Archive for June, 2009
The Empire (State) Strikes Back: New York AG Breaks OCC’s Federal Preemption Winning Streak in Cuomo v. Clearing House Association
After years of consistently siding with Office of the Comptroller of the Currency (OCC) on preemption issues, the United States Supreme Court has tossed a bone to state regulators. In a June 29, 2009 decision, Cuomo vs. Clearing House Association, the Court held that an OCC regulation purporting to preempt certain state law enforcement activities is not a reasonable interpretation of the National Bank Act (NBA). Given the preemptive force of the NBA, a clear assessment of how the decision will change the balance of power between federal and state regulators is impossible to make right now. But any decision breaking the OCC’s high-court winning streak must be considered a major victory for state regulators (as well as self-styled consumer “advocates”).
The facts of the case begin in 2005, when then-Attorney General (AG) Eliot Spitzer sent letters “in lieu of subpoena” to several national banks operating in New York. The letters requested non-public information about the banks’ lending practices. According to the AG, the state sought this information to determine whether the banks were violating state fair lending laws. The Clearing House Association, a banking trade group, filed suit in the Southern District of New York to enjoin the AG from seeking the information, contending that the NBA and the OCC’s regulations implementing the NBA preempt this type of state law enforcement against national banks.
Specifically, the Clearing House Association relied on (1) NBA § 484, which provides that no national bank is subject to a state’s “visitorial powers” except as expressly authorized by federal law and (2) 12 CFR § 7.4000, the OCC regulation implementing the NBA, which forbids states to “exercise visitorial powers with respect to national banks, such as conducting examinations, inspecting or requiring the production of books or records” or “prosecuting enforcement actions.”
The District Court granted the injunction, prohibiting the attorney general from enforcing state fair lending laws through demands for records or judicial proceedings. The Second Circuit Court of Appeals affirmed, and the United States Supreme Court granted cert to address whether the Comptroller’s regulation purporting to preempt state law enforcement constituted a reasonable interpretation of the National Bank Act, which allows the OCC to promulgate regulations prohibiting state actors from exercising visitorial powers over a national bank. More specifically, the Court confronted the question of whether the NBA allows the OCC to preempt a state attorney general’s request for the records of national bank, either by letter or subpoena, on the grounds that such a request constitutes an impermissible exercise of visitorial powers. After reciting the familiar Chevron deference framework, the opinion, drafted by Justice Scalia and joined by Justices Stevens, Souter, Ginsburg and Breyer, concludes that the OCC’s regulation is not a reasonable interpretation of the NBA.
The opinion centers on the hazy distinction between a state’s “visitorial powers,” which are preempted by the NBA, and a state’s basic law enforcement powers, which the court held are not. According to Justice Scalia, the OCC’s definition of visitorial powers, in 12 C.F.R. § 7.4000 simply reaches too far to constitute a reasonable interpretation of the NBA. While agreeing that the NBA allows the OCC to issue regulations preempting traditional “visitorial powers” that would allow the state to exercise general oversight and control over the everyday affairs of national bank—e.g., the power to inspect books and records at any time for “any or no reason,” the Court disagreed that the NBA’s preclusion of a state’s ability to exercise visitorial powers over a national bank means that a state cannot enforce laws against national banks operating in the state. Instead, the NBA preserves general state law enforcement powers, including law enforcement actions brought in the “courts of justice” within the states.
As a result the NBA’s reservation of state law enforcement powers, s reservation of power, the state attorneys general (and presumably other state regulators) may bring court actions against national banks to ensure that the national banks are complying with state law. The Court characterized the distinction between visitorial powers and law enforcement powers as follows: “If a State chooses to pursue enforcement of its laws in court, then it is not exercising its power of visitation and will be treated like a litigant.” Acknowledging the potential for abuse of the judicial process, the Court noted that “[i]n New York, civil discovery is far more limited than the full range of ‘visitorial powers’ that my be exercised by a sovereign.”
The banking community did not provide a warm reception for the opinion. Edward L. Yingling, president of the American Bankers Association issued a statement declaring that OCC-chartered banks “will face a patchwork of duplicative and conflicting federal and state regulation and enforcement actions . . . This will make it difficult to serve consumers in today’s hi-tech, mobile society where people and bank services move constantly across state lines.”
Yingling might be jumping the gun. Although this case is a stark departure from its recent national bank preemption jurisprudence, it still requires antsy attorneys general to invoke the judicial process. As a result, fears of massive invasive action by the states maybe premature. It will, however, be interesting to see whether state legislatures respond to the ruling by passing additional laws to target national banks, especially in the area of consumer protection law.
