Right now, the federal banking agencies (not including the CFPB) are engaging in a legally-required review process to examine what regulations are outdated, outmoded or unduly burdensome. Accordingly, the time is especially right for community banks to voice their concerns about their regulatory environment. Because of their lingering political unpopularity, many banks believe they have little or no leverage to seek reform of counterproductive regulations and improper regulatory enforcement tactics. But, by speaking with a consistent and united voice and by dealing with facts (in stark contrast to partisan attacks on banks), community banks can achieve real reform.
Here are suggestions for areas in which we can focus our reform efforts, beginning with the most urgent.
1. Seek genuine “right-sized” bank regulation. Community banks’ efficiency ratios severely lag those of large banks because the cost of regulation disproportionately burdens community banks. There is no serious dispute about this by scholars and industry insiders. Despite many carveouts in Dodd-Frank for sub-$10 billion banks, there still is not a genuine tiering or “right-sizing” of regulation. Without it, we will see the continued and inevitable disappearance of community banks (over 1,300 so far since 2010) without de novos to replace them. We will continue to see declines in assets held by community banks (at least 12% decline since Dodd-Frank’s enactment). There are several workable solutions, including the proposal from former FDIC Chairman Sheila Bair to simply give regulators discretion to exempt community banks from unsuitable regulations. And, many regulators and industry advocates favor defining community bank in terms of its complexity instead of size, which is an eminently sensible proposal. No one on any point of the political spectrum truly prefers a world dominated by a handful of extremely large banks. This issue is an urgent matter of survival for the entire community bank industry.
2. Preserve leadership of prudential banking regulators. The leading example of abdication by prudential regulators to politically-motivated enforcement is the notorious Operation Choke Point led by the Department of Justice. That Department has no institutional expertise in banking and makes no pretense of being a prudential regulator, particularly compared to the FDIC, which has decades of cradle-to-grave experience with banks and thoroughly understands the business and regulatory environment in which banks operate. Even the FDIC appears to have belatedly realized that it was a mistake to concede leadership to the Department of Justice when deciding what sorts of legal bank customers should be denied banking relationships. It is entirely appropriate for the banking industry to forcefully express its collective expectation that its prudential regulators must always exert leadership over banking. This leadership role is best documented by clear, written and published guidance that the prudential banking regulators direct at themselves. Not only must the banking regulators definitively end Operation Choke Point, banks and their regulators must ensure that they do not abdicate leadership in the future on other banking issues. Critically important to that goal is ensuring that prudential supervision and compliance enforcement remain at the same agency. Separating these functions, as is being urged by some, would hardwire the philosophy behind Operation Choke Point into our financial regulatory structure. Enforcement without the deep understanding acquired over decades by the prudential regulators will lead to banks and their customers being battered by enforcement crusades motivated by political considerations rather than careful analysis. Bankers and their regulators should unite against any effort to split these functions into separate agencies. Enforcement unhinged from supervision will dramatically raise compliance and litigation costs for community banks, something a challenged industry cannot afford.
In two recent posts on BryanCavePayments.com, Bryan Cave attorneys have addressed new developments related to the CFPB’s efforts to regulate payday lenders through their banking relationships as well as statements from New York’s top banking regulators suggesting that bank executives should be held personally liable for anti-money laundering violations.
On April 1st (but unfortunately not part of any April Fools joke), John Reveal published a post on the CFPB’s efforts against payday lenders.
In May 2014, the Department of Justice (DOJ) and the FDIC were criticized by the U.S. House of Representatives’ Committee on Oversight and Government Reform in May 2014 Report for using the DOJ’s “Operation Choke Point” to force banks out of providing services to payday lenders and other “lawful and legitimate merchants”. The Committee’s report noted, among other things, that the DOJ was inappropriately demanding, without legal authority, that “bankers act as the moral arbiters and policemen of the commercial world”.
Now the CFPB has announced that it is considering rules that would end “payday debt traps”. At least the CFPB is following standard regulatory processes in doing so rather than trying to regulate payday lenders by punishing their bankers. The CFPB’s announcement, published March 26, 2015 (available here), outlines its proposals in preparation for convening a Small Business Review Panel to gather feedback from small lenders, which the CFPB refers to as “the next step in the rulemaking process”.
