For the last few years, the Pew Charitable Trust has been conducting studies of consumer financial services disclosures and urging banks and other financial institutions to adopt simplified disclosure forms. For example, in April 2012, Pew developed a model disclosure form for consumer checking accounts, and Pew reports that 26 major banks have already adopted the form (we are aware of additional banks to have adopted the form). In February 2014, Pew published a similar model disclosure form for prepaid card accounts.
Both of these Pew disclosures are similar to the “Schumer Box” disclosures used for credit cards, though of course less complicated since not written by a regulator. The prepaid form is specifically designed to be printed on the inside flap of the packaging used for many prepaid cards sold in retail locations, and is designed to be opened and reviewed by consumers prior to purchasing the card. If one assumes that consumers read disclosures at all, the Pew-style disclosures arguably are an improvement.
Pew also is recommending legislators and regulators to require banks to use such disclosures, or at least provide information about account terms, conditions and fees in a concise, easy-to-read format. While bankers do not need more regulation, there could be certain upsides to a rule this time, if only the regulators can do it right.
As it stands, Pew-style disclosures for deposit and lending products are dangerously close to being “advertisements” for purposes of Truth in Savings (TISA) and Truth in Lending (TILA). If deemed to be advertisements, then additional information is generally required in the material, somewhat defeating the simplifying purpose of the forms. At the same time, these simplified disclosures do not satisfy the account opening disclosure requirements of TISA or loan closing disclosure requirements of TILA, thus forcing banks to provide more disclosures rather than fewer. And the Pew disclosures certainly omit important contractual details, raising yet another risk that a court or regulator will deem the disclosure to violate various unfair, deceptive and even abusive acts and practices laws (UDAP and UDAAP).
A clear rule that Pew-style disclosures are not subject to advertising rules, with clear standards to minimize UDAP or UDAAP claims, could therefore be useful. The question is whether regulators can write such rules without adding needless complications and liability.
One of the very powerful rights that the FDIC possesses in any receivership is a provision added by FIRREA which states that the FDIC may enforce any contract entered into by the depository institution notwithstanding any provision of the contract providing for termination, default, acceleration, or exercise of rights upon, or solely by reason of, insolvency or the appointment of or the exercise of rights or powers by a conservator or receiver (i.e., “ipso-facto” clauses). Many typical vendor contracts will oftentimes contain just such a clause providing that one party to the contract can terminate the contract at will if the other party files for relief under the Bankruptcy Code or is taken over by the government. The logic is pretty compelling, a party wants to be able to decide if it is comfortable dealing with an entity that is insolvent or attempting to reorganize.
A recent Georgia Court of Appeals decision raises interesting issues about how this specific FDIC power can be used in the context of a loan participation. In CRE Venture 2011-1, LLC v. First Citizens Bank of Georgia, First Citizens found itself the surviving bank of a group of four banks that had been involved in a loan participation. The lead bank and two others had been placed into receivership and the FDIC had sold the lead position to CRE Venture 2011-1, LLC. As is oftentimes the case in such situations, the local bank objected to the manner in which the lead was handling the credit, specifically, the proposed foreclosure of the real property securing the participated loan. First Citizens sought equitable relief based on its argument that if the foreclosure went forward, First Citizens would lose most of its interest in the loan and would be forced to account for the sale in a manner that would do it serious and irreparable harm to its finances and business prospects. First Citizens pointed out that unlike the two other loss-share banks that had succeeded to the other failed banks shares in the loan, it had not entered into a loss-sharing agreement with the federal government. Moreover, First Citizens argued that CRE Venture purchased the Loan at a significant discount and would not suffer the same loss, and might even profit from a quick sale of the property.
As cyber attacks against financial institutions have become more and more frequent, and the possibility of significant adverse consequences from a single attack have increased, financial institutions have been stepping up cyber security processes for some time. However, many institutions still grapple with the appropriate level of disclosure to shareholders regarding cyber security.
Cyber attacks can come from all directions and in all shapes and sizes—from the stolen employee laptop to a hacked computer system that allows fraudulent transfers from an account. Attacks where the criminals bypass both the computer systems of the bank and its customers and instead access the systems of the bank’s outside service providers can also leave the bank at risk. Which of these attacks or potential attacks merit disclosure?
Both Banks and Their Vendors Must Pay Attention
First there was the bulletin about third-party vendors issued by the Consumer Financial Protection Bureau (CFPB) in April 2012. Then it was the FFIEC’s guidance on IT service providers in October 2012. Next came the FDIC’s September 2013 Financial Institution Letter about payment-processing relationships with high-risk merchants. Then there was the news on October 30, 2013 about the OCC’s guidance on third-party relationships, followed shortly by the Federal Reserve Board’s guidance on managing outsourcing risks in December 2013.