TREASURY’S PROPOSED FINANCIAL REGULATORY REFORMS: PROVISIONS APPLICABLE TO COMMUNITY BANKING
The United States Department of the Treasury’s recently released “White Paper” has buzzed around for the past two weeks, with most talk about the paper focusing on the proposed expansion of the Federal Reserve’s regulatory authority and the proposed creation of a consumer protection regulator. While these topics probably deserve to receive most of the attention in the mainstream media, the White Paper is loaded with other proposals that, if adopted, would drastically shift the current legal framework in the community banking industry. Over the next few days, we intend to post several items to this blog that discuss some of these less-heralded proposals. Today, we are posting about the White Paper provisions that would affect the regulatory balance between federal and sate charters. Some of these include:
Elimination of the federal thrift charter. According to the White Paper,
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- The federal thrift charter is a relic of a bygone era. While federal thrifts were necessary to stabilize the housing market in the 1930s, securitization markets, commercial banks and the Federal Home Loan Banking System have supplanted federal thrifts as the key engines of the mortgage market, rendering federal thrifts unnecessary.
- Because federal thrifts are required to focus their lending on residential mortgages, they were more vulnerable to the current housing downturn
- “Private sector arbitrage” has exploited the financial regulatory system, especially through the use of federal thrift charters for residential mortgages. Eliminating the federal thrift charter would prevent such arbitrage.
- Reduce the differences in substantive regulations and supervisory policies applicable to national banks, state member banks and state non-member banks.
- Restrict the ability of troubled banks to switch charters and supervisors.
- Eliminate barriers to interstate branching by national and state banks.
- Eliminate states’ ability to prevent de novo branching across state lines
- allowing banks to enjoy the unrestricted ability to branch across state lines (a privilege currently afforded only to federal thrifts); or .
- imposiong minimum requirements on the age of in-state banks that can be acquired by an out of state bank.
- All consumer protections and deposit concentration caps with respect to interstate banking would remain.
- Eliminate states’ ability to prevent de novo branching across state lines
These proposals are ambitious. Although the elimination of the federal thrift charter might be feasible, state regulators and community banking groups will greet any attempt by Congress to impose uniform chartering standards or to eliminate interstate branching barriers with skepticism (at best) or open hostility (most likely).
The dual banking system is founded not only on basic principals of federalism, but also on the concept of regulatory innovation—i.e., the creation of effective and innovative regulatory policies and oversight that results from regulatory competition for institutions to charter. Enactment of the proposals in the White Paper would reduce the concept of regulatory innovation to nothing more than a quaint afterthought. On the other hand, if a uniform system of regulations would increase stability within the overall banking sector, it might be worth sacrificing some regulatory innovation. Stay tuned.
Tagging Out of the TAG Component of the FDIC’s Temporary Liquidity Guarantee Program
Today the FDIC announced that it is seeking public input on whether to extend the Transaction Account Guarantee (TAG) component of the Temporary Liquidity Guarantee Program (TLGP). As you may recall, the FDIC established the TAG program in October 2008 as part of a broader effort to stabilize the nation’s financial system. Under the TAG program, the FDIC guarantees all deposits held in qualifying noninterest-bearing transaction accounts at participating depository institutions. The TAG program is currently set to expire on December 31, 2009.
According to its announcement (available here), the FDIC is seeking input on whether to allow the TAG program to expire as scheduled, on December 31st, or whether to extend the TAG program for six months until June 30, 2010. If extended, depository institutions currently participating in the TAG program would be given the opportunity to opt out. However, any institution opting out of the program would be required to notify its customers that, beginning on January 1, 2010, deposits in qualifying noninterest-bearing transaction accounts would not be covered by the FDIC beyond standard deposit insurance limits.
For institutions that do not opt out of the extended TAG program, the FDIC would increase the fees currently assessed for the program by 10 to 25 basis points during the proposed extension period.
Bank Regulators Issue FAQS On Identity Theft Red Flag Rules
On June 11, 2009, federal bank regulators, the National Credit Union Administration (NCUA) and the Federal Trade Commission (FTC) issued frequently asked questions (FAQs) to provide financial institutions and creditors with further guidance on the scope and implementation of the Identity Theft Red Flag Rules (Red Flag Rules).
The Red Flags Rules went into effect for financial institutions on November 1, 2008 and will go into effect for non-financial institution creditors on August 1, 2009 (this deadline has been extended twice because many of the entities did not realize they fell under the Red Flag Rules).
Below is a quick summary of the FAQs. A complete copy of the FAQs is available here.
