Category: Financial Services Law

Corporate Transparency Act: Implications for Business Startups

Congress passed the Corporate Transparency Act (CTA) in January 2021 to provide law enforcement agencies with further tools to combat financial crime and fraud. The CTA requires certain legal entities (each, a “reporting company”) to report, if no exemption is available, specific information about themselves, certain of their individual owners and managers, and certain individuals involved in their formation to the Financial Crimes Enforcement Network (FinCEN) of the U.S. Department of Treasury. The beneficial ownership information (BOI) reporting requirements of the CTA are set to take effect on January 1, 2024. Those who disregard the CTA may be subject to civil and criminal penalties.

A recent advisory explaining the CTA reporting requirements in further detail may be found here.

While the CTA includes 23 enumerated exemptions for reporting companies, newly formed businesses (Startups) may not qualify for an exemption before the date on which an initial BOI report is due to FinCEN. As a result, Startups (particularly those created on or after January 1, 2024) and their founders and investors, must be prepared to comply promptly with the CTA’s reporting requirements.

As an example, businesses may want to pursue the large operating company exemption under the CTA. However, among other conditions, a company must have filed a federal income tax or information return for the previous year demonstrating more than $5 million in gross receipts or sales. By definition, a newly formed business will not have filed a federal income tax or information return for the previous year. If no other exemption is readily available, such a Startup will need to file an initial BOI report, subject to ongoing monitoring as to whether it subsequently qualifies for an exemption or any reported BOI changes or needs to be corrected, in either case triggering an obligation to file an updated BOI report within 30 days of the applicable event.

Startups also should be mindful that the large operating company exemption requires the entity to (i) directly employ more than 20 full time employees in the U.S. and (ii) have an operating presence at a physical office within the U.S. that is distinct from the place of business of any other unaffiliated entity. Importantly, this means that a mere “holding company” (an entity that issues ownership interests and holds one or more operating subsidiaries but does not itself satisfy the other conditions of this exemption) will not qualify. Startups may want to consider these aspects of the large operating company exemption during the pre-formation phase of their business.

Fundraising often requires Startups to satisfy competing demands among groups of investors, which can lead to relatively complex capitalization tables and unique arrangements regarding management and control. These features may cause BOI reporting for Startups to be more complicated than reporting for other small and closely held businesses. Founders, investors, and potential investors should familiarize themselves with the CTA’s reporting requirements and formulate a plan to facilitate compliance, including with respect to the collection, storage and updating of BOI.

By ensuring all stakeholders understand the BOI reporting requirements and are prepared to comply, your Startup can avoid conflicts with current and potential investors and ensure that it collects the information that it needs to provide a complete and timely BOI report.

Yezi (Amy) Yan and Jordan R. Holzgen contributed to this article.

© 2023 Varnum LLP
For more news on the Corporate Transparency Act, visit the NLR Corporate & Business Organizations section.

What Can We Learn From OFAC Enforcement Actions?

The Office of Foreign Assets Control (OFAC) has closed eight enforcement actions so far in 2023. These enforcement actions targeted companies, financial institutions, and individuals in the United States and abroad, and they resulted in more than $550 million in settlements.

What can other companies, financial institutions, and individuals learn from these enforcement actions? OFAC publishes Enforcement Releases on its website, and these releases provide some notable insights into OFAC’s sanctions enforcement tactics and priorities. By understanding these tactics and priorities, potential targets of OFAC enforcement actions can take strategic steps to bolster their sanctions compliance programs and efforts and reduce their risk of facing OFAC scrutiny.
Notably, all eight of OFAC’s enforcement actions so far in 2023 resulted in settlements with the target. As discussed further below, the majority of these enforcement actions also resulted from voluntary self-disclosures—so it makes sense that the companies and financial institutions involved were interested in settling. There are several other notable consistencies among OFAC’s 2023 enforcement actions as well.

OFAC Enforcement Actions in 2023

Here is a brief summary of each of OFAC’s enforcement actions so far in 2023:

1. Godfrey Phillips India Limited

Statutory Maximum Civil Monetary Penalty (CMP): $1.78 million

Base Penalty Amount: $475,000 (non-egregious violation, no voluntary self-
disclosure)
Settlement Amount: $332,500

Godfrey Phillips India Limited (GPI) faced an enforcement action related to its use of U.S. financial institutions to process transactions for exporting tobacco to North Korea. According to OFAC, GPI “relied on several third-country intermediary parties to receive payment, which obscured the nexus to the DPRK and caused U.S. financial institutions to process these transactions.”

In agreeing to a $332,500 settlement with GPI, OFAC considered the following
aggravating factors under its Economic Sanctions Enforcement Guidelines:

  •  GPI acted “recklessly” and exercised a “minimal degree of caution or care for U.S. sanctions laws and regulations.”
  • Several company managers had actual knowledge that the conduct at issue “concerned the exportation of tobacco to [North Korea].”
  •  The company’s actions harmed U.S. foreign policy objectives “by providing a sought-after, revenue-generating good to the North Korean regime.”

    Mitigating factors in this case included:

  • GPI had not received a Penalty Notice or Finding of Violation from OFAC in the previous five years.
  •  GPI took remedial measures upon learning of the apparent violations, including implementing new know-your customer measures and recordkeeping requirements.
  •   GPI cooperated with OFAC during its investigation.

2. Wells Fargo Bank, N.A.

Statutory Maximum CMP: $1.066 billion

Base Penalty Amount: $533,369,211 (egregious violation, voluntary self-disclosure)

Settlement Amount: $30 million

Wells Fargo Bank, N.A. faced an enforcement action related to its predecessor Wachovia Bank’s decision to provide software to a foreign bank that used the software to process trade-finance transactions with sanctioned nations and entities. While noting multiple failures by the bank (including its failure to identify the issue for seven years “despite concerns raised internally within Wells Fargo on multiple occasions”), OFAC agreed to settle Wells Fargo’s potential half-billion-dollar liability for $30 million. Aggravating factors in this case included:

  •  Reckless disregard for U.S. sanctions requirements and failure to exercise a minimal degree of caution or care.
  • The fact that senior management “should reasonably have known” that the software was being used for transactions with sanctioned jurisdictions and entities.
  • Wells Fargo undermined the policy of OFAC’s sanctions programs for Iran, Sudan, and Syria by providing the software platform.

Mitigating factors in this case included:

  • Wells Fargo had a strong sanctions compliance program at the time of the apparent violations.
  • The “true magnitude of the sanctions harm underlying the conduct” is less than the total value of the transactions conducted using the software platform.
  • Wells Fargo had not received a Penalty Notice or Finding of Violation from OFAC in the previous five years and remediated the compliance issue immediately.

3. Uphold HQ Inc.

Statutory Maximum CMP: $44,468,494

Base Penalty Amount: $90,288 (non-egregious violation, voluntary self-disclosure)

Settlement Amount: $72,230

Uphold HQ Inc., a California-based money services business, faced an enforcement action related to its processing of transactions for customers who self-identified as being located in Iran or Cuba or as employees of the Government of Venezuela. The 152 transactions at issue involved a total value of $180,575. Aggravating factors in this case included:

  •  Failure to exercise due caution or care when conducting due diligence on customers who provided information indicating sanctions risks.
  • Uphold had reason to know that it was processing payments for customers in Iran and Cuba and who were employees of the Venezuelan government.

