Federal Reserve and Washington DFI Execute Enforcement Action with Moonstone Bank
Three Questions
Yesterday the Federal Reserve Board and Washington Department of Financial Institutions entered into an enforcement action with Farmington State Bank and its holding company, FBH Corporation.
Farmington State Bank is the tiny Washington-chartered bank formerly known as Moonstone Bank whose parent company FBH Corporation received a still-mysterious investment from an FTX affiliate in March 2022.
Prior Commitments
The consent order begins with a series of recitals laying out various commitments made to the Board and Washington DFI by Farmington State Bank, FBH Corporation, and certain individuals over the course of 2020 and 2021.
Holding Company Commitments. As a condition to the Federal Reserve Bank of San Francisco’s September 2020 approval under delegated authority of the application by FBH Corporation (formerly GUVJEC Investment Corporation) to become a bank holding company, FBH was required to provide 30 days’ prior notice to the Federal Reserve before:
changing its business plan;
engaging in servicing activities on behalf of Farmington State Bank, including with respect to digital bank operations; or
moving the performance of any operational or risk management activities from the bank to FBH or its nonbank subsidiaries.
Chalopin Commitments. In connection with the holding company application the FRBSF also imposed commitments on Jean Jacques Pierre Chalopin, the principal shareholder of FBH and its President and Chairman. Chalopin is the largest shareholder of Deltec Bank, the Bahamas-based bank best known for providing banking services to Tether. Specifically, the FRBSF required that Chalopin:
on annual basis provide to the Federal Reserve Board certain financial information related to his (unnamed in the order) “foreign bank located in The Bahamas”; and
neither himself, nor his family, nor any entity that he controlled, request an extension of credit from Farmington State Bank or engage in other interest-related transactions with the bank.
WA DFI Commitments. In May 2020, the Washington DFI had also imposed certain requirements in connection with Chalopin’s acquisition of control of the bank.
For three years, all changes in senior management, changes to the business plan, or any significant changes in operations, including digital bank operations, required prior written regulatory approval;
for three years, FBH would “remain committed to serving the needs of the Bank’s historical customers and the Farmington community”;
FBH and Farmington State Bank could not “do business with or enter into any transactions with certain entities affiliated with Chalopin without prior written regulatory approval”; and
for three years, Farmington State Bank would maintain a Tier 1 leverage ratio of 9% or greater.
Bank Commitments. A year later in 2021 when the FRBSF acting under delegated authority approved Farmington State Bank’s application to become a member of the Federal Reserve System, the FRBSF imposed additional conditions (defined in the consent order as the “Bank Commitments”).
FBH and Farmington State Bank could not change the bank’s business plan “in in any manner, including, without limitation, hiring or replacing senior management, placing new directors on the Bank’s board, or expending material resources to develop the Bank’s digital banking products and customer-facing applications,” without first notifying and consulting with the Federal Reserve Board or the FRBSF to ensure that such changes would not constitute a change in the general character of the bank’s business under Regulation H.
FBH and Farmington State Bank could not either (1) “change the Bank’s business plan to pursue a strategy focused on digital banking services or
digital assets” or (2) “launch a digital banking application to the general public” without receiving prior approval under Regulation H.
Violation of Bank Commitments
The recitals to the consent order focus only on violations of the Bank Commitments, specifically that Farmington State Bank engaged in activities that changed its business plan and general character without receiving approval from the Board, FRBSF or WA DFI. The example the consent order mentions:
the Bank’s entering into a non-binding memorandum of understanding with a third party whereby the Bank committed to “work with” the third party “to design the necessary IT infrastructure” to facilitate the third party’s issuance of stablecoins to the public in exchange for receipt of 50 percent of mint and burn fees on certain stablecoins, and took material steps to implement that memorandum of understanding
The third party is not named in the order, but Moonstone Bank in October 2022 issued a press release regarding its plans to partner with Fluent Finance to “accelerate crypto adoption by issuing US+ stablecoin.”
Winding Down of Operations
The undertakings of the consent order all pertain to ensuring that Farmington State Bank, which per the Board’s press release has “previously announced that it will voluntarily sell its loans and deposits to the Bank of Eastern Oregon,” winds down its operations in an orderly manner. For example, FBH and the bank must conserve capital, preserve cash assets, limit their ongoing activities, and preserve records. In this respect, the consent order is similar to that entered into by the Board and the CA DFPI with Silvergate Bank and its holding company a few months ago.1
In a very brief press release yesterday, Farmington State Bank stated that the transaction with Bank of Eastern Oregon is expected to close by the end of August and that the bank “looks forward to working with the Federal Reserve and the Washington DFI on the orderly liquidation and wind down of the bank.”