Scope:
- The Red Flag Rules apply to:
- all banks, savings associations and credit unions, regardless of whether they hold a “consumer account”
- all banks, regardless of whether their powers are limited to trust activities
- brokers, dealers, investment advisors, or investment or insurance companies that are “financial institutions” or “creditors” under the Red Flags Rule, including subsidiaries of banks
- corporate credit unions
- credit union service organizations (CUSOs)
- The Red Flag Rules do not apply to foreign branches of U.S. banks.
Definitions:
- The definition of “covered account” has two parts:
(1) “an account that a financial institution or creditor offers or maintains, primarily for personal, family, or household purposes that involves or is designed to permit multiple payments or transactions” and
(2) “any other account that the financial institution or creditor offers or maintains for which there is a reasonably foreseeable risk to customers or to the safety and soundness of the financial institution or creditor from identity theft, including financial, operational, compliance, reputation, or litigation risks.
An account that falls under either part is a “covered account.”
- These types of accounts may be “covered accounts”:
- Business accounts
- Business loans guaranteed by a consumer
- Pre-paid card accounts (especially those that create a continuing relationship)
- Certificate of deposit accounts
- Investment retirement accounts (IRAs)
- Trust accounts
- Accounts established in the U.S. by non-U.S. residents
- Indirect consumer loans (including loans purchased by another financial institution or creditor)
- Leases
Identity Theft Program:
- Financial institutions and creditors may use automated solutions to detect red flags. They are not required to and an automated solution may need to be supplemented by non-automated policies and procedures.
- The Red Flag Rules do not require a specific response for any particular situation, but give examples of responses that may be appropriate.
- The obligation to oversee service provider arrangements includes fraud detection services and services in connection with opening or accessing covered accounts, such as providing an online banking platform, call center services, or debt collection.
- The Red Flag Rules do not require the oversight of service providers through a written contract, although it might be helpful.
Misc:
- The Red Flag Rules do not contain a specific record retention requirement.
- The Red Flag Rules do not require a financial institution or creditor to educate consumers.
- The list of examples of Red Flags in the supplement to the Guidelines is not a comprehensive list of Red Flags, nor must a financial institution or creditor incorporate all of those examples into its Program.
Missouri Bankers Association — Highlights from the Annual Convention
The 119thAnnual Convention of the Missouri Bankers Association concluded on June 19th in Branson, Missouri. The turbulent ride of the twelve months since last year’s convention resulted in a gathering that was anything but . . . conventional. Here are some notable highlights:
- Barry Asmus, a Senior Economist at the National Center for Policy Analysis, batted lead-off, storming the stage to warn of the downfalls of increased government influence on the private sector in general and the banking sector specifically. More than anything, Asmus understood his audience, and his message resonated with the bankers in attendance (even if he was a tad long-winded). We remain, however, skeptical of Asmus’ unstated but palpable desire to abolish government at pretty much every level.
- The investment banking firm, Sandler O’Neil Partners, L.P., discusses current trends in the M&A and capital markets. As one might imagine, acquisitions are significantly down and capital is tough to come by. The investment bankers recommend that banks identify their potential capital hole by running internal “stress tests” similar to those conducted on the 19 largest banks, giving the bank an accurate third party view of their institution. If your bank needs capital, you should consider raising it during the summer or fall, before the rush to raise capital during the fourth quarter by banks healthy enough to repay TARP clogs the capital markets.
- President Obama’s White Paper, titled “Financial Regulatory Reform, A New Foundation: Rebuilding Financial Supervision and Regulation“, on regulatory reform was released on Wednesday. (Click here for a summary).
- The release of the White Paper coincided with a regulatory panel discussion that included representatives from the FDIC, Federal Reserve, Missouri Division of Finance, OCC and OTS. Some interesting tidbits of the panel discussion include the following:
- The Missouri Division of Finance outlined the CAMEL ratings of Missouri banks. While over 80% of Missouri banks have 1 or 2 composite ratings, 10 Missouri banks have 4 ratings and five have 5 ratings.
- We would guess that at least 50% of the one-hour panel discussion centered on real estate collateral appraisals. Bankers are dubious of their relevance and weary of being hammered on by regulators to obtain updated appraisals, particularly when cash flow projections (of commercial property in particular) are considered by some to be a better evaluation tool. The regulators conceded the questionable utility of appraisals, but, somewhat apologetically, wouldn’t back off their necessity.
- Banks must closely monitor commercial real estate concentrations. This is a strong correlative link between banks that exceed recommended concentration levels (300%) and those with 3, 4 or 5 composite ratings.
- As part of the proposed regulatory reform, the OCC and the OTS would be folded into a single federal regulations called the “National Bank Supervisor.”
