Financial Services Law

Credit Union for Marijuana Industry Sues NCUA, Fed for Master Account

Why it matters

One Colorado credit union is taking matters into its own hands after the Federal Reserve Bank of Kansas City (FRB-KC) and the National Credit Union Association (NCUA) rejected the institution's application for deposit insurance. The Fourth Corner Credit Union, based in Denver, was formed to help marijuana businesses in need of financial services. But when the entity applied for a master account after being granted a license by the state regulator, both the FRB-KC and the NCUA denied the application. In response, the credit union filed suit alleging the NCUA acted arbitrarily and capriciously in violation of Fourth Corner's due process rights. As for the FRB-KC, the plaintiff charged violations of equal access to the payments system as mandated by federal law. "A request for a master account is processed … not decided upon," according to the complaint, and the FRB-KC lacks the discretion to consider the financial institution's customers. The complaints capture the tug-of-war between conflicting federal and state law with regard to marijuana, with financial institutions forced to wait and see who wins.

Detailed discussion

How should the financial services industry address the banking needs of the marijuana industry? The question remains unanswered, even as the number of states that have legalized marijuana continues to rise, to 23, with recreational use decriminalized in four states and Washington, D.C.

As businesses have grown to take advantage of the new market, they have faced an obstacle unique to the industry: a lack of access to financial institutions. Concerned about the reaction of federal regulators to working with marijuana-related businesses, banks have been hesitant to offer accounts or encourage relationships.

Marijuana remains illegal under federal law and banks are prohibited from knowingly providing services to illegal enterprises. In February 2014 the Department of Justice (DOJ) and the Financial Crimes Enforcement Network (FinCEN) released guidance that was ostensibly intended as a primer on how to work with marijuana-related businesses. But the guidance made clear that financial institutions are still required to file Suspicious Activity Reports (SARs) on transactions involving the proceeds of marijuana sales consistent with Bank Secrecy Act (BSA) obligations.

Banks must also keep in mind the "Cole Memo," a memorandum issued by the DOJ's Deputy Attorney General James M. Cole to all U.S. Attorneys on the issue of enforcement of federal anti-marijuana laws in light of growing state acceptance. And the California Bankers Association waded into the debate earlier this month, issuing a statement in support of repealing the criminal status of marijuana. Until then, "marijuana-related businesses engage in criminal activity," the group said, and "cannot be banked."

One credit union decided to take matters into its own hands. The Fourth Corner Credit Union (TFCCU) was founded last year to provide financial services to the marijuana industry, from businesses to employees to vendors. Denver-based TFCCU organized the credit union with an anti-money laundering program in compliance with both the FinCEN guidance and the Cole memorandum and was granted a charter from the Colorado Division of Financial Services (DFS) in July 2014. In August 2014 ACCUITY issued a Routing Number to the credit union.

TFCCU then submitted an application to both NCUA and the FRB-KC for a master account, providing all of the requested documents. Although the FRB-KC notes that processing of such applications may take 5-7 business days, FRB-KC took no action on TFCCU's application for nine months.

Both the NCUA and the FRB-KC denied the applications, with the FRB-KC writing that "[i]ssuance of a master account is within the Reserve Bank's discretion and requires that the Reserve Bank be in a position to clearly identify the risk(s) posed by a financial institution and how that risk can be managed to the satisfaction of the Reserve Bank."

After being rejected, TFCCU sued both the NCUA and the FRB-KC, requesting a declaration that the defendants grant the credit union a master account. The defendants "acted in concert to unlawfully deny TFCCU access to the Federal Reserve payments system," the credit union alleged.

Section 248a(c)(2) of the Monetary Control Act of 1980 requires that "All Federal Reserve Bank services covered by the fee schedule shall be available to nonmember depository institutions and shall be priced at the same fee schedule applicable to member banks." Based on this provision, "[t]he Federal Reserve must allow all depository institutions equal access to the Federal Reserve payment system on nondiscriminatory terms," TFCCU wrote in its complaint against the FRB-KC. "[T]he law prevents FRB-KC's owners from playing a discretionary role in deciding who gets into the monopolistic payments system, and who is kept out."

In order to maintain the nation's dual banking system, all federal and state-chartered depository institutions have equal access to the Federal Reserve payments system on non-discriminatory terms, TFCCU argued, and the denial of access to the payments system violates TFCCU's right to equal access.

"TFCCU seeks to enforce in this declaratory judgment action its federal statutory right, as a fledgling state-chartered credit union, to equal access to the payments system; a right granted by Congress to all depository institutions 35 years ago," according to the complaint against the FRB-KC. "Issues of central bank design were left to Congress. TFCCU seeks to compel FRB-KC to comply with the equal access law to which it is subject. FRB-KC must respect the 153-year-old constitutionally established dual banking system—and honor the structural design of the Federal Reserve System and its various components."

