In October 2021 Brian Barnes, the founder of M1 Finance, announced on M1's website that he had recently completed an acquisition of the First National Bank of Buhl, a century-old bank located in Mountain Iron, Minnesota.
This was a purchase made by Barnes in his individual capacity, not by M1 Finance, because although “M1 will ideally own a bank in the future [it] has work to do before it’s ready to become a bank holding company.”1
As for his nearer-term ideas for the bank, Barnes wrote:
As owner of the bank, I have two plans:
I have committed to supporting the bank in its current locale to serve the local community better.
I will be investing in the bank’s capabilities to become the premier banking as a service (BaaS) bank, primarily serving fintech clients such as M1.
The First National Bank of Buhl at the time of Barnes’s announcement had just under $35 million in total assets. Around two years on, the bank has now been renamed B2 Bank and, though still quite small, has seen its total assets double to around $72 million. Total employees have doubled as well (from 11 to 22).
Slow Down
On the BaaS page on its website, B2 Bank says that it is “working with finance companies and leaders to build exciting new products and bring them to market—fast.”
Based on a written agreement with B2 Bank made public by the Office of the Comptroller of the Currency yesterday, the OCC may have other ideas.
The enforcement action, dated November 14, 2023, takes issue with B2 Bank’s “unsafe or unsound practices including those relating to internal controls and less than satisfactory management.” Details of the specific facts underlying the OCC’s conclusions are not stated directly in the written agreement, but the agreement nonetheless gives a fairly clear indication as to some of the OCC’s concerns.
Affiliate Risk Management
M1 Finance is not a bank holding company, but because B2 Bank and M1 Finance share a common ultimate owner, they are still regarded as affiliates for purposes of certain banking regulations.
No affiliates are mentioned explicitly by name in the enforcement action released yesterday, but Article V of the written agreement directs B2 Bank to develop a comprehensive affiliate risk management program. This program must include policies or processes to, among other things:
Outline “relationships between the Bank, its affiliates, and Bank ownership, and the specific expectations, responsibilities, and authorities for each of those parties relative to the safe and sound operations of the Bank”;
Document “how contracts entered into with affiliates are on market terms and are in the Bank’s best interest”;
Ensure that “fees and financial transactions between the Bank and all affiliates are clearly defined by contracts, agreements, or fee schedules”;
Document “specific risk oversight and control processes the Bank will use to ensure that affiliate products and services have sufficient controls commensurate with the risk and can be implemented in a safe and sound manner”; and
Provide “credible challenge to affiliate products and services that do not meet Bank control expectations.”
Various other provisions of the written agreement also implicate (again unspecified) affiliate relationships.2
Strategic Plan Limitations
In connection with an application approved by the OCC in 2021, B2 Bank was operating under a business plan limitation:
The Bank shall provide the Assistant Deputy Comptroller at least sixty (60) days prior written notice of its intent to significantly deviate or change from its business plan or operations and receive the OCC’s written determination of no objection prior to engaging in any significant deviation from the business plan. This condition shall remain in place for the duration of the proposed business plan, or December 31, 2024.
This sort of limitation is very common for a de novo bank (or, as here, a bank with a new owner that intends to change its business model) and typically lasts for three years.
Article III of the written agreement requires B2 Bank to put together and get the OCC’s non-objection to an updated strategic plan, this one covering at least the next five years. The strategic plan must provide the bank’s board and management with “clear direction and prioritization with reasonable risk limits and timelines of all significant initiatives in alignment with a defined risk appetite.”
For so long as the written agreement is in effect, B2 Bank will need OCC approval before it may make a significant deviation from its strategic plan.3 For purposes of this enforcement action, and similar to other recent orders,4 significant deviation is defined as follows:
For the purposes of this Article, changes that may constitute a significant deviation include, but are not limited to, a change in the Bank’s marketing strategies, products and services, marketing partners, underwriting practices and standards, asset composition, credit administration, account management, collection strategies or operations, fee structure or pricing, accounting processes and practices, or funding strategy, any of which, alone or in the aggregate, may have a material effect on the Bank’s operations or financial performance; or any other changes in personnel, operations, or external factors that may have a material effect on the Bank’s operations or financial performance.
Other Provisions
Other notable provisions of the written agreement require B2 Bank to develop:
a risk assessment process for new products and services (including a backward-looking risk assessment for any new products or services introduced over the past year);
a comprehensive BSA/AML risk assessment program; and
a concentration risk management program that identifies the bank’s known and potential concentrations.
On this last point, concentrations that must be taken into account include, among others, “the Bank’s concentrations in high yield savings accounts and unsecured loans obtained through affiliates’ marketing channels.”
District Court Will Decide $1.9 Billion SVBFG v. FDIC Dispute
U.S. bankruptcy courts exist in kind of a weird place under the U.S. constitutional structure. Article III of the Constitution vests the “judicial power” of the United States in courts established under Article III. And because U.S. bankruptcy courts are courts established by Congress under Article I, rather than Article III, the Supreme Court thus has from time to time interpreted Article III as placing limits on the matters that bankruptcy courts may lawfully decide.
In light of those Supreme Court decisions, current law says that U.S. federal district courts, whose judges have been appointed under Article III, retain jurisdiction over proceedings arising under or related the U.S. Bankruptcy Code.
The law also says, however, that district courts may “refer” bankruptcy cases to the bankruptcy courts, and the fact is that district courts generally adopt standing orders referring all bankruptcy cases to their associated bankruptcy court.
