Better Know Your CEO: New York Issues Final Guidance on Character and Fitness

The New York Department of Financial Services (NYDFS) issued final supervisory guidance on January 22, 2024, to New York banking institutions and financial services companies licensed by the NYDFS. The guidance sets forth the NYDFS’ supervisory expectation that banking institutions and licensees develop, implement, and maintain a framework to review and assess the character and fitness of their directors, senior officers, and managers. We previously addressed the NYDFS’s original proposal on character and fitness in our May 25, 2023 edition of Licensing Link.

This article provides a summary of the guidance’s key points.

1. Who is Subject to the Guidance?

The NYDFS guidance applies to “Covered Institutions,” which include New York-regulated banks, as well as nondepository financial services companies licensed by the NYDFS. The guidance is not clear on whether it applies to registered mortgage servicers, since these companies are, as a formal matter, registered rather than licensed. However, since registered mortgage servicers are nevertheless subject to supervision and regulation by NYDFS, similar to other licensed financial services companies, we would expect NYDFS to assert that registered mortgage servicers are subject to the guidance.

The guidance does not apply to individuals that are licensed as mortgage loan originators, because mortgage loan originator licensees are already subject to initial and annual reviews of their fitness by the NYDFS in connection with their mortgage loan originator licenses.

2. What Does the Guidance Require?

The guidance sets forth the NYDFS’ expectation that Covered Institutions develop, implement, and maintain a framework for vetting the character and fitness of each member of a Covered Institution’s board of directors, board of trustees, and/or board of managers, as applicable, and each senior officer of a Covered Institution (collectively, “Designated Persons”). According to the NYDFS, requiring character and fitness reviews of directors, senior officers, and managers furthers the NYDFS’ mission to protect the safety and soundness of regulated entities, because “a compromised director, officer, or manager can threaten an organization’s safety and soundness at any time during that individual’s service.”

“Senior officers” include every officer who participates or has the authority to participate (other than in the capacity of a director) in major policy-making functions of a Covered Institution. The guidance does not provide examples of “major policy-making functions.” Any chief executive officer, chief financial officer, chief operations officer, chief compliance officer, chief legal officer, chief risk officer, president, senior executive vice president, executive vice present, secretary of the board of directors, or treasurer of a Covered Institution is considered a “senior officer,” unless the person is excluded from participation in major policy-making functions by a resolution of the board of directors or the Covered Institution’s bylaws, and the individual does not, in fact, participate in major policy-making functions. That being said, the fact that an individual does not hold one of these titles does not, by itself, provide a basis to conclude that a person is not a senior officer, nor does the fact that the individual is serving without salary or compensation. Instead, the inquiry is whether the individual participates or has the authority to participate in the major policy-making functions of a Covered Institution.

The NYDFS expects Covered Institutions to develop, implement, and maintain policies and procedures that require vetting of Designated Persons’ character and fitness, and to perform character and fitness assessments on Designated Persons, at the time of onboarding, and on a regular, ongoing basis thereafter. The guidance states that policies and procedures should include a “robust” framework for ongoing reviews, to confirm that there have been no intervening circumstances since the prior review that would make serving as a Designated Person inappropriate or improper.

The guidance also sets forth the NYDFS’ expectation for Covered Institutions to review materials that are generated in connection with character and fitness assessments of Designated Persons, and to report related findings to its board of directors or the equivalent function, as well as to the chief compliance officer or equivalent function. The guidance states that NYDFS will, as part of its examination process, review a Covered Institution’s character and fitness policies and procedures to confirm that the Covered Institution’s policies and procedures are satisfactory and consistent with the guidance, and that the Covered Institution is adhering to its policies and procedures.

3. What Must the Character and Fitness Review Entail?

The guidance contemplates that a Covered Institution has latitude to “appropriately tailor” character and fitness reviews to the risk profile of the institution, based on the Covered Institution’s determination using a risk-based and proportionate approach that takes into account the Covered Institution’s specific business needs, operations, and risks.

Covered Institutions are expected to define sensitive issues, warning signs, and other indicators that warrant additional scrutiny before the individual is permitted to serve (or continue serving) as a Designated Person. The NYDFS guidance uses the example of an individual who served as a Designated Person at a Covered Institution that has been subject to a regulatory action or proceeding, and then joins another Covered Institution. In that instance, the NYDFS would expect that the individual be subjected to an enhanced review by the hiring Covered Institution that is designed to ensure that the person did not play a significant role or otherwise contribute in a meaningful way to the conduct that led to the regulatory action or proceeding. The NYDFS also expects Covered Institutions to require Designated Persons to amend relevant materials between designated vetting periods in response to intervening circumstances, or if a Designated Person later determines that previously submitted information was materially incorrect or that relevant facts have materially changed.

The guidance does not dictate any defined period for review of Designated Persons’ vetting assessments. Although the guidance contains an Appendix with suggested questions that can be incorporated into a character and fitness review, the guidance does not mandate use of the questions in the Appendix. The scope of a Covered Institution’s character and fitness reviews, including the depth of initial reviews, the types of information requested or refreshed at the time of review, and the appropriate length of time between reviews, is left to the discretion of the Covered Institution.

4. How Does a Change in Control Impact Character and Fitness Reviews?

The NYDFS’ expectation that Covered Institutions perform character and fitness reviews extends to a variety of corporate or organizational transactions, such as mergers and acquisitions, changes in control, or a purchase and assumption. In connection with these transactions, an individual who served as a Designated Person at another Covered Institution may join the acquiring or surviving Covered Institution as a Designated Person. In these situations, the acquiring or surviving Covered Institution is expected to subject the individual to its own onboarding character and fitness review, and subsequently include the individual in the ongoing assessments that it performs on its other Designated Persons. The onboarding review should be conducted upon consummation of the transaction. The guidance cautions that Covered Institutions should not just rely on previous vetting or due diligence performed in connection with the new Designated Person’s service at a different institution.

5. What does DFS Require if the Character and Fitness Review Discovers Adverse Information?

The NYDFS guidance provides that Covered Institutions have discretion over the disposition of any negative findings related to an initial or ongoing character and fitness assessment, so long as the disposition is consistent with the Covered Institution’s internal controls framework. If a Covered Institution determines that information discovered in an ongoing character and fitness review should result in removal of a Designated Person from their position, the transfer of the Designated Person to another position or group, or modifications to the current functions of the Designated Person, then the Covered Institution must notify the NYDFS “promptly.”

6. What’s Next?

Although the NYFDS guidance does not set forth an express effective date for when the NYDFS will begin to examine regulated entities’ character and fitness policies and procedures, those entities that are Covered Institutions should take steps to develop and implement such policies and procedures in line with the final guidance.