On April 16, 2012, the Consumer Financial Protection Bureau (CFPB) issued a bulletin (the CFPB Bulletin) reminding supervised institutions of their obligations and responsibilities over third party service providers. A copy is available at:

http://files.consumerfinance.gov/f/201204_cfpb_bulletin_service-providers.pdf

The CFPB Bulletin emphasizes that the supervised institution is primarily liable for compliance with with applicable law and that engaging a third party service provider does not absolve the supervised institution from liability. The supervised institution is expected to manage the risk of engaging third party service providers by conducting thorough due diligence, reviewing the third party service provider’s policies and procedures and ensuring it is adequately training and overseeing those persons that have consumer contact or compliance responsibilities, including clear expectations in the written contract, establishing internal controls to ensure the third party service provider is complying with applicable law, and taking prompt action to address issues discovered during the monitoring process, including terminating the relationship. For a more specific understanding of the CFPB’s expectations, supervised institutions are directed to review the CFPB’s Supervision and Examination Manual: Compliance Management Review and Unfair, Deceptive, and Abusive Acts or Practices, available at:

http://www.consumerfinance.gov/wp-content/themes/cfpb_theme/images/supervision_examination_manual_11211.pdf

In addition, on May 2, 2012, the Board of Governors of the Federal Reserve System (the FRB) held a live webinar titled “Vendor Risk Management-Compliance Considerations” that further emphasized oversight and control of third party service providers. Copies of the slides and a recording of the webinar is available at:

http://www.visualwebcaster.com/FederalReserveBankSF/86290/event.html

In the webinar, the FRB emphasized that supervised institutions were expected to oversee third party service providers as they would any other division of their own institution. The FRB recognized that use of third party service providers is common to reduce costs, enhance performance, obtain access to specific expertise, and increase product offerings, but that use of them creates reputational, operational, transactional, credit, and compliance risk for the institution that must be adequately managed. The FRB highlighted common compliance issues such as over reliance on third parties, failure to understand and retain knowledgeable staff to understand and monitor risks, failure to monitor the third party service provider, failure to provide the third party service provider enough information necessary to perform, and failure to verify that third party service provider’s activities comply with applicable law. The FRB concluded by outlining best practices for use of third party services providers:

• Thorough due diligence prior to selecting a third party service provider (including references from other supervised institutions doing business with the third party service provider, financial information, and the background of third party principals)
• Preparing a detailed risk assessment and instituting processes and procedures to minimize those risks
• Ensuring the contract with the third party service provider includes expectations concerning compliance with consumer protection laws and regulations

-Specific terms to reduce risk should be included based on the supervised institution’s detailed risk assessment

-Ability to receive proof of compliance (including audit rights and monitoring of the third party service provider and any of its vendors)

• Implementing a comprehensive monitoring program (frequency and depth based on the risk assessment, but noting that all third party service providers require some level of monitoring)
• Implementing training for those conducting monitoring to ensure they understand risks and receive regulatory updates
• Tracking consumer complaints
• Ensuring the board of directors receives due diligence regarding the third party service provider, monitors reports, and training in order to properly oversee risks (the board must be active in these risk decisions)

What this means for you: Supervised institutions should immediately look at relationships with its third party service providers and assess risks, evaluate existing contracts, and institute internal policies and procedures to move toward compliance.

Please note that this e-alert is for informational purposes only. The information contained herein is provided only as a service to the public, and is not legal advice or a substitute for legal counsel, nor does it constitute advertising or a solicitation.

Summary: In Western Blue Print Co., L.L.C. v. Roberts, No. SC91831 (Mo. April 17, 2012), the Court reviewed a jury’s $600,000 verdict in favor of Western Blue against the defendant, Myrna Roberts, on claims for breach of fiduciary duty, tortious interference and violations of the Missouri Computer Tampering Act. The Missouri Court of Appeals, Western District, had affirmed the award.

The Supreme Court reversed in part, finding that Roberts did not owe officer-like fiduciary duties to the company, notwithstanding the significant authority and control she had over the Columbia office. The Court also rejected Western Blue’s argument that the defendant’s access to confidential information such as profit and loss data created a “confidential relationship” sufficient to support a fiduciary duty claim. The Court noted that Roberts “was not restricted by a non-compete agreement, and was not asked to maintain the alleged confidential nature of the information she obtained through her work at Western Blue.”

