Financial Services Law

California’s DBO Targets Payday Lenders, With a Little Help From Search Engines

Why it matters

At the intersection of Hollywood and Silicon Valley, the California Department of Business Oversight (DBO) announced a new initiative focused on the advertising of payday lenders. According to DBO Commissioner Jan Lynn Owen, unlicensed online payday lenders are “one of the most significant consumer protection threats” in the state, leading her office to work with major search engines—such as Google, Microsoft, and Yahoo—to limit the lenders’ online advertising. The DBO—which handled 15 enforcement actions against unlicensed payday lenders in 2014, including one lender that charged a 2,230 percent annual percentage rate—will identify an unlicensed lender and issue a cease and desist order. When the order becomes final, the DBO will reach out to the search engines, which will “take quick action” to block the lenders’ ads. The regulator is also working with the search engine providers “to optimize search results so its enforcement actions against payday lenders are displayed prominently and in a way that can be easily identified by consumers.” While many regulators have targeted online payday lenders—from the Federal Trade Commission to the Consumer Financial Protection Bureau to New York’s Department of Financial Services, the California DBO’s efforts to combat online advertising provide a new twist in enforcement activity.

Detailed discussion

The California Department of Business Oversight (DBO) announced a new way to tackle the problem of unlicensed, online payday lenders: eliminate their advertising.

“Unlicensed payday lenders who operate online rank as one of the most significant consumer protection threats the DBO fights,” DBO Commissioner Jan Lynn Owen said in a statement. To “protect borrowers from paying excessive fees and getting trapped in a debt spiral,” her office announced a new initiative in coordination with Google and Microsoft.

Under the program, the DBO will identify an unlicensed online payday lender and issue a cease and desist order. When the order becomes final, the DBO will notify designated individuals at Microsoft and Google (Yahoo is covered in the program because Microsoft’s Bing controls Yahoo’s search pages). If the search engines find that the lenders are advertising on their pages, the ads will be blocked.

The DBO has already provided both Google and Microsoft with a list of unlicensed lenders that have previously been the subject of enforcement actions. Based on that information, the search engines have already blocked the ads of 39 unlicensed lenders.

In addition to the reactive ad blocking, the DBO is working with the search engines to proactively warn consumers about certain lenders. For example, the parties are exploring “ways to optimize search results so [DBO] enforcement actions against payday lenders are displayed prominently and in a way that can be easily identified by consumers.”

The DBO noted that in 2014, the agency took 18 enforcement actions against payday lenders, 15 of which were against unlicensed online lenders. Some of the actions challenged loan fees (although state law caps payday loan fees, the DBO found one lender that charged an annual percentage rate of 2,230 percent) while other lenders made loans in excess of the $300 statutory limit.

“Nobody is pretending that this is not an extremely difficult fight,” DBO spokesman Tom Dresslar told the Los Angeles Times. “But if we can shut down the advertising, it’s a step in the right direction.”

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FDIC Receivership Precludes Shareholder Suit Against Failed Bank

Why it matters

A shareholder suit against a bank holding company and its directors and officers was precluded by the Federal Deposit Insurance Corporation’s (FDIC) receivership of the underlying failed bank, the Tenth Circuit Court of Appeals has ruled. A class of bank holding company shareholders sued after the Utah-based Barnes Banking Company collapsed in 2010, allegedly due to risky lending practices. Although the federal appellate panel was not immune to the position of the plaintiffs—noting that the allegations provided evidence of a pattern of financial recklessness—the court affirmed dismissal of the suit based on the principal that claims against the holding company represent derivative injuries to the Bank, and claims of a shareholder against a bank and assets of the bank belong to the FDIC as receiving under Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA). Accordingly, shareholders seeking to look through the corporate veil of a failed bank to get to the holding company will face a formidable task in any effort to obtain recovery apart from the efforts of the FDIC.

Detailed discussion

In January 2010, the Barnes Banking Company closed and the Federal Deposit Insurance Corporation (FDIC) was appointed as receiver. Two years later, three different shareholders filed derivative suits against the bank’s holding company, Barnes Bancorporation and its officers and directors.

Each of the complaints alleged the bank ran aground due to risky lending practices and that the officers and directors breached their fiduciary duty. As required by Utah law, a demand letter accompanying the complaints described the holding company as having a single asset: the bank.

