Indemnification Payments, 49987-49994 [2018-21592]

Agencies

• FEDERAL HOUSING FINANCE AGENCY

[Federal Register Volume 83, Number 193 (Thursday, October 4, 2018)]
[Rules and Regulations]
[Pages 49987-49994]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-21592]


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FEDERAL HOUSING FINANCE AGENCY

12 CFR Part 1231

RIN 2590-AA68


Indemnification Payments

AGENCY: Federal Housing Finance Agency.

ACTION: Final rule.

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SUMMARY: The Federal Housing Finance Agency (FHFA or Agency) is 
adopting this final rule establishing standards for identifying whether 
an indemnification payment by the Federal National Mortgage Association 
(Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), 
any of the Federal Home Loan Banks (collectively with Fannie Mae and 
Freddie Mac, the regulated entities), or the Federal Home Loan Bank 
System's Office of Finance (the OF) to an affiliated party in 
connection with an administrative proceeding or civil action instituted 
by FHFA is prohibited or permissible. This final rule applies to all 
regulated entities, each Federal Home Loan Bank, the Federal National 
Mortgage Association, the Federal Home Loan Mortgage Corporation and 
the OF. It does not, however, apply to any regulated entity operating 
in conservatorship or receivership, or to a limited-life regulated 
entity.

DATES: This rule is effective on November 5, 2018.

FOR FURTHER INFORMATION CONTACT: Mark D. Laponsky, Deputy General 
Counsel, [email protected], (202) 649-3054; or Peggy K. Balsawer, 
Associate General Counsel, [email protected], (202) 649-3060 
(these are not toll-free numbers), Office of General Counsel; Federal 
Housing Finance Agency, Constitution Center, 400 Seventh Street SW, 
Washington, DC 20219. The telephone number for the Telecommunications 
Device for the Hearing Impaired is (800) 877-8339.

[[Page 49988]]


SUPPLEMENTARY INFORMATION: 

I. Background

    FHFA published an Interim Final Rule on Golden Parachute and 
Indemnification Payments in the Federal Register on September 16, 2008 
(73 FR 53356). Subsequently, it published corrections rescinding that 
portion of the regulation that addressed indemnification payments on 
September 19, 2008 (73 FR 54309) and on September 23, 2008 (73 FR 
54673). On November 14, 2008, a proposed amendment to the Interim Final 
Rule was published in the Federal Register (73 FR 67424). FHFA 
specifically requested comments on whether it would be in the best 
interests of the regulated entities to permit indemnification of first 
and second tier civil money penalties where the administrative 
proceeding or civil action related to conduct occurring while the 
regulated entity was in conservatorship. The public notice and comment 
period closed on December 29, 2008. On January 29, 2009 (74 FR 5101), 
FHFA published a final rule on Golden Parachute Payments. On June 29, 
2009 (74 FR 30975), FHFA published a proposed amendment to that 2009 
Golden Parachute final rule. At the same time, FHFA re-proposed the 
November 14, 2008 proposed amendment on indemnification payments (2009 
re-proposal). The 2009 re-proposal noted that comments received in 
response to the November 14, 2008 publication on indemnification 
payments would be considered along with comments received in response 
to the 2009 re-proposal. The golden parachute provisions of the rule 
were re-proposed in 2013 (78 FR 28452, May 14, 2013), adopted in final 
form in 2014 (79 FR 4394, Jan. 28, 2014), and codified as 12 CFR 
1231.1, 1231.2, 1231.3, 1231.5, and 1231.6. Amendments to the golden 
parachute provisions of the rule were proposed on August 28, 2018 (83 
FR 43801).
    On September 20, 2016, FHFA again re-proposed a rule on 
indemnification payments to affiliated parties (2016 re-proposal, or 
proposed rule), redrafting the proposed rule to make it simpler and 
easier to understand. After an extension, the comment period expired on 
December 21, 2016.\1\ The substance of the 2016 proposed rule did not 
change from the 2009 re-proposal, other than to replace a provision 
concerning indemnification payments by regulated entities in 
conservatorship with one that clearly states that the regulation does 
not apply to such entities.\2\ FHFA further clarified that it does not 
consider indemnification payments to be subject to FHFA rules and 
procedures related to compensation, including 12 CFR part 1230.
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    \1\ See 81 FR 74739 (Oct. 27, 2016).
    \2\ While the 2016 re-proposal proposed to except from the rule 
entities operating in conservatorship or receivership and limited 
liability regulated entities (LLREs), it did not expressly address 
its application to an institution that is rehabilitated in 
conservatorship and emerges other than through receivership and 
liquidation. Consistency with the rationale underpinning the 
exception demands that the exception should apply with respect to an 
administrative proceeding or civil action initiated by FHFA after 
rehabilitation if the subject conduct occurred during a 
conservatorship or receivership.
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    The final rule generally adopts the 2016 re-proposal's approach to 
the indemnification provisions of the Federal Deposit Insurance 
Corporation's (FDIC) counterpart regulation. See 12 CFR part 359. Like 
the FDIC's regulation, and consistent with the Director's statutory 
discretion to ``prohibit or limit any . . . indemnification payment,'' 
\3\ the final rule creates a presumption that indemnification payments 
for costs, expenses, fees, and penalties by a regulated entity or the 
OF to affiliated parties are impermissible in connection with an FHFA-
initiated administrative proceeding or civil action. As required by 
section 4518(e)(2) of the Federal Housing Enterprises Financial Safety 
and Soundness Act of 1992, as amended (the Safety and Soundness Act, or 
the Act),\4\ the rule sets forth criteria and standards constituting 
the ``factors'' that the Director has determined are to be used to 
``prohibit or limit'' indemnification payments through this regulation. 
In application, each institution (whether a regulated entity or the OF) 
is required to ensure that no indemnification payments under this rule 
are made unless the criteria and standards are met.
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    \3\ 12 U.S.C. 4518(e)(1).
    \4\ See 12 U.S.C. 4501 et seq.
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II. Technical Corrections