Let’s face it. There has always been guidance and concern about banks and their relationships with third-party service providers. But in recent years it has become quite obvious that the bar has been raised on how banks relate to their third-party processors, program managers, and other service providers. These changes have occurred over time, by a matter of degrees. But it is increasingly plain that we are seeing a significant sea change in how regulators approach the relationships between banks and their third-party vendors. Examiners are digging deeper — especially into the content of bank contracts — and the scope of review is extending to more and more vendors.
In recent months, public commentary from some of the regulators has revealed even more clearly how this recent guidance will impact banks and their vendors. In this article we will describe the regulatory developments and provide some practical guidance as to what this will mean — not only for banks, but for their processors and other service providers. (A print-friendly version is also available.)
Recent Regulatory Developments
Banks and other financial institutions have always been expected to choose their vendors carefully and to monitor the performance of those vendors. Most institutions have done a reasonably good job in this regard. However, recent regulatory publications and the focus of recent regulatory examinations and enforcement actions indicate that the standards and expectations are now much higher.
The CFPB issued a bulletin on April 13, 2012 regarding the use of service providers, accompanied by a press release stating, “CFPB to Hold Financial Institutions and their Service Providers Accountable.” This bulletin, CFPB Bulletin 2012-03 (the CFPB Bulletin), states that the CFPB “expects supervised banks and nonbanks to oversee their business relationships with service providers in a manner that ensures compliance with Federal consumer financial law.” (emphasis added).
In virtually every transaction involving a publicly traded entity these days, a purported shareholder class action challenging the fairness of the merger has become almost inevitable. While these actions ostensibly seek monetary relief, such as an increase in the merger consideration, most of them ultimately settle on terms that call for some additional disclosures to the shareholders in advance of the vote on the transaction, and, of course, an attorneys fee award for the plaintiffs’ lawyers. There are two primary reasons for these settlements. First, the risk, however small, of having a large transaction enjoined or otherwise disrupted is often seen as outweighing the relatively minimal nature of the settlement relief. Second, a settlement is not without its benefits, as, once approved by the Court, the settling defendants can obtain a full and complete release of any claims that were or could have been brought by the shareholders in connection with the merger transaction. So long as these two dynamics remain in place, the settlement of the majority of these merger and acquisition cases will continue to be the norm. The Courts, however, particularly in Delaware, have begun to show a healthy skepticism about the plaintiffs lawyers’ application for fees in these cases. Ultimately, it will be the plaintiffs lawyers’ ability to obtain a profitable fee award that will determine the extent to which these cases remain so prevalent.
An abbreviated version of this response was first published on BankDirector.com.
Walt Moeling recently sat down with Donna Fay, the Director of Examinations for the Federal Reserve Bank of Atlanta, to discuss the future of community banking in connection with the Federal Reserve’s 2014 Banking Outlook Conference.
As noted by the disclaimer at the beginning of the video, Walt’s views unfortunately don’t necessarily represent the views of the Federal Reserve Bank of Atlanta. However, we can be hopeful that the Federal Reserve Bank of Atlanta continues to be open to our point of view.
In the bankers’ version of March Madness drama, on March 21, 2011, a three judge panel of the U.S. Court of Appeals for the D.C. Circuit handed down a decision that is broadly perceived as a significant victory for banks at the expense of merchants. (The decision is captioned NACS f/k/a National Association of Convenience Stores, et al. v. Board of Governors of the Federal Reserve System.)
The issue was the legality of the Federal Reserve’s rules implementing the “Durbin Amendment” portion of Dodd-Frank. That portion of the legislation is generally viewed as having required regulatory caps on the interchange fees that can be charged to merchants. Merchants criticized the Federal Reserve’s rules for allowing interchange fees at a level much higher than allowed by Dodd-Frank and for allowing interchange competition rules less strict (and thus more favorable to banks) than permitted under Dodd-Frank. The merchants essentially won this argument at the lower court, the U.S. District Court for the District of Columbia. The Court of Appeals reversed the district court on all key issues. The merchants can still appeal the decision to the entire D.C. Circuit appeals court, or to the U.S. Supreme Court. However, based on our review of this decision, such an appeal appears to have a limited chance of success. And it seems highly unlikely that either party in Congress is willing to legislate any further on interchange fee issues.
To understand the scope and effect of the decision, a brief review is in order. The Dodd-Frank Financial Reform Act passed in 2010 included a provision now widely known as the Durbin Amendment, due to its authorship by Illinois Sen. Richard Durbin. It is widely believed that Senator Durbin authored the provision at the request of the merchant Walgreens, one of his important constituents. One portion of the Durbin Amendment applies to banks and credit unions with over $10 billion in assets. For those institutions, the Federal Reserve was required to promulgate regulations to cap interchange or “swipe” fees on debit-card transactions at a level “reasonable and proportional” to the cost the financial institution actually incurs. Another part of the Durbin Amendment required the Federal Reserve to promulgate regulations to ensure that merchants had at least two unaffiliated networks through which debit card transactions could be routed.
