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.
With attorneys and staff worldwide, Bryan Cave attorneys are often quoted in the news. Recent mentions of Financial Institutions group attorneys include:
BankBryanCave.com in Banking and Finance Law Daily
Three recent blog posts from BankBryanCave.com were prominently featured Feb. 13 in Banking and Finance Law Daily. The publication’s “Blog Tracker” column, which highlights the week’s “most insightful, intriguing or entertaining blog posts from the banking and financial services community,” included our recent posts “Will 2014 be the year of UDAP and UDAAP?” by DC Partner John ReVeal and Associate Seyi Iwarere; “Should your bank do business with Bitcoin?” by DC Associate Courtney Stolz; and “Five practical tips to manage your vendor risk…,” by Atlanta Associate Karen Neely Louis. Click the post titles to read more.
Klingler in American Banker
Atlanta Partner Rob Klingler was quoted Jan. 28 by American Banker concerning Broadway Financial, which has struggled in recent years but managed to restructure its debt and recapitalize by bringing together the federal government, private equity, nonprofits and local banks. Today, the U.S. Treasury owns 52 percent of Broadway, or about $8.8 million in common stock. Broadway is one of five companies with common stock held by the Treasury as a result of a Tarp exchange, and is the only one majority owned by the government. Klingler said the Treasury typically moves quickly to cash out of such holdings. He said the stake is unlikely to scare off investors (the Treasury has vowed to be hands-off and vote along with the majority) but the government could have trouble finding investors to buy such a large block of shares.
Shumaker in Bank Safety & Soundness Advisor
Atlanta Associate Michael Shumaker was quoted at length in two front-page articles Feb. 17 in Bank Safety & Soundness Advisor concerning third-party vendor risk. Regulators are pushing for higher third-party due diligence standards, particularly the Office of the Comptroller of the Currency (OCC), which now requires banks to manage what it calls the full “life cycle” of a vendor relationship. “The regulators’ expectations are on a sliding scale,” Shumaker said. “The level and depth of risk management and vendor management for a $50 billion bank is not going to be expected necessarily for a $100 million bank.” A small community bank, he explained, may only have one or two material contracts that it needs to be on top of, such as for data processing and a credit or prepaid card program. Still, he said, having a “rational and structured” approach for entering those contracts not only keeps regulators happy but makes business sense.
While the issue of vendor oversight and management is not new to the financial services industry, recent enforcement actions by the Office of the Comptroller of the Currency (OCC) and the Consumer Financial Protection Bureau (CFPB) manifest heightened attention by federal regulators. A bank’s board of directors is required to remain vigilant to the hazards posed by outsourcing functions to third parties, or else risk significant financial and reputational harm to its institution.
Federal regulators traditionally have looked with an understanding, yet skeptical, eye towards the issue of outsourcing. Current guidance is clear, however, as to where the responsibility lies. As summarized by the Federal Deposit Insurance Corp. (FDIC) in FIL-44-2008, “An institution’s board of directors and senior management are ultimately responsible managing activities conducted through third-party relationships, and identifying and controlling the risks arising from such relationships, to the same extent as if the activity were handled within the institution.”
Meet the New Boss
Armed with its mandate by Title X of the Dodd-Frank Act to protect consumers, the CFPB entered the vendor management fray by issuing Bulletin 2012-03. Although the message contained in the bulletin was nearly identical to previously issued guidance by the OCC and FDIC, it did provide additional insight. First, the bulletin noted that Title X of Dodd-Frank provides a definition of a “service provider,” which includes “any person that provides a material service to a covered person in connection with the offering or provision by such covered person of a consumer financial product or service.” (Although the legislation did not specifically define the word material, bankers should assume such subjectivity will be interpreted broadly by federal regulators.) Secondly, and more importantly, the bulletin provided banks a non-exhaustive list of “steps to ensure that their business arrangements with service providers do not present unwarranted risks to consumers,” which include:
- Conducting thorough due diligence to verify that the service provider understands and is capable of complying with federal consumer financial law;
- Requesting and reviewing the service provider’s policies, procedures, internal controls, and training materials to ensure that the service provider conducts appropriate training and oversight of employees or agents that have consumer contact or compliance responsibilities;
- Including in the contract with the service provider clear expectations about compliance, as well as appropriate and enforceable consequences for violating any compliance-related responsibilities, including engaging in unfair, deceptive, or abusive act or practices;
- Establishing internal controls and on-going monitoring to determine whether the service provider is complying with federal consumer financial law; and
- Taking prompt action to address fully any problems identified through the monitoring process, including terminating the relationship where appropriate.
