Monthly LRA Update

JUDICIAL DEVELOPMENTS

Court Dismisses NQDC Plan Participants’ Lawsuit Versus FDIC

On July 12 the US District Court (Northern California) granted the FDIC’s motion to dismiss a lawsuit brought on behalf of a group of former First Republic Bank employees that were participants in a Deferred Compensation Plan. This lawsuit was interesting because the Plaintiffs staked positions that are inconsistent with the general understanding of how Non-Qualified Deferred Compensation plans operate.

Plaintiffs alleged that the FDIC (as receiver) inappropriately classified the Plaintiffs as unsecured creditors and deprived them of the assets held in the Non-Qualified Deferred Compensation Plan Trust (“Rabbi Trust”), which included some COLI policies. Plaintiffs asserted that they were entitled to the assets in the Rabbi Trust.

The FDIC’s response was consistent with our understanding. Interesting points include

● “This plan was unfunded and structured to pay benefits from assets held in a “rabbi trust,” a type of grantor trust whose assets are required, by operation of the plan and trust agreement, to belong to the plan sponsor (here First Republic) and to remain

available to pay its general creditors in order to meet tax-code requirements for deferred taxation.”

● “In fact, established law prohibits participants in such a non-qualified deferred compensation plan from having any preferred claim or beneficial ownership interest in assets held in a rabbi trust. Plan participants instead can have only unsecured contractual rights against the employer sponsoring the plan.”

● Of the 168 named Plaintiffs in this lawsuit, 165 submitted administrative claims directly to the FDIC. The FDIC fully allowed 70 of the claims (totaling $47.5 million). The FDIC partially allowed 94 claims (totaling of $84.8 million for this group; or ~97% of the submitted claim amounts). One claim was fully disallowed (where the participant sought a distribution of First Republic stock).

The Court ruled that it did not have jurisdiction because the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) expressly grants the FDIC authority to act as receiver with special powers expeditiously wind up the affairs of a failed financial institution.

Docket: Harrington v. FDIC Case No. 4:23-cv-06296-HSG

REGULATORY DEVELOPMENTS

FDIC Vice Chair Calls for Re-Proposal of Basel III Endgame

On July 24 FDIC Vice Chairman Travis Hill delivered a speech at the American Enterprise Institute. His remarks focused on bank liquidity (and the ability to rely on the Federal Reserve’s discount window), FDIC receivership funding, and capital (including thoughts on Basel III Endgame).

As it relates to Basel III Endgame, Mr. Hill expressed that the original proposal “…lacked appreciation for its real-world impacts…” and that he agrees with calls from others that a re-proposal is necessary. He also expressed skepticism for re-proposing only portions of the rule.

On a related note, House Financial Services Committee Chairman Patrick McHenry called for a full re-proposal of Basel III Endgame in a hearing on July 10.

Basel Committee Releases Consultative Document on Sound Third-Party Risk Management

On July 9 the BCBS issued a consultative document proposing Principles for the sound management of third-party risk in the banking sector. The report observed an ongoing trend toward banks’ increased dependency on third-party service providers (particularly related to digitalization).

Similar to US regulatory guidance for managing third-party risk, the BCBS document focuses on the “life cycle” of a third-party service provider relationship. The primary stages of the life cycle include Due Diligence, Contracting, Onboarding, Ongoing Monitoring and Termination. Overall, the guidance appears to be largely consistent with the Interagency Guidance on Third-Party Relationships: Risk Management issued in June 2023. See our June 2023 LRA update for additional details on that guidance.

One area that appears to be at least slightly expanded under the BCBS paper relative to US regulatory guidance is monitoring and assessing “nth parties.” Nth parties are additional parties that a third-party service provider relies upon, including subcontractors and key supply chain dependencies. The US guidance addresses subcontractors and various systems-related considerations directly but does not specifically address supply chain dependencies.