Tuesday, May 26, 2015
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In a recent press release, the CFPB announced a public inquiry into student loan servicing.  The CFPB is seeking information about: “industry practices that create repayment challenges, hurdles for distressed borrowers and economic incentives that may affect the quality of service.”  According to the CFPB, student loans account for the nation’s second largest consumer debt market.  The agency states there are more than 40 million federal and private student loan borrowers and those consumers owe more than $1.2 trillion.  About $240 billion in such loans are either in default or forebearance.

The CFPB is acting because of numerous borrower complaints about their loan servicers.  Complaints include billing problems associated with payment posting, prepayments and partial payments.  Borrowers have stated that payments have been processed in ways that make their borrowing more expensive.  Servicers are also accused of losing records and slow response times to fix errors.  The CFPB thinks student loan servicers fail to provide adequate customer service because they are typically paid a flat fee for each loan so they have no incentive to maintain high standards of serving.

Unlike credit card and mortgage servicers, no comprehensive system for overseeing the student loan servicing industry currently exists, according to the CFPB.  Given the CFPB’s penchant for promulgating more and more regulations, we believe this heightened scrutiny by the CFPB will lead to numerous new regulations affecting the student loan servicing industry.

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Thursday, May 7, 2015

FDIC bank examinations generally include a focus on the information technology (“IT”) systems of banks with a particular focus on information security. The federal banking agencies issued implementing Interagency Guidelines Establishing Information Security Standards (Interagency Guidelines) in 2001. In 2005, the FDIC developed the Information Technology—Risk Management Program (IT-RMP), based largely on the Interagency Guidelines, as a risk-based approach for conducting IT examinations at FDIC-supervised banks. The FDIC also uses work programs developed by the Federal Financial Institutions Examination Council (FFIEC) to conduct IT examinations of third party service providers (“TSPs”).

The FDIC Office of the Inspector General recently issued a report evaluating the FDIC’s capabilities regarding its approach to evaluating bank risk to cyberattacks. The FDIC’s supervisory approach to cyberattack risks involves conducting IT examinations at FDIC-supervised banks and their TSPs; staffing IT examinations with sufficient, technically qualified staff; sharing information about incidents and cyber risks with regulators and authorities; and providing guidance to institutions. The OIG report determined that the FDIC examination work focuses on security controls at a broad program level that, if operating effectively, help institutions protect against and respond to cyberattacks. The program-level controls include risk assessment, information security, audit, business continuity, and vendor management. The OIG noted, however, that the work programs do not explicitly address cyberattack risk.

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Tuesday, April 28, 2015

For a number of community banks, the management and ownership of the institution is truly a family affair. For banks that are primarily controlled by a single investor or family, these concentrated ownership structures can also bring about significant bank regulatory issues upon a transfer of shares to the next generation.

Unfortunately, these regulatory issues do not just apply to families or individuals that own more than 50 percent of a financial institution or its parent holding company. Due to certain presumptions under the Bank Holding Company Act and the Change in Bank Control Act, estate plans relating to the ownership of as little as 5 percent of the voting stock of a financial institution may be subject to regulatory scrutiny under certain circumstances. Under these statutes, “control” of a financial institution is deemed to occur if an individual or family group owns or votes 25 percent or more of the institution’s outstanding shares. These statutes also provide that a “presumption of control” may arise from the ownership of as little as 5 percent to 10 percent of the outstanding shares of a financial institution, which could also give rise to regulatory filings and approvals.

Upon a transfer of shares, regulators can require a number of actions, depending on the facts and circumstances surrounding the transfer. For transfers between individuals, regulatory notice of the change in ownership is typically required, and, depending on the size of the ownership position, the regulators may also conduct a thorough background check and vetting process for those receiving shares. In circumstances where trusts or other entities are used, regulators will consider whether the entities will be considered bank holding companies, which can involve a review of related entities that also own the institution’s stock. For some family-owned institutions, not considering these regulatory matters as part of the estate plan has forced survivors to pursue a rapid sale of a portion of their controlling interest or the bank as a whole following the death of a significant shareholder.

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Wednesday, April 22, 2015
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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.

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Tuesday, April 21, 2015
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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.

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Thursday, April 16, 2015
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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.

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Tuesday, April 14, 2015
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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:

  1. One- to four-family residential properties;
  2. Real property that would qualify as a community development investment;
  3. agricultural land; or
  4. 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.

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Friday, April 10, 2015
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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.

FINRA issued Notice To Members (NTM’s) in 1994 and 1996 discussing a firm’s supervisory obligations with respect to a representative’s RIA activities.

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.

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Thursday, April 9, 2015
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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.

Wednesday, April 8, 2015

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.

Procedural Issues

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…)