Mitigating factors in this case included:

  •  Uphold had not received a Penalty Notice or Finding of Violation from OFAC in the previous five years.
  • Uphold cooperated with OFAC’s investigation.
  •  Uphold undertook “numerous” remedial measures in response to OFAC’s investigation.

4. Microsoft Corporation

 
Statutory Maximum CMP: $404.6 million

Base Penalty Amount: $5.96 million (non-egregious violation, voluntary self-disclosure)

Settlement Amount: $2.98 million

Microsoft Corporation faced an enforcement action related to its exportation of “services or software” to Specially Designated Nationals (SDNs) and blocked persons in violation of OFAC’s Cuba, Iran, Syria, and Ukraine/Russia-related sanctions programs. According to OFAC’s Enforcement Release, “[t]he majority of the apparent violations . . . occurred as a result of [Microsoft’s] failure to identify and prevent the use of its products by prohibited parties.” Aggravating factors in this case included:

  • Microsoft demonstrated a reckless disregard for U.S. sanctions over a seven-year period.
  •  The apparent violations harmed U.S. foreign policy objectives by providing software and services to more than 100 SDNs or blocked persons, “including major Russian enterprises.”
  •  Microsoft is a “world-leading technology company operating globally with substantial experience and expertise in software and related services sales and transactions.”

Mitigating factors in this case included:

  • There was no evidence that anyone in Microsoft’s U.S. management was aware of the apparent violations at any time.
  • Microsoft cooperated with OFAC’s investigation.
  • Microsoft undertook “significant remedial measures and enhanced its sanctions compliance program through substantial investment” after learning of the apparent violations.

5. British American Tobacco P.L.C.

Statutory Maximum CMP: $508.61 billion

Base Penalty Amount: $508.61 billion (egregious violation, no voluntary self-
disclosure)
Settlement Amount: $508.61 billion

British American Tobacco P.L.C. entered into a settlement for the full statutory maximum CMP resulting from apparent violations of OFAC’s sanctions against North Korea. According to OFAC, the company engaged in a conspiracy “to export tobacco and related products to North Korea and receive payment for those exports through the U.S. financial system” by obscuring the source of the funds involved. Aggravating factors in this case included:

  •  The company “willfully conspired” to unlawfully transfer hundreds of millions of dollars from North Korea through U.S. banks.
  •  The company concealed its business in North Korea through “a complex remittance structure that relied on an opaque series of front companies and intermediaries.”
  • The company’s management had actual knowledge of the apparent conspiracy “from its inception through its termination.”
  •  The transactions at issue “helped North Korea establish and operate a cigarette manufacturing business . . . that has reportedly netted over $1 billion per year.”
  •  British American Tobacco is “a large and sophisticated international company operating in approximately 180 markets around the world.”

Mitigating factors in this case included:

  • British American Tobacco has not received a Penalty Notice or Finding of Violation in the past five years.
  •  British American Tobacco cooperated with OFAC’s investigation.

6. Poloniex, LLC

Statutory Maximum CMP: 19.69 billion

Base Penalty Amount: $99.23 million (non-egregious violation, voluntary self-disclosure)

Settlement Amount: $7.59 million

Poloniex, LLC, which operates an online trading platform in the United States, agreed to settle after it was discovered that the company committed 65,942 apparent violations of various sanctions programs by processing transactions with a combined value of over $15 million. In settling for a small fraction of the base penalty amount, OFAC noted that Poloniex was a “small start-up” when most of the apparent violations were committed and that its acquiring company had already adopted a more-robust OFAC compliance program.

7. Murad, LLC

Statutory Maximum CMP: $22.22 million

Base Penalty Amount: $11.11 million (egregious violation, voluntary self-disclosure)

Settlement Amount: $3.33 million

Murad, LLC, a California-based cosmetics company, faced an OFAC enforcement action after it self-disclosed that it had exported products worth $11 million to Iran. While OFAC found that the company acted willingly in violating its sanctions on Iran, as mitigating factors OFAC noted the company’s remedial response and the “benign
consumer nature” of the products involved.

8. Swedbank Latvia AS

Statutory Maximum CMP: $112.32 million

Base Penalty Amount: $6.24 million (non-egregious violation, no voluntary self-disclosure)

Settlement Amount: $3.43 million

Swedbank Latvia AS faced an enforcement action related to the use of its e-banking platform by a customer with a Crimean IP address to send payments to persons in Crimea through U.S. correspondent banks. While OFAC noted that Swedbank Latvia is “a sophisticated financial institution with over one million customers” and failed to exercise due caution or care, it also noted that the bank took “significant remedial action” in response to the apparent violations and “substantially cooperated” with its investigation.

Insights from OFAC’s 2023 Enforcement Actions To Date

As these recent enforcement actions show, OFAC appears to be willing to give substantial weight to companies’ and financial institutions’ good-faith compliance efforts as well as their remedial efforts after discovering apparent sanctions violations. Cooperation was a key factor in several of OFAC’s 2023 enforcement actions as well. When facing OFAC scrutiny or the need to make a voluntary self-disclosure, companies and financial institutions must work with their counsel to make informed decisions, and they must move forward with a strategic plan in place focused on achieving a favorable outcome in light of the facts at hand.

Oberheiden P.C. © 2023
By Dr. Nick Oberheiden of Oberheiden P.C.
For more news on OFAC Enforcement Actions, visit the NLR Corporate & Business Organizations section.

Taxpayer Makes Offer, But IRS Refused

James E. Caan, the movie actor most famous for playing Sonny Corleone in The Godfather, got into IRS trouble regarding the attempted tax-free rollover of his IRA.

Caan had two IRA accounts at UBS, a multinational investment bank and financial services company. One account held cash, mutual funds and exchange-traded funds (ETF) and the other account held a partnership interest in a hedge fund called P&A Multi-Sector Fund, L.P.

Because the hedge fund was a non-publicly traded investment, UBS required Caan to provide UBS with the year-end fair market value to prepare IRS Form 5498. Caan never provided the fair market value as of December 31, 2014. UBS issued a number of notices and warnings to Caan and finally on November 25, 2015, UBS resigned as custodian of the P&A Interest. UBS issued Caan a 2015 Form 1099-R reporting a distribution of $1,910,903, which was the value of the P&A Interest, used as of December 31, 2013. Caan’s 2015 tax return reported the distribution as nontaxable.

In June 2015, Caan’s investment advisor Michael Margiotta resigned from UBS and began working for Merrill Lynch. In October 2015, Margiotta got all UBS IRA assets to transfer to a Merrill Lynch IRA, except for the P&A Interest. The P&A Interest was ineligible to transfer through the Automated Customer Account Transfer Service. In December 2016, Mr. Margiotta directed the P&A Fund to liquidate the P&A Interest and the cash was transferred to Caan’s Merrill Lynch IRA in three separate wires between January 23 and June 21, 2017.