Why this matters: The case’s holding that the defendant did not owe a fiduciary duty to the company highlights the importance of Missouri employers obtaining confidentiality and non-compete agreements from key at-will employees in order to prevent those employees from profiting unfairly at the expense of the employer upon their departure. The best way to protect your company from information theft and unfair competition is through the use of appropriately tailored confidentiality and non-compete agreements.

Access the full PDF version of the Business Litigation Alert: Fiduciary Duty Ruling Highlights the Importance of Non-Compete Agreements

The case In re Gary M. Crane and Marsa S. Crane, (Bankruptcy No. 11-90592), held that if a mortgage does not contain all the requirements set forth in 765 ILCS 5/11, the mortgage would not be valid as to provide constructive notice to any potential lienholders. 765 ILCS 5/11 requires a mortgage to include the maturity date and interest rate along with the amount of the underlying debt. The court stated that 765 ILCS 5/11 is mandatory and not permissive; thus any failure to follow the statute makes a mortgage that lacks the 765 ILCS 5/11 requirements as failing to provide constructive notice. In Crane, a mortgage that did not contain the interest rate or the maturity date was held unenforceable against the bankruptcy trustee and resulted in the obligation secured by the mortgage becoming an unsecured claim rather than a secured claim. The court further held that a reference to the promissory note is not sufficient to satisfy the requirements of 765 ILCS 5/11. The Draconian result is that every mortgage recorded in Illinois must have the amount of the debt, the interest rate charged on such amount and the maturity date for the loan specifically referenced in the text of the recorded mortgage.

Not surprisingly, this decision is contrary to general practice in Illinois. For a variety of reasons, many Illinois mortgages do not describe the interest rate on the underlying loan amount. Currently, the case is being appealed and the Illinois House of Representatives has proposed legislation that would provide that the failure to list the interest rate or maturity date specifically in the mortgage would not nullify the recording of the mortgage as constructive notice and thus would not lose priority in bankruptcy or otherwise. Until this case is overturned or legislation is passed, it is unclear what the effects of this ruling will be.

While the Crane case is limited to the bankruptcy courts in Illinois, it could be persuasive in other courts and also could result in title insurance claims that may or may not be excluded from coverage. We will continue to monitor the case and send a follow-up regarding the results of the pending legislation and appeal.

Illinois lenders should review all form mortgages and revise them to comply with 765 ILCS 5/11, and, when modifying any mortgage, include the provisions required under 765 ILCS 5/11 in such modification. Stinson Morrison Hecker LLP has lawyers licensed in Illinois to assist in performing these tasks or advising on any other issues related to the Crane case.

For more information on this alert please contact Michael Campbell or any of the attorneys in Stinson’s Banking & Financial Services Division.

This article is designed to give general information on developments actually covered. It is not intended to be a comprehensive summary of the law or to treat exhaustively the subject covered. It does not constitute legal advice or opinion. Such advice and opinion is provided by the firm only upon engagement with respect to specific factual situations.

Stinson Parnter Bob Monroe Serves as Featured Panelist for Bank Director Webcast

Stinson Morrison Hecker LLP Partner Bob Monroe was a featured panelist for Bank Director’s “Strategic Alternatives for Banks Under $1B in Assets” on-demand webcast. This topic was the most popular session at Bank Director’s Acquire or Be Acquired conference.

The webcast counters the belief that banks must be $1 billion dollars in assets to survive – as many smaller community banks are thriving. During the webcast, the presenters explore case studies of successful community banks that have established strategies for growth, capital maintenance, profitability and other critical strategic initiatives. Along with Monroe, the other panelists are Craig J. Mancinotti and Richard F. Maroney, Jr., both are managing directors & principals at Austin Associates LLC.

Monroe is the co-chairman of Stinson’s Banking and Financial Services Division and serves as counsel to more than 150 financial institutions. He has significant experience in matters involving bank and bank holding company mergers and formations, branch acquisitions, conversion to S-Corporations, negotiating regulatory orders, bank examination issues, prompt corrective actions, reorganizations, succession planning, representing buyers of failed banks, interstate banking issues, director and officer liability issues, lender liability issues, and capital issues.

View a portion of the presentation here:  http://www.youtube.com/watch?feature=player_embedded&v=zVwp_K0Nfb0

To see the full presentation and more case studies, please visit BankDirector.com.