    In the process of drafting this final rule, FHFA staff observed 
that the definitional section of the existing Golden Parachute and 
Indemnification regulation required a technical correction to align it 
with the Safety and Soundness Act. See proposed Sec.  1231.2; 12 U.S.C. 
4518(e). The section of the Act explicitly authorizing the Director to 
prohibit or limit golden parachute and indemnification payments, 
applies to payments made to ``affiliated parties'' and does not mention 
``entity-affiliated parties.'' The Act does not define ``affiliated 
parties.'' FHFA had adopted the term ``entity-affiliated party'' and 
defined it for use in the rule. To align with the Safety and Soundness 
Act, the correct reference should be to ``affiliated party.'' In this 
final rule, FHFA is replacing the term ``entity-affiliated party'' with 
the term ``affiliated party,'' without any change to the substantive 
definition. The existing definition of ``entity-affiliated party'' will 
be the definition of ``affiliated party'' for the purposes of this 
final rule to effect this technical correction.\5\
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    \5\ Throughout this final rule ``entity-affiliated party'' has 
been replaced with ``affiliated party'' (unless the context requires 
retaining the former term) to reflect the technical change made to 
the regulation. The change in term has substantive effect in the 
proposed golden parachute amendments, see 83 FR 43801, 43808-09 
(Aug. 28, 2018).
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    FHFA is also making some minor, non-substantive changes to the rule 
text based on staff's determination that the words ``conditions for'' 
should precede the phrase ``prohibited and permissible indemnification 
payments'' in proposed Sec.  1231.1 to conform the semantic 
construction of the final rule's purpose to its other operational 
provisions; and staff's determination that changing the phrase ``the 
cost'' to ``any cost'' in clause (2) of the definition of ``liability 
or legal expense'' in Sec.  1231.2, and adding the word ``a'' in 
clauses (3) and (4) of Sec.  1231.4(c) would be more consistent and 
grammatically correct.\6\
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    \6\ The Agency also made minor grammatical changes to proposed 
Sec.  1231.4(b)(2)(i) to reduce the text's awkwardness in light of 
other substantive changes made to the exoneration standard discussed 
later in this preamble.
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III. Comments on the 2016 Re-Proposal

    In response to the 2016 re-proposal, FHFA received a public comment 
from one citizen and a joint comment letter from the 11 Federal Home 
Loan Banks and the OF. FHFA gave careful consideration to all issues 
raised by the commenters.

A. Public Comment From a Citizen

    A very brief comment from a member of the public was limited to 
agreeing with the proposed rule's exclusion of coverage for regulated 
entities in conservatorship. The commenter opined that because the 
Enterprises are in conservatorship, indemnification payments should be 
permitted, but that claw backs should be used to avoid excessive 
indemnification. Though the intended scope of the comment was not 
clear, the commenter referred to ``servicing agreements the GSEs have 
with issuing banks'' and to the ``conservatorship agreements.'' The 
comment reflects an apparent understanding of the import of excluding 
entities operating in

[[Page 49989]]

conservatorship from the rule's coverage and an endorsement of the 
proposal.