In April 2018, the IRS issued a Notice of Deficiency for the 2015 tax year asserting that distribution of the P&A Interest was taxable. On July 27, 2018, Caan requested a private letter ruling asking the IRS to waive the requirement that a rollover of an IRA distribution be made within 60 days. In September 2018, the IRS declined to issue the ruling.

Caan died July 6, 2022. In the Estate of Caan v. Commissioner, 161 T.C. No. 6 (October 18, 2023), the Tax Court ruled that Caan was not eligible for a tax-free IRA rollover of the P&A Interest for three reasons. First, to be a nontaxable rollover the taxpayer may not change the character of any noncash distributed property, but here, the P&A Interest was changed to cash before being rolled-over. Second, the contribution of the cash occurred long after the 60-day deadline. Third, only one rollover contribution is allowed in any one-year period, but Caan had three contributions. The Court also determined the 2015 fair market value of the P&A Interest.

Finally, the Tax Court determined that it has jurisdiction to review the IRS denial of the 60-day waiver request and that the applicable standard of review is an abuse of discretion. The Court ruled there was no abuse of discretion because Caan changed the character of the rollover property and even if the IRS waived the 60-day requirement, the rollover would still not be tax-free.

The case highlights some of the potential dangers in holding non-traditional, non-publicly traded assets in an IRA.

© 2023 Chuhak & Tecson P.C.
For more news on IRA rollovers, visit the NLR Tax section.

FINRA Facts and Trends: October 2023

Welcome to the latest issue of Bracewell’s FINRA Facts and Trends, a monthly newsletter devoted to condensing and digesting recent FINRA developments in the areas of enforcement, regulation and dispute resolution. This month, we report on ongoing constitutional challenges to FINRA’s enforcement authority, the possible expansion of the SEC’s WhatsApp record-keeping probe to Zoom and other video calling platforms, several multimillion-dollar settlements of FINRA enforcement actions, and more.

Federal Court Allows FINRA Enforcement Action to Proceed Despite Constitutional Challenges

In the wake of the DC Circuit’s July 2023 ruling that granted an injunction staying a FINRA enforcement proceeding against a broker-dealer based on constitutional challenges of FINRA’s authority, two more FINRA member firms have recently filed federal lawsuits seeking to enjoin FINRA proceedings against them on the same basis. First, in August, Eugene H. Kim filed a lawsuit in the District Court for the District of Columbia (the District Court) seeking a stay of a FINRA enforcement action brought against him for allegedly misusing customer funds. More recently, on October 18, Sidney Lebental filed a similar lawsuit in the District Court, seeking a stay of a FINRA enforcement action brought against him for alleged misconduct in connection with his execution of certain trades.

As we reported in July and September, the DC Circuit’s ruling in July granted a preliminary injunction based on a finding that the plaintiff in that case, Alpine Securities Corporation, had “raised a serious argument that FINRA impermissibly exercises significant executive power.” The two more recent lawsuits filed by Kim and Lebental seek to apply this logic to their own cases, and thus to enjoin FINRA’s Department of Enforcement from proceeding with the actions against them.

But in a ruling issued earlier this month, the District Court declined to grant a stay of the FINRA Enforcement proceeding against Kim. While the District Court acknowledged that it takes guidance from the DC Circuit’s preliminary injunction opinion in Alpine, it held that that opinion “does not suggest that courts must enjoin every challenged FINRA enforcement action pending the Alpine merits decision.” To interpret the DC Circuit’s decision as effectively halting all FINRA enforcement actions, the District Court said, “would upend FINRA’s work—a result that would put investors and US securities markets at risk.”

Will the SEC Turn Its Focus to Zoom Recordings After WhatsApp?

The SEC’s highly publicized sweep of financial service providers’ improper use of WhatsApp and other off-channel communication platforms has resulted in settlements exceeding $2.5 billion. Now, people familiar with the scope and findings of the SEC’s WhatsApp probe have raised concerns that the SEC will expand its record-keeping requirement to include calls over video calling platforms, including Zoom and Microsoft Teams. Those who believe that this expansion is inevitable have already taken steps to meet the SEC’s anticipated scrutiny.

Reuters has reported that the proactive steps taken by some firms include retaining technology specialists and risk consultants not only to ensure that video calls are properly monitored and retained, but also to prevent the use of these platforms for sharing non-public information. Already, two “major global banks” are capturing Zoom sessions, said sources with knowledge of the matter. One of these firms is recording calls by traders and other staff, while the other is capturing all calls so they can be accessed at a future time, if necessary. As of now, video calls are subject to little or no formal record-keeping requirements, as they are viewed as proxies for face-to-face encounters. That may change very soon, with regulators apparently poised to begin assessing the potential for compliance failures over video platforms.

Latest FINRA Dispute Resolution Statistics Point to an Increase in Arbitration Filings

FINRA has released its latest dispute resolution statistics for the current year through September 2023. According to FINRA, the number of arbitration filings has increased nearly 25 percent from this time last year. Customer claims have gone up 14 percent, and breach of fiduciary duty was cited as the most frequent customer claim with a total of 1,127 cases, up from 967 this time last year. The number of industry disputes was 43 percent higher than in September 2022 and breach of contract claims have been the most popular claims so far in 2023, with a total of 201 cases, up from 162 cases a year ago. Notably, filings of Regulation BI arbitration claims by customers continue to rise, with 320 claims filed so far this year, compared to just 216 claims in all of 2022. After cracking the top 15 controversy types in May 2022, Reg BI claims through September have moved the category up to 9th place, and the expectation is that heightened Reg BI scrutiny will give rise to even more claims.

We will report on year-end statistics in early 2024.

Source: FINRA, Dispute Resolution Statistics, https://www.finra.org/arbitration-mediation/dispute-resolution-statistics (last visited Oct. 31, 2023).

Lawsuit Against Broker-Dealer Highlights Risks of Online Impersonators

A Swedish woman recently filed a lawsuit in New Jersey federal court against a New Jersey-based FINRA broker-dealer, AlMax Financial Solutions. The complaint alleges that the plaintiff was defrauded out of more than $180,000 — not by AlMax, but by an impostor website that maintained a website falsely impersonating AlMax.

Notably for FINRA members, the plaintiff’s complaint references FINRA Regulatory Notice 20-30 (Fraudsters Using Registered Representatives Names to Establish Imposter Websites), which informs member firms about reports of fraudsters who run imposter websites while posing as FINRA members.

It is unclear whether the lawsuit, which asserts claims for negligence and violation of the New Jersey Consumer Fraud Act, has any legal merit. For one thing, FINRA Regulatory Notice 20-30 prescribes no mandatory measures that member firms must take to root out impostors, and instead only provides certain actions that members “can take” or that they “may also consider.” Nevertheless, the case is a reminder to member firms of the guidance provided by FINRA concerning these imposter websites, and the risks they may pose.

SDNY Judge Halts FINRA Arbitration Brought by Non-Customers

In a ruling issued on October 13, 2023, US District Judge Naomi Buchwald of the Southern District of New York confirmed that FINRA arbitrations may not be commenced by investors who are not customers of a FINRA member firm, and enjoined an ongoing FINRA proceeding on that basis.

