FDIC Board of Directors Approves Notice of Proposed Rulemaking to Revise Deposit Insurance Assessments

On April 13, 2010, the Board of Directors of the Federal Deposit Insurance Corporation (FDIC) approved a Notice of Proposed Rulemaking (NPR) to revise the deposit insurance assessment system for large institutions, which pose unique and concentrated risks to the Deposit Insurance Fund.  Under the proposal, risk categories and long-term debt ratings would no longer be used. The FDIC would continue to use the supervisory ratings as a factor in measuring risk. The FDIC would replace the financial ratios currently used with a scorecard consisting of well-defined financial measures that are more forward looking and better suited for large institutions. The proposal also includes questions about how to incorporate other risk measures, like the quality of underwriting or risk management practices, in the future.

The proposal would create two scorecards: one for large institutions and the other for highly complex institutions. A highly complex institution would be defined as an insured depository institution with greater than $50 billion in total assets that is fully owned by a parent company with more than $500 billion in total assets. The designation also would apply to a processing bank and trust company with greater than $10 billion in total assets. Each scorecard would have two components—a performance score and loss severity score—that are of particular interest to the FDIC as an insurer. Two scores would be combined to produce a total score, which would be translated into an initial assessment rate. Similar to the current system, the FDIC would retain an ability to make limited discretionary adjustments.

The entire proposed rule is available by clicking here.

FDIC Board of Directors Approves Extension of Transaction Account Guarantee Program

On April 13, 2010, the Board of Directors of the Federal Deposit Insurance Corporation (FDIC) approved an interim rule to extend the Transaction Account Guarantee (TAG) program to December 31, 2010. Last year the program was extended to June 30, 2010. Under the TAG program, customers of participating insured depository institutions are provided full coverage on transaction accounts. The interim rule gives the Board discretion to extend the program to the end of 2011, without additional rulemaking, if it determines that economic conditions warrant such an extension.

The TAG extension will provide a continued stable funding source for participating banks and will help them maintain their ability to secure low-cost, large deposits, thereby preserving their deposit franchise value and supporting the rebuilding of their earnings and capital, which in turn protects the Deposit Insurance Fund.

Nearly 6,400 insured depository institutions, about 80 percent of the industry, continue to participate in the TAG program and benefit from the guarantee provided by the FDIC. These institutions held an estimated $266 billion of deposits above the insured deposit limit and guaranteed by the FDIC through the TAG program as of the end of 2009. Under the interim rule, participating institutions can opt out effective July 1, 2010. Last year the Board adjusted the assessment rate to make it risk based and approved an increase in the rates; the current rates will remain unchanged under the interim rule. The Board also voted to require TAG assessment reporting be based on average daily account balances and to reduce the maximum rate that can be paid for qualifying NOW accounts to 0.25 percent from 0.50 percent.

The entire interim rule is available by clicking here.

Federal Regulators Release Model Consumer Privacy Notice Online Form Builder

On April 15, 2010, eight federal regulators released an Online Form Builder that financial institutions can download and use to develop and print customized versions of a model consumer privacy notice.

 The Online Form Builder, based on the model form regulation published in the Federal Register on December 1, 2009, under the Gramm-Leach-Bliley Act, is available with several options. Easy-to-follow instructions for the form builder will guide an institution to select the version of the model form that fits its practices, such as whether the institution provides an opt-out for consumers.

 To obtain a legal “safe harbor” and so satisfy the law’s disclosure requirements, institutions must follow the instructions in the model form regulation when using the Online Form Builder.

The Online Form Builder is available by clicking here.

 It is anticipated that such exchanges would allow bankers to:

• Gauge interest from other institutions, in buying and selling prepaid assessment credits in specified amounts at specified prices; and
• Indicate their interest in buying or selling assessment credits by entering a desired quantity and price (% of face value).

Apparently, the transfers will not be cleared by any exchange, but will instead be made only through the FDIC (via its electronic system FDICconnect) and after notice to the FDIC, which retains the right to reject any transfer on supervisory or other grounds.

Please note that Stinson Morrison Hecker does not endorse or sponsor the use of any exchange as described herein.

• Realize from the outset that small banks are at a competitive disadvantage in the bidding process. 
• Track potential targets by monitoring regulatory actions every month. 
• Raise capital well before making a bid.   It demonstrates stability. 
• Target fewer and smaller banks. 
• Demonstrate that experienced management will be in charge of the failed bank after the acquisition.