B. Regulated Entity Public Comments

    The eleven Federal Home Loan Banks and the OF (collectively, Banks) 
jointly submitted the second public comment. See Joint Comment of the 
Federal Home Loan Banks and Office of Finance on Proposed Rule on 
Indemnification Payments, dated December 21, 2016 (Joint Comment). The 
Banks addressed several matters related to the 2016 re-proposal, 
including: (1) The scope of the rulemaking; (2) certain standards and 
processes relating to the advancement of defense expenses; (3) 
insurance coverage issues; (4) partial indemnification issues; (5) the 
treatment of pre-existing indemnification agreements; and (6) potential 
impacts of the rulemaking. As discussed below, FHFA has decided to 
adopt some, but not all, of the suggestions it received.
1. Scope of ``Prohibited Indemnification Payment''
    The Banks raised four issues relating to the scope of the 
prohibition on indemnification payments. First, though they applauded 
FHFA's decision to except regulated entities in conservatorship from 
the rule's restrictions, they argued this would also lead to what they 
considered a perverse situation where those entities could be permitted 
to make indemnification payments for first and second tier civil 
monetary penalties which healthier institutions would be barred from 
making under the rule. The Banks recommended that institutions not in 
conservatorship should have the same breadth of authority to indemnify 
as entities in conservatorship. This argument for uniform treatment is 
one that had been raised by commenters--including some Banks--on a 
prior proposal. FHFA answered the objection and explained its 
disagreement in the 2016 proposed rule. The Banks' comment letter 
offers no reason for FHFA to revisit or change its earlier decision 
declining in general to permit regulated entities not in 
conservatorship to make indemnification payments for first and second 
tier civil money penalties. See 81 FR at 64358.
    Second, the Banks contended that the proposed rule conflicts with 
the Safety and Soundness Act. Joint Comment p.2. The Banks argued that 
since the Safety and Soundness Act expressly prohibits indemnification 
with respect to third tier civil money penalties (12 U.S.C. 4636(g)), 
the Director may not also prohibit payments relative to first and 
second tier civil money penalties. FHFA disagrees with the Banks' 
assertion that a rule prohibiting or limiting indemnification payments 
with respect to first and second tier civil money penalties conflicts 
with, or exceeds, authority granted by the Safety and Soundness Act. 
The Safety and Soundness Act both expressly prohibits indemnification 
for third tier Civil Money Penalties and expressly grants authority to 
the Director to ``prohibit or limit, by regulation or order, any . . . 
indemnification payment'' (12 U.S.C. 4518(e)(1)) (emphasis added). The 
absence of a specific limitation on the Director's authority relative 
to first and second tier penalties places them squarely within the 
Director's broad authority to ``prohibit or limit'' indemnification 
payments under 12 U.S.C. 4518(e)(1).
    Third, the Banks also argued that indemnification should be 
permissible for the costs and expenses associated with the first and 
second tier penalties, whether or not the regulated entities are in 
conservatorship. This comment can be read in two ways. If the Banks are 
suggesting that indemnification of defense fees and costs should be 
allowed even when a first or second tier civil money penalty is 
imposed, FHFA rejects the prospect as undermining the intent and 
effectiveness of the fundamental presumption of impermissibility, and 
therefore, the regulation itself. If, however, the Banks mean that 
indemnification of defense fees and costs should be allowed if the 
defense against civil money penalties is successful, FHFA believes no 
revision is necessary because this final rule is clear that such 
indemnification of defense expenses, and in appropriate cases partial 
indemnification, is permitted.
    Fourth, the Banks argue that the prohibitions in the proposed rule 
are stricter than typical state governance statutes as may have been 
selected by an institution under FHFA's corporate governance 
regulation, 12 CFR part 1239. They believe that the Banks should be 
allowed to follow state law standards for indemnification and 
advancement of expenses to avoid confusion and conflicts in 
implementing standards from disparate sources. FHFA agrees that the 
proposed rule is more restrictive than many state laws, but nonetheless 
is satisfied that the proposed rule strikes the correct balance by 
applying federal law to its regulated entities in actions brought by 
the Agency, as specifically authorized by the Safety and Soundness Act, 
12 U.S.C. 4518(e)(1). Since each regulated entity may identify a 
singular state or model law for corporate governance purposes under 12 
CFR 1239, that choice of law would apply to indemnification payments to 
the extent not inconsistent with federal law and safety and soundness. 
12 CFR 1239.3(a).\7\ But the corporate governance rule does not 
constitute a limitation of FHFA's responsibility and authority to 
establish stricter standards for the regulated entities when the Agency 
deems them appropriate. The purpose of the federal statute is to 
provide the Director authority to prohibit or limit indemnification 
payments in proceedings brought by the Agency, regardless of what other 
law would permit. FHFA has carefully considered the Banks' comments and 
observations, but considers it appropriate to apply federal standards 
for the federal cases it brings. Finally, FHFA does not accept the 
Banks' generalized and unsupported assertions of ``practical 
conflicts'' and confusion in applying this rule to FHFA-initiated 
actions. FDIC-insured banks and savings associations successfully 
operate under the parallel FDIC regulation and have done so for the 
past 20 years.
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    \7\ See 12 CFR 1239.3(a) (``The corporate governance practices 
and procedures of each regulated entity, and practices and 
procedures relating to indemnification (including advancement of 
expenses), shall comply with and be subject to the applicable 
authorizing statutes and other Federal law, rules, and regulations, 
and shall be consistent with the safe and sound operations of the 
regulated entities.'').
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2. Standards and Processes Relating to the Advancement of Defense 
Expenses
    The Banks expressed concern that the proposed rule would require 
both a prior investigation and board findings by the regulated entity 
or the OF before an affiliated party could be advanced defense fees and 
expenses. They argued that a prior investigation is excessive, time 
consuming and unnecessary, that sufficient facts to make the required 
findings are likely to be unavailable at the early stage when 
advancement of expenses is sought, and that a board decision to deny 
the request under such circumstances could trigger litigation against a 
Bank by the affiliated party. Therefore, the commenters argued that a 
prior investigation and board findings should not be a precondition for 
indemnification. The Banks observed that an investigation and board 
findings would not be required under the proposed rule to permit a 
third party insurer to advance expenses directly under insurance 
policies or fidelity bonds purchased by the Banks, and so should not 
apply even in the absence of those circumstances. Finally, the Banks 
contend that, in the interests of Bank safety and soundness and to 
counter potential confusion and conflicts with

