requiring a stop at OMB or notice to Congress has thrown 
a wrench into the traditional cultural mode.
---------------------------------------------------------------------------
    There is no need for 3 years of law school to understand these 
critical concepts. We also need not be purists worrying about the 
unauthorized practice of law. Instead, it should be possible, 
especially in light of the quality of the credentialed examination 
staff and the base of the past training, to add more of the following 
elements to the training of supervisory staff so that they are better 
able, in light of the shortage of lawyers at the agencies, to handle 
legally infused judgments: \67\
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     \67\ I began my life in the law by taking, as is common in the 
Midwest, a 6-week paralegal certification. I can attest that if a 22-
year-old from a small town in Michigan could grasp the basics of these 
concepts in a paralegal certification course, then the much more highly 
educated and mature supervisory staff should be able to with ease.

    The principle of the separation of powers and how the 
        delegation of authority by Congress to agencies is based solely 
        on written statutory authority with their being no such thing 
        as ``inherent authority''; \68\
---------------------------------------------------------------------------
     \68\ The safety and soundness statute, 12 U.S.C. 1831p-1, is 
broad and delegates discretion to the banking agencies. It is not, 
however, unlimited and does not create ``inherent authority.''

    Fundamental principles of due process, including the 
        distinction between prospective and retroactive application of 
---------------------------------------------------------------------------
        rules, regulations, and other standards;

    The legal hierarchy among the Constitution, statutes, 
        regulations and guidance, including the distinction between 
        binding law and nonbinding written public guidance;

    The statutes, regulations, other laws and guidance that are 
        binding on the supervisory staff;

    The key major cases that impact the work of supervisory 
        staff;

    Why reading the legal framework involves cannons of 
        construction and deference, so that it is not like ordinary 
        reading; \69\ and
---------------------------------------------------------------------------
     \69\ See Margaret E. Tahyar, ``Legal Interpretation Is Not Like 
Reading Poetry--How To Let Go of Ordinary Reading and Interpret the 
Legal Framework of the Regulatory State'', at 9-11 (Dec. 4, 2018, 
Working Draft), available at link.

    Why adhering to the rule of law and fundamental principles 
        of due process is fundamental in a representative democracy and 
---------------------------------------------------------------------------
        binding upon agency staff.

    The lack of training about the legal framework, the principles of 
how legal texts must be interpreted, the binding nature of court 
decisions, and the regulatory State has real world consequences. One 
real world consequence is the creation of matters requiring attention 
and matters requiring immediate attention, with all that implies, based 
on misunderstandings of the legal framework. Another consequence is the 
historical failure to keep track of appeals from examinations \70\ or 
not being sensitive to the fact that some examination judgments or 
matters requiring attention are legally infused. \71\ One clue that 
there is not enough sensitivity to the role of the rule of law is that 
risk governance guidance on the role of risk and compliance did not 
mention in-house legal departments at banking organizations. \72\ 
Another clue is the three lines of defense ideology, developed post-
Financial Crisis, which was drafted and adopted by the auditing 
profession without consideration of the role of the rule of law or the 
in-house legal function. \73\
---------------------------------------------------------------------------
     \70\ See Hill, supra n. 58, at 1115-60 (describing appeals process 
at OCC, Federal Reserve, FDIC and NCUA, and noting data issues).
     \71\ See Davis Polk and Wardwell LLP, Comment Letter on Proposed 
Amendments to Guidelines on an Internal Appeals Process for 
Institutions Wishing to Appeal an Adverse Material Supervisory 
Determination, Docket No. OP-1597, at 4-5 (Apr. 30, 2018), available at 
link.
     \72\ See Davis Polk and Wardwell LLP, Comment Letter on the 
``Proposed Guidance on Supervisory Expectation for Boards of 
Directors'', Docket No. OP-1570, at 9-11 (Feb. 15, 2018), available at 
link (``The Management Proposal is similarly silent on the importance 
of a firm having a sufficiently robust legal department with 
appropriate resources, budget and independence and a general counsel 
with sufficient stature and authority, instead addressing only risk 
management, internal audit and compliance functions.'').
     \73\ See generally The Institute of Internal Auditors, supra n. 
37.
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    Increased training in the hierarchy of the legal framework, why 
legal interpretation is not like normal reading and a wider 
understanding of the separation of powers and the regulatory State 
would, I believe, also have positive knock-on effects in the private 
sector. Many in the growing professions of risk management and 
compliance had their initial training in the banking agencies. They 
take their confusion about the legal framework, the role of guidance 
and the limits of secret lore with them to the private sector.
Conclusion
    Change is hard but, the longstanding uneasy truce is now untenable. 
I suspect that both banking organizations and supervisors might be made 
a little uncomfortable by what I am saying here today. If, however, the 
changes I recommend are made, and if both supervisors and banking 
organizations are a little bit uncomfortable, the balance is moving in 
the right direction.
                                 ______
                                 
                PREPARED STATEMENT OF PATRICIA A. MCCOY
              Professor of Law, Boston College Law School
                             April 30, 2019
    Chairman Crapo, Ranking Member Brown, and Members of the Committee: 
Thank you for inviting me here today to discuss nonbinding guidances by 
Federal bank regulators. \1\
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     \1\ I use the term ``Federal bank regulators'' in this statement 
to refer to the Board of Governors of the Federal Reserve System, the 
Federal Deposit Insurance Corporation, the Office of the Comptroller of 
the Currency, and the Consumer Financial Protection Bureau (CFPB).
---------------------------------------------------------------------------
    Imagine a world in which Federal bank regulators did not provide 
guidances. They would still have statutory responsibility to administer 
and enforce the statutes and legislative rules under their 
jurisdiction. Regulated firms would still have to obey those statutes 
and rules. The only difference is, firms would not have insight into 
the agencies' interpretations, priorities, or positions in the form of 
guidances. In the process, financial providers would be deprived of an 
essential source of transparency that they vocally want and benefit 
from today.
    Some are calling for changes that would require nonbinding agency 
guidances to undergo notice-and-comment proceedings and Congressional 
Review Act oversight. Such changes would be badly misguided. Agencies 
would either respond by converting flexible, nonbinding guidances into 
binding legislative rules or by continuing to discharge their 
supervisory and enforcement responsibilities without the illumination 
provided by guidances. In all likelihood, ``regulation by enforcement'' 
would become a self-fulfilling prophecy, for the reasons I explain.
I. Guidances Provide Vital Transparency in Banking Regulation
    Guidances are informal agency statements that advise the public of 
an agency's construction of its statutes or rules or the agency's 
prospective plans to exercise discretion. As such, guidances are ``an 
essential instrument of [F]ederal administration'' and ``facilitate[] 
stakeholders' knowledge of agency positions and intentions ahead of 
enforcement or similar actions.'' \2\
---------------------------------------------------------------------------
     \2\ Bureau of Consumer Financial Protection, Request for 
Information Regarding Bureau Guidance and Implementation Support, 83 FR 
13959, 13959 (Apr. 2, 2018) (citations omitted) (hereinafter CFPB 
Guidance RFI).
---------------------------------------------------------------------------
    The term ``guidances'', the topic of this hearing, refers broadly 
to a variety of nonbinding agency statements. Guidances encompass 
interpretive rules, policy statements, guidance, supervisory bulletins, 
opinion letters, frequently asked questions, and compliance guides, 
among other things.
    The APA requires interpretive rules and policy statements of 
general applicability to be published in the Federal Register but 
expressly exempts them from the notice-and-comment requirements for 
legislative rules. \3\ Nevertheless, sometimes Federal bank regulators 
solicit public comment on proposed guidances at their discretion in 
order to refine the final versions. \4\ Guidances are nonpartisan in 
nature and are issued by Republican and Democratic appointees alike. 
\5\
---------------------------------------------------------------------------
     \3\ 5 U.S.C. 552(a)(1)(D), 553(b)(A); see CFPB Guidance RFI, 
supra n. 2, at 13960.
     \4\ CFPB Guidance RFI, supra n. 2, at 13960.
     \5\ See, e.g., Bureau of Consumer Financial Protection, ``Changes 
to Types of Supervisory Communications'', BCFP Bull. 2018-01 (Sept. 25, 
2018) (issued by the CFPB under former Acting Director Mick Mulvaney), 
https://files.consumerfinance.gov/f/documents/bcfp_bulletin-2018-
01_changes-to-supervisory-communications.pdf; Office of the Comptroller 
of the Currency, ``Description: Cyber-Related Sanctions'', OCC Bull. 
2018-40 (Nov. 5, 2018) (guidance on the potential impact of Office of 
Foreign Assets Control sanctions on financial institutions' operations; 
issued under Comptroller Joseph M. Otting), https://www.occ.treas.gov/
news-issuances/bulletins/2018/bulletin-2018-40.html#; Securities and 
Exchange Comm'n, TurnKey Jet, Inc., SEC No-Action Letter (Apr. 3, 
2019), https://www.sec.gov/divisions/corpfin/cf-noaction/2019/turnkey-
jet-040219-2a1.htm.
---------------------------------------------------------------------------
    Guidances are distinguishable from notice-and-comment legislative 
rulemakings under Section 553 of the Administrative Procedure Act (APA) 
in at least two important respects. First, unlike legislative rules, 
which can affect individual rights and obligations, guidances are 
nonbinding on third parties. \6\ Second, guidances are highly flexible 
and allow agencies to more nimbly respond to changing market conditions 
because they can be amended without going through a time-consuming 
notice-and-comment process. \7\
---------------------------------------------------------------------------
     \6\ See, e.g., Administrative Conference of the United States, 
Agency Guidance Through Policy Statements, Recommendation 2017-5, at 1 
(Dec. 14, 2017) (hereinafter Administrative Conference); CFPB Guidance 
RFI, supra n. 2, at 13960.
     \7\ Administrative Conference, supra n. 6, at 2.
---------------------------------------------------------------------------
    Except in rare instances, Federal bank regulators are not required 
to issue guidances. \8\ Instead, they do so to provide transparency for 
what might otherwise be an opaque regulatory process. Agencies 
increased their use of guidances before the 2008 financial crisis, in 
response to industry requests for a ``principles-based approach'' to 
regulation. Guidances have continued to be important post-2008.
---------------------------------------------------------------------------
     \8\ Recently, however, in the Economic Growth, Regulatory Relief, 
and Consumer Protection Act, Pub. L. No. 115-174 (2018), Congress urged 
or required Federal agencies to provide additional guidance. Id. 
109(b) (on integrated mortgage disclosures), 209(e) (on shared 
waiting lists for public housing facilities).
---------------------------------------------------------------------------
    Guidances serve an essential function, given the intricacy of 
Federal banking law. Federal bank regulators administer the Federal 
banking statutes and implement those statutes through binding, notice-
and-comment legislative rules. This thicket of banking statutes and 
rules is voluminous and complex.
    Against this backdrop of statutes and rules, regulated entities 
find guidances valuable because they shed light on agencies' 
supervisory perspectives and concerns. When they are issued as policy 
statements, guidances can advise the public prospectively on how an 
agency proposes to exercise one of its discretionary powers. \9\ When 
issued as interpretive rules, guidances apprise the public of an 
agency's construction of the statutes and rules it administers. \10\ 
Other types of guidances provide a useful possible roadmap for 
compliance, while leaving companies free to propose alternative models 
or interpretations or consideration of additional facts. In this way, 
guidances ``can make agency decision making more predictable and shield 
regulated parties from unequal treatment, unnecessary costs, and 
unnecessary risk . . . .'' \11\ Finally, guidances can flag potential 
compliance issues for regulated entities' attention.
---------------------------------------------------------------------------
     \9\ Attorney General's Manual on the Administrative Procedure Act 
30 n.3 (1947).
     \10\ Id.
     \11\ Administrative Conference, supra n. 6, at 2.
---------------------------------------------------------------------------
    Guidances can emanate out of rulemaking or out of supervision. 
During the rulemaking process, for example, it is common for regulated 
firms to request guidance to help them comply with an agency's 
legislative rules (particularly new rules). This was especially 
important during the implementation of the Dodd-Frank Act, when 
Congress instructed Federal bank regulators to adopt multiple complex 
rules. These industry requests for guidance are often time-sensitive, 
because firms are eager for guidance to be in place by a rule's 
effective date.
    Other guidances come out of supervision. Bank supervision requires 
confidentiality, to protect regulated firms' sensitive proprietary 
information and to prevent bank runs. For this reason, bank examination 
reports and the findings of bank examinations are secret and may not be 
released to the public, on pain of criminal sanction. \12\ Importantly, 
other financial institutions are not privy to the examination reports 
or findings of sister institutions. Against this backdrop, supervisory 
guidances provide a crucial sightline into the supervisory process by 
informing regulated companies of supervisors' viewpoints, priorities, 
and concerns.
---------------------------------------------------------------------------
     \12\ See, e.g., 12 CFR 4.32(b), 7.4000(d), 261.21(a), 309.6(b), 
1070.42. There are narrow exceptions permitting public disclosure of 
the nonconfidential portion of Community Reinvestment Act examination 
reports, 12 U.S.C. 2906(a)-(b), and of summaries of capital adequacy 
stress test results, see, e.g., 12 CFR 252.17, 252.46, 252.58.
---------------------------------------------------------------------------
    For these reasons and more, regulated companies want guidance and 
they are vocal about asking for it. As the National Association of 
Realtors put it last year: \13\
---------------------------------------------------------------------------
     \13\ Letter from the National Association of Realtors to the CFPB 
on Docket No. CFPB-2018-0013, at 1 (July 2, 2018) (hereinafter NAR 
Comment Letter).