The Tenth Amendment reserved the authority to charter financial institutions to the states, the credit union noted. Once Colorado issued a state charter to TFCCU, "FRB-KC must honor that official state action and allow TFCCU access to the Federal Reserve payments system so it can operate."

According to TFCCU, the processing of a master account "is a routine ministerial act" that does not require the exercise of discretion by FRB-KC, particularly not investigation into possible customers of the financial institution. The Colorado DFS is TFCCU's sole regulator and supervisor, the credit union told the court. Once it granted a charter, FRB-KC lacked the jurisdiction to do anything but approve the application for a master account.

The complaints request a declaration ordering FRB-KC and NCUA to grant TFCCU a master account.

To read the complaint in Fourth Corner Credit Union v. Federal Reserve Bank of Kansas City, click here.

To read the complaint in Fourth Corner Credit Union v. National Credit Union Association, click here.

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Pay-Ratio Rules Are Final—Could Banks Feel the Impact?

Why it matters

In a split vote, the Securities and Exchange Commission (SEC) adopted a final rule requiring public companies to disclose the "pay ratio" between the chief executive officer's (CEO) annual total compensation and the median annual total compensation of all other employees in the company. The controversial rule—the SEC released a proposed version in September 2013 that drew almost 300,000 comments—provides some flexibility to companies, including the allowance of a statistical sample of the total employee population and the ability to identify the median employee once every three years. Companies must disclose the methodology used for identifying the median employee's compensation, and the total compensation for both CEOs and the median employees must be calculated in the same manner. Mandated by Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the pay ratio rule will take effect the first full fiscal year beginning on or after January 1, 2017, meaning disclosures will first appear in 2018. A renewed focus on any perceived "disparity" in CEO pay as compared to pay for others in a public organization will put increased pressure on Boards of Directors and Compensation Committees to justify the rate of CEO pay. For nonpublic institutions, the potential for such disclosures to "trickle down" poses similar risks.

Detailed discussion

When the Dodd-Frank Wall Street Reform and Consumer Protection Act passed in 2010, the statute imposed an obligation on the SEC to establish a rule requiring the disclosure of the ratio of the compensation of CEOs to the median compensation of employees.

Specifically, Section 953(b) directed the SEC to amend Item 402 of Regulation S-K to require companies to disclose the median of the annual total compensation of all employees of the company (except the CEO), the annual total compensation of the CEO, and the ratio of the median annual total compensation of all employees of the company (except the CEO) to the annual total compensation of the CEO, or the pay ratio.

Intended to help inform shareholders when voting on "say on pay," the rule requires disclosure of the pay ratio in registration statement, proxy and information statements, and annual reports where executive compensation is disclosed. Disclosure of pay ratios will begin the first fiscal year beginning on or after January 1, 2017.

Whom does the rule cover? All companies required to provide executive compensation disclosure under Item 402(c)(2)(x) of Regulation S-K must comply, meaning all public companies, with some exceptions, will provide disclosure.

To address concerns about the cost of compliance, the agency said it attempted to provide companies with flexibility about the reporting requirements. Companies are permitted to select the methodology used for identifying the median employee and that employee's compensation, using statistical sampling of the employee population or other "reasonable methods," the SEC said. A cost-of-living adjustment to the compensation measure used to identify the median employee is permissible if the same adjustment is used in calculating the employee's annual total compensation and if the company also discloses the total compensation and pay ratio without the cost-of-living adjustment.

Median employee identification need only occur once every three years (absent a change to the employee population), with a determination date chosen within the last three months of a company's fiscal year. The company should include all employees—in the United States and beyond the borders, full-time and part-time, temporary and seasonal—it and its consolidated subsidiaries have on payroll.

Accompanying the disclosure should be a brief statement describing the methodology used to identify the median employee as well as any material assumptions, adjustments, or estimates used.

Some exemptions apply. Non-U.S. employees from countries where data privacy laws prohibit such information sharing are exempt from the rule, while certain types of reporting companies (such as registered investment companies, smaller reporting companies, emerging growth companies) do not need to comply. Transition periods are also provided under the rule for new companies or a smaller reporting company that grows, for example. And pay-ratio information does not need to be disclosed in reports that do not require executive compensation information, such as quarterly reports.

Each of the Commissioners filed a statement with the release of the pay-ratio disclosure rule. While Luis A. Aguilar praised the new rule as "another step to fulfill its congressional mandate to provide better disclosure for investors regarding executive compensation at public companies," Commissioner Daniel M. Gallagher disagreed. The SEC adopted "a nakedly political rule that hijacks the SEC's disclosure regime to once again effect social change desired by ideologues and special interest groups," he said, and unlawfully compelled corporate speech.

