On April 13, the State of Wyoming took the extraordinary step of filing a request for permission to intervene in the ongoing dispute between Custodia Bank, Inc. (“Custodia”) and the Board of Governors of the Federal Reserve System (“the Fed”) and the Federal Reserve Bank of Kansas City. This dispute involves a complaint (now amended) filed by Custodia – a state-chartered special purpose depository institution (“SPDI”) based in Cheyenne, Wyoming – against the Fed and the Federal Reserve Bank of Kansas City, alleging that the defendants improperly denied Custodia’s application for a “master account” with the Fed. Generalizing greatly, having a master account allows financial institutions to operate in the normal course as a custodial bank in the U.S. Having a Fed master account is therefore critical to any institution looking to operate in the U.S. financial system.
In a nutshell, Wyoming’s request to intervene critiques the defendants because of their “view of perceived inadequacies in Wyoming’s laws and regulations for SPDIs, [which are] partially responsible” for the denial of Custodia’s master account application. More specifically, Wyoming accuses the defendants of seeking to treat Wyoming SPDIs in an inequitable manner, thereby “treating state-chartered non-federally regulated banks as second-class banks ineligible to compete with federally-regulated ones.”
This blog post focuses on an important issue referenced seemingly in passing in Wyoming’s request for permission to intervene, which is clearly motivating in part the filing by Wyoming: on March 24, 2023, the Fed made public its January 27, 2023 Order Denying Application for Membership (the “Order”) by Custodia, which had requested the Fed’s approval under Section 9 of the Federal Reserve Act to become a member of the Federal Reserve System. According to Wyoming, the Fed’s decision to deny Custodia’s application has the effect of preventing Custodia and other Wyoming SPDIs from ever being able to attain the status of federal regulation. We focus here on the Order because of its much broader anti-money laundering (“AML”) and sanctions implications for any banks which are contemplating targeted services for the digital asset industry. The 86-page Order is very detailed, and often also discusses safety and soundness concerns, as well as other issues.
As we discuss, the Order suggests that any bank will have a hard time convincing the Fed that crypto-heavy banking services can comply with the requirements of the Bank Secrecy Act (“BSA”) and U.S. sanctions law. Likewise, the Fed has expressed its skepticism in the Order that blockchain analytics services, even when applied skillfully and with the best of intentions, actually can satisfy the BSA and U.S. sanctions law due to limitations inherent in crypto transactions relating to knowing with confidence who is actually conducting the transactions. This same issue was also noted by the recent report by the U.S. Treasury regarding perceived AML and sanctions vulnerabilities in decentralized finance providers.
Continue Reading State of Wyoming Wades Into Custodia Bank Dispute with Federal Reserve — In Wake of Fed’s Rejection of Bank Due to Crypto-Related AML and OFAC Concerns