        [I]t is imperative that necessary guidance, including 
        interpretive rules and nonrule guidance, be provided to 
---------------------------------------------------------------------------
        regulated entities to ensure compliance across the industry.

    The American Financial Services Association (AFSA) has emphasized 
the importance of guidance to financial providers in similar terms: 
\14\
---------------------------------------------------------------------------
     \14\ Letter from AFSA to the CFPB on Docket No. CFPB-2018-0013, at 
4 (July 2, 2018); see also id. at 3 (``There is a clear need for 
guidance that is responsive to operational difficulties or unintended 
consequences resulting from new regulations'').

        There is undoubtedly a need for written, explanatory guidance. 
        Written guidance can be a useful tool to help financial 
        institutions obtain clarification on specific practices. With 
        many regulations, particularly long and complex regulations, 
        operational difficulties or unintended consequences arise. In 
---------------------------------------------------------------------------
        these cases, clarifying guidance is need[ed] quickly.

    As these industry statements stress, guidance serves important 
functions and we should be wary of jettisoning it.
II. Regulated Entities Have Ample Recourse if Guidances Are Given 
        Binding Effect
    Despite the many benefits of guidances, agencies are sometimes 
criticized for penalizing third parties for failure to comply with 
guidances. Whether this is really a problem or its extent is unclear. 
Agencies are statutorily responsible for enforcing the statutes and 
legislative rules with which they are charged. The fact that those 
statutes and legislative rules may overlap with guidances does not 
relieve agencies of that statutory responsibility.
    Criticisms of guidance often assert that examination reports 
downgrade companies for failure to follow guidance or that enforcement 
actions are based on guidance violations. This might raise concerns 
that guidances were being given binding effect against third parties 
without prior public input into their substance through the notice-and-
comment process. In the more likely case, Federal banking regulators 
base negative exam ratings, exam citations, and enforcement actions on 
violations of statutes or rules, on unsafe or unsound practices (in the 
case of the prudential banking regulators), or on unfair, deceptive or 
abusive practices (in the case of the Consumer Financial Protection 
Bureau), and not on any guidances that happen to overlap.
    At this juncture, it is critical to dispel the mistaken impression 
that financial institutions are helpless if they are penalized for 
violating guidances alone. To the contrary, if financial institutions 
are experiencing this problem, they already have ample recourse. 
Regulated entities have multiple avenues of review if agencies seek to 
penalize them for violating guidances:

    Suits to invalidate guidances: Affected parties can sue to 
        invalidate guidances that are given binding effect for failure 
        to comply with the notice-and-comment provisions of Section 553 
        of the APA. \15\
---------------------------------------------------------------------------
     \15\ 5 U.S.C. 704, 706(2)(A), (2)(D); see, e.g., United States 
v. Gypsum Co. v. Muszynski, 209 F. Supp. 2d 308, 310 (S.D.N.Y. 2002).

    Informal meetings with regulators: In addition, regulated 
        entities can and do meet privately with Federal bank regulators 
---------------------------------------------------------------------------
        to request guidance, propose changes, and contest its use.

    Agency ombudsmen: All Federal bank regulators maintain an 
        ombudsman that provides an independent, impartial, and 
        confidential resource to help firms resolve any problem they 
        may have resulting from the regulatory activities of an agency. 
        \16\
---------------------------------------------------------------------------
     \16\ See 12 U.S.C. 4806(d) (requiring every Federal bank 
regulator to establish an ombudsman); Consumer Financial Protection 
Bureau, ``Appeals of Supervisory Matters'' 5-6 (Oct. 28, 2015), https:/
/files.consumerfinance.gov/f/documents/
201508_cfpb_ApprovedSupervisoryAppealsProcess.pdf (CFPB Supervisory 
Appeals).

    Supervisory appeals: In the supervision context, proposed 
        citations go through special scrutiny and multiple layers of 
        agency review before they can be included in examination 
        reports. Informally, this gives companies the opportunity to 
        raise any concerns about the use of guidances with examiners' 
        supervisors. In addition, all Federal bank regulators provide 
        formal procedures in which companies can appeal examination 
        findings. \17\
---------------------------------------------------------------------------
     \17\ 12 U.S.C. 4806 (requiring every Federal prudential banking 
regulator to establish a supervisory appeals process); CFPB Supervisory 
Appeals, supra n. 16.

    Judicial review of enforcement actions: In the enforcement 
        process, aggrieved respondents have the right to judicial 
        review to contest sanctions based on guidance violations. \18\
---------------------------------------------------------------------------
     \18\ 12 U.S.C. 1818(h).

    Legislation: Finally, financial providers can petition 
---------------------------------------------------------------------------
        Congress to enact legislation overturning guidances.