(Not the) Same as the Old Boss
While the message from the federal regulators has not varied over the years, recent actions by the various agencies indicate they are more likely to use enforcement as a means of guaranteeing compliance with their vendor management mandates. A detailed discussion of the cases listed below is beyond the scope of this article, but to a large degree each case focused on deceptive sales practices by third-party vendors while marketing a bank product:
- CFPB – Discover Bank, $14 million civil penalty (September 2012)
- OCC — American Express Bank, estimated $6 million in restitution (September 2012)
- CFPB — J.P. Morgan Chase, $309 million in restitution and $20 million civil penalty (September 2013)
- CFPB – American Express, $59.5 million in restitution and $9.6 million civil penalty (December 2013)
Although neither the FDIC, OCC nor the CFPB provides community banks with an explicit exemption from the vendor management mandates, each set of rules does include a statement similar in content to that expressed in FIL-44-2008: “The precise use of a risk management process is dependent upon the nature of the third-party relationship, the scope and magnitude of the activity, and the risk identified.” For community banks that offer only traditional banking services, senior management and the board should use a common sense level of due diligence before, during and after a third-party relationship is commenced.
We Won’t Be Fooled Again
Bank management and boards of directors should not allow recent enforcement actions to deter their use of third-party vendors to provide critical functions. The economics supporting such outsourcing decisions certainly outweigh the risks posed by potential regulatory enforcement action. However, regulators have given notice that a failure to implement and follow vendor management protocols will no longer be tolerated, and boards and management bear ultimate responsibility for any harm caused by a vendor’s failure to adhere to federal consumer financial law.
This article was originally published on BankDirector.com.
Expect 2014 to be a banner year for enforcement actions under the Unfair or Deceptive Acts or Practices law (UDAP) and the new Unfair, Deceptive or Abusive Acts and Practices law (UDAAP). While predicting regulatory trends can be difficult, we believe this to be a safe bet in light of the trends in 2013 and early indications in bank examinations already this year.
Below are some of the enforcement trends from last year and tips highlighting what can be done to reduce the risks of UDAP and UDAAP enforcement actions in 2014.
In 2013, the FDIC imposed civil money penalties against banks in 89 instances, 16 of which were for UDAP violations and many of those also required consumer restitution. The only compliance area triggering more civil money penalties in 2013 was the Flood Disaster Protection Act, accounting for 27 of the 89 cases, which is roughly consistent with the percentages in that area since Katrina.
If you hear the word “Bitcoin” and roll your eyes, a glimpse into the Bitcoin economy may inspire a new respect. In Spring 2013, the Bitcoin economy topped the $1 billion mark for a time, which is more than the economy of some small countries. This is not a pyramid scheme — this is potentially a whole new way of making payments.
What is Bitcoin?
If you are not a technology guru, Bitcoin can be a difficult concept to wrap your arms around. Bitcoin is a crypto-currency designed to create a new kind of money. Bitcoin uses cryptography, or a combination of mathematical theory and computer science, to control bitcoin transactions rather than centralized authorities. Bitcoin can be traded within the Bitcoin network, or used to purchase items through online bitcoin retailers, small businesses, and even to purchase drinks in bars.