The FINRA proceeding in question was filed against Interactive Brokers LLC, a FINRA member firm, by a group of investors in funds managed by EIA All Weather Alpha Fund I Partners, LLC (EIA). According to the FINRA Statement of Claim, EIA misled its investors and misappropriated their investment assets.

EIA separately maintained trading accounts with Interactive Brokers during the relevant period, the FINRA Statement of Claim said. The investor-claimants filed claims against Interactive Brokers, arguing that — even though the investors themselves had no direct relationship with Interactive Brokers — Interactive Brokers had a responsibility to detect and prevent EIA’s misconduct, but failed to do so. And, because EIA’s relationship with Interactive Brokers was governed by an agreement that contained a broad arbitration provision, the investors contended that its claims against Interactive Brokers were subject to FINRA arbitration, either as third-party beneficiaries of EIA’s agreement with Interactive Brokers, or pursuant to FINRA Rules.

In its ruling after Interactive Brokers filed a lawsuit to stay the arbitration, the Court rejected these arguments. Most significantly, the Court reiterated the Second Circuit’s bright-line rule that to qualify as a “customer” for purposes of FINRA Rule 12200, a person must either purchase a good or service from a FINRA member, or maintain an account with a FINRA member. Since the EIA investors had no such relationship with Interactive Brokers, the Court rejected their claim to be “customers” entitled to avail themselves of FINRA Rules. The Court also found that the investors were not third-party beneficiaries of EIA’s agreement with Interactive Brokers, since they did not meet the “heightened threshold for clarity” required to find that a third party has the right to compel arbitration.

Reminder: New Expungement Rule Is Now Effective

This is a reminder that effective October 16, 2023, FINRA amended its rules to provide a stricter standard and procedural process for registered representatives seeking to expunge negative customer-related complaints. We previously provided a comprehensive analysis of the new FINRA expungement rule.

Notable Enforcement Matters and Disciplinary Actions

  • Inaccurate Trade Data. A multinational financial services firm was sanctioned a total of $12 million by FINRA and the SEC for allegedly submitting inaccurate trading data to the two regulators for nearly a decade. The Letter of Acceptance, Waiver, and Consent (AWC) detailing FINRA’s findings on this matter is available here, and the SEC’s administrative order is available here.Firms submit electronic blue sheets (EBSs) to regulators in response to requests for trade information. These EBSs provide examiners with trade details, including the nature of each transaction, the buyer and seller, and the transaction price. According to the SEC and FINRA, the respondent firm submitted tens of thousands of EBSs between November 2012 and October 2022 that were rife with inaccuracies for hundreds of millions of individual transactions.
  • The firm’s reporting failures allegedly stemmed from outdated and inaccurate code, manual validation errors and inadequate verification procedures. Prior to being notified of the inaccuracies, the firm had already begun voluntary remedial efforts, including a full-scale, line-by-line analysis of the code underlying its EBS program, automation of the EBS processing procedures and migration of data to a new reporting system.
  • Trading Approval. A multinational brokerage firm agreed to pay more than $1.6 million to FINRA and the state of Massachusetts to settle claims that it failed to exercise due diligence when approving investors for options trading. The AWC detailing FINRA’s findings is available here.According to regulators, at least some of the alleged violations resulted from a deluge of new account applications in response to the “meme stock” craze of 2020 and 2021. Among other things, the firm’s automated screening system allegedly approved approximately 400 teenagers under the age of 19 to trade options (an impossibility, since the firm’s rules required all customers seeking to trade options to have at least one year of investment experience after the age of 18). The firm also permitted customers to re-submit rejected applications after artificially inflating their trading experience, income and net worth.
  • Inaccurate Research Reports.  A multinational brokerage firm incurred a $2 million sanction over claims that it published thousands of equity and debt research reports with inaccurate conflicts disclosures between 2013 and 2021. The AWC detailing FINRA’s findings is available here.According to FINRA, the firm not only failed to disclose conflicts, but also disclosed conflicts that did not exist. The violations, amounting to more than 300,000 disclosure inaccuracies, allegedly resulted from a series of technical and operational issues, including problems with data feeds, mistakes in the aggregation of client information and a failure to update old data.

FINRA Notices and Rule Filings

  • Regulatory Notice 23-16 – FINRA amended its By-Laws to exempt from the Trading Activity Fee any transaction by a proprietary trading firm that is executed on an exchange of which the firm is a member. This exemption relates to the SEC’s recent amendments to Exchange Act Rule 15b9-1, which we reported on last month. The TAF exemption for proprietary trading firms will be effective November 6, 2023.
  • SR-FINRA-2023-013 – FINRA has proposed a rule change that would amend the FINRA Codes of Arbitration Procedure to disallow compensated representatives who are not attorneys from representing parties in FINRA arbitrations and mediations. The proposed rule change would also codify that law students enrolled in a law school clinic and practicing under the supervision of an admitted attorney may represent parties in FINRA arbitrations and mediations.

© 2023 Bracewell LLP

By Joshua Klein , Keith Blackman , Russell W. Gallaro of Bracewell LLP

For more on FINRA Trends, visit the NLR Financial Institutions & Banking section.

Businesses Beware: Penalties for Failure to Comply with Reporting Requirements of the Corporate Transparency Act

Businesses, especially small and privately-owned businesses, should be aware of federal reporting requirements becoming effective Jan. 1, 2024. Congress enacted the Corporate Transparency Act (“CTA”) in 2021 to combat money laundering, terrorism financing, securities fraud, and other illicit financial activities by requiring businesses to be transparent about their ownership. With significant exceptions, the CTA generally requires businesses to report certain information—known as Beneficial Ownership Information (“BOI”)—to the federal government. BOI must be reported to the Financial Crimes Enforcement Network (“FinCEN”)—a Bureau of the U.S. Department of Treasury—where the information will be stored in a secured database. Last year, FinCEN published final regulations implementing the CTA’s reporting requirements. These regulations become effective Jan. 1, 2024.

Businesses should begin preparing for compliance with the CTA, as initial reports for existing businesses must be submitted prior to Jan. 1, 2025, and the penalties for non-compliance are severe.

What is BOI?
The CTA generally requires most domestic and foreign business entities doing business in the United States to report BOI concerning:

persons who directly or indirectly hold a 25% or greater interest in the business;
persons who directly or indirectly “exercise substantial control over” the business; and
for businesses formed after Jan. 1, 2024, persons who assisted in the preparation of the business’s organic documents.
To Whom and When Must BOI be Reported?
For existing businesses, BOI must be reported prior to January 01, 2025.
Businesses formed after Jan. 1, 2024, will have 30 days from confirmation of their formation, incorporation, or registration to report BOI.
If a business’s beneficial ownership changes following the submission of a BOI report, the business must report updated BOI to FinCEN within 30 days after such change.
Penalties for Failure to Comply with the CTA
The penalties for willfully failing to comply with the CTA’s reporting requirements are quite severe. Any person who willfully fails to report BOI or reports it inaccurately may be subject to civil and criminal penalties, including fines up to a maximum of $10,000 and imprisonment up to 2 years. Businesses should be aware that, although they may have been required to supply information regarding the entity to the secretary of state or other similar office upon formation or registration, BOI reports concern the business’ owners or controllers and must be submitted to FinCEN in addition to any information supplied to a state during the entity’s formation or registration.