    In short, financial institutions already have ample recourse for 
any agency misuse of guidances. Proposals to make it more difficult to 
issue guidances would throw the baby out with the bath water, as I 
discuss.
III. Recent Initiatives To Increase the Procedural Requirements for 
        Guidances
    Recently, some have proposed stringent curbs on guidances issued by 
Federal bank regulators. The two leading initiatives in this regard 
involve Congressional reversal of agency guidances under the 
Congressional Review Act and mandatory notice-and-comment requirements 
for guidances akin to those for legislative rules in Section 553 of the 
APA. Above, I discussed the current APA requirements for guidances. In 
this section, I discuss the debate surrounding the Congressional Review 
Act's applicability to guidances.
a. The Provisions of the Congressional Review Act
    The Congressional Review Act (CRA) \19\ is a major vehicle for 
Congressional oversight of agency rulemaking. Under the CRA, before a 
rule can take effect, every Federal agency that promulgates a rule must 
submit a copy of the rule, ``a concise general statement relating to 
the rule,'' and the proposed effective date of the rule to each House 
of Congress and the Comptroller General. \20\ In the case of major 
rules, upon receipt, Congress has a statutorily specified time period 
to enact a joint resolution of disapproval of the rule. \21\ If 
Congress allows the statutory time period to expire without enacting a 
joint resolution of disapproval, the rule will take effect. \22\ If 
Congress enacts a joint resolution of disapproval and the joint 
resolution survives any veto, the rule will not take effect. \23\
---------------------------------------------------------------------------
     \19\ 5 U.S.C. 801-808.
     \20\ Id. 801(a)(1)(A). The CRA requires other accompanying 
materials as well. Id.
     \21\ Id. 801(b)(1), 802; see also id. 801(a)(4).
     \22\ Id. 801(a)(3). The statute sets forth a timeframe for 
effective dates. Id. 801(a)(3), (d)-(e), 808. The same result occurs 
if the President vetoes a joint resolution of disapproval and Congress 
does not override the veto. Id. A rule that Congress disapproved may 
also take effect where the President makes a written determination that 
the rule is necessary based on narrow statutory grounds or was issued 
pursuant to any statute implementing an international trade agreement. 
Id. 801(c).
     \23\ Id. 801(b)(1); see also id. 801(a)(3), (f).
---------------------------------------------------------------------------
    Where Congress has struck down a major rule through a joint 
resolution of disapproval that has withstood any veto, the rule may not 
be reissued in substantially the same form unless it is specifically 
authorized by a law enacted after the date of the joint resolution. The 
same result holds for any new rule that is substantially the same as 
the original rule that Congress disapproved. \24\
---------------------------------------------------------------------------
     \24\ Id. 801(b)(2).
---------------------------------------------------------------------------
    The CRA's procedures for joint resolutions of disapproval only 
apply to major rules. For purposes of CRA review, a ``major rule'' is 
any rule that the Office of Information and Regulatory Affairs (OIRA) 
of the Office of Management and Budget (OMB) finds has resulted in or 
is likely to result in: \25\
---------------------------------------------------------------------------
     \25\ Id. 804(2).

---------------------------------------------------------------------------
  1.  An annual effect on the economy of $100,000,000 or more;

  2.  A major increase in costs or prices for consumers, individual 
        industries, Federal, State, or local government agencies, or 
        geographic regions; or

  3.  Significant adverse effects on competition, employment, 
        investment, productivity, innovation, or on the ability of 
        United States-based enterprises to compete with foreign-based 
        enterprises in domestic and export markets.