Three Questions2
What About the Other Commitments?
One thing that puzzles me about the consent order is the contrast between the two pages of recitals listing out all the various commitments by the holding company, the bank, and Chalopin, and then the single paragraph focusing only on the violation of the bank’s commitments relating to its business plan.
As usual, the boring and straightforward answer may be best: the Board and WA DFI were simply being thorough in laying out the events of the past few years, even if ultimately not directly at issue in the consent order.
I wonder, though, if something else may at least partially explain this.
For one thing, the Board and Reserve Bank have faced criticism for permitting the Deltec-linked Chalopin to acquire the bank in the first place and then allowing Farmington State Bank to convert to being a member bank. Attention has focused, for example, on the very brief form letter on FRBSF letterhead signed by Mary Daly informing banks in the Twelfth Federal Reserve District that Farmington State Bank had been approved by the FRBSF to become a member bank.
This was always sort of silly — the form letter does not itself evidence the level of diligence (or not) conducted by the Reserve Bank in reviewing Farmington’s application — and one purpose of these recitals may be to make the point that the Board and FRBSF were aware of the potential risks here, and imposed commitments accordingly. Of course it is still fair to question whether these commitments were enough and whether the Board and FRBSF appropriately monitored compliance with them.
Even more speculatively, as someone who used to spend more time than is healthy caring about this sort of thing, I could not help but notice that the consent order in its description of the other commitments includes defined terms “FBH Commitments” and “Chalopin Commitments” but then those defined terms are never used elsewhere in the consent order. I am curious if there was an earlier draft of this order which also discussed compliance (or not) with those other commitments, rather than only the Bank Commitments, such that the consent order did at one point have a need for those defined terms.
What Led to the P&A Agreement with the Bank of Eastern Oregon?
Some of the reporting on the consent order has characterized this as the banking regulators forcing Farmington State Bank to shut down. For example, CoinDesk, describes the enforcement action as the Board having “ordered FTX-linked Farmington State Bank to wind down its operations.”3
Based on what is laid out in the consent order at least, I am not sure this is right. According to the order, months before this enforcement action was brought Farmington State Bank had reached an agreement in May 2023 for the Bank of Eastern Oregon to purchase all loans and assume all deposits of Farmington State Bank. And pursuant to that purchase and assumption agreement Farmington “will be contractually obligated to cease its operations after consummation.”
So based on the face of the order, it is not that the Federal Reserve Board is requiring Farmington State Bank to wind down, but rather that the bank already had plans to wind down, and the banking regulators are taking steps to ensure it does so in a safe and sound manner.
Of course, this is not to say that the Board or Washington DFI are disappointed with the bank’s decision to wind down operations, and obviously we do not know what sort of implicit encouragement was provided behind the scenes.
In any case, here is what can be pieced together from publicly available materials as to the timeline, although this surely leaves some things out.
On January 19, 2023, Farmington State Bank announced that it was going to cease using the Moonstone Bank name, return to its original mission as a community bank, and discontinue its “pursuit of an innovation-driven business model.”
In a caption to a photograph accompanying a January 24, 2023 report, The Spokesman-Review, a Spokane-based newspaper, wrote that “Bank officials have sent letters to customers informing them that their assets have been purchased by Bank of Eastern Oregon.”
According to the consent order, though, the purchase and assumption agreement was “dated May 12, 2023.”
The FDIC’s applications search page for the Bank of Eastern Oregon, a non-member bank, says that the bank submitted an application under the Bank Merger Act on June 21, 2023, and that the application was accepted on July 10, 2023.
As of the end of July (the last time the FDIC’s page was updated), this application remained pending, but assuming this application relates to the purchase and assumption with Farmington State Bank, and given Farmington’s statement that the transaction is expected to close by the end of August, presumably the FDIC has since approved the application.
Was This a Regulation H Violation?
Section 208.3(d)(2) of Regulation H provides that a state member bank may not, without prior approval, “cause or permit any change in the general character of its business or in the scope of the corporate powers it exercises at the time of admission to membership.”
