In recently-issued guidance, the New York State Department of Financial Services (DFS) advises banks to vet the "character and fitness" of their top personnel.
The directive, issued in January, applies to New York state-regulated banking organizations, as well as branches, agencies, and representative offices of foreign banking organizations licensed by DFS. The guidance also applies to non-depository financial institutions, licensed or chartered, under the New York Banking Law. Each institution's board of directors and C-suite executives are covered by the guidance.
The guidance includes actual questions to pose to executives at the time of hiring that hit a range of issues—indebtedness, lobbying activities, lawsuits, and past regulatory queries. This list also includes questions on payment of taxes, judgments and liens, and prior employment terminations. The agency suggests additional questions that address past or ongoing litigation, criminal convictions, and relationships with outside auditors. The guidance recommends periodically repeating the vetting process after people are already in their role for a while.
The guidance represents a regulatory recognition that tone starts at the top. It would be easy to view the guidance as a continued focus by DFS on its seizure of Signature Bank, considering the draft guidance was issued for public comment just weeks after the bank was seized in March 2023. In a report shortly after the seizure, the agency cited "emerging weaknesses in corporate governance" as a concern in prior examinations of the bank. At the time, commentators suggested Signature Bank's involvement with the crypto industry, in part, led to its seizure. DFS's leadership, on the other hand, repeatedly asserted the seizure was unrelated to the bank's crypto ties. At the same time, however, DFS had increased its focus and attention on the intersection of the banking and crypto industries following multiple crypto exchange failures in 2022. Weeks after the high-speed collapse of FTX in December 2022, for example, DFS directed New York state-licensed banks and other financial institutions to seek its approval before engaging in or expanding crypto-related activity.
Politicians and regulators may seek to impose stricter compliance requirements on corporate America given these recent insolvencies, coupled with the prospect of a recession in a presidential election year. The recent high-profile federal criminal prosecutions of FTX CEO, Sam Bankman-Fried, and Celsius CEO, Alex Mashinsky, underscore the need for greater executive vetting. Codification of the agency's guidance into law could amount to an easy legislative win in New York and several other states.
Most mature financial institutions likely already have in place similar policies and extensively vet senior executives and board members. But those banks, crypto exchanges, and other financial institutions with vetting gaps should take to heart the DFS guidance. A financial institution should ensure, for example, that vetting is appropriately in-depth, given the overall risk profile of the institution's operations.
Financial institutions should also ensure that initial vetting assessments are reviewed periodically and not viewed as required only at the time of an executive's hiring. Corporate transactions such as mergers and acquisitions should likewise trigger vetting of newly onboarded executives.
Admittedly, the DFS guidance does not have the same effect as a binding regulation or law and therefore is merely advisory in nature. At the same time, financial institutions would do well to cast a critical eye over their vetting policies and address any deficiencies they find when compared to these new guidelines.
By taking the DFS guidance to heart today, a financial institution could avoid finding itself in regulatory crosshairs tomorrow.
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