    The term ``major rule'' excludes any rule promulgated under the 
Telecommunications Act of 1996 and the amendments made by that Act. 
\26\ In addition, nothing in the CRA applies to rules concerning 
monetary policy proposed or implemented by the Federal Reserve Board or 
the Federal Open Market Committee. \27\
---------------------------------------------------------------------------
     \26\ Id.
     \27\ Id. 807.
---------------------------------------------------------------------------
    No determination, finding, action, or omission under the CRA is 
subject to judicial review. \28\
---------------------------------------------------------------------------
     \28\ Id. 805.
---------------------------------------------------------------------------
    On two recent occasions, Congress invalidated Federal banking 
pronouncements under the CRA. In late 2017, Congress issued a joint 
resolution disapproving the mandatory arbitration rule issued by the 
Consumer Financial Protection Bureau (CFPB or the Bureau). \29\ Last 
year, Congress invoked the CRA to nullify the CFPB's 2013 bulletin on 
indirect auto lending. \30\
---------------------------------------------------------------------------
     \29\ Pub. L. No. 115-74, 131 Stat. 1243 (2017); see CFPB, 
Arbitration Agreements, 82 FR 55,500 (Nov. 22, 2017); CFPB, Arbitration 
Agreements, 82 FR 33,210 (July 19, 2017).
     \30\ Pub. L. No. 115-172, 132 Stat. 1290 (2018) (disapproving 
CFPB, Bulletin re: Indirect Auto Lending and Compliance with the Equal 
Credit Opportunity Act (Mar. 21, 2013), https://
files.consumerfinance.gov/f/201303_cfpb_march_-Auto-Finance-
Bulletin.pdf).
---------------------------------------------------------------------------
b. The Recent OMB Memorandum Interpreting CRA
    Under the CRA, Congress tasked OIRA with determining whether agency 
rules are ``major rules'' for purposes of the statute. \31\ The CRA is 
silent on the timing of that determination vis-a-vis agency publication 
of final rules.
---------------------------------------------------------------------------
     \31\ 5 U.S.C. 804(2).
---------------------------------------------------------------------------
    On April 19, 2019, the Acting Director of OMB, Russell T. Vought, 
issued a memorandum that announced new, stricter procedures for 
Congressional Review Act compliance (OMB Memo). \32\ OMB addressed the 
memorandum, which it termed a ``guidance'', to all executive 
departments and agencies, including all Federal bank regulators and 
other independent Federal agencies. According to OMB, the memorandum 
takes ``full effect'' on May 11, 2019. \33\
---------------------------------------------------------------------------
     \32\ Memorandum from Russell T. Vought titled ``Guidance on 
Compliance With the Congressional Review Act'', OMB Memorandum M-19-14 
(Apr. 11, 2019), https://www.whitehouse.gov/wp-content/uploads/2019/04/
M-19-14.pdf (OMB Memo).
     \33\ Id. at 2.
---------------------------------------------------------------------------
    The OMB Memo took an aggressive position on CRA's compliance 
requirements in at least three respects. First, in the OMB Memo, Mr. 
Vought asserted that agencies ``should not publish a rule--major or not 
major--in the Federal Register, on their websites, or in any other 
public manner before OIRA has made the final determination and the 
agency has complied with the requirements of the CRA.'' \34\ Second, 
OMB required all independent Federal agencies, when providing ORA with 
their analyses whether a rule is a ``major rule'' under the CRA, to 
comply with OMB's cost-benefit analysis methodology and requirements in 
OMB Circular A-4 and Part IV of the OMB Memo. \35\ Finally, OMB took 
the position that ``guidance documents, general statements of policy, 
and interpretive rules'' are subject to CRA review, in addition to 
notice-and-comment legislative rules. \36\
---------------------------------------------------------------------------
     \34\ Id. at 4; see also id. at 5.
     \35\ Id. at 5.
     \36\ Id. at 3.
---------------------------------------------------------------------------
c. The Congressional Review Act Does Not Apply to Guidances
    This last OMB pronouncement followed two separate opinions by the 
Government Accountability Office (GAO) in 2017 finding that a guidance 
document \37\ and a supervisory bulletin \38\ by Federal bank 
regulators were ``rules'' and therefore had to undergo CRA review.
---------------------------------------------------------------------------
     \37\ GAO, Office of the Comptroller of the Currency, ``Board of 
Governors of the Federal Reserve System, Federal Deposit Insurance 
Corporation--Applicability of the Congressional Review Act to 
Interagency Guidance on Leveraged Lending'', GAO Opinion No. B-329272 
(Oct. 19, 2017), https://www.gao.gov/assets/690/687879.pdf.
     \38\ GAO, ``Bureau of Consumer Financial Protection: Applicability 
of the Congressional Review Act to Bulletin on Indirect Auto Lending 
and Compliance with the Equal Credit Opportunity Act'', GAO Opinion No. 
B-329129 (Dec. 5, 2017), https://www.gao.gov/assets/690/688763.pdf.
---------------------------------------------------------------------------
    The CRA only applies to ``rules.'' The statute defines the term 
``rule'' as having the same meaning as in 5 U.S.C. 551. \39\ In turn, 
5 U.S.C. 551(4) of the APA defines a ``rule'' as: ``the whole or a 
part of an agency statement of general or particular applicability and 
future effect designed to implement, interpret, or prescribe law or 
policy or describing the organization, procedure, or practice 
requirements of an agency . . . .''
---------------------------------------------------------------------------
     \39\ 5 U.S.C. 804(3).
---------------------------------------------------------------------------
    Section 551(4) sets forth three requirements to satisfy the 
definition of a rule. First, there must be an ``agency statement of 
general or particular applicability.'' Second, that statement must have 
``future effect.'' Finally, the agency statement must be ``designed to 
implement, interpret, or prescribe law or policy . . . .''
    That is not the end of the story, however. CRA goes on to expressly 
exclude any rule of particular applicability, any rule relating to 
agency management or personnel, and any rule of agency organization, 
procedure, or practice that does not substantially affect the rights or 
obligations of nonagency parties from its definition of a ``rule.'' 
\40\ Consequently, nonbinding guidances are not rules under the CRA 
because they do not substantially affect the rights or obligations of 
nonagency parties. \41\
---------------------------------------------------------------------------
     \40\ 5 U.S.C. 804(3).
     \41\ There is another reason why guidances are not ``rules'' under 
the CRA. Because guidances are nonbinding by definition, they do not 
``take effect.'' As such, they lack ``future effect'' for purposes of 
Section 551(4) of the APA and the CRA. See Adam Levitin, 
``Congressional Review Act Confusion: Indirect Auto Lending Guidance 
Edition'' (a/k/a ``The Past and the Pointless''), Credit Slips (Apr. 
17, 2018), https://www.creditslips.org/creditslips/2018/04/
congressional-review-act-confusion.html. This distinction between 
binding rules that ``take effect'' and nonbinding guidances has real 
significance when it comes to the CRA. For the CRA states that a rule 
cannot ``take effect'' until the agency submits the rule and its 
``proposed effective date'' to Congress and to GAO. 5 U.S.C. 
801(a)(1)(A). It is impossible, however, for an agency to transmit a 
``proposed effective date'' for a guidance that does not take 
``effect.'' Strikingly, GAO did not explain how guidances have ``future 
effect'' in its 2017 opinions.
---------------------------------------------------------------------------
    In an opinion letter last year, GAO affirmed that the Justice 
Department's zero-tolerance policy \42\ was not subject to CRA review 
based on that exclusion. \43\ According to GAO, ``the rights and 
obligations in question [were] prescribed by existing immigration laws 
and remain unchanged by the agency's internal enforcement procedures at 
issue here.'' \44\ In so concluding, GAO relied on Federal case law 
holding that ``rules were `procedural' . . . when the rules did not 
have a `substantial impact' on nonagency parties.'' \45\ GAO reasoned: 
``Although the memorandum changes previous policy, there is no 
underlying change in the legal rights of aliens who cross the border.'' 
\46\
---------------------------------------------------------------------------
     \42\ The policy instructed Federal prosecutors to give higher 
priority to certain immigration offenses with the goal of deterring 
first-time improper entrants along the southwest border. Department of 
Justice, Office of the Attorney General, Memorandum to Federal 
Prosecutors along the Southwest Border, Zero-Tolerance for Offenses 
Under 8 U.S.C. 1325(a) (Apr. 6, 2018).
     \43\ GAO, U.S. Department of Justice--Applicability of the 
Congressional Review Act to the Attorney General's April 2018 
Memorandum, GAO Opinion No. B-330190, at 1 (Dec. 19, 2018), https://
www.gao.gov/assets/700/696164.pdf.
     \44\ Id.
     \45\ Id. at 4 (citing Brown Express, Inc. v. United States, 607 
F.2d 695, 702 (5th Cir. 1979)).
     \46\ Id. at 5.
---------------------------------------------------------------------------
    If we change the phrase ``aliens who cross the border'' in GAO's 
letter to ``regulated financial institutions,'' it is hard to 
understand how a nonbinding guidance by Federal bank regulators is a 
``rule'' for purposes of the CRA when the Justice Department's zero-
tolerance policy is not. For as the CFPB emphasized under then-Acting 
Director Mick Mulvaney last year, ``neither an interpretive rule nor a 
general statement of policy can create new rights and obligations for 
regulated entities.'' \47\
---------------------------------------------------------------------------
     \47\ CFPB Guidance RFI, supra n. 2, at 13960.
---------------------------------------------------------------------------
    Other provisions in the CRA highlight why it is advisable to 
exclude guidances from the definition of a ``rule'' for purposes of 
that statute. Rules that Congress disapproves under the CRA may not be 
reissued in substantially the same form unless they are specifically 
authorized by a law enacted after the date of the joint resolution. Nor 
may an agency issue a new rule that is substantially the same as the 
original rule that Congress disapproved unless a later statute 
specifically authorizes the new rule. \48\
---------------------------------------------------------------------------
     \48\ 5 U.S.C. 801(b)(2).
---------------------------------------------------------------------------
    But what does it mean for Congress to disapprove a nonbinding 
guidance? The answer is murky, to say the least. Take disapproval of a 
policy statement that adopts Federal judicial decisions construing a 
statute that the agency is charged with enforcing. Nothing relieves the 
agency of its statutory duty to carry out the statute. Similarly, 
nothing prevents the agency from observing the case law discussed in 
the policy statement when enforcing the statute. This is doubly true 
when Congress does not amend the underlying statute or relieve the 
agency of its responsibility to enforce it. Under these circumstances, 
it is unclear what disapproval of the policy statement actually means.
    For these reasons, the text and spirit of the CRA excludes 
guidances from the definition of ``rules.'' \49\ However, there is an 
even more important reason for not imposing added procedural hurdles 
such as CRA, which is the adverse effect that doing so would have on 
regulated parties and the larger financial system.
---------------------------------------------------------------------------
     \49\ See Levitin, supra n. 41. GAO's and OMB's interpretations to 
the contrary are only opinions unless and until they are affirmed by 
the courts.
---------------------------------------------------------------------------
IV. Imposing More Procedural Hurdles To Adopting Agency Guidances Is 
        Unwise
    Both of the initiatives to put guidances through notice-and-comment 
proceedings and CRA review are overkill because they would result in 
serious negative effects on regulated companies and the financial 
system. In this section, I discuss why it would be counterproductive to 
impose stiffer procedural requirements on guidances.
    If nonbinding agency guidances had to undergo the notice-and-
comment procedures in the APA plus CRA review, the negative effect on 
regulated persons would be palpable. Normally, a fast-track notice-and-
comment procedure takes at least 2 years and many rulemakings take 
longer. Congressional Review Act transmission and review prolongs this 
process even further.
    At a minimum, the new procedural requirements would result in 
protracted uncertainty and loss of transparency during the periods for 
notice and comment and CRA review. During the intervening 2-plus years, 
the public would be in the dark as to the content of the final guidance 
and the agency's current position. The OMB Memo would prolong that 
uncertainty and loss of transparency by prohibiting agencies from even 
publishing final guidances until receiving a go-ahead from OIRA.
    The adverse consequences for industry could be even worse, 
depending on how Federal agencies respond. One way agencies might 
respond is by elevating nonbinding guidances into binding legislative 
rules. This would increase the number of binding rules on financial 
providers and with it, their attendant legal risk and regulatory 
burden.
    Alternatively, agencies might respond by declining to formulate 
guidances at all. Agencies would have strong internal pressures to 
choose this path, given the daunting staffing and budgetary challenges 
of what otherwise would be a vast increase in notice-and-comment 
proceedings.
    Is this what companies really want? Federal bank regulators have 
statutory responsibility to enforce the existing statutory authorities 
and binding rules under their jurisdiction. If agencies stopped issuing 