An Evolving Landscape: Interplay between State Law and the Impact of the CTA on Businesses
It is yet to be seen whether states will adopt similar or identical BOI reporting requirements. As of the date of this post, legislation is pending in New York that would require LLCs to submit BOI to the New York Department of State upon organization or registration with the state. This same legislation also requires existing LLCs to amend their organic documents to include BOI.

Pennsylvania amended its Business Corporation Law effective Jan. 1, 2023, and now requires businesses conducting business in the state to file annual reports containing information regarding the entity itself. Pennsylvania does not currently require reporting of BOI. However, it is likely that Pennsylvania and many other states will soon follow the lead of the federal government and New York in requiring businesses to report BOI on a state level.

Conclusion
The CTA’s adoption is a watershed moment in the regulation of business entities. For the first time, businesses will be required to internally track and monitor their BOI to ensure compliance with the CTA. Moreover, compliance with the CTA will require businesses to evaluate their control structures and contractual relationships. For example, while it may be simple to determine whether a person owns 25% or more of a business, the determination of whether someone “exercises substantial control over” the business may not be so straightforward.

It is strongly recommended that businesses consult an experienced and qualified attorney to determine whether they are subject to the CTA’s reporting requirements, as well as any similar requirements imposed by states in the future.

©2023 Norris McLaughlin P.A., All Rights Reserved

By Rocco L. Beltrami , John F. Lushis, Jr. of Norris McLaughlin P.A.

For more on the Corporate Transparency Act, visit the NLR Corporate & Business Organizations section.

Upstream and Affiliate Guaranties in NAV Loans

Guaranties are a common feature in fund finance transactions. Particularly in NAV loans, upstream and affiliate (or “sideways”) guaranties are used. Below we discuss some of the context for the use of these types of guaranties, as well as some of the issues that lenders should consider in relying on them.

Upstream Guaranties

It is not uncommon in NAV loan transactions for the borrower to hold the underwritten assets for the financing (i.e., the fund’s portfolio of investments) through one or more controlled subsidiary holding vehicles (each, a “HoldCo”). Lenders may take a pledge of the management and economic interests in the HoldCos (rather than the underlying investments). In order to get as close to the underlying investments as possible (without taking a pledge), lenders may require that a HoldCo issue a guaranty directly to the lenders (or the administrative agent, on behalf of the lenders), guaranteeing the borrower’s obligations under the NAV loan facility. This “upstream” guaranty provides the lenders a direct claim against the HoldCo for amounts due under the loan, mitigating some of the risk of structural subordination to potential creditors (expected or unexpected) at the level of the HoldCo.[1]

Affiliate Guaranties

It is also common in NAV loan facilities for the borrower’s portfolio of investments to be held by multiple subsidiaries and/or affiliates of the borrower. Each such subsidiary or affiliate may be designated as a guarantor for repayment of the loan. As a result, such entities end up guaranteeing the obligations of their affiliates. The purpose of these affiliate guaranties is the same as the upstream guaranties discussed above – namely, to provide the lenders with a more direct enforcement claim in a default scenario.

Use of Such Guaranties

Motivations for the use of such upstream and affiliate guaranties may include:

a lender’s desire to underwrite a broader portfolio of investments, mitigating concentration risk to the portfolio of a single holding entity;
a lender’s desire to ensure that it is not subordinate to creditors that may arise at the level of the entity that directly owns the investment; or
a borrower’s desire to obtain a higher loan-to-value ratio than the lenders would otherwise provide based on the investments alone.
While upstream and affiliate guaranties can help to address these issues, they may raise nuanced legal issues that should be discussed with counsel in light of the relevant facts and circumstances.

Enforceability Considerations

Guaranties constitute the assumption of the liabilities of another entity and are contingent claims against the guarantor. Under certain insolvency laws, guaranties may be subject to challenge, and payments under guaranties may be subject to avoidance. Upstream or affiliate guaranties may be subject to heightened scrutiny and challenge in a bankruptcy or distress scenario. Below are a few potential issues lenders should bear in mind with respect to upstream and affiliate guaranties.

1. Constructively Fraudulent Transfer Avoidance. Under Bankruptcy Code section 548 and certain state laws, (a) transfers of property (including grants of security interests or liens), or (b) obligations assumed (such as incurring a loan or guaranty obligation) may be avoided as constructively fraudulent if BOTH of the following requirements are satisfied:[2]

  • (i) the transferor/guarantor does not receive reasonably equivalent value; AND
  • (ii) the transferor/guarantor is insolvent or undercapitalized or rendered insolvent, undercapitalized or unable to pay its debts because of the transfer or the assumed liability.

A guaranty by a parent of the obligations of a wholly owned and solvent subsidiary, a so-called downstream guaranty, is generally regarded as providing the parent with reasonably equivalent value through an enhancement of the value of its equity ownership of the subsidiary.

Upstream and affiliate guaranties require more scrutiny than guaranties by a borrower parent to determine whether any potential enforceability issues are present.

a. Reasonably Equivalent Value. The determination of value is not formulaic or mechanical, but rather generally determined by the substance of the transaction. Value or benefits from a transfer may be direct (e.g., receipt of loan proceeds) or indirect. But if indirect, they must be “fairly concrete.”

In each of the above scenarios, we are assuming that the upstream or affiliate guarantor would not use the proceeds of any loans and, consequently, would not be added to the loan facility as a borrower. However, other indirect but tangible benefits or value to the guarantor should be identified, e.g., favorable loan terms or amendments, use of the NAV facility proceeds that may indirectly but materially benefit the guarantor, maintenance of the entire fund group of entities that benefits the guarantor, etc.

b. Financial Condition of Guarantor. The financial condition of the transferor/guarantor is evaluated at the time of the incurrence of the guaranty. The evaluation is made from the debtor/guarantor – in what condition was the guarantor left after giving effect to the transfer or assumption of the obligation. Diligence regarding a guarantor’s financial condition may demonstrate that such guarantor is sufficiently creditworthy to undertake the guaranty and remain solvent and able to conduct its respective businesses. Representations from the guarantor may be sought to confirm its financial condition.

c. Potential Mitigants. In addition to performing diligence with respect to the above points, lenders and their counsel will often include contractual provisions to mitigate the possibility that a guaranty may be found to constitute a fraudulent transfer. Savings clauses, limited recourse guaranties, and net worth guaranties are all tools that can be used to address the issues noted above. The scope and appropriateness of such provisions is beyond the scope of this article and should be discussed with external deal and restructuring counsel.

2. Preference Challenge. Under Bankruptcy Code section 547, a transfer made by a debtor to a creditor, on account of an antecedent debt, that is made while the debtor was insolvent and within 90 days before the bankruptcy case has been commenced may be subject to avoidance as a preferential transfer. Certain defenses may apply to a potential preferential transfer, including the simultaneous exchange of “new value” by the creditor. However, note that any pre-bankruptcy transfers of value, like payments under a guaranty, may be subject to scrutiny and potential challenge by the guarantor/debtor or a bankruptcy trustee.