The FDIC filed a motion to intervene in the state court suit, arguing that it possessed the exclusive statutory authority under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) to assert the derivative claims at issue. When the state court granted the FDIC’s motion, the agency removed the case to federal court.

Fighting the FDIC’s involvement in the case, the plaintiffs tried to move the case back to state court and moved to dismiss the FDIC from the litigation for failure to state a claim. Both motions were denied and a federal district court judge granted the FDIC’s motion to dismiss, albeit with room to amend.

The shareholders responded with a second amended complaint trying to refocus their allegations from harm at the bank level to mismanagement at the holding company, claiming that the bank’s management should have been removed and replaced, for example, and that the holding company improperly issued dividends. An additional claim that the holding company misused $265,000 to pay for an insurance policy for the directors and officers was also added.

On the FDIC’s second motion to dismiss, the district court not only granted the motion but also did so without leave to amend. The plaintiffs appealed.

Agreeing with the district court, the Tenth Circuit Court of Appeals affirmed dismissal. “Because almost all of the plaintiffs’ claims assert injury to the Holding Company that is derivative of harm to the Bank, those claims belong to the FDIC,” the panel wrote. The one claim advanced by the plaintiffs not owned by the FDIC—that the bank directors and officers misappropriated $265,000—lacked sufficient details to survive the motion, the court added.

First, the panel reviewed whether the federal courts had proper jurisdiction over the dispute. The crisis to the United States banking system in the 1980s and subsequent passage of FIRREA, which provides that all suits to which the FDIC is a party shall be deemed to arise under federal law, pointed the way.

The shareholders’ argument that the FDIC never filed a pleading—just a motion to intervene—and was therefore never a party to the case failed to sway the panel. A majority of courts to consider the issue have excused the failure to file a pleading in some circumstances, the court said, and the FDIC successfully intervened before it removed the case.

Treating an intervening entity as a party even without requiring them to file a pleading “is consonant with the Federal Rules,” the court said, as defendants who have not filed pleadings in response to a complaint are still referred to by the Rules as “parties.” Further, “allowing the FDIC to intervene and remove the case is consistent with Congress’ purpose in enacting FIREEA: providing the FDIC a federal forum.”

That settled, the court turned to the merits of the dispute.

FIRREA grants the FDIC “all rights, titles, powers, and privileges of the [bank], and of any stockholder . . . of such [bank] with respect to the [bank] and the assets of the [bank],” so that when the FDIC became Barnes’ receiver, FIRREA gave the FDIC all rights that the holding company, a stockholder of the bank, possessed with respect to the bank and its assets.

Lacking guidance in the Tenth Circuit on whether FIRREA applied to a situation where a suit for breach of fiduciary duty was brought against a bank holding company’s officers after a subsidiary bank has gone into FDIC receivership, the panel turned to decisions from the Fourth and Seventh Circuits, as well as an unpublished opinion from the Eleventh Circuit.

In each of those cases, the courts found the FDIC’s receivership trumped the plaintiffs’ claims. “If the Holding Company’s claims are based on harm derivative of injuries to the Bank, then they qualify as claims of a shareholder ‘with respect to the [bank] and the assets of the [bank]’ and belong to the FDIC,” the panel wrote.

Under Utah law, derivative suits are defined as “those which seek to enforce any right which belongs to the corporation,” the court explained. Other than the claim regarding the $265,000 allegedly misused by the defendants, the shareholders “do not allege any harm to the Holding Company that is distinct and separate from the harm to the Bank.”

For example, the claim that the defendants made improper dividend payments to the Holding Company’s shareholders could not be distinguished, the court said, because “even if the plaintiffs could show that dividend payments weakened the Holding Company’s finances, this weakening would not have injured plaintiffs absent the Bank’s failure,” and the payments “thus did not cause any independent harm, but rather resulted in injury because of the Bank’s failure.”

“Plaintiffs allege that mismanagement by the defendants harmed the Bank and in turn the Holding Company,” the panel said. “They have attempted to carefully plead their claims, alleging that the defendants breached their duties to the Holding Company by failing to protect the Holding Company from mismanagement—by these same defendants—at the Bank level. But plaintiffs nonetheless seek redress for injuries that first befell the Bank, and reached the Holding Company only derivatively as a result of its ownership interest in the Bank. Under Utah law, such claims are decidedly derivative in nature.”

The result was also consistent with the requirement that shareholders not circumvent the interests of creditors and the FDIC, the court added.