guidances, they would still be responsible for enforcing those statutes 
and rules. In the meantime, regulated persons would lack any guidance 
about agency interpretation of those statutes and rules or about ways 
to achieve compliance. This could result in precisely the type of 
``gotcha'' enforcement actions that regulated entities complain about 
and that guidances are designed to avoid. Moreover, we would lose the 
constraints that guidances may practically place on agency enforcement. 
Ironically, subjecting guidances to notice-and-comment procedures and 
CRA review would result in less transparency, not more. Doing so might 
well leave regulated entities to fend for themselves and produce the 
``regulation by enforcement'' that they intensely dislike.
    Putting guidances through notice-and-comment proceedings and CRA 
scrutiny also is a slippery slope. Clearly, statements of policy and 
interpretive rules are guidance. Generally, so are official ex ante 
agency announcements that are labeled as ``guidance.'' But how about 
individually tailored communications by regulators with specific 
regulated entities, such as no-action letters, which industry members 
find valuable? \50\ Similarly, would concerns about issuing 
``guidance'' cause examiners to clam up when companies ask them for 
compliance advice? The CFPB, under the leadership of Mr. Mulvaney, 
stated in 2018 that it ``uses the term guidance . . . broadly to [also] 
refer to compliance guides and other materials and activities that it 
does not believe are rules within the meaning of the APA . . . .'' \51\ 
A sweeping position that all such materials must undergo notice and 
comment and CRA review would have a severe chilling effect on those 
materials.
---------------------------------------------------------------------------
     \50\ Securities and Exchange Commissioner Hester Peirce recently 
described S.E.C. no-action letters as guidance. ``SECret Garden: 
Remarks at SEC Speaks by Commissioner Hester M. Peirce'' (Apr. 8, 
2019), https://www.sec.gov/news/speech/peirce-secret-garden-sec-speaks-
040819.
     \51\ CFPB Guidance RFI, supra n. 2, at 13960. These sorts of 
``nonrule guidances,'' to use the Bureau's term, include frequently 
asked questions, compliance guides, checklists, institutional and 
transactional coverage charts, webinars, staff manuals, and oral 
informal guidance in response to individual inquiries. Id.
---------------------------------------------------------------------------
    Undoubtedly for these reasons, the Mortgage Bankers Association 
(MBA) explained last year that ``[t]here are times when the costs of 
public participation outweigh its benefits. . . . [T]he extent of 
public participation should vary on the nature of the guidance 
document.'' \52\ The National Association of Realtors has pointed out 
that ``time is of the essence'' in certain regulatory situations and 
argued for ``quick responses'' in the form of agency guidances in those 
situations. \53\ The MBA similarly called on agencies (and specifically 
the CFPB) to ``frequently revise implementation and compliance support 
materials to ensure they remain relevant.'' \54\
---------------------------------------------------------------------------
     \52\ Letter from the Mortgage Bankers Association to the CFPB on 
Docket No. CFPB-2018-0013, at 4 (July 2, 2018) (hereinafter MBA Comment 
Letter).
     \53\ NAR Comment Letter, supra n. 13, at 1. See also id. at 2 
(``compliance bulletins are often useful due to the expedited timeframe 
for issuance without formal notice and comment procedures . . . .'').
     \54\ MBA Comment Letter, supra n. 52, at 6.
---------------------------------------------------------------------------
    Needless to say, companies cannot have it both ways. Imposing 
notice-and-comment requirements on agency guidance indiscriminately 
would make these types of quick responses and frequent revisions 
impossible. \55\
---------------------------------------------------------------------------
     \55\ Indeed, the Administrative Conference of the United States 
has advised that a ``Government-wide requirement for inviting written 
input from the public on policy statements is not recommended, unless 
confined to the most extraordinary documents.'' Administrative 
Conference, supra n. 6, at 6.
---------------------------------------------------------------------------
    Furthermore, erecting stringent procedural barriers to guidance 
would pose enormous risks to the financial system and the public writ 
large. Regulators issue guidance to increase the level of compliance 
with the law. Losing this vital information source for the bulk of 
companies that want to comply with banking law would likely increase 
the level of unsafe and unsound practices and raise the aggregate risk 
in the financial system.
    We cannot afford to take that risk, especially after the 
devastating losses from the 2008 financial crisis. Currently, leveraged 
loans pose one of the biggest threats to U.S. financial stability. \56\ 
But after GAO classified the leveraged loan guidance as a ``rule'' 
under the CRA, the Comptroller of the Currency lifted that guidance for 
the biggest players in that market, which are national banks. \57\ This 
is not good for anyone, be it national banks or the financial system at 
large.
---------------------------------------------------------------------------
     \56\ See ``Financial Stability Oversight Council, 2018 Annual 
Report'' 11-12 (2018), https://home.treasury.gov/system/files/261/
FSOC2018AnnualReport.pdf; ``Office of Financial Research, Annual Report 
to Congress'' 18-20 (2018), https://www.financialresearch.gov/annual-
reports/files/office-of-financial-research-annual-report-2018.pdf.
     \57\ ``OCC Head Says Banks Need Not Comply With Leveraged Lending 
Guidance'', Ropes and Gray (March 1, 2018), https://www.ropesgray.com/
en/newsroom/alerts/2018/03/OCC-Head-Says-Banks-Need-Not-Comply-with-
Leveraged-Lending-Guidance.
---------------------------------------------------------------------------
    Part of the controversy about guidances involves Matters Requiring 
Attention (MRAs) and Matters Requiring Immediate Attention (MRIAs) that 
examiners issue from time to time in individual companies' 
examinations. Concerns have been raised that some examiners at the 
Federal prudential banking agencies write up violations of guidance as 
MRAs and MRIAs.
    In addressing this issue, it is important to stress the important 
role of MRAs and MRIAs in resolving safety and soundness problems and 
violations of statutes and rules short of initiating enforcement. 
Without those notices, problems could fester until sanctions were 
unavoidable or the institution flat-out failed. Requiring all MRAs and 
MRIAs to go through notice and comment--including those that address 
unsafe and unsound practices and violations of statutes and rules--
would ban them for all intents and purposes. Instead, a better approach 
would be for senior bank regulators to carefully review proposed MRAs 
and MRIAs and to train examiners on their appropriate use. Supervised 
companies can also appeal MRAs and MRIAs through the supervisory 
appeals process. \58\
---------------------------------------------------------------------------
     \58\ See, e.g., CFPB Supervisory Appeals, supra n. 16, at 2; 
Comptroller of the Currency, OCC Banking Bull. 2013-15 (June 7, 2013), 
https://www.occ.treas.gov/news-issuances/bulletins/2013/bulletin-2013-
15.html.
---------------------------------------------------------------------------
    In sum, putting nonbinding guidances through notice and comment and 
CRA review would result in the worst of both worlds. Either agencies 
would issue even more binding legislative rules or they would enforce 
their statutes and rules without the benefit of guidance. Given these 
undesirable results, this is an area where Congress should tread 
carefully.
V. The OMB Memo Improperly Seeks To Curtail Federal Bank Regulators' 
        Independence
    In this final section, I close by discussing other problems with 
the OMB Memo and specifically its attempt to infringe on the 
independence of Federal bank regulators.
    In the OMB Memo, OMB purports to prohibit independent Federal bank 
regulators from publishing their final rules on their websites or in 
the Federal Register before OIRA has made its major determination under 
the CRA. \59\ In addition, the memorandum also seeks to prescribe the 
methodology independent agencies are to use when conducting their cost-
benefit (impact) analyses through the back door. \60\
---------------------------------------------------------------------------
     \59\ See OMB Memo, supra n. 32, at 4.
     \60\ See id. at 5.
---------------------------------------------------------------------------
    In adopting this stance, the OMB Memo improperly treads on Federal 
bank regulators' independence and violates Executive Order No. 12,866. 
Historically, the courts and Federal law have guarded the independence 
of Federal bank regulators from the Executive Branch to shield the 
financial system from political intervention for short-term gain. \61\ 
This is why Federal bank regulators are exempt from the requirement 
that agencies submit their rules to OIRA for review and cost-benefit 
analysis. \62\ This results from the express exemption in Executive 
Order 12,866 for agencies designated as ``independent regulatory 
agencies'' under the Paperwork Reduction Act. \63\ The Paperwork 
Reduction Act's list of independent regulatory agencies includes the 
CFPB and all other Federal bank regulators. \64\
---------------------------------------------------------------------------
     \61\ See, e.g., Humphrey's Executor v. United States, 295 U.S. 602 
(1935).
     \62\ Exec. Order No. 12,866, 58 FR 51,735, 51,753 (Oct. 4, 1993).
     \63\ Id.
     \64\ 44 U.S.C. 3502(5) (2012).
---------------------------------------------------------------------------
    Because OMB is an arm of the White House, \65\ Executive Order 
12,866 effectively shields Federal bank regulators from White House 
review of their rules. The purpose of this carve-out is to ensure the 
expert neutrality of bank regulators and to insulate those rules from 
political manipulation by the White House and OMB. Instead, Congress, 
not the White House, retains ultimate control over Federal bank 
regulators' rules.
---------------------------------------------------------------------------
     \65\ 31 U.S.C. 501 (2012) (establishing OMB as ``an office in the 
Executive Office of the President''). Because OMB resides within the 
White House, its website is nested within the White House website. See 
``Office Mgmt. and Budget, White House'', https://www.whitehouse.gov/
omb.
---------------------------------------------------------------------------
    The OMB Memo seeks to intrude on Federal bank regulators' cost-
benefit analyses by requiring them to submit a major rule analysis that 
is consistent with OIRA's cost-benefit analysis methodology. To begin 
with, it is not clear how Federal bank regulators can even do a 
meaningful cost-benefit analysis of nonbinding guidance. Beyond that, 
there are important reasons why Congress exempted cost-benefit analyses 
by Federal bank regulators from OIRA and OMB oversight in Executive 
Order 12,866. In financial regulation, it is generally harder to 
quantify benefits in the form of harms avoided than it is to quantify 
costs. Federal bank regulators must make numerous rulemaking decisions 
under conditions of incomplete data and uncertainty. Requiring Federal 
bank regulators to monetize all harms avoided--which might prove 
impossible--would dangerously tilt rulemaking analyses toward inaction 
and the status quo.
    In short, Executive Order 12,866 means that OIRA's standards for 
cost-benefit analyses do not apply to Federal bank regulators' major 
rule analyses and may not be wielded as a threat to ``delay OIRA's 
determination and an agency's ability to publish a rule and to make the 
rule effective.'' OMB's threat to hold up final rules by Federal bank 
regulators indefinitely for ``insufficient or inadequate analysis'' in 
OIRA's view \66\ poses the added, serious concern that OMB or OIRA 
might call a regulator's bluff and press to renegotiate the provisions 
of a final rule pending publication of the rule's text, with no 
judicial review. Any attempt to do so would be a blatant affront to 
Federal bank regulator independence and a rank violation of Executive 
Order 12,866. Even more seriously, any such move by OIRA would 
represent an attempt under the unitary executive theory to bottle up 
rules, detaining them from Congressional review and wresting CRA 
oversight from Congress in the process. In that respect, it is well 
known that OIRA has mired final rules of executive agencies 
indefinitely while conducting its review.
---------------------------------------------------------------------------
     \66\ OMB Memo, supra n. 32, at 5.
---------------------------------------------------------------------------
    In the OMB Memo, OIRA implicitly commits itself to making a CRA 
determination on independent agency rules within 40 days. \67\ 
Fortunately, if OIRA does not respect the 40-day timeframe, no statute 
or rule stops Federal bank regulators from publishing their rules at 
that point and transmitting their rules directly to Congress for CRA 
review. Any suggestion in the OMB Memo to the contrary has no legal 
effect.
---------------------------------------------------------------------------
     \67\ Id. The memorandum states that OIRA may inform agencies that 
rules are not major within 10 days of notification. Other rules must 
undergo the major rule determination, for which OIRA advises 
independent agencies to allocate 30 days. Id.
---------------------------------------------------------------------------
    To conclude, nonbinding agency guidances bring important 
transparency to Federal banking regulation and regulated firms depend 
heavily on them. In all likelihood, requiring those guidances to go 
through notice and comment and CRA review would backfire by causing 
agencies to scrap guidances altogether and increasing the likelihood of 
the ``regulation by enforcement'' that industry fears.
        RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
                         FROM GREG BAER