In response to the Durbin Amendment, the Federal Reserve initially proposed capping interchange fees at about $0.12 per transaction. Then, after considerable study, analysis and uproar from the banking industry that argued with some force that a $0.12 rate would force them to operate at a loss, the Fed’s final regulation capped interchange fees at approximately $0.24 per debit transaction. The Fed also provided in its final regulations that debit cards may use one PIN debit network and one signature debit network, as long as the two networks were not affiliated.
FDIC Atlanta Regional Director Tom Dujenski announced this week that he will retire from the FDIC effective May 3, 2014. Tom has held the Atlanta post since 2010 and wraps up a 30-year career with the FDIC. We wish Tom all the best.
FDIC Atlanta Deputy Regional Director Michael Dean has been announced as acting Regional Director, and is the leading candidate to be named as the permanent Regional Director. Mike has served most recently as the Deputy Regional Director for Compliance & CRA Examinations and Enforcement, where we have gotten to know him well. Through out interactions, we have found him to be a solid, experienced banking regulator. He is approachable and candid, and open to listen to problems and even help in fixing those problems in some cases. With his previous service in DC, he is also well positioned to assist the Atlanta region work with the national FDIC office. We look forward to continuing to work with Mike in his new role.
Out of the original investment of $204.9 billion in 707 institutions under the TARP CPP program, the U.S. Treasury currently only holds its original investment in 67 financial institutions representing a total outstanding investment of $641 million. In other words, the Treasury still holds its investment in about 10% of the financial institutions invested in through the CPP program, but those institutions represent less than 0.4% of the amount invested. As the U.S. has already collected $225.0 billion in total TARP CPP proceeds, the ultimate disposition of the remaining 67 financial institutions will have no material impact on the $20 billion gain recognized by the U.S. Treasury through the TARP CPP program.
The 67 remaining TARP CPP investments range from $470 thousand to just over $50 million, with an average original investment of $9.6 million. 53 of the 67 remaining institutions have missed dividend/interest payments, with a total of $106 million in missed dividend payments (which includes $20 million in missed non-cumulative dividends in which the institutions have no obligation to repay).
In addition to the 67 institutions where Treasury continues to hold the original CPP investment, the Treasury also holds common stock in four institutions in which Treasury originally invested approximately $386 million and trust preferred securities in one institution in which the Treasury originally invested $935 million. The average remaining institution received $9.6 million in TARP CPP funds, has missed 10 quarterly dividend payments, and currently owes an additional $1.6 million in missed dividend payments.
A loan negotiation generally follows the lines of each party setting out its “want” list and then using whatever leverage it brings to the table to accomplish its goals. The lender typical wants to get paid back in a reasonable time frame and at a market rate while possibly generating other business income from things such as selling cash management services while the borrower wants to obtain favorable repayment terms that leave it with as much discretion to run their business as possible. The size of the loan, documentation costs, regulatory pressures and possible past dealings are all issues that affect the negotiation.
Sometimes the lender’s “want list” includes things such as the borrower providing guarantees or additional collateral or even retaining a consultant to advise the borrower on developing a better business plan. In preparing its request for such items, lenders must work within the strictures set out in the anti-tying provisions of the Bank Holding Company Act. The Act, with some exceptions, generally prohibits a lender from conditioning an extension of credit other services on the requirement that the borrower purchase some other credit, property or services from the lender. (See generally, Blanchard, Lender Liability: Law., Practice and Prevention, Chapter 16, Anti-Tying Provisions.)
The typical loan covenants that lenders ask for such as financial reporting and financial ratios do not violate the anti-tying provisions. The requirements are fairly traditional and both generally understood by both the lender and borrower. Lenders get into trouble, however, when they begin asking for things from a borrower that don’t seem to have anything to do with maintaining the soundness of the borrower’s loan.
A recent example of this is found in the case of Halifax Center, LLC, et al. v. PBI Bank, a decision from the Western District of Kentucky. In this case an investor named David Chandler wanted to purchase a note and mortgage from HUD involving a 165 unit apartment complex in Chicago. The total purchase price was $9,145,020.06. The investor sought financing for $6 million of the purchase price from PBI Bank. In his lawsuit against PBI the investor alleged that PBI indicated that they were willing to extend the requested loan but only on the condition that he purchase some unrelated property located in Owensboro, Kentucky on which the Bank currently held a mortgage (the “Halifax Property”). The underlying loan was in default. The investor did not know the owner of the property and knew nothing about the property but agreed to purchase the property in order to obtain the sought after financing.