Guaranties can be an important element in structuring NAV loan transactions to achieve the terms desired by the parties and to provide necessary protections for the lenders, but consideration needs to be given to the legal issues, such as the ones mentioned here, that their inclusion can present.

[1] Lenders will typically also require the HoldCo to pledge its accounts to which proceeds of the underlying investments are paid, allowing lenders to foreclose on such cash at the HoldCo level, without the need for such cash to first be distributed up to the borrower.

[2] Note that the precise language of certain state fraudulent transfer laws may differ, but conceptually, most state statutes require a showing of (i) insufficient or unreasonably small consideration in exchange for the transfer or liability incurred, and (ii) the transferor/debtor being insolvent at the time of the transfer, or becoming insolvent or subject to financial distress as a result of the transfer.

© Copyright 2023 Cadwalader, Wickersham & Taft LLP

Navigating the Business Landscape After Silicon Valley Bank and Signature Bank

NOTE: The information contained in the following alert is up-to-date as of March 15, 2023. News and events are evolving, so check the websites for the FDIC and the applicable banks for updates and announcements.

Start-up, emerging, middle market and other companies and their founders, executives, and investors, are facing heightened demands in the wake of recent developments involving Silicon Valley Bank (SVB) and Signature Bank. You can navigate the situation and be well-positioned for continued growth and success by considering the suggestions below.

We banked with Silicon Valley Bank or Signature Bank. How can we get our funds?

  • All funds, including those above Federal Deposit Insurance Corporation (FDIC) insurance limits, were transferred to Silicon Valley Bridge Bank, N.A. and Signature Bridge Bank, N.A., respectively, and depositors have full access to their money beginning March 13, 2023

  • You may continue to use the same online banking access, checks and/or ATM/debit cards to access your funds

What are the applicable FDIC insurance limits generally?

  • The FDIC exercised its authority under the systemic risk exception to cover uninsured deposits at Silicon Valley Bank and Signature Bank, but has not otherwise modified the FDIC insurance thresholds

  • Deposits are insured up to at least $250,000 per depositor, per FDIC-insured bank, per ownership category

  • Legal entities with independent operations are generally entitled to $250,000 in FDIC-insurance per FDIC-insured bank

  • Bank customers do not need to purchase deposit insurance; it is automatic for any deposit account opened at an FDIC-insured bank

  • Funds swept into money market funds on an overnight basis are not treated as deposits of the bank, are not subject to FDIC insurance, and the FDIC will honor the banks obligation to convert the money market funds back into cash the next day

  • Banks may also offer a multibank sweep vehicle, often via IntraFi’s ICS or CDARS program, which allows balances in excess of the $250,000 amount to be transferred to other banks to take advantage of each bank’s $250,000 FDIC insurance limit

  • FDIC Link to Are My Deposit Accounts Insured by the FDIC

  • FDIC’s Electronic Deposit Insurance Estimator

We have venture debt or another form of loan from Silicon Valley Bank or Signature Bank. Do we need to continue to make payments? Are the terms of the facility or any security interest modified? Can we continue to draw on a line of credit? Is a letter of credit issued by one of those banks still valid?

  • Payment obligations continue, and the terms of any arrangements are unchanged

  • The FDIC can repudiate contracts under certain circumstances, and so it may not honor advances or letters of credit

  • The FDIC’s general policy is that its role as receiver generally precludes continuing the lending operations of a failed bank

  • The FDIC will consider advancing funds if it determines that the advance is in the best interest of the receivership

  • Upon receiving a funding request, the FDIC may: make all or a portion of the requested loan advance, undertake discussions to reach a mutually satisfactory agreement to restructure the loan, or exercise its statutory right as receiver to repudiate its funding obligations with respect to the loan

  • Accordingly, letter of credit counterparties may  not view Silicon Valley Bank-issued or Signature Bank-issued letters of credit as creditworthy in the current circumstances, and it may be beneficial to take proactive steps to make alternate arrangements where possible

  • However, Silicon Valley Bridge Bank has indicated that it will honor all commitments to advance under existing credit agreements

  • As receiver, the FDIC is looking to maximize recovery and will likely sell the assets of the banks in receivership, either individually or collectively to a successor institution.

What about any warrants issued to such institutions?

  • Warrants issued to a bank in receivership should remain valid and outstanding with no change impacting the cap table

  • As receiver, the FDIC is looking to maximize recovery and will likely sell the assets of the banks in receivership, either individually or collectively to a successor institution.

Can we leave our current bank or at least diversify our deposits across financial institutions?

  • Examine banking relationships and review loan agreements and lines of credit for restrictions and covenants that may require you to maintain primary banking relationship or certain deposit accounts (e.g., your receivables) at the lender

  • Look into ICS or CDARS programs at network banks, which provide FDIC insurance coverage for certain business deposits of $250,000 or more

  • New bank relationships require “Know Your Customer” processing, which requires lead time that could be even more protracted in the current climate

  • An international company considering cash repatriation will want to consider tax implications

Payroll is coming due. Can we delay payments to employees? What should our company do if it is tight on cash?

Labor and wage payment laws and regulations impose requirements on when employers must pay employees

  • Under the Federal Fair Labor Standards Act, employers must pay non-exempt employees for hours worked and exempt employees for their regularly weekly rate of pay on regularly scheduled pay days for the covered pay period

  • Where state law imposes higher standards regarding unpaid wages, minimum wage, and other wage payment obligations, consider furloughs or changes for future wages to avoid violations

  • Failure to pay wages when due can subject U.S. employers to, among other things, fines and liquidated damages including double or treble damages, attorney fees (for litigation) and individual personal civil and, in some cases, criminal liability on owners and executives

  • Employers remain obligated to deduct and remit payroll taxes from wages even when under stress caused by the insolvency of its bank

  • If company has employees or independent contractors outside the United States, consult local lawyer(s)

Assess payroll, legal and contractual requirements and alternatives

  • Identify other available funds to ensure that payroll requirements can be met and, if not, explore alternative sources of funding

  • Request company owners, senior executives and board to consider pay cuts

  • Consider measures ranging from furloughs of nonexempt employees to pay cuts and/or reductions in hours in compliance with labor and employment laws, and clearly communicate changes to employees

  • Consider use of retention/stay bonuses

  • If an employee decides to leave or a decision is made to let an employee go, consider separation agreement issues and limits on use of non-compete, non-solicitation, non-disclosure, non-disparagement and appropriate release terms in specific context, including in light of existing employee agreements

  • Confirm and comply with prior employee documentation, including employment agreements, offer letters, employee handbooks and policies, IP assignment terms, confidentiality terms, and option or other equity terms

  • Consider governance and contractual requirements with respect to changes in compensation, bonus plans, etc.

  • Take control and communicate with employees as appropriate, to manage the situation and help allay fears and risk of departures and to enhance productivity

What are our options for payments owed to lenders, landlords, suppliers, vendors and other creditors?

  • Consider contacting creditors to negotiate short-term credit and payment extensions in light of cash flow needs and credit risk issues

  • Consider drawing existing and available lines of credit to shore up working capital position

  • Consider strategically stretching out payments to certain other non-critical trade creditors

  • Consider reaching out to investors for short-term liquidity or equity infusions

How can we identify and secure alternative sources of funding?