Q.1. The Financial Services Roundtable and The Clearing House 
Association, predecessors of the Bank Policy Institute, have 
previously requested written guidance from Federal agencies, 
including:

  A.  a 2013 request for written guidance from CFPB and HUD on 
        Dodd-Frank mortgage standards;

  B.  a 2014 request for written guidance from CFPB on the 
        TILA/RESPA integrated mortgage disclosures rule;

  C.  a 2015 request for guidance from the Federal banking 
        agencies, through the FFIEC, on Call Reports; and

  D.  a 2016 comment letter suggesting guidance from the 
        Federal Reserve and IRS on the tax consequences of 
        total loss-absorbing capacity (TLAC) rules.

    Please provide to the Committee all instances in which the 
Bank Policy Institute or its predecessors have requested or 
advocated guidance from the Federal financial institution 
regulatory agencies since July 21, 2010.

A.1. We are unable to provide a full accounting of ``all 
instances'' in which BPI or any of its predecessors have 
requested or advocated guidance. At least in our most recent 
iteration, we have consistently expressed concern about the 
agencies use of guidance because that guidance has often been 
treated as a binding rule through the examination process, even 
where no public notice was provided or comment sought. Such 
action is inconsistent with the Administrative Procedure Act 
and, unless the guidance is submitted to the Congress for 
review, with the Congressional Review Act. And it is poor 
Government, in the sense that public comment--not just from 
banks but other groups or individuals with interest and 
expertise in banking policy--tends to make for a better rule. 
Postcrisis, the combination of voluminous issuance of guidance 
along with agency treatment of that guidance as binding, 
effectively created a whole new regulatory regime about which 
the public had no input.
    Therefore, we strongly support a 2018 interagency statement 
that reaffirmed that supervisory guidance ``does not have the 
force and effect of law, and the agencies do not take 
enforcement actions based on supervisory guidance.'' To the 
extent that in recent years the agencies have strayed from that 
practice, we are advocating a return to the appropriate role of 
guidance: to State the views of the agency, but not create 
binding obligations on regulated entities.
    None of this is to deny that guidance can sometimes play a 
useful role, as it did until relatively recent times. If 
treated as nonbinding, guidance can inform regulated entities 
of agency priorities, and let them know of best (or worse) 
practices that the agency is observing. It is only when it is 
treated as binding in practice that we believe it needs to be 
issued as a rule under the law.
                                ------                                


               RESPONSES TO WRITTEN QUESTIONS OF
              SENATOR CORTEZ MASTO FROM GREG BAER

Q.1. During this hearing, a number of my colleagues floated the 
idea of a neutral arbiter or an independent ombudsman to 
represent financial institutions who have concerns with Federal 
regulators' overreach. Would you support such a proposal? If 
so, what should this review process look like? What review 
powers do you believe the arbiter should have? If you do not 
support the proposal, please explain why.

A.1. We support the idea of a neutral arbiter for financial 
institutions concerned with regulatory overreach, but would 
caution that its utility can be quite limited. Each of the 
banking agencies currently has an intra-agency appeals process 
and an ombudsman, but a recent article that analyzed the 
process and outcomes of those regimes concluded that they were 
a failure. See Hill, Julie Anderson, ``When Bank Examiners Get 
It Wrong: Financial Institution Appeals of Material Supervisory 
Determinations'', Washington University Law Review (2015). 
https://openscholarship.wustl.edu/law_lawreview/vol92/iss5/5/
    In sum, banks are loathe to appeal any adverse 
determination, for two reasons. First, and most significantly, 
they fear retaliation through the examination process. 
Moreover, this may seem like overreaction needing to be 
addressed by the institutions, but one must keep in mind that 
failing to address examiner concerns can result in a downgrade 
to the bank's Management rating. As noted in my testimony, such 
a downgrade--and until relatively recently--any unremediated 
examiner mandate--can act as a prohibition on expansion by the 
bank. And that prohibition is nonpublic and therefore 
effectively nonappealable. Second, appeals are made to the same 
agency that made the initial determination, and thus unlikely 
to succeed.
    While the second concern could be resolved by allowing 
appeal to a third party, the first would remain. Therefore, we 
believe that reform in this area should focus more on requiring 
the agencies to adhere to statutory standards for deciding 
whether a firm can expand, rather than employing a ``penalty 
box'' approach, and revisiting the CAMELS rating regime to make 
it more objective, as the current approach is to make the most 
subjective of its component (Management) the most significant.
                                ------                                


               RESPONSES TO WRITTEN QUESTIONS OF
          SENATOR CORTEZ MASTO FROM MARGARET E. TAHYAR

Q.1. During this hearing, a number of my colleagues floated the 
idea of a neutral arbiter or an independent ombudsman to 
represent financial institutions who have concerns with Federal 
regulators' overreach. Would you support such a proposal? If 
so, what should this review process look like? What review 
powers do you believe the arbiter should have? If you do not 
support the proposal, please explain why.

A.1. Stronger ombudsmen and examination appeals processes are 
needed to start the cultural change. Recent efforts by the 
banking regulators to strengthen the authority of their 
internal ombudsmen and their examination review processes are 
welcome signs of progress. I do not think that an external 
ombudsman outside of the banking agencies is the optimal 
structure; instead, more power and authority should be given to 
the current ombudsmen. Strong ombudsmen and robust appeals 
processes will not, however, be enough because of legitimate 
fears of retaliation despite attempts to provide protection 
against such retaliation. The root causes also need to be 
addressed. These are lack of transparency, limitations on the 
practical ability of the agency principals to oversee the 
supervisory staff's compliance with applicable legal 
restrictions on their discretion, the lack of any clear limits 
on the supervisory discretion to classify any shortcoming as a 
safety and soundness violation based on an individual 
supervisor's policy preferences, and the lack of legal training 
for bank supervisors. Congress should also focus on this more 
fundamental reform. Increased transparency of the supervisory 
process, including appropriate limits on the perimeter of what 
can be classified as confidential supervisory information or as 
safety and soundness violations, as well as better oversight of 
the supervisory staff's compliance with applicable legal 
restrictions on their discretion and better training about such 
legal restrictions, would increase the odds that supervisory 
staff would become more accountable to the public and agency 
leadership.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR SINEMA
                    FROM MARGARET E. TAHYAR

Q.1. In your experience, what is the best approach to balance 
the competing demands of providing regulatory clarity while 
ensuring rigorous supervision that protects the safety and 
soundness of the U.S. financial system?

A.1. The best approach is to narrow the realm of confidential 
supervisory information to the core minimum necessary to 
protect financial stability or individual bank safety and 
soundness. As a bank regulatory lawyer, I fully recognize that 
some secrecy is needed to ensure candid conversations and 
protect the financial system. Yet we need to move away from the 
current situation, in which nearly anything a bank gives its 
regulator in the course of the supervisory process might be 
transformed into confidential supervisory information, with all 
the attendant consequences. Part of the solution is for bank 
examinations to return to a focus on the quantitative core and 
move away from qualitative judgments that reflect examiner 
policy preferences on how to run the business--the examiner as 
management consultant. Ultimately, however, confidential 
supervisory information is a creature of regulation, not etched 
in stone, and Congress can exert pressure on the banking 
agencies to reform their approach or even take legislative 
action to force change if needed.
    Regulators should also take efforts to increase 
transparency, even within the current bounds of confidential 
supervisory information. In particular, the banking agencies 
should strive to release more granular data on the state of 
banking supervision, aggregated across the industry to 
anonymize the information. The Federal Reserve's November 2018 
and May 2019 Supervision and Regulation Reports represent 
admirable efforts in the right direction. The banking sector is 
a critical part of our economy and the banking agencies are a 
critical part of our Government, so it is imperative that bank 
supervisors are accountable to the public.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
                     FROM PATRICIA A. MCCOY

Q.1. Congress designed Federal regulatory agencies to be 
independent from the President's continuing influence so that 
they could make rules for our economy based on technocratic 
analysis and data, rather than political considerations. Can 
you describe why independence at regulatory agencies is 
critical?

A.1. Congress wisely conferred independence on Federal 
regulatory agencies for the long-term welfare of the American 
people. Independence promotes the general good in several 
important ways. First, it helps ensure that regulators will 
make informed decisions on the basis of data, scientific 
expertise, and facts. Second, it insulates regulators from 
pressure by the President and the Executive Branch to rig 
decisions in order to boost the reelection prospects of the 
President or the President's political party, to the detriment 
of the public generally. Such pressure could occur in at least 
two scenarios. Pressure might be exerted to curry favor with 
politically powerful industries or groups in tacit exchange for 
campaign contributions. Alternatively, the White House could 
lean on regulators to stimulate the economy in order to win 
election, indifferent to the long-term risks to the economy. 
Finally, independence helps shelter Federal regulators from 
lobbying by politically powerful and well-oiled industry 
interests seeking exceptions from regulatory actions that are 
designed to protect the American people. Independence, simply 
put, helps ensure that Federal regulators make decisions for 
the betterment of ordinary families and not as political 
favors.

Q.2. After abusive mortgages crashed the economy in 2008, you 
led the team at the Consumer Financial Protection Bureau (CFPB) 
that wrote the rules to fix the mortgage market and prevent 
another financial crisis. Can you describe, broadly, who wrote 
those rules and what evidence they used?