[[Page 49990]]

different legal standards, the advancement of expenses and costs be 
permitted pursuant to the provisions already contained in a Bank's 
bylaws, existing indemnification agreements, and state law for 
governance chosen under 12 CFR 1239.
    FHFA is not persuaded by the Banks' position. The FDIC considered 
such issues in developing its indemnification rule. The FDIC's first 
proposed rule would have required a board investigation and a more 
fulsome determination that the affiliated party had a ``substantial 
likelihood of prevailing on the merits.'' 60 FR 16069, 16075 (March 29, 
1995). In response to objections to this standard, the FDIC scaled back 
its proposal to something more on par with the requirements of FHFA's 
2016 re-proposal, which requires a prior board investigation and good 
faith findings that the affiliated party acted in good faith, believing 
the conduct was in the best interest of the regulated entity or the OF, 
and that the safety and soundness of the regulated entity or the OF 
will not be materially and adversely affected (and, also requiring a 
repayment of advances by the affiliated party if the defense is 
unsuccessful). See proposed Sec.  1231.4(c)(1); 81 FR at 64360.
    Like the FDIC, FHFA considers the foregoing standard to be 
reasonable. It encourages consistency in interpretation of 
indemnification standards under similar statutes administered by 
different agencies, and FHFA's regulation will apply only in FHFA-
initiated matters. As the FDIC observed in its final rule, such matters 
are first subject to significant investigation by the agency in the 
context of an extensive regulatory scheme. See 61 FR 5926, 5929 (Feb. 
15, 1996). At the time of an indemnification or advancement request, 
substantial factual allegations have been made to focus issues, and 
nothing inhibits the board from conducting its ``due investigation'' 
under the circumstances.
    Finally, the Banks' repeated broad assertion that ``practical 
conflicts'' and confusion would result from applying these standards 
instead of disparate and less stringent state standards is unpersuasive 
for many of the same reasons discussed above regarding the scope of the 
indemnification prohibition. FHFA again agrees with the FDIC that 
applying an entity's state law choice for governance issues is 
inappropriate. See 60 FR at 16075 (FDIC rejecting suggestion to use 
state law); see also 61 FR at 5929 (FDIC rejecting proposal to adopt 
Model Business Corporation Act standards). FHFA considers a single 
federal standard, under a federal statute, implemented by FHFA as a 
federal agency, applying only to matters initiated by FHFA, and 
involving institutions chartered by Congress, to be superior to a 
regulation deferring to disparate state law standards for 
indemnification payments. This final rule may be more stringent than 
state law, but FHFA considers it appropriate given the federal 
interests involved.
3. Insurance Coverage Issues
    The Banks correctly observed that the rule would allow regulated 
entities to pay insurance premiums for policies that provide 
reimbursement of costs and expenses, but would not allow them to use 
the proceeds of the policies to pay or reimburse for civil money 
penalties or an adverse judgment. They also correctly interpreted the 
proposed rule as prohibiting payment of insurance premiums on any 
policy that would cover civil money penalties or judgments. Such a ban 
means that costs and expenses could not be insured against through a 
policy that by its terms could cover civil money penalties, even if the 
Banks agreed to take steps to ensure policy proceeds were not actually 
used to pay those penalties. The Banks contend that if they are 
prohibited from purchasing policies that include the broader coverage, 
they may be forced to forgo insurance policies that would cover even 
those fines and penalties that are not FHFA-related.
    FHFA is not persuaded to change the regulation to permit the 
regulated entities and the OF to pay premiums for insurance policies 
with the broad coverage requested by the Banks. The various 
alternatives they offer do not address the purpose of this provision--
to avoid back-door payment of civil money penalties and judgments in 
favor of FHFA through the use of insurance policies. FHFA is concerned 
that insurance coverage provided by a regulated entity or the OF for 
the benefit of its affiliated parties would be enforceable directly by 
the affiliated party, thereby evading the proposed rule's 
indemnification restrictions. FHFA believes that its goal is best 
accomplished by prohibiting any insurance coverage of civil money 
penalties assessed by FHFA or judgments in FHFA's favor.
    However, FHFA is not unsympathetic to the larger concerns implicit 
in the Banks' comment, namely, that the regulated entities and the OF 
not be unduly limited from accessing a broad insurance market 
particularly if they might be required to forego certain insurance 
policies in order to remain compliant with the regulation. FHFA has 
determined to counter this concern by expanding the market of available 
insurance products beyond ``professional liability insurance'' to also 
entitle the regulated entities and the OF to pay premiums on ``any 
commercial insurance policy'' so long as the other requirements of the 
final rule are satisfied. In addition to increasing the types of 
policies that may be employed, this change has the added benefit of 
aligning the final rule with both the language of the statute and the 
FDIC's treatment of the issue. See 12 U.S.C. 4518(e)(6); see also 12 
CFR 359.1(l)(2)(i) (the FDIC described the product that may be 
purchased as ``any commercial insurance policy or fidelity bond.'').
    Another insurance issue raised by the Banks (though somewhat 
obliquely) is whether the prohibition on paying premiums for policies 
that cover civil money penalties and judgments is intended to prohibit 
coverage of any civil money penalties, or only those imposed by FHFA. 
FHFA agrees that the language of the proposed rule is ambiguous and 
could chill the regulated entities from purchasing insurance coverage 
covering penalties imposed by other state or federal regulators, which 
is not in keeping with FHFA's intent. The final rule therefore 
expressly clarifies in Sec.  1231.4(b)(1) that the prohibition on 
indemnification payments only applies to a civil money penalty when it 
is ``imposed by FHFA.''
4. Partial Indemnification and Expenses
    The Banks' comments on the partial indemnification provisions of 
the proposed rule covered three distinct objections: first, that the 
rule's standard for ``exoneration'' is too narrowly crafted; second, 
that the obligation to repay is capable of being prematurely triggered; 
and third, that the rule does not sufficiently account for the precise 
allocation of defense expenses when an affiliated party faces more than 
one charge.
    The Banks objected to the exoneration standard in the proposed 
rule--expressed in the rule as ``not exonerated''--as being too 
narrowly tailored and unlikely to permit, in keeping with the proposed 
rule's presumed intent, an affiliated party to retain expenses advanced 
to it in connection with charges for which it ultimately is not found 
to be at fault. They expressed concern that an affiliated party often 
will not receive an affirmative ruling of exoneration with respect to 
charges against it, and in such circumstances, there would be few if 
any judicial or administrative processes available at a reasonable cost 
to obtain such an affirmative ruling. The Banks