The CFPB’s proposal considers payday loans, deposit advance products, vehicle title loans, and certain other loans, and includes separate proposals for loans with maturities of 45 days or less, and for longer-term loans. Broadly speaking, the CFPB is considering two different approaches – prevention and protection – that lenders could choose from.
You can read the rest of John’s post here.
As year-end results are finalized, many financial institutions are now budgeting for the coming year. With many banks struggling to find new revenue sources, these conversations are often focused on operational matters, including diversifying into new loan products and electronic payment applications designed to attract and retain new and existing customers. And while some boards of directors have a productive conversation regarding new products, these detail-rich discussions can result in the board overlooking the impact of the new product line on the bank’s strategic direction.
Directors, as part of their duty to maximize shareholder value, are responsible for charting the strategic course of the bank. Too strong of a focus on operational matters may have the effect of muddling the important distinction between the roles of directors and officers going forward, leaving management feeling micro-managed and directors overwhelmed by reports and data in their “second” job. Instead, a higher-level discussion may be necessary in order to ensure that the board is focused on overseeing the institution’s strategic plan, while management is charged with safely and profitably executing the new business line.
As previously mentioned, the federal banking regulators have been working on a FAQ on the topic. The interagency FAQ was published on April 6, 2015. While there were no surprises in what was published there were a number of takeaways from the FAQ that lenders need to keep in mind and I have added those to my previous list of FAQ. Under Basel III, as a general rule, a lender applies a 100% risk weighting to all corporate exposures, including bonds and loans. There are various exceptions to that rule, one of which involves what is referred to as “High Volatility Commercial Real Estate” (“HVCRE”) loans. Simply put, acquisition, development and construction loans are viewed as a more risky subset of commercial real estate loans and are assigned a risk weighting of 150%.
HVCRE is defined to include credit facility that, prior to conversion to permanent financing, finances or has financed the acquisition, development, or construction (ADC) of real property, unless the facility finances:
- One- to four-family residential properties;
- Real property that would qualify as a community development investment;
- agricultural land; or
- Commercial real estate projects in which:
- The loan-to-value ratio is less than or equal to the applicable regulator’s maximum amount (i.e., 80% for many commercial bank transactions);
- The borrower has contributed capital to the project in the form of cash or unencumbered readily marketable assets (or has paid development expenses out-of-pocket) of at least 15 percent of the real estate’s appraised ‘‘as completed’’ value; and
- The borrower contributed the amount of capital before the lender advances funds under the credit facility, and the capital contributed by the borrower, or internally generated by the project, is contractually required to remain in the project throughout the life of the project.
A FINRA Hearing Panel issued a decision on March 9, 2015 that will have a potential significant impact on any broker-dealer that allows its registered representatives to have their own investment adviser. In light of this decision, broker-dealers should assess and evaluate the adequacy of their supervisory systems and procedures relating to supervision of a representative’s outside advisory activities.
In DOE v. Fox Financial Management Corporation (“Fox Financial”), Brian Murphy and James Rooney, the FINRA Hearing Panel found that the firm, its President, and its Chief Compliance Officer failed to adequately supervise a representative (Representative James Rooney, hereafter “JER”). Specifically, the Respondents failed to adequately supervise JER with respect to his independent registered investment adviser (RIA). Instead of treating JER’s RIA business as a private securities transaction, the Respondents instead treated JER’s RIA business as an outside business activity. The Panel imposed principal bars on the supervisors, along with an expulsion of the firm.
In these NTM’s, FINRA indicated that firms were specifically required to assess whether the advisory activities of a representative constituted private securities transactions that were required to be supervised as such and recorded on a firm’s books and records. FINRA has also issued a series of Interpretive Letters since the NTM’s were released, reiterating that firms were required to assess whether outside RIA activities needed to be treated as private securities transactions.