A.2. When Congress charged the CFPB with promulgating the 
mortgage rules in the Dodd-Frank Act, ensuring sustainable 
mortgages while advancing access to credit and minimizing 
industry burden were of uppermost importance to the Bureau. For 
this reason, the CFPB's mortgage rules were the product of 
extensive factual research, mortgage expertise, and public 
consultation. The economists, lawyers, and markets experts in 
the Bureau's Research, Markets, and Regulations Division took 
the lead in drafting the mortgage rules, following voluminous 
written public comment and outreach to all affected parties, 
including consumers, financial providers, independent 
researchers, community housing organizations, industry 
associations, consumer advocacy groups, and sister State and 
Federal regulators. In the rulemaking for the integrated 
mortgage disclosures, the Bureau even posted each new draft of 
the prototype disclosures online and asked the crowd to suggest 
needed improvements. Based on the public's suggestions, the 
Bureau then improved the draft and posted the next version 
online. This crowdsourcing was repeated every month and the 
public eventually submitted over 30,000 comments on the 
prototype forms. I can say from personal experience that the 
final disclosure forms were markedly better due to this public 
input.
    Meanwhile, the Bureau's economists and researchers drew 
heavily on a wide assortment of other empirical data in 
designing the mortgage rules. Much of that data came from large 
national data sets reporting every residential mortgage 
origination in specific channels over a substantial time 
period. These data sets contained tens of millions of 
observations and allowed the Bureau's researchers to conduct 
sophisticated analyses of the projected effect of different 
rules on expected default rates, the cost of credit, and access 
to credit. In other instances, the Bureau created data sets to 
analyze questions such as the size of potential legal liability 
to lenders from specific types of mortgage rules. Separately, 
the CFPB's markets analysts conducted ongoing, in-depth studies 
of the business models and earnings reports of mortgage lenders 
to ensure that mortgage lending remained profitable and 
sustainable following adoption of the rules. This was augmented 
by CFPB analysis of the vast economics literature on the 
effects of residential mortgages and specific types of 
regulatory intervention on key outcomes such as delinquencies 
and cost of credit. In one notable instance--the integrated 
mortgage disclosure rule--the CFPB used the most sophisticated 
field testing available to ensure that the disclosure rule was 
broadly understandable and useful to consumers and industry 
participants.

Q.3. When you were writing the rules at CFPB, President Obama 
was in the White House and his appointees were leading the 
agency. Did you ever submit CFPB rules to the White House for 
review? Why or why not?

A.3. Neither I nor the CFPB submitted CFPB rules to the White 
House or the Office of Management and Budget (OMB) for review. 
This practice conformed to the Dodd-Frank Act, which prohibits 
OMB from asserting ``jurisdiction or oversight over the affairs 
or operations of the Bureau.'' 12 U.S.C. 5497(a)(4)(E). 
Furthermore, this practice comported with Executive Order No. 
12,866, 58 FR 51,735, 51,753 (Oct. 4, 1993), which exempts all 
Federal bank regulators, including the CFPB, from the 
requirement that agencies submit their rules to OMB for review 
and cost-benefit analysis. This express exemption applies to 
agencies designated as ``independent regulatory agencies'' in 
the Paperwork Reduction Act. The Paperwork Reduction Act's list 
of independent regulatory agencies includes the CFPB and all 
other Federal bank regulators. 44 U.S.C. 3502(5) (2012).
    This exemption from OMB review of rules is a crucial 
mainstay of Federal bank regulators' independence. Because OMB 
is located within the White House and is subject to White House 
control, any provision requiring the CFPB and/or other Federal 
bank regulators to submit their rules to OMB would open up 
their rulemaking processes to White House pressure for short-
term political benefit. Effectively, Executive Order No. 12,866 
shields the CFPB and other Federal bank regulators from White 
House review of their rules. The purpose of this carve-out is 
to ensure the expert neutrality of CFPB rules and to insulate 
those rules from political manipulation by OMB and the White 
House. Instead, Congress, not the White House, retains ultimate 
control over CFPB rules.

Q.4. On April 11, 2019, Acting OMB Director Russel Vought sent 
a memo to all heads of executive departments and agencies, 
including independent agencies, creating a ``systematic process 
to determine whether rules that would not be submitted to OIRA 
. . . are major,'' \1\ a determination that should be made by 
looking at whether a rule will cost $100 million or more 
annually, will cause a major increase in costs or prices, or 
will have a significant adverse effect on players in the 
market. Are you concerned that the review of the cost-benefit 
analysis by OIRA of rules promulgated by independent agencies 
could substantively affect the rules?
---------------------------------------------------------------------------
     \1\ Office of Management and Budget, ``Guidance on Compliance With 
the Congressional Review Act'', Russell T. Vought, April 11, 2019, 
https://www.whitehouse.gov/wp-content/uploads/2019/04/M-19-14.pdf.

A.4. I am deeply concerned that the OMB's back-door attempt to 
subject rules promulgated by independent agencies to cost-
benefit analysis by OIRA could distort the content of those 
rules, to the detriment of the American public.
    The April 11, 2019, OMB Memo \2\ seeks to intrude on 
independent agencies' rulemaking autonomy by requiring them to 
submit major rule analyses under the Congressional Review Act 
(CRA) that are consistent with OIRA's cost-benefit analysis 
methodology. However, there are important reasons why Congress 
exempted cost-benefit analyses by independent agencies from 
OIRA and OMB oversight in Executive Order No. 12,866. One 
reason, discussed above, is to protect independent agencies 
from White House pressure for purposes of political gain. 
Another reason, discussed in my response to Senator Cortez 
Masto's Question 1, involves the precautionary nature of many 
rules by independent agencies. Precautionary rules are ones 
that seek to avoid harm. These types of rules pose challenges 
in cost-benefit analyses, because quantifying harms avoided is 
generally more difficult than quantifying costs. Because OIRA's 
cost-benefit methodology gives no or little weight to benefits 
that cannot be quantified, OIRA's methodology overweights costs 
and thus biases rulemaking decisions in favor of agency 
inertia. As such, OIRA's approach is poorly suited to a 
precautionary approach to harm.
---------------------------------------------------------------------------
     \2\ Memorandum from Russell T. Vought titled ``Guidance on 
Compliance With the Congressional Review Act'', OMB Memorandum M-19-14 
(Apr. 11, 2019), https://www.whitehouse.gov/wp-content/uploads/2019/04/
M-19-14.pdf (OMB Memo).
---------------------------------------------------------------------------
    Here, it bears emphasizing that the OMB Memo lacks legal 
validity as applied to independent agencies. Executive Order 
No. 12,866 means that OIRA's standards for cost-benefit 
analyses do not apply to independent agencies' major rule 
analyses and may not be wielded as a threat to ``delay OIRA's 
determination and an agency's ability to publish a rule and to 
make the rule effective.'' OMB's threat to hold up final rules 
by independent agencies indefinitely for ``insufficient or 
inadequate analysis'' in OIRA's view (see OMB Memo at 5) poses 
the added, serious concern that OMB or OIRA might call a 
regulator's bluff and press it to renegotiate the provisions of 
a final rule pending publication of the rule's text, with no 
judicial review. Any attempt to do so would be a blatant 
affront to agency independence and a rank violation of 
Executive Order No. 12,866. Even more seriously, any such move 
by OIRA would represent an attempt to bottle up rules, detain 
them from Congressional review, and wrest CRA oversight from 
Congress in the process. OIRA has mired final rules of 
executive agencies indefinitely while conducting its review in 
the past and there is reason to think the same would occur if 
independent agencies had to submit the cost-benefit analyses of 
their rules to OIRA.

Q.5. This review ``applies to more than just notice-and-comment 
rules; it also encompasses a wide range of other regulatory 
actions, including, inter alia, guidance documents, general 
statements of policy, and interpretive rules.'' \3\ How will 
the mandatory submission of guidance documents for review 
affect the ability of agencies to do their jobs?
---------------------------------------------------------------------------
     \3\ Id.

A.5. Please see my response to Question 3 from Senator Cortez 
---------------------------------------------------------------------------
Masto.

Q.6. If Donald Trump was president when you were writing the 
mortgage rules in 2011 and his OMB demanded the opportunity to 
review cost benefit analysis as it just did, what do you 
believe could have happened to those rules?

A.6. Please see my response to Question 4 above. The CFPB used 
rigorous cost-benefit analyses in the mortgage rules. Despite 
the strong foundation supporting those rules, the OMB Memo, had 
it been in effect at the time, would have raised concerns that 
OMB might have withheld the major rule determination required 
by the Congressional Review Act on grounds that the CFPB's 
regulatory impact analyses did not adhere to OIRA's cost-
benefit analysis methodology.
                                ------                                


               RESPONSES TO WRITTEN QUESTIONS OF
          SENATOR CORTEZ MASTO FROM PATRICIA A. MCCOY

Q.1. In our discussion, you raised concerns with the OMB memo 
specifying the methodology for cost-benefit analysis. Do you 
believe there is a better process by which to determine cost-
benefit or a rulemaking or guidance?