[[Page 49991]]

also included a hypothetical example to demonstrate their concerns, 
describing a situation where an affiliated party is initially 
investigated on three different claims and advanced the expenses to 
defend against them. The Banks argued that if only two of the claims 
were pursued and the affiliated party ultimately was found liable on 
only one claim, the proposed rule's exoneration standard would produce 
an inequitable result by requiring repayment of all of the expenses 
advanced despite the affiliated party having been found culpable on 
only one of the three original claims. The Banks therefore suggested it 
is more appropriate to replace the ``exoneration'' standard with a more 
conventional legal standard, namely, one examining ``whether the party 
is found to be liable based on a judgment not subject to judicial 
review.'' Joint Comment p.4.
    FHFA agrees with the Banks' conclusions and acknowledges that the 
exoneration standard under the proposed rule could have led to the 
undesirable outcomes set out in their hypothetical example. In fact, 
the standard itself is too amorphous to be useful; it resists 
consistent interpretation from case-to-case and year-to-year, and thus 
may very often lead to an application of the regulation that is 
inconsistent with the Agency's intent. The Agency therefore finds that 
the term ``not exonerated'' under the proposed rule warrants 
reconsideration and revision. FHFA has determined to revise Sec.  
1231.4(b)(2)(i) to make the final rule clearer, more in keeping with 
familiar standards already in the regulation and more definitive in its 
application. The final rule turns the question of exoneration (or 
rather, non-exoneration) into one of ``culpab[ility] for violating a 
law or regulation that is the basis for the charges to which the 
expenses specifically relate'' thereby clarifying the standard to be 
that for which culpability is assessed and unambiguously linking it to 
the charges at hand. The concept of culpability is also a more familiar 
benchmark in that it ties in to the standard used for indemnification 
after settlements (has not ``admit[ted]''). See Sec.  1231.4(b)(2)(ii). 
Perhaps even more importantly, the final rule adopts a concept of 
finality, requiring an order to be final and non-reviewable before a 
lack of culpability qualifies an affiliated party for partial 
indemnification. See Sec.  1231.4(b)(2)(i).
    In making these changes, FHFA acknowledges that it is diverging 
from the FDIC's parallel provision requiring ``a formal and final 
adjudication or finding in connection with a settlement that the 
[affiliated party] has not violated certain banking laws or regulations 
or has not engaged in certain unsafe or unsound banking practices'' to 
describe the standard that qualifies for partial reimbursement. 12 CFR 
359.1(l)(2)(ii). FHFA's final rule diverges from the FDIC's regulation 
by: (1) Temporarily relieving the financial burden of defense on an 
affiliated party pending a proceeding's finality; and (2) creating a 
scope of permissible indemnification beyond that available under the 
FDIC's regulation. With these changes, indemnification becomes 
permissible if the party to be indemnified is not held responsible for 
a violation of law or regulation. In contrast, the FDIC regulation is 
constructed to prohibit indemnification unless the party is found 
(presumably via an express determination) not to have violated a law or 
regulation at issue. In the potentially very large zone in which there 
is no determination or admission that the affiliated party has engaged 
in wrongdoing, but similarly no exoneration, FHFA's final rule permits 
the affiliated party to keep the indemnification payments for expenses 
of defense, while the FDIC's regulation requires that he or she repay 
them. FHFA's changes as reflected in the final rule provide clearer 
regulatory standards and greater certainty to FHFA, the regulated 
entities, and affiliated parties, and do not require explanatory 
hypotheticals. FHFA believes that the balance of interests in this 
instance is in favor of greater certainty and clarity.
    The Banks' second objection to the partial indemnification 
provisions in the proposed rule concerns the possibility that an 
affiliated party's obligation to repay advanced expenses would be 
triggered prematurely upon the issuance of an unfavorable order, even 
when that order is not final. The commenters argued that such a trigger 
does not allow for appeal or review, nor any possible changes before 
the order becomes final, essentially cutting off funding before the 
legal process is complete. The Banks instead suggested that proposed 
Sec.  1231.4(b)(2)(i) be changed from ``results in an order'' to 
``results in a final order not subject to judicial review.'' They also 
argued for a corresponding change to Sec.  1231.4(b)(2)(iii), relating 
to the issuance of a prohibition order to prevent an affiliated party 
having to repay advances pending resolution of any request for a 
judicial stay with respect to such order.
    FHFA agrees with the Banks that the obligation to repay advances 
should not be triggered upon the issuance of an order until the order 
is final and no longer subject to review. Such a change is consistent 
with the Agency's intent regarding application of the final rule 
generally, as well as with the rule changes discussed above and made in 
the context of the ``exoneration'' standard. In the discussion 
accompanying the 2016 re-proposal, FHFA responded to several Bank 
commenters' requests to clarify what was meant by ``final prohibition 
order'' and in doing so relied on a reference to section 1377(c)(5) of 
the Act.\8\ FHFA's clarification at that time did not adopt the measure 
of finality sought by the Banks. To account for the Banks' concerns and 
also to reflect the Agency's intent with regard to when advanced 
expenses ought to be repaid, FHFA is revising proposed Sec.  
1231.4(b)(2)(i) to require that repayment be based on a ``final and 
non-reviewable order.'' For the sake of consistency, FHFA is also 
revising proposed Sec.  1231.4(b)(2)(iii) to reference a ``final and 
non-reviewable prohibition order.''
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    \8\ FHFA expressly defined ``final prohibition order'' as ``an 
order under section 1377 of the [Safety and Soundness] Act (12 
U.S.C. 4636a) prohibiting . . . [an affiliated party] from 
continuing or commencing to hold any office in, or participate in 
any manner in the conduct of the affairs of, a regulated entity, 
which order has become and remains effective as described in section 
1377(c)(5) of the Safety and Soundness Act (12 U.S.C. 
4636a(c)(5)).'' 81 FR at 64358.
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    The Banks' third objection to the partial indemnification 
provisions concerns the appropriate apportionment of expenses when 
multiple charges are at issue against an affiliated party. The 
commenters correctly noted that the proposed rule would have permitted 
partial indemnification of defense costs and expenses only when they 
``specifically relate to'' a charge or charges on which an affiliated 
party is exonerated, if the proceeding results in an order; or on which 
the affiliated party enters a settlement without admitting culpability. 
See proposed Sec.  1231.4(b), 81 FR at 64360. The Banks contend that 
this narrow construction is insufficient to account for a precise 
allocation of defense expenses among multiple charges where each charge 
may result in a different outcome for the affiliated party. To the 
extent that this comment suggests partial indemnification should permit 
an affiliated party to recover the proportion of all costs and expenses 
represented by the charge(s) on which he or she is successful, FHFA 
already considered and rejected the suggestion in the 2016 proposed 
rule \9\ and finds no reason to reconsider the comment here.
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    \9\ As FHFA noted in the preamble to the Proposed Rule: ``In 
many cases the appropriate amount of partial indemnification will be 
difficult to ascertain with certainty. The value of each charge 
might not equal each other charge. Services provided often will 
relate to multiple charges or all charges and cannot conveniently be 
segregated.'' 81 FR at 64359.

