United States: interagency statement on role of supervisory guidance to become a rule

In response to a call for a rulemaking by two leading bank industry trade associations, the federal banking agencies1 have issued a proposed rule to codify an earlier interagency statement that their supervisory guidance—unlike regulations—does not carry the force of law, and to expressly provide that supervisory guidance will not serve as the basis for examiner criticisms and formal or informal enforcement actions.

The proposed rule, if adopted, would clarify that issuances such as the 2013 Leveraged Lending Guidance do not create binding legal requirements. It is less clear, however, whether such a rule would represent a meaningful shift from the agencies' current approach or view of their authority to issue examiner criticisms or enforcement actions based on conduct that does not violate a specific statute or regulation.

Background

The proposed rule,2 which was issued jointly with the Consumer Financial Protection Bureau ("CFPB") and the National Credit Union Administration ("NCUA"), would codify the Interagency Statement Clarifying the Role of Supervisory Guidance ("2018 Statement") issued in 2018. The 2018 Statement was issued following determinations by the Government Accountability Office ("GAO") that the Leveraged Lending Guidance issued by the FRB, FDIC and OCC in 2013, as well as certain other guidance issued by the CFPB and FRB, were "rules" for purposes of the Congressional Review Act ("CRA") and, as such, could not take effect until Congress had reviewed them.

Congressional Review of the Leveraged Lending Guidance and Other Agency Issuances

The Leveraged Lending Guidance—which was the subject of considerable controversy in the banking industry and Congress—as well as certain other guidance issued by the CFPB and the FRB were reviewed by the GAO and determined to be "rules" as defined in the Administrative Procedure Act ("APA"),3 which is used for CRA purposes. The GAO made those determinations notwithstanding the banking agencies' position that the Leveraged Lending Guidance (and the others) were not rules because, among other things, they did not establish legally binding standards and did not substantially affect the rights or obligations of third parties.

Under the CRA process, the GAO determination left the FRB, the OCC and the FDIC with the choice of (1) submitting the Leveraged Lending Guidance to Congress, (2) issuing similar new guidance as a formal regulation that would also have to be submitted to Congress for CRA review, or (3) abandoning the Leveraged Lending Guidance altogether in favor of an alternative approach.4 Because the agencies have not pursued any of those actions, the Leveraged Lending Guidance has effectively been in regulatory "limbo" following the GAO determination. Public remarks by the FRB Chairman and OCC Comptroller on the topic in 2018 were viewed by many industry observers as indicating that the federal banking agencies were backing away from the Leveraged Lending Guidance.5 The agencies do not refer specifically to the Leveraged Lending Guidance in the 2018 Statement or the proposed rule when discussing the role and legal status of supervisory guidance.

While the GAO determination could be viewed as requiring agency action to clarify the role and legal effect of the Leveraged Lending Guidance, the 2018 Statement and the proposed rule can be read to mean that agency guidance that is deemed to be a rule by the GAO for CRA purposes may nonetheless continue to be treated by the issuing agency as nonbinding supervisory guidance. The characterization of the Leveraged Lending Guidance as "interagency guidance" suggests that it is likely the type of agency issuance that, under the proposed rule, would not have the force and effect of law and cannot form the basis of examiner criticisms and regulatory enforcement actions. Although the Leveraged Lending Guidance was issued following public notice and comment requirements—which is the type of procedure required for regulations—the proposed rule would clarify that seeking public comment on supervisory guidance does not mean that an agency intended the guidance to be a regulation.

The 2018 Statement

The 2018 Statement was issued to make clear that supervisory guidance, unlike a law or regulation, does not have the force and effect of law. The 2018 Statement explains the difference between supervisory guidance, on the one hand, and laws and regulations, on the other, as follows:

The agencies issue various types of supervisory guidance, including interagency statements, advisories, bulletins, policy statements, questions and answers, and FAQs to their respective supervised institutions. A law or regulation has the force and effect of law. Unlike a law or regulation, supervisory guidance does not have the force and effect of law, and the agencies do not take enforcement actions based on supervisory guidance. Rather, supervisory guidance outlines the agencies' supervisory expectations or priorities and articulates the agencies' general views regarding appropriate practices for a given subject area.

Supervisory guidance often provides examples of practices that the agencies generally consider consistent with safety-and-soundness standards or other applicable laws and regulations, including those designed to protect consumers. Supervised institutions at times request supervisory guidance, and such guidance is important to provide insight to industry, as well as supervisory staff, in a transparent way that helps to ensure consistency in the supervisory approach.6

The 2018 Statement also notes that it was issued to clarify a number of policies and practices relating to supervisory guidance, including in particular that:

Examiners will not criticize a supervised financial institution for a "violation" of supervisory guidance. Rather, any citations will be for violations of law, regulation or non-compliance with enforcement orders or other enforceable conditions. During examinations and other supervisory activities, examiners may identify unsafe or unsound practices or other deficiencies in risk management, including compliance risk management, or other areas that do not constitute violations of law or regulation. In some situations, examiners may reference (including in writing) supervisory guidance to provide examples of safe and sound conduct, appropriate consumer protection and risk management practices, and other actions for addressing compliance with laws or regulations.7

The 2018 Statement also explains that the agencies intend to limit the use of numerical thresholds or other "bright-lines" in describing expectations in supervisory guidance, and where numerical thresholds are used, the agencies intend to clarify that the thresholds are exemplary only and not prescriptive. The 2018 Statement further provides that the agencies may sometimes issue supervisory guidance for notice and comment in the same manner as a regulation, as they did with the Leveraged Lending Guidance,8 but the use of the notice and comment process does not mean that such guidance is intended to be a regulation or have the force and effect of law.