The Board has in prior statements made clear that Regulation H may apply when a member bank seeks to engage in digital asset activities. It also in 2021 published an FAQ referencing a now decades-old SR letter on this point (emphasis added).
Q1: What constitutes a change in the general character of a state member bank's business for purposes of section 208.3(d)(2) of Regulation H?
A1: Under Regulation H, a member bank must "at all times conduct its business and exercise its powers with due regard to safety and soundness" and "may not, without the permission of the Board, cause or permit any change in the general character of its business or in the scope of the corporate powers it exercises at the time of admission to membership." 12 CFR 208.3(d)(1) and (2). Changes in the general character of a bank's business are ones that fundamentally or materially change a bank's core business plan. Examples include becoming a primarily internet-focused or an internet-only operation, or concentrating solely on subprime lending or leasing activities. A change to primarily or exclusively focus on such activities would generally constitute a change in the general character of a bank's business because: (i) such activities may present novel risks for the bank, depending on how they are conducted and managed, and may present risks to the deposit insurance fund; and (ii) such activities may involve aggressive growth plans that may give rise to significant financial, managerial, and other supervisory issues.
So does the Board believe Farmington State Bank’s actions violated Regulation H? Presumably yes, but the consent order does not exactly say so explicitly.
Instead, the consent order takes issues with the bank not complying with the Bank Commitments, broadly defined. As set out above, the Bank Commitments include a reference to specific business plan changes that the parties agreed would require approval under Section 208.3(d)(2) of Regulation H (pursuing a digital banking strategy or launching a public digital bank app) but also reach more broadly than Regulation H by requiring that any manner of change to the bank’s business plan be brought to the Board or Reserve Bank to ensure that Section 208.3(d)(2) of Regulation H is not implicated. In other words, the commitment made by Farmington State Bank was not just to comply with Regulation H, but to double check with its regulators before doing anything that even in theory could mean that Regulation H applied.
The consent order does not say whether the Board believes Farmington State Bank violated both elements of the Bank Commitments or only one of them.
Obviously for Farmington State Bank specifically this does not matter very much — the bank plainly violated at least one of the Bank Commitments, if not both — but better clarity on this point may have been helpful for other member banks. This is particularly so because the specific example the Board cites as a violation of the Bank Commitments is the bank’s entry into a “non-binding memorandum of understanding” and the taking of “material steps to implement” that non-binding MOU.
Read expansively, and of course without knowing what exactly these “material steps” involved, this could be understood to suggest that, when it comes to digital assets at least, the Board would like to receive notice under Regulation H when a bank is considering engaging in an activity (even by virtue of having signed only a non-binding MOU) that would constitute a change in the general character of its business.4
Thanks for reading! Thoughts on this post, including anything you think I am over- or under-reading in the order, are welcome at bankregblog@gmail.com
One difference is that the Silvergate consent order includes provisions requiring Silvergate, which had previously announced plans to voluntarily liquidate, to actually formulate a plan to do so, and to have that plan approved by its regulators. Presumably this was deemed unnecessary for FBH and Farmington State Bank because they already have in place the P&A with Bank of Eastern Oregon, as discussed above.
Not discussed in this post, but perhaps still to be resolved in a different forum, are the questions of the FTX investment in FBH, whether FTX’s valuation of FBH had much basis in reality, and whether the parties appropriately concluded that no regulatory applications were required in connection with the investment.
Another example is in Morning Money today, which used the sub-header “Fed shutters bank tied to FTX.” To be fair the story this header links to is more precise about what happened.
See also the Board’s letter last week to state member banks seeking to engage in certain activities involving dollar tokens, which I read as telling to banks to receive non-objection even prior to the testing phase.
A state member bank seeking to engage in such dollar token activities, including for the purpose of testing, must notify its lead supervisory point of contact at the Federal Reserve of the bank’s intention to engage in the proposed activity and should include a description of the proposed activity.
Note, though, that this is not necessarily the same thing as being required to file an application under Regulation H. The supervisory letter says elsewhere:
A state member bank seeking to engage in activities permitted for national banks under OCC Interpretive Letter 1174, including issuing, holding, or transacting in dollar tokens to facilitate payments, is required to demonstrate, to the satisfaction of Federal Reserve supervisors, that the bank has controls in place to conduct the activity in a safe and sound manner. [FN]
[FN] Depending on the specifics of the proposed activity, filing requirements may apply. For example, some activities involving dollar tokens may represent a change in the general character of a bank’s business. See 12 CFR 208.3.