The Georgia case.  In White v. Wachovia Bank N.A., 563 F. Supp. 3d 1358 (N.D. Ga. 2008),  the plaintiffs opened a joint checking account with Wachovia in August 2007.  The deposit agreement they executed granted Wachovia the right either to refuse to pay any transaction that would create an overdraft, or to pay the overdraft and assess a service charge.  The deposit agreement also notified the plaintiffs that Wachovia could use HTL posting, stating:

[Wachovia] may pay checks or other items drawn upon your account . . .  in any order determined by us, even if (1) paying a particular check or item results in an insufficient balance in your account to pay one or more other checks or other items that otherwise could have been paid out of your account; or (2) using a particular order results in the payment of fewer checks or other items or the imposition of additional fees.  Although we generally pay larger items first, we are not obligated to do so and, without prior notice to you, we may change the order in which we generally pay items.

Despite the language in the deposit agreement, plaintiffs alleged that “Wachovia delays, reorders, or otherwise manipulates posting transactions to an account and imposes overdraft fees even where the account contains sufficient funds.”  Although the district court’s order is unclear on several details of the allegations, the gist of the plaintiffs’ attack seems to be that Wachovia not only used HTL posting, but it also waited “days after” debits were received to post them.  This purported delay allowed Wachovia to dump several items  into the posting “bucket” at once even though these items had accumulated over a period of several days.  With the bucket full, Wachovia then applied HTL posting, increasing the number of overdrafts (and overdraft fees). 

            Citing Wachovia’s alleged misconduct, the plaintiffs filed a class action in Georgia state court.  The complaint included claims for: (1) failure to perform contractual duties in good faith, (2) violations of Georgia Fair Business Practices Act (FBPA), (3) unconscionability, (4) conversion and (5) unjust enrichment.  Wachovia removed the case to federal court and filed a motion to dismiss. 

            Implied duty of good faith.  Without disputing that Georgia law imposes a duty of good faith and fair dealing upon all parties to a contract, Wachovia contended that Georgia law does not recognize a breach of the implied covenant of good faith where a party has done what the contract’s provisions give it the express right to do.  Since the deposit agreement expressly granted the right to use HTL posting and to charge overdraft fees, Wachovia argued that the plaintiffs could not state a claim for breach of the implied duty of good faith. 

In response, the plaintiffs cited an exception to the general rule relied upon Wachovia.  This exception applies where the manner of performance of the obligation is left “more or less” to the discretion of one party without being within the “absolute” discretion of that party.  While acknowledging that the language in the deposit agreement stated that Wachovia “may” post debits to an account in order form largest to smallest, the word “may” did not endow Wachovia with “absolute” discretion. 

Because the court found that Wachovia lacked absolute discretion under the deposit agreement, it held that the plaintiffs could establish a breach of the implied duty of good faith by showing that Wachovia manipulated and delayed the order of posting transactions against plaintiffs’ accounts.  However, the court concluded its discussion of the implied duty of good faith by noting that Wachovia could still prevail at the summary judgment stage by establishing that its posting orders were commercially reasonable. 

Preemption of other state law claims.  Wachovia asserted that the balance of plaintiffs’ claims were preempted by the National Bank Act (NBA) and its implementing regulations—specifically, 12 C.F.R. §§ 7.4002 & 7.4007– and OCC Interpretive Letter No. 916 (May 22, 2001).  The key federal regulation, 12 CFR 7.4002, allows national banks to establish non-interest charges and fees, which the court interpreted as applying only to legitimate overdraft fees, not fees imposed for overdrafts that result from a bank’s illegitimate posting methods.  Accordingly, the court found no conflict between the plaintiffs’ claims and § 7.4002. 

Nor did the court find the other OCC regulation, § 7.4007,  preempted  plaintiffs claims.  While § 7.4007 preempts any state law that impairs a national bank’s ability to exercise its deposit-taking powers, it also contains a carve-out for state “contract” and “tort” law.  Because the court concluded that the plaintiffs’ complaints “sound in tort and contracts,” § 7.4007′s preemption power was inapplicable. 

In a similar manner, the Georgia court found that OCC Interpretive Letter No. 916 (May 22, 2001) did not justify preemption of plaintiffs’ claims.  As Wachovia correctly pointed out, the OCC letter concludes that a national bank’s decision to use HTL posting constitutes “a pricing decision” authorized by federal law.   The court acknowledged the letter’s authoritativeness, but found it inapplicable.  Instead of contesting the propriety of applying HTL posting to debits received during a 24-hour period, the plaintiffs in this case were alleging that Wachovia was applying HTL posting to a bucket of transactions collected over a period of several days. 