Summary of the Facts.  In June 2000, Fischer & Frichtel, Inc. (“FFI”) borrowed $2.5 million from First Bank to finance the acquisition of lots for residential development. After several extensions to the loan’s maturity date, the loan ultimately matured in September 2008 leaving First Bank with an unpaid principal balance of approximately $1.1 million.  First Bank foreclosed on the unsold lots and purchased the property at the foreclosure sale with a credit bid of $466,000.  In November 2008, First Bank filed suit against FFI to recover the deficiency.  Evidence presented by FFI at trial indicated that the fair market value of the property was $918,000.  At the conclusion of the lawsuit, the trial court instructed the jury to determine the amount of the deficiency based on the “fair market value” of the property at the time of the foreclosure sale.  The jury determined the deficiency to be the difference between the fair market value ($918,000) and the amount of the debt ($1.1 million).  First Bank appealed claiming that the jury instruction erroneously instructed the jury to calculate the deficiency using the fair market value rather than the foreclosure sale price.  The trial court granted First Bank’s motion for a new trial.  FFI appealed.  The Missouri Court of Appeals transferred the Case to the Missouri Supreme Court.

Decision of the Missouri Supreme Court.  The Missouri Supreme Court upheld the trial court’s decision to grant a new trial based upon the erroneous jury instruction and held that deficiencies are properly based upon the foreclosure sale price rather than the fair market value.  The opinion affirms a prior holding that debtors may void a properly noticed and carried out foreclosure sale only by showing that the sale price is so inadequate that “it shocks the conscience… and is in itself evidence of fraud.”  Missouri’s standard for voiding a foreclosure sale is very strict.  The Court, citing a previous decision, notes that “more than one Missouri case has refused to set aside a sale that was only 20 to 30 percent of the fair market value because of Missouri’s historical practice of requiring an inference of fraud in addition to a sale price that ‘shocks the conscience.’”

Does This Holding Put the Fair Market Value Debate to Bed for Good?

Not necessarily.  The Court considered the sophistication of the debtor in its analysis of FFIs argument.  In fact, the Court noted that the policy arguments asserted by FFI “principally apply to individuals and small businesses that have no realistic ability to bid themselves, not to a sophisticated entity such as Fischer & Frichtel…”  Would the Court have used a different standard if the debtor was an individual or small business?

Further, although the Court upheld the practice of using foreclosure sale price to determine deficiencies, it did acknowledge that the policy debate in favor of fair market value has merit.  “The policy debate presented by the parties may explain why so many states have chosen to deal with this issue by statute, rather than by the common law, as still is the case in Missouri.”  Will the Missouri legislature be persuaded by FFIs arguments and introduce legislation to change the way lenders calculate deficiencies?

Background Information

Financial institutions and their counsel have sought protection from disclosure by asserting one or more of the following privileges: (i) attorney-client privilege, (ii) work-product privilege, (iii) self-assessment privilege and (iv) accountant-client privilege.  When a privilege attaches, the materials and communications are generally immune from discovery unless the privilege has been waived.  A privilege may be waived in a number of ways, but it occurs most commonly when a client voluntarily discloses the privileged information to a third-party.  For financial institutions required to disclose materials to their regulators, the possibility that a court could waive the aforementioned privileges because of previous disclosures to their regulators caused concern among supervised institutions and their counsel. 

Federal Statute Enacted to Protect Privilege

To alleviate this concern, Congress enacted a Federal statute in 2006 that allows supervised institutions to submit privileged materials to their regulators without waiving privilege.  Specifically, 12 U.S.C. § 1828(x) states that:

[t]he submission of information to any Federal banking agency, State banking supervisor, or foreign banking authority for any purpose in the course of any supervisory or regulatory process of such agency, supervisor, or authority shall not be construed as waiving, destroying, or otherwise affecting any privilege such person may claim with respect to such information under Federal or State law as to any person or entity other than such agency, supervisor, or authority.

The term “Federal banking agency” is currently defined as “the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, or the Federal Deposit Insurance Corporation.”  12 U.S.C. § 1813(z).  Thus, as long as a disclosure is made to the OCC, Federal Reserve, or FDIC “for any purpose in the course of any supervisory or regulatory process,” the supervised institution will not waive any privilege attached to the disclosed materials.