The decentralized nature of the Bitcoin network makes it difficult to regulate and control. There is no single government or organization controlling the Bitcoin network; rather it is an open source project that is governed by consensus of its users. Bitcoin users value the privacy, security and freedom created by the decentralized network, and there is a strong interest in a currency that is not tied to one particular government. Developed in 2012, the Bitcoin Foundation, based in Seattle, works to promote the currency, improve standardization and security, and advance the core principles of “non-political economy, openness and independence.” Regulators are not standing on the sidelines and the regulatory field changes almost daily. Courts are finding Bitcoin is a “currency.” State and federal regulators are determining that virtual currencies are subject to money transmitter requirements. In March, FinCEN issued guidance indicating certain virtual currencies and exchanges need to comply with money services business requirements. In recent weeks, New York and California, among other states, took steps to pull certain Bitcoin companies within the requirements of the state money transmitter licensing laws.
… and not micromanage your vendors!
A cursory review of the Risk Management Guidance issued by the Office of the Comptroller of the Currency (OCC), and similar guidance from the Federal Reserve, may impart the notion that a financial institution is obligated to essentially run its vendor’s business as well as its own, meticulously examining every policy and procedure for each of its vendors and testing operational compliance issues. (See OCC Bulletin 2013-29 Third-Party Relationships (October 30, 2013))
Despite the initial impression, a financial institution can implement a vendor management and monitoring program that is both prudent and practical. Focusing on both the spirit and detail of the regulatory guidance can be essential. Institutions have an overarching obligation to manage their risk and ensure that vendors are conducting business in a way which is “safe and sound and in compliance with all applicable laws.” The level of risk and complexity of the vendor activity are key factors to consider.
Prior to Dodd-Frank, Section 701(e) of the Equal Credit Opportunity Act provided that a loan applicant had the right to request copies of any appraisals used in connection with his or her application for mortgage credit. Section 1474 of Dodd-Frank amended Section 701(e) to require that lenders affirmatively provide copies of appraisals and valuations to loan applicants at no additional cost and without requiring applicants to affirmatively request such copies.
The appraisal documentation must be provided to the loan applicant in a timely manner and no later than three days prior to the loan closing unless the applicant waives the timing requirement. The lender must provide a copy of each written appraisal or valuation at no additional cost to the applicant, though the creditor may impose a reasonable fee on the applicant to reimburse the creditor for the cost of the appraisal.
In September of 2013 the Consumer Financial Protection Bureau adopted final regulations amending Regulation B to implement the statutory changes. The amendments to Regulation B went into effect on January 18, 2014. Among other things, the revised Regulation requires lenders to provide a notice to a loan applicant not later than the third business day after the creditor receives an application for credit that is to be secured by a first lien on a dwelling, a notice in writing of the applicant’s right to receive a copy of all written appraisals developed in connection with the application.
Commercial and consumer loans commonly accrue interest at a rate calculated in reference to LIBOR, the London Interbank Offered Rate. LIBOR was designed to be the average interest rate that leading banks in London, England would charge other banks. The British Bankers Association (BBA) administered LIBOR and many loan documents refer to BBA LIBOR. Effective February 1, 2014, the BBA no longer administers LIBOR. The Intercontinental Exchange Benchmark Administration Ltd (ICE) now has responsibility for LIBOR. The handover is part of the fallout from the recent scandal caused by banks trying to manipulate LIBOR.
Going forward any references to BBA LIBOR in your loan document templates should be updated. There is no need to refer to the entity administering LIBOR. A general reference to the London Interbank Offered Rate should suffice. Even better, many loan documents refer to LIBOR as reported by Reuters because that is where the lender is actually obtaining the rate. Loan documents should also contain provisions to accommodate future, unexpected changes in LIBOR or the Reuters reporting service.