With respect to the specific facts of the case, the Panel found JER joined Fox Financial in May 2008, and was with the firm until October 2012. Immediately after joining Fox Financial, the firm had JER complete the firm’s “Outside Activity Approval” form. Beyond that, however, the firm did not take any steps to supervise JER’s RIA business. Specifically, the Panel found Respondents’ supervision deficient in the following respects:
- The firm did not review any customer suitability information for investors;
- The firm failed to obtain duplicate account information, confirmations and statements from the executing broker-dealer;
- The Respondents did not take any action to ensure that JER’s actions complied with regulatory requirements; and
- The firm failed to record the RIA’s transactions on the firm’s books and records.
Jim McAlpin and Walt Moeling recently sat down with the American Bankers Association to address bank board practices, which formed the basis for an article in the ABA’s Directors and Trustees Digest for March 2015.
Some of the best practice recommendations were:
- fostering a meaningful agenda;
- making the committees work is the foundation of the board’s oversight role;
- use directors in the examination process; and
- make use of special-purpose board meetings.
The complete article is available here.
Upon reaching a letter of intent to acquire or sell a financial institution, many bank directors will breathe a sigh of relief. Following the economic challenges of the past several years, the directors of each institution have charted a course for their banks that will likely result in their respective shareholders realizing the benefits of a strategic combination. Although directors should be focused on “big picture” issues during the negotiation of a definitive agreement, they should not overlook the resolution of the many issues that can arise from executive compensation arrangements in a potential transaction. While often seemingly minor, compensation matters can raise unexpected issues that can delay or de-rail a transaction.
In addition to considering the economic features of a proposed merger, directors should also consider their individual interests in the transaction, including the potential payout of supplemental retirement plans, deferred fee arrangements, stock options, and organizer warrants that are not available to the “rank and file” of the company’s shareholder base. These arrangements may pose conflicts of interest for members of the board and are subject to different types of disclosure:
Disclosure of potential conflicts: Early in the negotiation of a potential sale, individual directors should identify deal features that may create the appearance of a conflict of interest or an actual conflict of interest. With help from legal counsel, these personal interests should be disclosed and documented in the board resolutions approving the transaction. Appropriate disclosure and documentation of these actual or potential conflicts usually resolves these issues, but if significant conflicts exist, counsel may advise the use of a special committee or special voting thresholds for the transaction. (more…)
You might have seen it this March in the New York Times: an article about American troops having their vehicles repossessed by auto lenders while on active duty, and the troops being unable to fight repossession in court because of mandatory arbitration clauses in their lending contracts.
The poignant story on vets and car repossession is just one piece in the ongoing discussion about what actions the CFPB will take regarding provisions in consumer contracts limiting the consumer to arbitration in the event of a future dispute, referred to as “pre-dispute arbitration clauses.” Under Section 1028 of Dodd-Frank, the CFPB was required to conduct a study on use of arbitration clauses in connection with offering consumer financial products and services. If, through study, the CFPB finds that prohibiting or limiting the clauses in agreements between market participants it regulates and consumers “is in the public interest and for the protection of consumers,” it can impose regulations to that effect. Further, Section 1414 of Dodd-Frank already prohibits pre-dispute arbitration clauses in mortgage contracts.
With the CFPB recently releasing its final, 728-page arbitration study finding that arbitration agreements “limit relief for consumers,” indications are that the CFPB will conduct some rulemaking to curtail, or at least significantly limit, them in the consumer financial product market, and likely over industry objections. The study, which began in April 2012 and was followed by a preliminary report released in December 2013 before the final report was published, involved analysis of data from consumer contracts and the courts regarding the resolution of consumer disputes.
Author’s Note: On April 9, 2015, the Federal Reserve adopted a final rule to implement the changes discussed below. The final rule will be effective 30 days after publication in the Federal Register.
For many years, bankers have asked the question, “What size is the right size at which to sell a small community bank?” Some offer concrete asset size thresholds, while others offer more qualitative standards. We have always believed the best answer is “whatever size allows an acquirer’s profits and capital costs to deliver a better return than yours can.” While that answer is typically greeted with a scratch of the head, a recent change in law impacts the answer to that question for smaller companies. Given a proposed regulatory change by the Federal Reserve, a growing number of small bank holding companies will soon have lower cost of capital funding options that are not available to larger organizations.