The Dodd-Frank Act Creates Uncertainty

When Congress enacted the Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), it did not amend the definition of “Federal banking agency” to include the CFPB. Without this statutory protection, depository institutions and their affiliates subject to examination by the CFPB are faced with a difficult decision when asked by the CFPB to produce privilege materials or communications: (i) produce the requested material and risk that a court in a future proceeding will hold that the disclosure waived the privilege and, as a result, compel the institutions to produce the privileged material in those proceedings, or (ii) refuse to produce the privileged material and face an enforcement action by the CFPB.   

The CFPB Bulletin

The Bulletin issued by the CFPB assures institutions that disclosure of privileged materials will not result in a waiver of privilege for two reasons: (i) the disclosure of privileged material would not be voluntary and, thus, could not waive privilege, and (ii) “Congress intended the [CFPB's] examination authority to be equivalent to that of the prudential regulators” and, as such, the CFPB is authorized to receive information without effecting privilege to the same extent as the OCC, Federal Reserve and FDIC.  For these reasons, the CFPB declared that it will pursue all available remedies under 12 U.S.C. § 5565 if a CFPB supervised institution refuses to provide privileged information responsive to a CFPB supervisory request.

The Bulletin also explains that the CFPB recognizes the importance of this issue and “is prepared to take all reasonable and appropriate steps to assist supervised institutions in rebutting any claim that they have waived privileges by providing information to the [CFPB].”  Ultimately, while the Bulletin issued by the CFPB is helpful to CFPB supervised institutions and may reduce the risk of waiving privilege, the Bulletin is not a legal regulation, court decision or a substitute for an amendment to the Federal Deposit Insurance Act (“FDIA”) to expressly include the CFPB as a “Federal banking agency,” which would conclusively resolve the uncertainty.  

Courts may disagree with the CFPB’s analysis and conclusion

While courts have not directly addressed whether a disclosure of privileged material to the CFPB waives the privilege as to the same information in a subsequent civil case, the case law in similar contexts illustrates that a court could easily disagree with the CFPB’s Bulletin.  To predict how a court may rule, we look to the how courts have addressed this issue in the context of other federal agencies that, like the CFPB, do not have a statute explicitly protecting disclosure of privileged material.  A review of these decisions provides little comfort to CFPB supervised institutions as courts have reached inconsistent, even contradicting, results in their analysis of whether disclosure of privileged material to a federal agency waives privilege.  In fact, the majority rule articulated in Westinghouse Elec. Corp. v. Republic of the Philippines, 951 F.2d 1414 (3d Cir. 1991), holds that privilege is waived following disclosure of privileged data to federal agencies.

Going Forward

Officer and directors of CFPB supervised institutions need to understand that producing privileged documents to the CFPB could waive the institutions right to later assert privilege as to those documents.  Until the FDIA is amended to include the CFPB as a “Federal banking agency,” entities supervised by the CFPB must take proactive measures to protect the privilege in order to limit the possibility that a future court will deem the disclosure to the CFPB a waiver of privilege.  To respond to a request by the CFPB for materials, we recommend, at a minimum, the following:

1. Immediately consult with your counsel to determine what response, if any, is appropriate in the circumstance;
2. Request a written demand from the CFPB that (i) clearly identifies the privileged material, (ii) clarifies that the institution’s disclosure of the material is not voluntary, and (iii) clarifies that the disclosure is made in the course of the CFPB’s supervisory and examination powers; and

Require the CFPB to certify that it will treat the information confidentially and not disclose the privileged information to third parties without the consent of the supervised institution or a court order compelling the CFPB to produce the material.

 -Height and reach requirements;

-Sufficient perimeter floor space;

-Speech control;

-Braille instructions to initiate voice guidance;

-Input device controls that are tactilely discernible;

-Numeric keypads

-Function key requirements; and

-Display screen and privacy screen requirements.

 ATM owners that are non-compliant on March 15 could face fines.  However, some operators of cash machines are facing unanticipated difficulties making the necessary changes.  Backlog at major ATM manufacturers means that some banks simply can’t meet the deadline despite their efforts.  Financial institutions facing supplier delays should document their efforts to meet the deadline and consult with counsel about how to best deal with the challenges of meeting the 2010 Standards. While structural elements have been grandfathered by the DoJ under safe harbor provisions, auxiliary aids, including voice guidance and Braille instructions, are mandated for every machine, which may mean changes to software and hardware in existing machines is required.  A recent article in the Wall Street Journal cites supplier delays and financial constraints as the top reasons many banks’ ATMs won’t be compliant by March 15.  Financial institutions with older ATM equipment may be faced with the cost of replacing the machines or taking them out of service altogether. 