With attorneys and staff worldwide, Bryan Cave attorneys are often quoted in the news. Recent mentions of Financial Institutions group attorneys include:
Rob Klingler in Bank Safety and Soundness Advisor
Atlanta Partner Robert Klingler was quoted Jan. 27 by Bank Safety and Soundness Advisor concerning an eagerly awaited amendment to the Volcker Rule, which will exempt most bank-issued Trust Preferred Securities (or TruPS). The interim final rule, however, does not exempt insurer or REIT-backed TruPS. Klingler said the exemption does not include insurer and REIT TruPS because the Collins Amendment didn’t either, and regulators modeled the Volcker exemption after the Collins Amendment. “They were looking to the Dodd-Frank Act itself for the statutory authority,” he said. “They used the Collins Amendment to form the basis for why they’re able to exempt [these TruPS]. They don’t have a statutory basis for excluding insurer-backed TruPS. They probably wanted to make sure the final rule wasn’t going to be challenged. The way to do that was to lock in the $15 billion bank asset threshold.”
Judith Rinearson in Multiple Outlets
New York Partner Judith Rinearson was quoted a number of times recently in connection with hearings in New York on the future of virtual currency, including the popular Bitcoin. She was quoted Jan. 28 by The Verge, Inc. magazine and IDG News Services (in an article that ran in IT World and CFO World) and Jan. 27 by Upstart Business Journal. Rinearson acted as an expert witness at the hearings, which could lead to the creation of “BitLicenses” to allow the introduction of Bitcoin ATMs and other Bitcoin-related startups in New York. “New York has always been one of the lead states when it comes to money transmitter licenses,” said Rinearson, who is also regulatory counsel for the Network Branded Prepaid Card Association and serves as chair for the association’s Government Relations Working Group. “But I think a lot of other states are going to be watching and a lot of states will be waiting to see what happens.” Click here to read the full Upstart Business Journal article.
Dan Wheeler in Financial Services Publications
San Francisco Partner Daniel Wheeler authored an article for the January edition of Western Independent Bankers’ Lending & Credit Digest on common regulatory errors in making a commercial loan. Lenders often ignore or misunderstand several regulations and other laws that affect the origination of a commercial loan. Wheeler’s article discussed some surprising aspects of bank regulations and laws that can catch a commercial lender by surprise and result in a compliance violation. Click here to read the Lending & Credit Digest article. Dan authored an article for the January edition of Western Independent Bankers’ Directors Digest regarding current opportunities and regulatory issues related to common non-interest income opportunities, including overdraft protection. Click here to read the Directors Digest article. Dan also authored a lengthy article for the December edition of Banking & Financial Services Policy Report on basic interest rate swaps, which he said remain a viable and necessary tool for small community banks. “Despite Congress’ and the regulators’ enactment of thousands of pages of burdensome and frequently counterproductive swap regulation, community banks still have compelling reasons to offer swap capability to their customers,” he wrote. “Community bank management need not become experts in swap accounting or regulation; they merely need to understand the risks and strategy involved in the swaps they offer.”
The SEC announced on January 13, 2014 that compliance with the final municipal advisor registration rules will be phased in beginning July 1, 2014, notwithstanding that the final rules are effective on January 13, 2014 (following their September 30, 2013 adoption date). Municipal advisors currently registered under the temporary regime (there are currently about 1,100) are required to register under the permanent regime on a phased-in basis. As set forth in the table below, a municipal advisor’s temporary registration number determines the applicable compliance period during which the municipal advisor is required to register as such on the final registration forms under the final rules.
Temporary Registration Number Range –>Period for Filing Complete Application for Registration
- 866-00001-00 through 866-00400-00 –> July 1, 2014 to July 31, 2014
- 866-00401-00 through 866-00800-00 –> August 1, 2014 to August 31, 2014
- 866-00801-00 through 866-01200-00 –>September 1, 2014 to September 30, 2014
- after 866-01200-00 –> October 1, 2014 to October 31, 2014
If a person provides regulated “advice” after January 13, 2014, fits the definition of a municipal advisor, does not qualify for an exemption or exclusion and has not previously registered, then that person must register under the temporary registration rule and then register under the final rules under the above phase-in schedule. If a person enters the municipal advisory business after October 1, 2014, then the advisor must apply and register under the permanent registration regime. In any case, an advisor must register before engaging in municipal advisory activities.