“Ultimately, even though plaintiffs in this case may not have been to blame for the losses incurred, they did fail to prevent the officers and directors from incurring the losses at issue,” the panel wrote. “After the Bank had run aground, these plaintiffs then brought suit to recover their losses. However, the Bank’s failure imposed losses not only on sophisticated parties like plaintiffs, who had the ability to inspect the Bank’s records, but also on ordinary depositors, whom the FDIC is obliged to make whole.”

The fact that the FDIC may ultimately elect not to pursue litigation against the defendants does not entitle the plaintiffs to pursue it, the court noted.

A final claim that the defendants wasted $265,000 in company funds on insurance premiums for the directors and officers and “potential business opportunities” could not save the suit. Although the FDIC asserted no claim to the funds, the plaintiffs failed to plead sufficient facts to explain how these “common expenditures would constitute an actionable wrong.”

“We are not unmoved by the frustration that plaintiffs express as they describe the collapse of the Barnes Banking Company,” the panel concluded, refusing to permit the plaintiffs to file a third amended complaint. “And our decision should not be read as evincing approbation of the conduct allegedly engaged in by its officers and directors, much less the larger pattern of misconduct exemplified by those alleged actions. The allegations demonstrate a pattern which, when repeated in many instances, inflicted severe injury on our financial system and on the many families whose livelihoods were dependent on that system.

“But, we uphold the district court’s order because we recognize the broad scope of authority afforded the FDIC in dealing with the aftermath of just such a bank failure. Bank holding company shareholders, concerned about the potential collapse of a bank, must employ their powers as shareholders to stave off a bank collapse. When they fail to do so, they cannot then get underfoot and attempt to advance claims which are inconsistent and interfere with the cleanup efforts properly delegated by Congress to the FDIC.”

To read the opinion in Barnes v. Harris, click here.

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New Delaware Law Promises “Prompt, Cost-Effective, and Efficient” Arbitration for Business Disputes

Why it matters

In a hurry? A new law in Delaware could impact businesses and financial institutions across the country by establishing a streamlined arbitration process for the “prompt, cost-effective, and efficient” resolution of business disputes. The Delaware Rapid Arbitration Act was signed into law by Governor Jack Markell in April and will take effect May 4. The new process is completely voluntary and all parties must explicitly agree to arbitration under the Act with Delaware law governing the agreement. The statute is limited to disputes between business entities and not available to resolve consumer disputes. In addition, the Act does not restrict disputing parties from utilizing other forms of dispute resolution. Pursuant to the new law, arbitrators are endowed with the authority to make interim rulings and issue interim orders; to speed up the process, neither can be challenged. Arbitrators can also administer oaths, compel attendance of witnesses or document production, issue subpoenas, and even impose sanctions. To ensure a timely outcome in line with the Act’s goals, arbitrators must issue a final award within 120 days of the acceptance of his or her appointment to the dispute, with the power to grant whatever legal or equitable relief deemed appropriate, absent limitations in the parties’ agreement. The speed of resolution (with financial penalties for arbitrator awards that run late), limited review options, and exclusive arbitrator jurisdiction over issues related to arbitrability may appeal to business entities looking for a quick, private, and inexpensive dispute resolution.

Detailed discussion

Beginning May 4, 2015, businesses and financial institutions will have the opportunity to take part in Delaware’s new high-speed arbitration process. As the legislation itself states, the “purpose of the Delaware Rapid Arbitration Act is to give Delaware business entities a method by which they may resolve business disputes in a prompt, cost-effective, and efficient manner, through voluntary arbitration conducted by expert arbitrators, and to ensure rapid resolution of those business disputes.”

To take advantage of the Delaware Rapid Arbitration Act (DRAA), at least one of the parties must be a business entity formed in Delaware or have its principal place of business in the state (only business entities are allowed to partake of the new law, which does not apply to consumer disputes). All parties must explicitly agree to arbitration under the DRAA, with Delaware law governing the process.

To begin the process, parties will agree in writing to submit to arbitration under the DRAA. The parties have options for selecting an arbitrator, with the law permitting a specific individual to be designated by the parties, allowing the agreement between the parties to set forth a selection process, or having the Delaware Court of Chancery appoint an arbitrator.

The selected arbitrator is invested with a host of powers to keep the process streamlined and fast-paced. Issues related to substantive and procedural arbitrability are decided by the arbitrator (not the courts) and arbitrators are endowed with the ability to make interim rulings and issue interim orders with regard to evidence and witnesses, decisions which cannot be appealed.