State-law claims survive Wachovia’s motion to dismiss.  In addition to refusing to dismiss the plaintiffs’ claim for breach of the implied duty of good faith, the court also permitted the plaintiffs’ claims for violating Georgia’s FBPA and for conversion.  Because the FBPA applies to any unfair or deceptive business practice, and the plaintiffs claimed Wachovia had systematically charged overdraft fees where the overdraft was caused by Wachovia’s manipulation of the sequence and timing for debits posted to the account, the court allowed the claim to proceed.  On that same note, the court allowed the conversion claims to proceed because the plaintiffs had demanded a return of the fees and Wachovia refused.  The court dismissed the other claims.

The lesson in the Georgia case is clear:  in the absence of a strictly enforced 24-hour time limit for posting transactions to an account, use of HTL posting is like sending up the “Bat Signal” for the plaintiff’s bar.  Although banks need fee-generated income more than ever, they should closely monitor the use of HTL posting (or any other program) that increases overdraft fee revenue.  

The Georgia case settled soon after the court issued its order on the 12(b)(6) motion.  But another class action has been filed in the same district on virtually the same grounds.  This time, Wachovia filed a motion with the Judicial Panel on Multidistrict Litigation to consolidate the new action with similar actions throughout the country.  That motion is still pending.  We will keep you updated as events unfold.

The California case.  The second recent high-to-low case comes from California.  In Gutierrez v. Wells Fargo Bank, N.A., 2008 WL 4279550 (N.D. Cal. Sept. 11, 2008),

In that case, the putative class plaintiffs not only challenged Wells Fargo’s use of HTL posting, but they also challenged Wells Fargo’s procedures for posting account debits online.  Both challenges were based on alleged violations of California law.  (The court’s order does not specify which law).  Wells Fargo moved for summary judgment, arguing that federal preemption under the OCC regulations shielded it from the claims of the purported class.   The plaintiffs brought essentially the same HTL argument as the plaintiffs in the Georgia case.  However, if the Georgia court viewed HTL posting with measured skepticism, the California court viewed it with open disdain.  Consider the language used in the opening sentence of the decision:  ”This action challenges the practice of Wells Fargo Bank, N.A., to post multiple daily debits against a checking account in a revised sequence that maximizes overdraft penalties against the customer rather than in the actual sequence in which the charges were incurred.”  Despite the difference in the tone of the two decisions, many of the legal issues involve the same analysis.  In fact, Wells Fargo presented the same preemption arguments that failed in Georgia. 

In rejecting federal preemption, the California court was unwilling to concede that the OCC regulations authorize the use of HTL posting.  In the court’s view, preemption “would likely apply” if Wells Fargo’s right to assess an overdraft fee were being challenged, but was unwilling to extend preemption where “Wells Fargo has been manipulating” or “even downright altering” transaction records to maximize overdraft penalties (i.e. using HTL posting).  Accordingly, as in the Georgia case, the California court concluded that the plaintiffs’ claims sounded in “tort and contract” and were therefore not preempted by federal regulation.  Whereas the Georgia court focused not only on the defendant’s use of HTL posting, but also on Wachovia’s allegedly purposeful delays in posting transactions in order to boost the odds that HTL posting would result in an overdraft, the California court seems concerned with HTL posting even where all items are posted on the day received. 

Wells Fargo drafted an airtight deposit agreement, but not airtight enough.

The California court concluded that the plaintiffs’ deposit agreements neither provided for federal preemption of California law nor established HTL posting as a  routine practice.  The agreement states: “[T]he bank may, at its option, pay or refuse to pay any Item if it would create an overdraft . . . without regard to whether the Bank may have previously established a pattern or honoring or dishonoring such an Item.”  It also stipulates: “The Bank may post items presented against the Account in any order the Bank chooses, unless the laws governing your Account either require or prohibit a particular order. For example, the Bank may, if it chooses, post items in the order of the highest dollar amount to the lowest dollar amount.”  The Wells Fargo agreement also notifies the accountholder that HTL posting will likely cause an increase in the number of overdrafts. 

The court construed the phrase “unless the laws governing your Account either require or prohibit a different order” to mean that California state law would govern the order of posting items.  Wells Fargo pointed out that OCC Interpretive Letters 916 and 1083 explicitly and unequivocally state that a national bank may use HTL posting in California without violating state or federal law.  The court dismissed those arguments on the ground that “the [OCC letter] did not have the force of law.  It is merely interpretive rather than legislative.”  Notably, the court did not address California UCC 4303(b), which allows banks to post items “in any order.”