- Participations are a good diversifier for bank loan portfolios if used in moderation. Banks must be weary of participations where the primary bank is at risk of failure. If such a bank fails and the borrower has a deposit at the failing bank, the FDIC can offset the deposit against the loan. That offset work in the favor of depositors of the failed bank and the participating bank will be stuck with a receivership claim. In short, participating banks must do their due diligence on lead banks.
The closing remarks of Susan Barrett, the MBA’s new chairwoman, and Art Johnson, the Chairman-Elect of the ABA, seemed to accurately reflect the mood of the week. The Missouri bankers are optimistic about the future, emboldened by their recent success on the special deposit insurance assessment and ready to stay the course. It will be an interesting 2009.
FDIC and ABA Clarify Required Repo Sweep Disclosures
On February 2, 2009 the FDIC issued a final rule that, among other things, requires certain disclosures regarding repo sweep accounts, effective July 1, 2009. The final rule can be found at 12 C.F.R. § 360.8(e).
Required Disclosures
The final rule requires institutions to inform sweep account customers if their swept funds are deposits under 12 U.S.C. 1813(l): (1) within the first sixty days after July 1, 2009 and periodically thereafter, but not less than annually; (2) in all new sweep account contracts; and (3) in all contract renewals. If the accounts are not deposits the institution must also disclose the status of the funds should the institution fail, for example, secured creditor or general creditor status.
Additional Requirements
These disclosures must be consistent with how the institution reports the funds on its Call Reports or Thrift Financial reports. The disclosure requirements do not apply to sweep accounts where: “transfers are within a single account, or a sub-account;… [or involve] only deposit to deposit sweeps,… unless the sweep results in a change in the customer’s insurance coverage.” The final rule does not require any specific language in the disclosures, allowing institutions to draft their own disclosures. Finally, the FDIC listed several examples of the means by which disclosures may be made, including client letters, transaction confirmation statements or account statements.
ABA Request for Guidance
The ABA recently asked the FDIC for guidance on how banks can ensure that repurchase agreements that are tied to sweep accounts are “properly executed,” such that customers possess perfected security interests in the underlying securities. This is significant, because an unperfected security interest would result in funds being treated as deposits and potentially uninsured in the case of a bank failure.
The ABA hosted a May 21 telephone briefing on these issues. It appears, from the telephone briefing and subsequent guidance from the ABA, that the focus of the FDIC regarding “properly executed” repurchase agreements that are tied to sweep accounts is “control.” In particular, this requires (1) identification of specific securities in the daily written confirmations that are required by the Government Securities Act, (2) inclusion of provisions in the repurchase agreement that appoint the bank as the customer’s agent and that give the customer the right in an event of default (such as bank failure) to direct the bank to sell the securities and apply the proceeds to the bank’s obligations under the agreement and (3) removal of any provisions in the repurchase agreement (and in any confirmations) that permit the bank to unilaterally substitute securities.
Treasury Releases Executive Compensation Restrictions for TARP Participants
The U.S. Treasury Department has released an Interim Final Rule (the Executive Compensation Rule) establishing governance and compensation standards for institutions participating in the Troubled Asset Relief Program (TARP). Any institution participating in the TARP Capital Purchase Program is subject to these rules so long as any obligation to Treasury remains outstanding. Review the press release announcing the IFR, and review the entire IFR.
Some of the IFR’s most important provisions include the following:
- Limitations on the amounts and types of bonuses payable to senior executive officers and other highly compensated employees.
- A ban on golden parachute payments—a term that reaches much farther than most people think, including almost any type of compensation received upon a covered employee’s departure from the institution.
- A “clawback” provision that requires an institution to recover any bonus, retention award or incentive compensation paid to a covered employee if the bonus, retention award or incentive compensation was paid in reliance on inaccurate financial information.
- Several corporate governance and board certification requirements, including a requirement for perquisite disclosures and for implementing luxury expense controls.
- A requirement for all TARP participants to provide shareholders with an annual, non-binding vote on the compensation of the institution’s executives.
- An affirmation that the rule’s restrictions will not apply to institutions receiving indirect financial assistance from UST, such as institutions receiving loans from the Term Asset Loan Facility.
If your institution is currently participating in any TARP program, you are required to comply with these rules. The following initial steps should help:
- Identify which of your employees will be subject to which restrictions. The number of employees covered by a given restriction varies depending on the type of restriction and the amount of Capital Purchase Program funding the institution has received.
- Review your institution’s employment and other compensation-based agreements, especially severance provisions, to verify that they comply with the IFR.
- Designate appropriate board committees to confer with the institution’s senior risk officers to identify compensation policies that may encourage unnecessary risk taking.