  • Focus on maintaining current payments to lifeblood sources

  • Consider reaching out to investors for short-term liquidity or equity infusions

  • Consider straight loan or promissory note if the company is in a position to pay a fixed sum or interest, and evaluate valuation, dilution and cap table impacts if considering SAFE, convertible note, warrant, preferred or other equity

  • Consider governance issues including necessary board and investor approvals, creditor consents, intercreditor and tax issues

  • Consider selling non-core assets

How do we obtain a line of credit in this environment?

  • New bank relationships require “Know Your Customer” processing, which require lead time that could be even more protracted in the current climate

  • New lines of credit require lead time for underwriting, credit approval and documentation and, if you have other debt facilities in place already, potential consent from existing lenders

  • Consider expanding existing banking relationships to shorten potential lead times,

What else should we take into account if we are considering bridge financing or other funding from our investors?

  • In addition to above, consider SAFE, convertible note or a preferred stock round and extending any repayment terms

  • Obtain interested party transaction approvals and addition to typical governance requirements such as board and investor approvals

What are my company’s reporting or disclosure obligations? What information should we share internally?

  • Your obligations depend in part on whether the company is public or private, accounting standards, securities laws, exchange rules, state corporate law, and your governance documents

  • For a private company, managing the situation through open and informal communications with stakeholders may provide insight and useful information for financial and operational issues and reporting to the Board

  • A public company affected by a bank shutdown or experiencing a liquidity challenge may have SEC disclosure obligations, and communications with stakeholders will be governed by securities laws

What should I keep in mind about board decision-making

  • Maintain acute awareness of the possibility of self-dealing or even the appearance of self-dealing, and obtain appropriate approvals for any insider transactions, such as disinterested director or stockholder approval

We are focused on conserving and managing cash. What should we be doing?

  • Engage or hire experienced financial and accounting advisors (whether an outside consulting or other firm, or a fractional or full-time experienced finance employee or independent contractor)

  • Track financial position and obligations closely, with an eye on foot faults that could arise in the near, medium, and long-term horizon

  • Challenge assumptions: long-term risks might suddenly become near-term ones.

  • Focus on liquidity issues (cash position, cash flow and burn rate) and forecast for several months to meet obligations to creditors, considering limits on access to significant deposits or credit lines if a banking partner has closed and potential changes in the credit market more broadly

  • Assess availability of alternative funding sources

  • Update financial statements, plans and projections and underlying assumptions, and consult with board, advisors and key investors about appropriate adjustments

  • Consult with advisors and partners on appropriate cash management, financial institution diversification and risk management strategies for your situation

How do we know if our business insurance is the right kind and amount to cover the risks our company and its directors and officers may face?

  • Determine whether losses from a bank closure are covered by business interruption or other insurance

  • Review current D&O insurance coverage, including the applicable limits and periods of coverage

Our company’s insurance premium payment is coming due. Can we delay or defer payment if we are tight on cash?

  • Insurance premiums should be paid when due, as failing to pay an insurance premium could cause the policy to lapse leaving it without coverage

  • Consider contacting the insurance company to clarify any grace period or adjust any deductible

  • Consult with an insurance broker and the board to evaluate whether there is a more affordable option. Review governance terms to see whether changes to insurance may require investor approval

Article By Lori Anne Czepiel, Robert Klingler, James W. Bartling, Mitch Boyarsky, Jason L. Watkins, Paul Z. Rothstein, Joe Daniels, Jackson Hwu, Neil Grayson, Benjamin Barnhill, J. Brennan Ryan, Dowse Bradwell Rustin IV, Richard Levin, and Craig Nazarro of Nelson Mullins.

For more financial and banking legal news, click here to visit the National Law Review.

Copyright ©2023 Nelson Mullins Riley & Scarborough LLP

The Silicon Valley Bank Failure: Implications on Commercial Leasing

This past Friday, March 10, 2023, the Federal Deposit Insurance Corp. (FDIC) announced its takeover of the failed Silicon Valley Bank (“SVB”) after a run on the bank late last week caused the largest-scale U.S. bank failure since Washington Mutual in the 2008 financial crisis. Two days later, New York regulators shuttered Signature Bank (“Signature”). The federal government has made it clear that, while FDIC will guaranty all deposits, including uninsured ones, bailouts of these banks will not occur. The failures of SVB and Signature are likely to have widespread ramifications across many industry sectors, including commercial leasing.

How will the bank failures impact landlords in the commercial leasing sector?

  • SVB was a very common issuer of tenant letter of credit security deposits. A letter of credit security deposit is the issuing bank’s contractual obligation to pay the landlord beneficiary the amount that such landlord’s tenant is in default.
  • Landlords holding tenant letters of credit issued by SVB or Signature as security deposits will be directly impacted by the bank failures. Any undrawn standby letters of credit issued by SVB, Signature or any other bank under FDIC receivership may be repudiated by the FDIC, making any such letter of credit worthless. Any affected landlord will want to act promptly to provide proper protection of their interests under any applicable lease.

How can landlords protect their interests under such leases?

  • Any landlord holding a letter of credit security deposit should identify the issuing bank.
  • In any lease where the security deposit is a letter of credit issued by SVB or Signature, the landlord should carefully review the terms of the lease regarding the security deposit and the landlord’s approval rights over the issuing bank, but in any event require the tenant to provide it with a letter of credit issued by a different financial institution.
  • All landlords should review the terms their lease agreements relating to landlord approval rights over issuing banks, draw procedures and requirements and the process for replacing a letter of credit.
  • In the event the lease agreement in question does not provide landlord with adequate approval rights over the issuing bank, clear draw procedures and stringent replacement requirements, the landlord should consider amending the lease agreement to so require.

Article By Jeff Bates and Blake Young of Winstead

For more finance and banking legal news, click here to visit the National Law Review.

© 2023 Winstead PC.

Information for Borrowers with Loans from Silicon Valley Bank or Signature Bank

This alert provides information for borrowers with loans from Silicon Valley Bank (“SVB”) or Signature Bank (“Signature”) based on information available from the FDIC and our clients’ experiences over the last few days. We have also included information regarding the FDIC’s general policies and procedures when selling and administering loans of failed banks. We will update this alert as additional information becomes available.

Borrowers with loans from SVB or Signature continue to wait for information from the FDIC, and the new bridge banks it formed, with respect to their loans, including any information regarding the sale of their loans, new bank contact information and updates to borrowing procedures and payoff logistics. At present, we understand that the bridge banks are attempting to operate in the same manner with respect to their borrowers (and depositors) that SVB and Signature operated prior to their failures, including through use of the existing relationship managers/bank contacts and online platforms and consistent borrowing and payment mechanics.