Next, the court pointed out that the disclosure language in the deposit agreements “is arguable inadequate” because (1) it “is buried deep within a lengthy statement” and (2) the disclosure language states only that the bank “may” use HTL posting.  The court found that use of the word “may” rather than “will” led customers to believe HTL posting is “not automatic but merely an exception.” 

Available balance disclosures and the problem of “debit holds”.  The second practice at issue in the California case  centered on “available balance” information that Wells Fargo provided online.  Although every Wells Fargo customer received a monthly account statement, those who signedd up for online banking also received access to more up-to-date information on recent account activity, pending transactions and Wells Fargo’s current calculation of the customer’s available balance.  Wells Fargo’s website defined “available balance” as:

The most current picture of funds you have available for withdrawal. It reflects the latest balance based on transactions recorded to your account today including deposited funds, paid checks, withdrawals and point-of-sale purchases. (Please note that some transaction activity may not be immediately recorded to your account and will then not be reflected in the available balance. . . .  [T]he remaining funds will be added as items are processed and any holds are removed. . . .  [C]omplete details on funds availability are reflected in our Funds Availability Policy.)

According to the plaintiffs’ complaint, the available balance information is potentially misleading because certain items are at first reflected in a customer’s available-balance information (to lower the balance) but then deleted (to increase the balance), misleading customers into overestimating their account balance and inducing them to incur overdraft penalties.  The experience of a putative class member, William Smith, is instructive.   

Smith maintained that he monitored his available-balance information online every day.  According to Smith, on July 3, 2007, his available balance, as reflected in the on-line report, was approximately $300.  He then spent $68.65 on fireworks, using his debit card.  The transaction was posted shortly thereafter as a pending transaction online and deducted from his available balance.  On July 12, he checked his available balance online and noted that he had about fifty dollars.  At the time, he thought all of his debit card transactions had posted to his account and were reflected in his available-balance information.  

Smith then purchased groceries for $24.76, unaware that Wells Fargo had removed the fireworks transaction from his available balance appearing online.  Thus, he had less money available than he thought.  The online number indicated Smith had $50,  but his actual account balance was really a negative number because the fireworks purchase was deleted three days after it posted.  Smith was then charged two overdraft charges: one for the groceries and one for the fireworks.  

Wells Fargo admitted to reversing debit “holds” after three business days, stating:

For “signature-based” transactions, the Bank’s policy is to keep the memo hold in place until the earlier of (1) receipt and posting of the final settlement information for the transaction or (2) three business days.  The Bank must limit a memo hold to three business days to comply with VISA rules, which recognize that after three business days there is an increased possibility that either (a) the transaction will never be submitted for settlement or (b) the transaction has been submitted and posted but has not “matched” with the memo hold (for example, because of a difference in the final transaction amount).  

Wells Fargo, however, did not formally disclose its debit holds policy to customers.  According to Smith, had he known the fireworks transaction was no longer reflected in his available balance, he would have transferred funds into his account to pay for his groceries.

Because of the confusion surrounding this practice, the plaintiffs claim that Wells Fargo had a duty to provide notice that a transaction had been deleted from the online register.  The court agreed with the plaintiffs, finding it “likely that this practice will regularly mislead customers into overdraft situations (and more penalty fees) by leading them to believe they have more money available than they really do.”  

It appears that Wells Fargo attempted to explain the removal of debit holds as a requirement for participating in the VISA Network.  In a footnote, the court explains that “Wells Fargo claims that it is required to delete certain transactions after they have already posted because of ‘VISA rules.’  Wells Fargo, however, provides no such rule. Nor does it provide any adequate justification why VISA would have such a rule.  Nor does it explain how a private organization like VISA could force Wells Fargo to engage in a misleading practice.”

Unsatisfied with the VISA rationale, the court found that Wells Fargo had not adequately explained the practice or why it went undisclosed.  As a result, the court declined to “categorically bless these seemingly predatory practices without a complete record of how they work, their justification, and how they square with the reasonable expectations of consumers.”  Thus, Wells Fargo’s motion for summary judgment was denied, and the court certified plaintiffs as a class.