Thus, as a practical matter, bankruptcy cases are overseen by bankruptcy courts, and most important bankruptcy-related judicial decisions are still made by bankruptcy judges (subject to appeal).5
A few months ago, as part of its ongoing Chapter 11 proceedings, SVB Financial Group sued the FDIC to recover over $1.9 billion that SVBFG had deposited at Silicon Valley Bank when SVB failed. Consistent with what is described above, this case was brought in the first instance as an adversary proceeding in bankruptcy court.
The substance of SVBFG’s complaint is that, pursuant to the systemic risk exception, “all depositors” of Silicon Valley Bank were to have been protected, even those with amounts deposited at SVB above the otherwise applicable deposit insurance limit. In SVBFG’s view, this means that its bankruptcy estate, like any other depositor of Silicon Valley Bank, has a right to all the money it had deposited with SVB before the bank failed.
The FDIC disputed, and continues to dispute, that claim on the merits, but also raised several procedural objections. This week it scored a victory on one of them.
Withdrawing the Reference
As noted above, 28 USC 157 permits district courts to refer bankruptcy cases to the bankruptcy courts. That same statute, however, also describes circumstances in which that reference may (or must) be withdrawn — i.e., circumstances in which a district court judge, and not a bankruptcy judge, may (or must) re-take control of the proceeding and adjudicate the claim at issue. See 28 USC 157(d).
After SVBFG brought its complaint, the FDIC argued that SVBFG’s pursuit of the return of its $1.9 billion is exactly the sort of case for which withdrawal of the reference is mandatory under Section 157(d) because to decide SVBFG’s claim a judge will need to “probe deeply into the intricacies” of various substantial provisions of federal banking law, some of which present novel issues.
SVBFG, as well as its unsecured creditors, opposed the FDIC’s motion to withdraw the reference, but earlier this week Judge Cronan in the Southern District of New York sided with the FDIC:
the Court concludes that the issues implicated in the Adversary Proceeding require a court to address novel and substantial questions of federal law, which exist outside of the Bankruptcy Code, making withdrawal of the reference mandatory
To be clear, this is not a decision for the FDIC on the merits. It is only a decision about where the SVBFG vs. FDIC dispute will in the first instance be decided.6
That said, in the course of pointing out all the novel, non-bankruptcy issues that he will need to decide (thus weighing in favor of mandatory withdrawal of the reference), Judge Cronan could be read to hint that he thinks SVBFG may have a difficult time proving its case.
SVB Group’s briefing devotes significant attention to arguing the effect of the Secretary’s unprecedented action of invoking the Systemic Risk Exception following SVB’s failure, suggesting the novelty and complexity of that issue. […]
Yet despite this extensive briefing, SVB Group offers no caselaw interpreting the import of the Systemic Risk Exception or supporting its associated claimed entitlement to funds held in a deposit account of a bank in receivership. Nor does there appear to be any. That should not come as a surprise; the Exception has never been deployed as it was here. Prior to SVB’s failure, the Exception had only been invoked during the 2008-2009 Financial Crisis, and even then, the invocation was not in connection with a bank placed into receivership. […]
Furthermore, SVB Group’s asserted property right in the Deposit Account Total relies largely on public statements by the Secretary and the FDIC in press releases and congressional testimony, see, e.g., Tr. at 28:7-29:2, yet it provides no authority attaching legal significance to such public statements with respect to the scope and significance of the Secretary’s invocation of the Exception.
At the conclusion of the ruling, Judge Cronan directed the parties to submit by December 18 a joint letter advising him whether further briefing or argument is necessary or whether the case can be decided on what has already been filed by the parties with the bankruptcy court.
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In terms of regulatory approvals, Barnes was required to file a notice with the OCC under the CIBC Act. The bank also sought and received OCC approval to undergo a substantial change in assets.
No Federal Reserve Board approval was required for the initial transaction, but after the transaction closed Barnes received approval from the Board (under delegated authority) to set up a bank holding company through which he now holds his interest in B2 Bank. This holding company later elected FHC status.
In addition to the concentration risk management point discussed below, see for example Article III(f) (requiring the bank to develop a process quantify risks “associated with current and/or future products or services that result from the Bank’s current or future relationships with affiliated companies and/or financial services partners”) and Article VII(c) (requiring an updated BSA/AML risk assessment that takes into account the “significant increase in volume of new customer accounts from affiliates’ marketing programs”).
Also, I mentioned in the introduction to this post that the bank currently has 22 employees. That is based on what the bank’s most recent call report says, but the written agreement suggests that maybe that number needs further context. See Article V(1)(b)(ii), which directs B2 Bank to “identify and document all dual employees of Bank affiliates and the Bank and establish formal separation of duties for any dual employees.”
At least I think this is the case. Article III(3) refers to “Any request by the Bank for prior written determination of no supervisory objection to a significant deviation described in paragraphs (2) of this Article” but Article III(2) only talks about the need to get OCC approval to make amendments to the strategic plan and doesn’t actually describe or otherwise mention the term significant deviation. It should amount to the same thing though.
The definition of significant deviation in this B2 Bank written agreement is identical to the definition in the OCC’s recent enforcement action against Vast Bank, except here for B2 Bank a change in “asset composition” is also mentioned as something that might be a significant deviation.
I am sure actual bankruptcy lawyers will (fairly) take issue with various aspects of my description of the law here and in the above paragraphs, but for our purposes I think it gets the big picture right, or comes close enough.
Also, I think this is clear but just in case: the overall Chapter 11 proceedings for SVBFG will continue in the bankruptcy court, notwithstanding the withdrawal of the reference with respect to the SVBFG v. FDIC adversary proceeding.