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[[Page 49992]]

    However, in reviving this allocation issue the Banks are asserting 
a slightly different proposition than the earlier comment, one not 
necessarily resulting in the same proportional allocation of expenses 
permitted for partial indemnification. In their latest comment, the 
Banks recommended that FHFA allow the board of directors of the 
regulated entity or the OF to determine the weight of each charge and 
accordingly allow indemnification of expenses for the proportion of the 
charges otherwise satisfying the rule's standards. According to the 
Banks, the board is in the best position to conduct such an 
apportionment. The Banks contend that without a board-driven allocation 
of costs and expenses, the proposed rule would be a disincentive to 
settlement of charges, since the affiliated party would not have 
certainty in advance as to that portion of expenses for which he or she 
could expect reimbursement or be required to repay.
    FHFA does not believe the Banks' comment is sufficiently distinct 
to warrant a change to the final rule. It remains a proportional 
allocation, just one determined by the board's collective perception of 
value instead of one based on a simple arithmetic formula. In reality, 
the Banks' proposal provides less certainty than a formula-driven 
proposal and no more certainty than the proposed rule, unless the 
board's apportionment is known in advance of a settlement or final 
order. This lack of certainty was among the reasons FHFA rejected the 
analogous comment to the proposed rule.\10\ Moreover, it is far from 
clear that, as the Banks assert, the board would be in a better 
position to assign weight to different charges than would the parties 
involved in negotiating a settlement or a judge receiving evidence. 
Permitting the board to tip the scales in this manner would improperly 
substitute the board's judgment for the Agency of the parties involved 
or usurp the authority of the judge presiding over the matter. FHFA 
therefore continues to believe, as it noted when it issued the 2016 re-
proposal, ``that the appropriate amount of any partial indemnification 
is best determined on a case-by-case basis rather than by applying a 
predetermined formula.'' 81 FR at 64359.
---------------------------------------------------------------------------

    \10\ In this view, FHFA again aligns with the FDIC's views as 
reflected in its corresponding regulation. Even the Banks note that 
the FDIC also recognized the lack of certainty in determining 
partial indemnification amounts. Joint Comment p.3 n.2. The FDIC, 
like FHFA, decided not to constrain partial indemnification 
determinations with an artificial and predetermined formula.
---------------------------------------------------------------------------