President Obama recently signed into law an act meant to enhance “the ability of community financial institutions to foster economic growth and serve their communities, boost small businesses, and increase individual savings.” The new law directs the Board of Governors of the Federal Reserve System to amend its Small Bank Holding Company Policy Statement by increasing the policy’s consolidated assets threshold from $500 million to $1 billion and to include savings and loan holding companies of the same size. By design, more community banks will qualify for the advantages of being deemed a small bank holding company.
The Federal Reserve created the “small bank holding company” designation in 1980 when it published its Policy Statement for Assessing Financial Factors in the Formation of Small One-Bank Holding Companies Pursuant to the Bank Holding Company Act. The policy statement acknowledged the difficulty of transferring ownership in a small bank, and also acknowledged that the Federal Reserve historically had allowed certain institutions to form “small one-bank holding companies” with debt levels higher than otherwise would be permitted for larger or multibank holding companies. The first version of the policy statement had a number of criteria for what constituted a small bank holding company, most importantly that the holding company’s subsidiary bank have “total assets of approximately $150 million or less.” The asset threshold has been revised on several occasions, most recently in 2006 to the current level of $500 million in consolidated assets.
Can Inclusion Of A Boilerplate Duty Of Loyalty Provision
Invalidate Your Covenant Not To Compete?
The Early v. MiMedx Decision
On February 10, 2015, the Georgia Court of Appeals held in Early v. MiMedx Grp, Inc., that a provision in a consulting agreement requiring an employee to devote her full working time to the performance of her duties for the employer was not a loyalty clause but, instead, constituted an illegal restraint on trade. In and of itself, the decision in Early is interesting and will undoubtedly affect how employers draft their duty of loyalty provisions. Perhaps a less obvious consequence of this decision, however, is that by reading a loyalty clause as a restrictive covenant, the Court has now placed employers in jeopardy of having their
otherwise valid, and properly tailored, restrictive covenants invalidated if they are contained in an agreement signed prior to May 11, 2011.
Sometime in January 2011, MiMedx Group, Inc. (“MiMedx”), a developer and manufacturer of patent protected bio-material based production, began discussing a potential business relationship with Ms.
Ryanne Early. As part of these discussions the parties entered into a Mutual Confidentiality and Nondisclosure Agreement (the “Nondisclosure Agreement”) which “prohibit[ed] Early from disclosing trade secrets and confidential information, which might be revealed to her during negotiations with MiMedx.” Shortly thereafter MiMidex and Ms. Early entered into a Consulting Agreement, whereby Ms. Early’s company ISE Professional Testing and Consulting Services (“ISE”) agreed to provide certain consulting services to MiMidex (the “Consulting Agreement”).
As part of the Consulting Agreement, Ms. Early was required to “devote her full working time (not less than forty (40) hours per week) to [the] performance of Consultant’s duties . . .” (the “full working time provision”). The Consulting Agreement was subsequently terminated and MiMidex filed a complaint against Ms. Early and her company seeking damages and specific performance under the Consulting Agreement and the Nondisclosure Agreement. Ms. Early filed a motion for judgment on the pleadings “contending . . . among other things that the full-time working provision of the Consulting Agreement was void and unenforceable as either a general or partial restraint of trade.” The primary issue considered on appeal involved the enforceability of the full-working-time provision.
In assessing the issue, the Georgia Court of Appeals determined that the full-time-working provision required that “Early would devote any working time to MiMedx’s business, whether or not that working time was related in any way to the type of enterprise in which MiMedx is engaged.” In fact, the parties agreed that Early would be prohibited from even doing jobs such as babysitting on the weekends or working at a bookstore. Looking to its earlier decision in Atlanta Bread Co. Intl., Inc. v. Lupton–Smith, the Court held that a provision that requires an employee to spend all her working time on the employer’s business, regardless of the type of job, is a “partial restraint of trade designed to lessen competition. ” Accordingly, the Georgia Court of Appeals deemed the full-working-time provision “a restraint of trade, rather than a loyalty provision.” The Court went on to find the provision unenforceable as it was not limited in time, territory or scope.