Banking Trade Associations' Petition for Rulemaking

In response to the 2018 Statement, the Bank Policy Institute and the American Bankers Association submitted a petition9 under the APA supporting the 2018 Statement, but asking for it as part of a formal rulemaking rather than a statement.10 In submitting the petition, the two industry groups were concerned that the 2018 Statement was itself only supervisory guidance and, as such, did not have the force of law and was not binding on the agencies, but rather, was subject to change simply by the issuance of different guidance.

The petition also requested that such a rule expressly provide that matters requiring attention ("MRAs") and other "criticisms" or "citations" by examiners would not be based on supervisory guidance and would be limited to a violation of law or regulation, including a "demonstrably unsafe and unsound practice," which constitutes a violation of law under the regulatory enforcement provisions of the Federal Deposit Insurance Act ("FDI Act").11 The petition noted that some examiners might defeat the purpose of the 2018 Statement by replacing guidance-based examination criticisms with MRAs and matters requiring immediate attention ("MRIAs") grounded in generic and conclusory assertions about "safety and soundness." The petition further noted that the 2018 Statement's general reference to a "criticism" or "citation" had engendered some confusion about whether MRAs, MRIAs and other adverse supervisory actions were in fact covered by the 2018 Statement, which might lead some examiners to conclude that they retained authority to issue MRAs and similar actions on the basis of supervisory guidance.

Key Points of the Proposed Rule

The proposed rule, if adopted, would provide added weight and clarity to the 2018 Statement, but also leaves some open questions.

What the Proposed Rule Would Clarify and Confirm

The proposed rule would effectively reiterate the 2018 Statement and adopt most of the changes requested in the petition. If adopted, it would constitute a formal regulation for administrative law purposes that would bind each of the agencies and could not be amended or withdrawn without undertaking a new rulemaking process that complied with administrative law requirements. The principles of the proposed rule would be set forth in an "Interagency Statement Clarifying the Role of Supervisory Guidance" as an appendix to a formal regulation adopted by each agency on the use of supervisory guidance. Each regulation would state that such interagency statement describes the official policy of the issuing agency with regard to the use of supervisory guidance in the supervisory process and that it is binding on the agency.

The proposed rule would clarify and confirm the following:

  1. Supervisory guidance does not have the force and effect of law.12
  2. Supervisory guidance would be used to communicate supervisory expectations or priorities, including to provide examples of practices generally considered consistent with safety-and-soundness standards, consumer protection or other applicable laws and regulations.
  3. Examiners would not issue MRAs, MRIAs, matters requiring board attention, documents of resolution or supervisory recommendations based on a violation of, or noncompliance with, supervisory guidance.
  4. The agencies would not issue an enforcement action based on a violation or noncompliance with supervisory guidance.
  5. Supervisory criticisms should be specific as to practices, operations, financial conditions, or other matters that could have a negative effect on the safety and soundness of the financial institution, could cause consumer harm, or could cause violations of laws, regulations, final agency orders or other legally enforceable conditions.
  6. The use of numerical thresholds or other "bright-lines" in describing expectations in supervisory guidance would be limited, other than as examples or to clarify a statutory requirement.

The Open Questions

While the proposed rule does clarify that supervisory guidance does not have the force and effect of law and will not form the basis for examiner criticisms and formal agency enforcement action, there remain questions as to its intended scope and the extent to which it would change how examiners approach issuing criticisms.

Supervisory guidance may come with many names and may not always be readily identifiable. The proposed rule retains the style of the 2018 Statement and does not include any definitions, including for what constitutes "supervisory guidance." The proposed rule acknowledges that supervisory guidance may be issued in a variety of forms, including interagency statements, advisories, bulletins, policy statements, questions and answers, and FAQs and also that guidance, like a formal rulemaking, may sometimes be submitted by the agencies for public comment. The lack of a clear definition or a requirement for the agencies to designate existing and future issuances as "supervisory guidance" seems likely to create continuing industry and examiner confusion, at least as to whether certain agency issuances constitute supervisory guidance, and as a result, whether they could be used as the basis for supervisory criticisms and enforcement actions.