5. Treatment of Pre-Existing Indemnification Arrangements
    The Banks also objected to the proposed rule's treatment of pre-
existing indemnification agreements. They generally restated earlier 
objections to the text and the effect of the indemnification agreement 
grandfathering provision in Sec.  1231.4(b)(3), see 81 FR at 64360, 
which would have permitted payment of amounts due under individualized 
indemnification agreements with a named affiliated party. The 
commenters argued that the proposed rule did not define an 
indemnification ``agreement'' sufficiently to inform affected parties 
about what would, or would not, be grandfathered. The Banks further 
protested that individualized indemnification agreements are rare since 
most state laws would consider a regulated entity's bylaws provisions 
on indemnification to be enforceable contractual obligations to 
officers, directors, employees and agents, as exercises of the Banks' 
express authority under section 7 of the Federal Home Loan Bank Act, 12 
U.S.C. 1427(k). Consequently, the Banks urged FHFA to consider bylaws 
provisions on indemnification to be ``agreements'' entitled to 
grandfathering under the rule. In the alternative, they asked that FHFA 
delay the effective date of this final rule for 60 days during which 
regulated entities could execute individualized indemnification 
agreements that then will be subject to grandfathering. Finally, the 
Banks requested that FHFA confirm that those whose agreements are 
grandfathered will not also be subject to any new limitation that did 
not exist before the effective date of the final rule.\11\
---------------------------------------------------------------------------

    \11\ In effect, such a confirmation would override the proposed 
grandfathering date and replace it with the effective date of the 
final rule, unless extended.
---------------------------------------------------------------------------

    As the Banks themselves admitted in their comment letter, FHFA has 
already addressed many of their stated objections in the preamble 
discussion accompanying the 2016 re-proposal. See Joint Comment p.5. At 
that time, FHFA rejected those comments, and the Banks have not 
presented any new arguments warranting reconsideration of this Agency's 
position. FHFA identified indemnification agreements as ``specific 
indemnification agreements entered into by a regulated entity with a 
named [affiliated party] on or before the day this proposed amendment 
is published'' and clarified that ``only agreements of that type . . . 
justify grandfathering.'' 81 FR at 64359. This definition of what 
constitutes an ``indemnification agreement'' subject to grandfathering 
is clear enough that the Banks should need no further explanation. The 
commenter's observation that the Bank Act offers the Banks express 
authority to determine indemnification terms and conditions, does not 
in any way limit the Director's unambiguous authority to introduce 
additional prohibitions on indemnification pursuant to section 4518(e) 
of the Act. Finally, the commenters' request for a delay in the Final 
Rule's effective date, to permit execution of new agreements that would 
be subject to grandfathering but no new rule restrictions, is but a 
minor variation on comments previously submitted and dismissed. FHFA 
dismissed those comments in the 2016 proposed rule and in so doing 
rejected any circumstances leading to a scenario like the one proposed 
by the Banks that would permit a Bank to immunize ``[its] entire corps 
of managers and directors from the effect of this regulation in 
perpetuity.'' 81 FR at 64359. FHFA rejects the Banks' requests to 
change the final rule in any manner with respect to the treatment of 
pre-existing indemnification agreements. The final rule retains 
September 20, 2016 (the 2016 re-proposal's publication date) as the 
grandfathering date for pre-existing individualized indemnification 
agreements. See Sec.  1231.4(b)(3).
6. Deterrent Effects on Service as a Bank Director
    The Banks' final objection to the proposed rule concerns its 
potential detrimental impact. The commenters contended that because the 
proposal departs from current corporate governance and indemnification 
practices, recruiting for, and the continuing service of, directors, 
officers, and employees could be adversely affected.
    FHFA is not persuaded by this objection. Although FHFA recognizes 
the risk of deterrence, the Banks offer no evidence to demonstrate that 
the risk is as great as they suggest, and FHFA remains unconvinced that 
the asserted deterrent effect is likely to materialize. As noted above, 
FDIC-insured banks and savings associations have been operating under 
the equivalent FDIC rule for the past 20 years and have been able 
consistently to recruit well-qualified directors and officers. FHFA 
believes it has struck the correct balance between traditional state 
law-based indemnification and a regime that is appropriate for these 
institutions, specially subject to and created under

[[Page 49993]]

federal law, and therefore has not made an accommodation for this 
comment.

IV. Consideration of Differences Between the Banks and the Enterprises

    Section 1313(f) of the Safety and Soundness Act, as amended, 
requires the Director, when promulgating regulations relating to the 
Banks, to consider the differences between Fannie Mae and Freddie Mac 
(collectively, the Enterprises) and the Banks with respect to: The 
Banks' cooperative ownership structure; mission of providing liquidity 
to members; affordable housing and community development mission; 
capital structure; joint and several liability; and any other 
differences the Director considers appropriate. See 12 U.S.C. 4513(f). 
The Director considered the differences between the Banks and the 
Enterprises as they relate to the above criteria and determined that 
the Banks should not be treated differently from the Enterprises for 
purposes of this final rule. Any regulated entity in conservatorship 
(or receivership or a limited-life regulated entity), whether a Bank or 
an Enterprise, would be outside the scope of the rule.

V. Paperwork Reduction Act

    This final rule does not contain any information collection 
requirement that requires the approval of the Office of Management and 
Budget (OMB) under the Paperwork Reduction Act (44 U.S.C. 3501 et 
seq.). Therefore, FHFA has not submitted any information to OMB for 
review with respect to information collection.