For more information on the application of the 2010 Standards to ATM machines, please contact one of the attorneys in our Financial Services division.

Any institution which receives a subpoena or other demand for information concerning the existence or content of a SAR should contact FinCEN’s Office of Chief Counsel at (703) 905-3590 and may need to inform its primary federal regulator of the demand.

Companies Required To Register as Commodity Pool Operators

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rule.

SUMMARY: The Commodity Futures Trading Commission is proposing

amendments to its regulations regarding requirements applicable to

investment companies registered under the Investment Company Act of

1940 (“registered investment companies”) whose advisors will be

subject to registration as commodity pool operators due to changes that

the Commission is adopting.

DATES: Comments should be received on or before April 24, 2012.

Interests in, and Relationships With, Hedge Funds and Covered Funds

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

SUMMARY: The Commodity Futures Trading Commission (“CFTC” or

“Commission”) is requesting comment on a proposed rule that would

implement Section 619 of the Dodd-Frank Wall Street Reform and Consumer

Protection Act (“Dodd-Frank Act”) which contains certain prohibitions

and restrictions on the ability of a banking entity and nonbank

financial company supervised by the Board of Governors of the Federal

Reserve System (the “Board”) to engage in proprietary trading and

have certain interests in, or relationships with, a hedge fund or

private equity fund (“CFTC Rule”).

    On November 7, 2011, the Office of the Comptroller of the Currency,

Treasury (“OCC”); the Board; the Federal Deposit Insurance

Corporation (“FDIC”); and the Securities and Exchange Commission

(“SEC”) published a joint proposed rule implementing Section 619 of

the Dodd-Frank Act (the “Joint Release”).\1\ The CFTC is adopting the

entire text of the proposed common rules section from the Joint Release

(the “Joint Rule”) as part of its proposed rule.\2\ Similar to the

OCC, the Board, the FDIC, and the SEC in the Joint Release, the CFTC is

modifying the Joint Rule with CFTC-specific rule text. The CFTC Rule

also contains additional questions specific to the CFTC in Section III

and does not include Subpart E of the Joint Release because Subpart E

deals exclusively with the Board. The Commission solicits comments on

all aspects of this proposed rule.

DATES: Comments should be received on or before April 16, 2012.

Disclosure to Investors in System-wide and Consolidated Bank Debt

Obligations of the Farm Credit System

AGENCY: Farm Credit Administration.

ACTION: Proposed rule.

SUMMARY: The Farm Credit Administration (FCA, us, we, or our) proposes

to amend our regulations related to the Federal Farm Credit Banks

Funding Corporation (Funding Corporation) System Audit Committee (SAC)

and the Farm Credit System (System) annual report to investors. The

proposed rule would remove the provision that a two-thirds majority

vote of the Funding Corporation board of directors be required to deny

a request for resources by the SAC to engage independent legal counsel,

outside advisors or consultants. The proposed rule would instead

require appropriate funding to the SAC to perform these duties,

quarterly reporting by the SAC to the Funding Corporation board on

resources used, and annual reporting to investors.

DATES: Submit comments on or before April 16, 2012.

Defining Larger Participants in Certain Consumer Financial

Product and Service Markets

AGENCY: Bureau of Consumer Financial Protection.

ACTION: Proposed rule; request for public comment.

SUMMARY: The Bureau of Consumer Financial Protection (Bureau) is

proposing a new regulation pursuant to

section 1024 of the Consumer Financial Protection Act of 2010. That

provision grants the Bureau authority to supervise certain nonbank

covered persons for compliance with Federal consumer financial laws and

for other purposes. The Bureau has the authority to supervise nonbank

covered persons of all sizes in the residential mortgage, private

education lending, and payday lending markets. In addition, the Bureau

has the authority to supervise nonbank “larger participant[s]” in

markets for other consumer financial products or services. The Bureau

must define such “larger participants” by rule, and such an initial

rule must be issued by July 21, 2012.

    In this proposal, the Bureau proposes to define larger participants

in the markets for consumer debt collection and consumer reporting. The

Bureau intends that this proposal and subsequent initial rule will be

followed by a series of rulemakings covering additional markets for

consumer financial products and services. The Bureau also proposes to

include provisions in this proposal that will facilitate the

supervision of nonbank covered persons.

DATES: Comments must be received on or before April 17, 2012.