On the other hand, "interpretive rules," by any name, will continue to be used as the basis for examiner criticisms and formal enforcement actions. The agencies note in the rulemaking release that "interpretive rules" are not addressed by the proposed rule. Although the proposed rule does not provide a clear distinction between what the agencies intend to treat as "supervisory guidance" rather than "interpretive rules," the rulemaking release cites Supreme Court precedents, among others, to the effect that interpretive rules are rules or statements issued by an agency to advise on the agency's construction of the statutes and rules that it administers. However, another Supreme Court decision also explains that the term "interpretive rule" is not specifically defined in the APA and that "its precise meaning is the source of much scholarly and judicial debate."13 Similarly, the agencies recognize in the rulemaking release that questions concerning the status of interpretive rules are case-specific. The proposed rule does not provide either an explicit definition or other mechanism to permit a definitive identification of issuances that are intended as interpretive rules, rather than supervisory guidance.

Safety and soundness concerns remain a valid basis for examiner criticisms and enforcement actions. The proposed rule provides a rule of construction that expressly notes that "guidelines" issued under the FDI Act's authority to prescribe standards for safety and soundness (e.g., the Interagency Guidelines Establishing Standards for Safety and Soundness) would remain binding legal obligations,14 as would any other agency guidelines specifically authorized by statute.

The petition requested that a rulemaking stipulate that MRAs, as well as memoranda of understanding, examination downgrades and any other formal examination mandate or sanction, be based only on a violation of a statute, regulation or order, including a "demonstrably unsafe or unsound practice" (which is treated as a violation of law under the enforcement provisions of the FDI Act). The agencies, instead, indicated in the rulemaking release that the intended scope of the proposed rule would be limited to how supervisory guidance should be used in the supervisory process, not the standards or processes used by examiners to issue supervisory criticisms more generally. They note that the agencies' authority to exercise visitorial powers with respect to supervised banking institutions allows examiners to identify deficient practices before they rise to violations of law or regulation, or before they constitute unsafe or unsound banking practices, and that the agencies believe that this early identification of deficient practices serves the interest of the public and supervised institutions. The proposed rule would require only that any such deficiencies and resulting MRAs could not be based on a "violation" of supervisory guidance.

The language of the proposed rule also suggests that the agencies regard current supervisory practices relating to examiner criticisms as meeting the petition's request to avoid citations based on "generic" or "conclusory" references to safety and soundness. The proposed rule states that "[s]upervisory criticisms should continue to be specific,"15 suggesting that the agencies deem examiner practices to date in issuing MRAs and other criticisms to be within the limits that would be formalized by adoption of the proposed rule. We also note that the proposed rule does not establish any materiality or other standards as a threshold for when noncompliance or deficiencies would merit criticism on the grounds of safety and soundness.

The proposed rule may lessen the availability and utility of supervisory guidance. The clarity the proposed rule may provide as to the legal effect of supervisory guidance may come with a quid pro quo. The proposed rule reiterates the provision in the 2018 Statement that the agencies will aim to reduce or limit the issuance of multiple guidance documents on a single topic. That seemingly contrasts with the recognition that supervisory guidance "is important to provide insight to industry, as well as supervisory staff, in a transparent way that helps to ensure consistency in the supervisory approach." Fewer statements, FAQs and similar issuances, especially in respect of new or complex requirements, could lead to uncertainty as to regulatory objectives and the potential for confusion among both financial institutions and examiners. Conceivably, examiners also may become less willing to treat compliance with supervisory guidance as evidence of compliance with the requirements imposed by the underlying statute or regulation being addressed in the guidance.

Supervisory guidance should be expected to continue to inform the agencies' supervisory processes, even if not used specifically as the basis for examiner criticisms or enforcement actions. While the proposed rule would preclude the agencies from citing a violation of (or noncompliance with) supervisory guidance as the basis for examiner criticism or an enforcement action, supervisory guidance would continue to inform examiners' evaluations of particular banking practices. Where the supervisory guidance identifies examples of practices that the agencies generally consider consistent with safety-and-soundness standards or other applicable laws and regulations, examiners could regard banking practices that are at substantial variance with such guidance as indicating the existence of unsafe and unsound practices for which examiner criticisms or enforcement actions could apply.

Reliance on supervisory guidance alone may not be sufficient evidence of compliance. Although examiners may continue to look to supervisory guidance to inform their examinations, it is not clear what weight examiners will give to supervisory guidance as evidence that a product, service or practice is being properly conducted, when an institution that is being examined seeks to rely on it.

The effect of a change in US administration on the proposed rule is currently unclear. The change in US administration in January 2021 is expected to lead to leadership changes at some of the agencies and to their regulatory and supervisory priorities. As a result, it is not clear whether: (1) the proposed rule will fundamentally change, (2) various agencies may back out of this interagency rulemaking process, or (3) the proposed rule will go any further at all. Although most of the key points in the proposed rule are relatively uncontroversial or reflect established principles of administrative law, the new administration may prefer to avoid having those points set forth in formal regulations that are legally binding on the agencies rather than in non-binding guidance such as the 2018 Statement. It is also possible that the agencies may seek to issue final regulations based on the proposed rule quickly after the end of the 60-day public comment period, which would then require the agencies to undertake a subsequent rulemaking process following any change in agency leadership in order to amend or rescind those regulations.

Comments on the proposed rule are due no later than January 4, 2021. Although the proposed rule embraces most of the requests of the banking industry trade associations in their petition, commenters may wish to submit comments of their own to seek clarity on remaining open questions.

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