VI. Regulatory Flexibility Act

    The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) requires that 
a regulation that has a significant economic impact on a substantial 
number of small entities, small businesses, or small organizations must 
include an initial regulatory flexibility analysis describing the 
regulation's impact on small entities. Such an analysis need not be 
undertaken if the agency has certified that the regulation will not 
have a significant economic impact on a substantial number of small 
entities. 5 U.S.C. 605(b). FHFA has considered the impact of this final 
rulemaking under the Regulatory Flexibility Act. The General Counsel of 
FHFA certifies that this final rule is not likely to have a significant 
economic impact on a substantial number of small entities because it 
would apply primarily to the regulated entities and the OF, which are 
not small entities for purposes of the Regulatory Flexibility Act.

VII. Congressional Review Act

    In accordance with the Congressional Review Act, FHFA has 
determined that this action is not a major rule and has verified this 
determination with the Office of Information and Regulatory Affairs of 
the Office of Management and Budget (OMB). See 5 U.S.C. 804(2).

List of Subjects in 12 CFR Part 1231

    Golden parachutes, Government-sponsored enterprises, 
Indemnification payments.

    Accordingly, for the reasons stated in the preamble, and under the 
authority of 12 U.S.C. 4511, 4513, 4517, 4518, 4518a, and 4526, FHFA 
amends part 1231 of subchapter B of chapter XII of title 12 of the CFR 
as follows:

PART 1231--GOLDEN PARACHUTE AND INDEMNIFICATION PAYMENTS

0
1. The authority citation for part 1231 is revised to read as follows:

    Authority:  12 U.S.C. 4511; 4513; 4517; 4518; 4518a; and 4526.


0
2. In part 1231, wherever they occur:
0
a. Revise all references to ``entity-affiliated party'' to read 
``affiliated party'';
0
b. Revise all references to ``entity-affiliated parties'' to read 
``affiliated parties''; and
0
c. Revise all references to ``entity-affiliated party's'' to read 
``affiliated party's''.

0
3. Revise Sec.  1231.1 to read as follows:


Sec.  1231.1   Purpose.

    The purpose of this part is to implement section 1318(e) of the 
Safety and Soundness Act (12 U.S.C. 4518(e)) by setting forth the 
standards that the Director will take into consideration in determining 
whether to limit or prohibit golden parachute payments and by setting 
forth conditions for prohibited and permissible indemnification 
payments that regulated entities and the Office of Finance may make to 
affiliated parties.

0
4. In Sec.  1231.2 add definitions for ``Indemnification payment'' and 
``Liability or legal expense'' in alphabetical order to read as 
follows:


Sec.  1231.2   Definitions.

* * * * *
    Indemnification payment means any payment (or any agreement to make 
any payment) by any regulated entity or the OF for the benefit of any 
current or former affiliated party, to pay or reimburse such person for 
any liability or legal expense.
    Liability or legal expense means--
    (1) Any legal or other professional expense incurred in connection 
with any claim, proceeding, or action;
    (2) The amount of, and any cost incurred in connection with, any 
settlement of any claim, proceeding, or action; and
    (3) The amount of, and any cost incurred in connection with, any 
judgment or penalty imposed with respect to any claim, proceeding, or 
action.
* * * * *

0
5. Add Sec.  1231.4 to read as follows:


Sec.  1231.4   Indemnification payments.

    (a) Prohibited indemnification payments. Except as permitted in 
paragraph (b) of this section, a regulated entity or the OF may not 
make indemnification payments with respect to an administrative 
proceeding or civil action that has been initiated by FHFA.
    (b) Permissible indemnification payments. A regulated entity or the 
OF may pay:
    (1) Premiums for any commercial insurance policy or fidelity bonds 
for directors and officers, to the extent that the insurance or 
fidelity bond covers expenses and restitution, but not a judgment in 
favor of FHFA or a civil money penalty imposed by FHFA.
    (2) Expenses of defending an action, subject to the affiliated 
party's agreement to repay those expenses if the affiliated party 
either:
    (i) When the proceeding results in a final and non-reviewable 
order, is found culpable for violating a law or regulation that is the 
basis for the charges to which the expenses specifically relate; or
    (ii) Enters into a settlement of those charges in which the 
affiliated party admits culpability with respect to them; or
    (iii) Is subject to a final and non-reviewable prohibition order 
under 12 U.S.C. 4636a.
    (3) Amounts due under an indemnification agreement entered into 
with a named affiliated party on or prior to September 20, 2016.
    (c) Process; factors. With respect to payments under paragraph 
(b)(2) of this section:
    (1) The board of directors of the regulated entity or the OF must 
conduct a due investigation and make a written determination in good 
faith that:
    (i) The affiliated party acted in good faith and in a manner that 
he or she reasonably believed to be in the best interests of the 
regulated entity or the OF; and
    (ii) Such payments will not materially adversely affect the safety 
and

[[Page 49994]]

soundness of the regulated entity or the OF.
    (2) The affiliated party may not participate in the board's 
deliberations or decision.
    (3) If a majority of the board are respondents in the action, the 
remaining board members may approve payment after obtaining a written 
opinion of outside counsel that the conditions of this regulation have 
been met.
    (4) If all of the board members are respondents, they may approve 
payment after obtaining a written opinion of outside counsel that the 
conditions of this regulation have been met.
    (d) Scope. This section does not apply to a regulated entity 
operating in conservatorship or receivership or to a limited-life 
regulated entity.

    Dated: September 28, 2018.
Melvin L. Watt,
Director, Federal Housing Finance Agency.
[FR Doc. 2018-21592 Filed 10-3-18; 8:45 am]
 BILLING CODE 8070-01-P