Systemic Risk Exception

As widely reported, on Sunday, March 12, the Federal Reserve, the FDIC and the Treasury Secretary announced a systemic risk exception and created Silicon Valley Bridge Bank, N.A. and Signature Bridge Bank, N.A. (together, the “Bridge Banks”). The systemic risk exception is an attempt to avoid a widespread bank run and to ensure that all of SVB and Signature Bank’s depositors would be made whole after the failures of the two banks. The systemic risk exception is an exception to federal law that otherwise would require the FDIC to resolve a bank failure at the lowest cost to the Government’s deposit insurance fund.  See Crisis and Response: An FDIC History, 2008-2013, p. 36. Otherwise, the FDIC would not have been in a position to backstop uninsured deposits beyond the $250,000 insured limit per depositor per ownership category. For more information about FDIC deposit insurance limits please see our prior alert: SVB Receivership – What You Need to Know.

Prior to Sunday, the only uses of the systemic risk exception occurred in 2008 and 2009.  Id., pp. 35-36. The systemic risk exception has never before been used to create bridge banks at which loans at failed institutions would then be sold or administered by the FDIC.

Sale of SVB and Signature Loans

The general expectation after a bank failure is that the failed bank’s loans will be sold to a new lender as expeditiously as possible. The FDIC conducted an auction for the assets of SVB (including its loan portfolio) on Sunday, March 12. The Wall Street Journal reported on Monday, March 13 that, while none of the largest U.S. Banks bid on SVB at the initial auction, there was at least one offer which was declined by the FDIC. The WSJ is also reporting that regulators are planning to hold another auction of SVB’s assets. We also anticipate an auction of Signature’s assets. The timing of these auctions remains unclear.

In the event that either or both of these auctions produce buyers of the Bridge Banks’ respective assets in bulk, those buyers will become the lenders under the failed banks’ loans. In that case, the applicable successor lender will advise its new borrowers of their new bank contacts and provide relevant loan administration information including loan payment procedures.

If either or both of the auctions fail to produce a buyer for all of the bank’s assets, a bank’s loan portfolio may be split up and sold piecemeal. In this event it may take longer before borrowers know the identity of their new lender. If some or all of the loans are not purchased, they will continue to be administered by the respective Bridge Banks or the FDIC. As noted above, the intent of the FDIC is to continue to operate the Bridge Banks pending substantial completion of the sale process.

Borrowing Under an SVB or Signature Line of Credit

In general, when the FDIC is appointed receiver, it immediately begins analyzing loans that require special attention, such as unfunded and partially funded lines of credit, and construction and development loans. Typically speaking, the role of receiver generally precludes the FDIC from continuing the lending operations of a failed bank; however, the FDIC will consider advancing funds if it determines an advance is in the best interest of the receivership, such as to protect or enhance collateral, or to ensure maximum recovery to the receivership. See A Borrowers Guide to an FDIC Insured Bank Failure.

When the FDIC is operating as receiver, its general procedures provide that if a borrower submits a request for additional funding, the FDIC will conduct a thorough analysis to determine the best course of action for the receivership. The FDIC uses information contained in the failed bank’s loan files to the extent available and considered reliable. Because the files of failed banks are often incomplete or poorly documented, the FDIC may require additional financial information to perform its analysis and make decisions.

In the current circumstances, with the Bridge Banks operating under the systemic risk exception, these general FDIC rules appear to have been relaxed, at least for the time being and our clients are reporting that borrowing (and deposit) operations are generally functioning in the ordinary course. We have not yet heard from any clients that additional information has been required in connection with advances from the Bridge Banks.

SVB Contact Information

The FDIC is currently directing SVB borrowers with questions about drawing on lines of credit to contact their existing relationship manager/bank representative at SVB. SVB also has a call center at 800-774-7390 open from 5:00 AM to 5:30 PM (Pacific) with representatives that can assist borrowers.

Signature Contact Information

The FDIC is currently directing Signature borrowers with questions about drawing on lines of credit to contact their existing relationship manager/bank representative at Signature Bank. Signature Bank also has a 24-hour call center at 866-744-5463 with representatives that can assist borrowers.

On Monday, March 13, our clients had mixed results contacting their existing bank relationship managers and drawing on lines of credit. Some clients requested online draws but have not been successful as a result of system malfunctions (and we heard the same reports with respect to some attempts to access and move deposits). On the other hand, we heard reports from our clients that automatic draws and account sweeps have continued to function (and many borrowers successfully accessed their accounts). Today (March 14), clients appear to be having more success in accessing their lines of credit. We will continue to gather information about borrowers’ ability to access their lines as it becomes available.

Loan Payoff/Lien Release Information

Many clients have inquired about the mechanics for arranging a loan payoff/refinancing of their SVB loan or Signature loan. In the event that the loan is sold, the borrower can coordinate payoff with the new lender that purchased the loan. In the meantime, borrowers should reach out to their relationship managers or otherwise contact the bank using the means provided above to arrange any payoff and/or lien release. Further information regarding lien releases may also be found on the FDIC lien release website. In the event that borrowers’ loans are not sold quickly by the FDIC to a new lender, we expect that those borrowers will be strongly encouraged by the FDIC to arrange for a refinancing. See A Borrowers Guide to an FDIC Insured Bank Failure.

Continue Performing Obligations under Loan Documents

Notwithstanding the failures of SVB and Signature, their borrowers should continue to abide by their loan documents, including submitting payments as required by their loan documents at the same addresses and complying with all other covenants and agreements. Borrowers will be advised by the FDIC, the Bridge Banks or a subsequent purchaser of their loan if there are any updates to payment mechanics or bank contact information.

Article By Timothy John Carter, Jonathan C. Hayden, Trevor Hoffmann, Muryum Khalid, Kevin Renna, Douglas B. Rosner, Andrew Rothstein, Jesse Rubinstein, and Jesse Scott of Goulston & Storrs.

Click here for more financial legal news from the National Law Review.

2023 Goulston & Storrs PC.

Silicon Valley Bank Fails After Run on Deposits

“The Federal Deposit Insurance Corporation took control of the bank’s assets on Friday. The failure raised concerns that other banks could face problems, too.”

Read the New York Times article (Free Subscription Required)

In light of the news this morning that Silicon Valley Bank (SVB) has been closed by the California Department of Financial Protection, which appointed the Federal Deposit Insurance Corporation as SVB’s receiver, it’s fair to ask if this is the beginning of a trend among regional banks or an isolated incident. SVB, while unique in the banking industry, since it would lend against illiquid (pre-IPO) securities, mainly issued by ventured-backed companies, faced challenges in a rising interest rate environment that are not unique and which, many similarly situated regional banks, are still facing.

As the Federal Reserve considers whether to raise interest rates by 0.25% or 0.5%, in order to combat inflation, a key factor in their analysis will be the impact these interest rate hikes have on regional banks and their portfolios. Regional banks, unlike their Fortune 100, multi-national counterparts, derive their value from vast portfolios of bonds, which are very sensitive to interest rate hikes (as interest rates rise, the value of these bonds fall). For instance, the S&P Regional Banks Select Industry Index is down 3.69% today, 19.92% month-to-date, and 13.02% year-to-date.

Therefore, in the coming days, it will be crucial to watch both the Federal Reserve’s Federal Open Market Committee meeting on March 21-22 and whether SVB’s collapse signals a contagion among the regional bank sector. SVB’s closure is the biggest bank collapse since the financial crisis and many start-up/early-stage companies will be very interested to see if it is the last or the first of many.

© 2023 ArentFox Schiff LLP