To read the SEC's Final Rule, click here. We will be providing more detailed analysis of the pay-ratio rules in the coming weeks.

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CFPB Reaches Out to Offshore Payday Lenders With Federal Complaint

Why it matters

The Consumer Financial Protection Bureau (CFPB) filed a new complaint against several commonly owned payday lenders, alleging that the defendants engaged in unfair, deceptive, and abusive acts and practices in violation of the Dodd-Frank Wall Street and Consumer Protection Act. A "complex web of commonly controlled companies"—based in Canada and Malta—engaged in a host of unlawful practices, the Bureau said, including the collection of loan amounts and fees that were void (i.e., that consumers had no obligation to pay), making false representations about the nonpayment of debt (e.g., threatening lawsuits, arrests, or wage garnishment), and the use of unlawful wage-assignment clauses in loan agreements purporting to allow the defendants to take payments directly from employers' payroll accounts. The CFPB's complaint seeks restitution, refunds, and an injunction against future illegal acts. Of the Bureau's reach beyond the borders of the United States, CFPB Director Richard Cordray said in a statement that "[c]ompanies making loans within the U.S. have to comply with federal law, and the Consumer Bureau will work to ensure that American consumers receive the protections and fair treatment they deserve."

Detailed discussion

NDG Enterprise based its operations in Canada and Mexico but offered payday loans over the Internet to consumers in all 50 states. The ten corporations named as defendants in the CFPB's complaint engaged in numerous unlawful activities, the agency alleged, most notably the collection of money not owed by consumers, since at least July 2011.

The loans themselves typically lasted 14 days and ranged from $100 to $1,500, with finance charges of between $19.98 and $26.98 per $100 borrowed, the CFPB said. The high interest rates made the loans illegal pursuant to many state usury laws and the collection of payments therefore unlawful. The defendants also lacked the necessary licensure to offer loans, in violation of dozens of state laws.

Specifically, the New York federal court complaint charges the defendants with violating the Credit Practices Rule and the Dodd-Frank Wall Street Reform and Consumer Protection Act's prohibition on unfair, deceptive, and abusive acts and practices in three ways.

First, the defendants deceived consumers about their debts. The NDG Enterprise defendants told consumers they were obligated to repay loan amounts and fees they did not actually owe under state law, the Bureau said.

Second, the defendants made false threats to consumers of arrest, imprisonment, lawsuits, or wage garnishment if they failed to pay their debt. The defendants lacked the legal authority to take such actions as well as the intent, the CFPB alleged.

Finally, the NDG entities made use of illegal wage-assignment clauses. According to the Bureau, the defendants placed irrevocable provisions in loan agreements that allowed them to directly withdraw payments from the employer payroll accounts of consumer borrowers.

To remedy the violations, the CFPB requested monetary damages and relief from the defendants, requesting that the court order NDG to refund money taken from consumers where the loans were void or no obligations existed requiring repayment. In addition, the complaint seeks an order prohibiting future violations of federal consumer laws and adherence to prohibitions on unfair, deceptive, and abusive acts and practices.

To read the complaint in CFPB v. NDG Financial Corp., click here.

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SEC: It Doesn't Matter Where You Blow the Whistle

Why it matters

In a new rule interpretation, the Securities and Exchange Commission (SEC) declared that whistleblowers that report allegedly unlawful activity internally are entitled to the same protections as those who report to the agency. Likely triggered by a decision from the Fifth Circuit Court of Appeals reaching the opposite conclusion, the agency acknowledged that the rules relating to whistleblower protections can be confusing. "Although we appreciate that if read in isolation Rule 21F-9(a) could be construed to require that an individual must report to the Commission before he or she will qualify … that construction is not consistent with Rule 21F-2 and would undermine our overall goals in implementing the whistleblower program," the agency wrote. In the Fifth Circuit case, Khaled Asadi contended that although he never reported his company to the SEC, he was protected by a Dodd-Frank Wall Street Reform and Consumer Protection Act provision for those who make "required or protected" disclosures under SOX. The panel disagreed in Asadi v. GE Energy. In what appears to be an attempt to limit the Fifth Circuit's decision from spreading to other jurisdictions, the SEC issued the new interpretation to make its position clear: whistleblowers who report alleged wrongdoing internally or to agencies other than the SEC are still entitled to anti-retaliation protections.

Detailed discussion

The SEC wants to make something very clear: a whistleblower is still protected by the anti-retaliation provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act no matter where he or she first reports alleged wrongdoing.