A.1. To answer this question, it is necessary to distinguish 
between regulations and guidances. In the case of regulations, 
the most important consideration is preserving the discretion 
of the independent Federal bank regulators to determine the 
appropriate methodology for their regulatory impact or cost-
benefit analyses. Federal bank regulators take regulatory 
impact analyses extremely seriously. Since the enactment of the 
Dodd-Frank Act, they have strengthened and refined their 
regulatory impact and cost-benefit analyses, particularly given 
the heightened judicial scrutiny that those analyses now 
receive after the D.C. Circuit's decision in Business 
Roundtable v. Sec. and Exch. Comm'n, 647 F.3d 1144, 1148 (D.C. 
Cir. 2011). \1\
---------------------------------------------------------------------------
     \1\ See, e.g., Board of Governors of the Federal Reserve System, 
Response to a Congressional Request Regarding the Economic Analysis 
Associated with Specified Rulemakings 9, 20 (June 2011), http://
oig.federalreserve.gov/reports/Congressional-Response-economic-
analysis-2011web.pdf (stating that the Federal Reserve ``conducts its 
rulemaking activities in a manner that is generally consistent with the 
philosophy and principles outlined in the Executive orders'' and 
suggesting that the Federal Reserve acts consistently with at least 
some aspects of the guidance in OMB Circular A-4); GAO Report GAO-12-
151, Dodd-Frank Act Regulations: Implementation Could Benefit From 
Additional Analyses and Coordination 12 (Nov. 2011), http://
www.gao.gov/new.items/d12151.pdf (reporting statements by the Federal 
Reserve Board, FDIC, NCUA, and OCC that their agencies follow OMB's 
guidance in spirit or principle. CFPB officials also stated that the 
Bureau expects to follow the spirit of OMB's guidance, ``in a manner 
consistent with the Dodd-Frank Act, which speaks directly to the 
consideration of benefits, costs, and impacts'').
---------------------------------------------------------------------------
    An overly rigid cost-benefit methodology that required 
quantification of all costs and benefits could jeopardize 
financial institutions' solvency, consumer welfare, or 
financial stability. That is because in financial regulation, 
it is generally harder to quantify benefits in the form of 
harms avoided than to quantify costs. Federal bank regulators 
must make numerous rulemaking decisions under conditions of 
incomplete data and uncertainty. Requiring Federal bank 
regulators to monetize all harms avoided--which might prove 
impossible--would dangerously tilt rulemaking analyses toward 
inaction and the status quo.
    In the case of guidances, it is difficult or impossible to 
conduct regulatory impact or cost-benefit analyses because 
guidances are not binding on private third parties and 
therefore do not impose defined costs.

Q.2. In your testimony, you raise concerns regarding political 
influence on our Nation's economy and financial system. Can you 
elaborate on the potential harms political influence on our 
financial system may have?

A.2. Insulating bank regulation from political influence is 
vital to the long-term economic welfare of our Nation and the 
American public. A couple of examples illustrate why this is 
the case. If Federal bank regulators lacked independence, a 
President could pressure those agencies to deregulate the 
banking industry to an excessive degree in order to increase 
bank lending, goose the economy, and boost the President's 
reelection prospects. If the ensuing deregulation resulted in 
unwise lending and an eventual spike in loan delinquencies, the 
economy might experience a short-term bump but long-term 
losses. In a similar way, White House pressure on the Federal 
Reserve Board to lower interest rates could stimulate the 
economy in the short term, to the President's political 
benefit, but inflict harm on the economy in the long term by 
stoking inflation and reducing the buying power of ordinary 
Americans.

Q.3. Could you discuss the potential impact that a drawn out 
OIRA review or Congressional Review Act process on guidance 
could have on the markets, or the economy as a whole?

A.3. As I noted in my written testimony (p. 9 [p. 54 herein]), 
notice-and-comment proceedings for major rules take at least 2 
years and normally longer. Congressional Review Act 
transmission and review prolong this process even further.
    Imposing those same procedures on guidance would have 
unintentional effects redounding to the detriment of markets or 
the economy as a whole. For instance, agencies might respond by 
issuing pronouncements that otherwise would be nonbinding 
guidances as binding legislative rules. This would put a drag 
on financial firms by unnecessarily increasing the number of 
binding rules they had to observe and raising their legal 
exposure for violation of those new rules. If the financial 
sector became less efficient and increasingly cautious in 
lending and investment as a result, the larger economy could 
suffer adverse knock-on effects in the form of reduced access 
to capital and credit.
    Alternatively, agencies might respond to more onerous 
guidance procedures by issuing fewer compliance guidances or 
none at all. This would hurt honest companies' efforts to 
comply with regulations, because many guidances are designed to 
aid industry with compliance. As a result, firms would face 
increased legal exposure for violations of rules, with a 
potential negative impact on earnings and their willingness to 
take reasonable business risks. Any such excessive business 
caution could dampen the financial sector and reduce credit and 
investment to the economy as a whole.

Q.4. Some of your fellow witnesses raised concerns regarding 
the opacity of the Matters Requiring Attention (MRA) and the 
Matters Requiring Immediate Attention (MRIA) process, and have 
suggested giving financial institutions a process by which to 
arbitrate or contest these actions. Would you support such a 
process and if so, why? If not, please explain why.

A.4. Depository institutions and their holding companies 
already have several avenues of recourse to challenge MRAs and 
MRIAs with which they disagree (see pp. 4-5 [50-51 herein] of 
my written testimony). First, they can meet privately with 
examiners and their supervisors to propose changes to or 
contest those actions. Second, all Federal bank regulators 
maintain ombudsmen whom financial institutions can enlist to 
help resolve any problems from MRAs and MRIAs. Third, Federal 
bank regulators all have procedures for formal agency reviews 
of examination results, including MRAs and MRIAs. And fourth, 
the banking industry can informally petition Federal bank 
regulators to reduce the burden of MRAs and MRIAs through 
across-the-board reforms. Indeed, in response to banking 
industry calls, the Board of Governors of the Federal Reserve 
System proposed a guidance in 2017 that would reduce the burden 
on financial institutions' boards of directors to respond to 
MRAs and MRIAs. See Federal Reserve System, ``Proposed guidance 
on Supervisory Expectation for Boards of Director'', 82 FR 
37219 (Aug. 9, 2017).
    In view of these multiple avenues of relief from MRAs and 
MRIAs, there is no justification for tying Federal bank 
supervisors in knots by conferring depository institutions with 
a right to arbitrate MRAs and MRIAs. Such a cumbersome 
procedure would intensify the problem experienced during the 
lead-up to the 2008 financial crisis, when Federal bank 
examiners routinely failed to insist that institutions address 
and resolve outstanding MRAs and MRIAs from their prior 
examinations and regularly failed to take enforcement for 
persistent unsafe and unsound practices. IndyMac Bank, F.S.B., 
was an especially egregious example, but it was not alone. See 
Office of Inspector General, Department of the Treasury, Safety 
and Soundness: Material Loss Review of IndyMac Bank, FSB 17-19, 
24-26, 33-34, 63-70 (OIG-09-032, Feb. 26, 2009). This 
widespread regulatory inaction contributed to the 2008 
financial crisis and its fallout. If anything, the regulatory 
inaction that culminated in the crisis of 2008 underscores the 
importance of preserving today's stronger MRA and MRIA process, 
not weakening it through rigid arbitration procedures. Adopting 
such arbitration procedures would embolden unsafe institutions 
to discourage Federal examiners from writing up needed MRAs and 
MRIAs, thereby endangering the Deposit Insurance Fund, 
uninsured depositors, and the banking system as a whole.

Q.5. During this hearing, a number of my colleagues floated the 
idea of a neutral arbiter or an independent ombudsman to 
represent financial institutions who have concerns with Federal 
regulators' overreach. Would you support such a proposal? If 
so, what review powers do you believe the arbiter should have? 
If you do not support the proposal, please explain why.

A.5. Federal statutes already provide financial institutions 
that are aggrieved by Federal regulators' actions with a 
neutral, independent arbiter in the form of Article III courts. 
Under the Administrative Procedure Act (APA), aggrieved 
institutions can seek federal judicial review of a broad array 
of final agency actions, including rules and agency 
enforcement. 5 U.S.C. 701-706. This right to Article III 
judicial review is on top of the multiple avenues of internal 
agency relief to which financial institutions are entitled (see 
pp. 4-5 [50-51 herein] of my written testimony).
    Superimposing the right to another neutral arbiter or 
independent arbiter would be unwise and potentially disastrous. 
First, it would undermine the carefully drafted procedures in 
the APA for independent, neutral judicial review and the 
judiciary's constitutional responsibility for conducting that 
review. Second, it would supplant the judgment of Federal bank 
regulators with decisions by outside arbiters who lack 
responsibility for the safety of the larger financial system. 
Especially in this era of heightened systemic risk, that would 
be a dangerous path to tread. Finally, it would hamper the 
nimbleness of Federal bank regulators to respond to emerging 
threats by bogging them down in unnecessary and time-consuming 
procedures.

Q.6. In your conversation, you discussed improvements to the 
MRA and the MRIA process. What are the problems with the 
current process? What reforms do you believe need to be made to 
the process? Do you believe there should be a threshold of some 
sort for what MRAs and MRIAs go through the process?

A.6. It would be a mistake to hamstring Federal bank 
regulators' ability to cite depository institutions for unsafe 
and unsound practices and seek remediation of those practices 
by legislating artificial limits on the MRA and MRIA process. 
Regulators need full latitude to address practices that 
threaten the safety and soundness of depository institutions 
and MRAs and MRIAs are important to that flexibility and 
discretion. To the extent that the MRA and MRIA process could 
benefit from streamlining, that should be resolved through 
transparent engagement with the public by Federal bank 
regulators. The banking industry is fully capable of exploring 
any needed reforms with regulators and, indeed, those 
discussions have already set in motion a pending guidance by 
the Federal Reserve Board to reduce the demands imposed by MRAs 
and MRIAs. See Federal Reserve System, ``Proposed Guidance on 
Supervisory Expectation for Boards of Director'', 82 FR 37219 
(Aug. 9, 2017).
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