A hearing at which the parties may present evidence and cross-examine witnesses is included in the DRAA process unless the parties agree otherwise. Arbitrators have the authority to compel witnesses and the production of evidence and documents, to issue subpoenas, and administer oaths. Rulings, orders, and even the imposition of sanctions are also within the arbitrator’s purview.

Arbitrators have 120 days from acceptance of the appointment over a case to issue a final award. The DRAA does permit extensions with the unanimous consent of parties, but no more than 60 days after the expiration of the original deadline. To encourage timeliness, the Act provides for financial penalties imposed on an arbitrator who can’t issue a decision within the set period (a 25 percent reduction in the arbitrator’s fee if the final award is less than 30 days late; a 75 percent reduction if the final award comes between 30 and 60 days late; and a complete loss of fees if the award is more than 60 days late).

The relief ordered by an arbitrator can be legal or equitable in nature—including money damages, injunctions, and specific performance—unless the parties have placed limitations in their agreement. An appeal of the arbitrator’s award is limited to a single direct challenge to the Delaware Supreme Court within 15 days. An appeal to the court is public and subject to review under the standards of the Federal Arbitration Act. The parties may agree to waive appellate review in their agreement or provide for a review by another arbitrator.

To read the Delaware Rapid Arbitration Act, click here.

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CFPB: Military Allotment Processor to Pay More Than $3M

Why it matters

A military allotment processor will pay $3.065 million for charging servicemembers millions of dollars in hidden, recurring fees, the Consumer Financial Protection Bureau (CFPB) has announced. Fort Knox National and a subsidiary failed to disclose fees tacked onto allotment payments, which allow direct deductions from military paychecks to send money home or pay creditors, the Bureau alleged. Over a four-year-period, the companies added a $5 fee to send letters to servicemembers if a residual balance remained in the account, the CFPB said, or charged $12 to $20 for an account with a positive balance that remained idle for more than six months. Compounding the problem: servicemembers did not receive monthly statements or acknowledgements about the fees, leaving the charges—which were made on top of monthly maintenance fees of $3 to $5—a mystery to most military members, the Bureau said. A consent order with the companies requires a $3.065 million payment for restitution, with affected servicemembers estimated to receive about $100 each. In a press release about the action, CFPB Director Richard Cordray cautioned that “others should take note.” This enforcement action underscores the continuing efforts by the CFPB to protect servicemembers.

Detailed discussion

From approximately 2010 to 2014, Fort Knox National Company and its subsidiary, Military Assistance Company (MAC), charged servicemembers millions of hidden, recurring fees that were not clearly disclosed, the Consumer Financial Protection Bureau (CFPB) charged in a new enforcement action.

The Kentucky-based company was one of the nation’s largest third-party processors of military allotments, the Bureau said. The military allotment system was created to help servicemembers deployed overseas send money home to their families as well as pay creditors prior to the advent of electronic transfers. Military members can deduct payments directly from their earnings through the system.

MAC set up its system so that servicemembers created an allotment that transferred a specific amount of their earnings into a MAC-controlled bank account. To have MAC make a payment to a creditor—such as an auto lender or retail merchant—servicemembers were charged between $3 and $5. Residual balances remained in the account, sometimes when a servicemember paid off a debt in full but had yet to stop the automatic deductions.

These residual balances were “slowly drained” by MAC, the CFPB alleged, with recurring, undisclosed fees—an unfair, deceptive, or abusive act in violation of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Fort Knox and MAC failed to provide clear disclosures that the fees would be deducted, the circumstances under which they would be incurred, and the amount of the fees, the Bureau added.

The fees themselves ranged from $5 for MAC to send a letter to a servicemember that a residual balance remained in an account to a $5 fee to send a letter to a current or past creditor of a servicemember to a recurring $12 to $20 fee if an account with a positive balance remained idle for more than six months.

Servicemembers remained in the dark about the fees, the Bureau said. Military members were not informed when fees were charged, the fees were not listed as part of a customer’s online account information with MAC, and neither the bank holding the funds nor MAC provided monthly statements for the account.

To settle the charges, Fort Knox—which began winding down MAC’s allotment business in 2014—agreed to provide $3.065 million for servicemembers. The Bureau said it will contact eligible servicemembers, estimating that individuals will receive approximately $100 each.

To read the consent order in In the Matter of Fort Knox National Company, click here.

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