"[F]or purposes of the employment retaliation protections provided by Section 21F of the Securities Exchange Act of 1934, an individual's status as a whistleblower does not depend on adherence to the reporting procedures specified in Exchange Act Rule 21F-9(a), but is determined solely by the terms of Exchange Act Rule 21F-2(b)(1)," according to the agency's new rule interpretation. "[A]n individual may qualify as a whistleblower for purposes of Section 21F's employment retaliation protections irrespective of whether he or she has adhered to the reporting procedures specified in Rule 21F-9(a). Rule 21F-2(b)(1) alone governs the procedures that an individual must follow to qualify as a whistleblower eligible for Section 21F's employment retaliation protections."

The problem arose because of the two-pronged definition of "whistleblower" found in the Dodd-Frank Act. The statute amended the Exchange Act with the addition of Section 21F, which established a series of new incentives and protections for individuals to report possible violations of the federal securities laws.

Lawmakers utilized a broad catchall provision at Section 21F(h)(1)(A) prohibiting an employer from (among other things) retaliating against a whistleblower for "making disclosures that are required or protected under" the Sarbanes-Oxley Act, the Exchange Act, or other laws, rules, or regulations of the Commission. But the statute also defined a whistleblower in Section 21F(a)(6) as "any individual who provides … information relating to a violation of the securities law to the Commission," leading some to argue that the anti-retaliation protections were limited to those whistleblowers who reported to the SEC.

The SEC promulgated two separate definitions of whistleblower in its rules to implement the program, each with its own specified reporting procedures. First, Rule 21F-2(a) provides that an individual is a whistleblower "if, alone or jointly with others, [the individual] provide[s] the Commission with information pursuant to the procedures in [Rule] 21F-9(a)." This definition applies only to the award and confidentiality provisions of Section 21F, the SEC said.

Found in Rule 21F-2(b)(1), the second definition specifies that "[f]or purposes of the anti-retaliation protections afforded by Section 21F(h)(1) of the Exchange Act … [an individual is] a whistleblower if … [the individual] provide[d] that information in a manner described in 21F(h)(1)(A) of the Exchange Act." This definition does not require reporting in accordance with Rule 21F-9(a)'s procedures.

Since adoption of these rules, the agency has "consistently" understood Rule 21F-9(a) as "a procedural rule that applies only to help determine an individual's status as a whistleblower for purposes of Section 21F's award and confidentiality provisions," the SEC wrote. "Similarly, it has been our consistent view that Rule 21F-2(b)(1) alone controls the reporting methods that will qualify an individual as a whistleblower for the retaliation protections."

However, the Fifth Circuit Court of Appeals reached a contrary decision, dismissing a suit brought by Khaled Asadi against GE Energy. Asadi believed he had uncovered company conduct that violated the Foreign Corrupt Practices Act and reported the issue to his supervisor and the GE ombudsperson. But according to Asadi, he then received a "surprisingly negative" performance review and received pressure to step down from his position. He was terminated one year later.

Asadi filed suit pursuant to the whistleblower protection provision of Dodd-Frank, and GE moved to dismiss the suit. Because Asadi did not report his concerns to the SEC, he did not meet the statutory definition of a "whistleblower," the company argued. The Fifth Circuit agreed.

"[T]he plain language of the Dodd-Frank whistleblower-protection provision creates a private cause of action only for individuals who provide information relating to a violation of the securities laws to the SEC," the three-judge panel wrote. "Because Asadi failed to do so, his whistleblower-protection claim fails."

In response, the SEC sought to make its position even more clear with the new rule interpretation. "Although we appreciate that if read in isolation Rule 21F-9(a) could be construed to require that an individual must report to the Commission before he or she will qualify as a whistleblower eligible for the employment retaliation protections provided by Section 21F, that construction is not consistent with Rule 21F-2 and would undermine our overall goals in implementing the whistleblower program."

Rule 21F-2(b)(1) makes clear that an individual is entitled to the anti-retaliation protections whenever he or she makes any of the broader array of disclosures specified in Section 21F(h)(1)(A), the agency wrote, and the existence of separate procedures to recover an award demonstrates that the availability of employment retaliation protection is not conditioned on adherence to the Rule 21F-9(a) procedures.

Most importantly, "our interpretation best comports with our overall goals in implementing the whistleblower program," the SEC explained. "Specifically, by providing employment retaliation protections for individuals who report internally first to a supervisor, compliance official, or other person working for the company that has authority to investigate, discover, or terminate misconduct, our interpretive rule avoids a two-tiered structure of employment retaliation protection that might discourage some individuals from first reporting internally in appropriate circumstances and, thus, jeopardize the investor-protection and law-enforcement benefits that can result from internal reporting."

Providing equivalent employment retaliation protection for all types of reporting removes a potentially serious disincentive to internal reporting, the agency said, and an individual who reports internally and suffers employment retaliation should be no less protected than an individual who comes immediately to the Commission.

To read the Fifth Circuit's opinion in Asadi v. GE Energy, click here.

To read the SEC's rule interpretation, click here.

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