Concluding Thoughts

• The Georgia court seemed to acknowledge HTL posting as a valid banking practice, provided that HTL is not used in conjunction with any other misleading practices.  However, the California court refused to acknowledge the legitimacy of HTL posting, regardless of the OCC’s Interpretive Letters condoning the practice in California.  It will be interesting to see how the California court’s analysis fares on appeal.
• Both cases suggest that, by informing the customer that the bank “may” use HTL posting, the banks were not reserving complete discretion to do so.  The California court concludes that the term “may” suggests that HTL would only be used occasionally.  But the word “may” seems appropriate,   since it allows the bank to diverge from a default of HTL posting if the circumstances require.  
• Will the California cases lead to a new line of “available balance” litigation?  The court reacted incredulously to Wells Fargo’s claim that it was required by its agreement with VISA to release debit holds within a few days of the authorization request.  But the obligation is actually a standard provision in all VISA agreements and is designed to make a consumer’s funds available for use.  Why did the court not understand this?  

Bottom line.  With potential class actions litigation on the horizon, banks would be wise to review their deposit agreements to make sure that consumers understand the nature of HTL Posting.  Further, if a dispute arises with a customer, banks would be wise to consider waiving any overdraft fees if there is any possibility that the banks’ online balance information was not clear.  In any event, given the complexion of the current Congress, it would not be surprising to see a strong push for a legislative solution.   

A Different Version of this Article First Appeared in Clarks’ Bank Deposits and Payments Monthly.

According to the release, in 2010 the Accounting Standards will make substantive changes to how financial service organizations account for many items—including securitized assets—that currently are excluded from these organizations’ balance sheets.  The regulators view the proposal as a way to better align regulatory capital requirements with the actual risks of certain exposures.  The main proposition in the proposal is a requirement to for financial service organizations affected by the Accounting Standards to increase their regulatory capital. 

The thirty-day comment period for the rule will begin once the proposal appears in the Federal Register.  The regulators seek specific feedback on (1) whether a phase-in of the increased regulatory capital requirements is needed, (2) the features and characteristics of transactions that, although consolidated under the Accounting Standards, might merit an alternative capital treatment (3) and the potential impact of the Accounting Standards on lending, provisioning and other activities.

According to the FDIC, the standards provide for:

• capital support of the acquired depository institution;
• agreement to a cross guarantee over substantially commonly owned depository institutions;
• limits on transactions with affiliates;
• maintenance of continuity of ownership;
• clear limits on secrecy law jurisdiction vehicles as the channel for investments;
• limitations on whether existing investors in an institution could bid on it if it failed; and
• disclosure commitments.

 In applying these standards, the FDIC’s proposed policy statement includes some burdensome requirements.  Of particular significance, any private equity investors would be required to agree to cause the depository institution acquiring deposit liabilities and/or assets of failed depository institution to be initially capitalized at a minimum 15% Tier 1 leverage ratio for a period of 3 years.  Failure to meet this requirement would result in the institution being treated as “undercapitalized” for purposes of Prompt Corrective Action triggering the measures available to an institution’s regulator in such a situation.  In addition, an insured depository institution acquired or controlled by such investors would be prohibited from providing these investors and their affiliates any extensions of credit. 

While the initial proposal included these onerous burdens for interested private investors, the proposal remains open for comment  (here) until August 10th.  Whether such steep requirements remain in the final Statement of Policy will surely impact the number of private investors who are willing to qualify and bid on failed bank acquisitions.

Judging by the Statement’s tone, the FFIEC is concerned that financial institutions are seeking charter conversions to avoid regulatory scrutiny, not for “legitimate” reasons.  For example, the Statement notes that “rating downgrades and supervisory actions have become more frequent. To maintain the integrity of the regulatory system and the safety of financial institutions, it is essential that the opportunity for charter conversions does not undermine current or prospective supervisory actions.”

For charter conversion requests lodged by financial institution with “serious or material enforcement actions” pending, the Statement points out that such requests “should not be entertained.”

The Statement goes on to remind regulators of their duty to “consult with the FDIC (NCUA when appropriate), in its role as deposit insurer and receiver, and the Board, as the consolidated holding company supervisor, on any application involving an institution for which its current supervisor has either rated or proposes to rate that institution a 3, 4, or 5 . . .  or has instituted or plans to institute a serious or material corrective program with respect to that institution.” 

If an institution subject to an existing corrective action, the Statement points out that any ” prospective chartering authority agrees to a conversion, the FFIEC expects that corrective program’s requirements will be maintained and compliance overseen by the successor supervisor.”

Given the current economic conditions, especially in the banking community, it is unsurprising that an institution incurring harsh regulatory scrutiny would want to seek an a new regulator—if for no other reason that to gain a fresh start.  The Statement suggests that any plans to change regulators will likely need to be postponed if your institution is subject to a serious enforcement action. 

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.

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.