Financial Services Law

Georgia Supreme Court: Business Judgment Rule Valid, But Bank Officers Can Still Be Liable

In the context of Federal Deposit Insurance Corporation (FDIC) litigation against the former directors and officers of a failed bank, the Georgia Supreme Court has upheld the validity of the business judgment rule in the state – while leaving the door open for some negligence claims.

Answering a certified question from a federal district court, Georgia’s highest court determined that the business judgment rule is enshrined in state case law dating back to 1913 and has not been overruled by state statute. However, the court held that negligence claims alleging that decisions were made without deliberation or the requisite due diligence, or in bad faith, could be actionable.

The case involved nine former directors and officers of the failed Buckhead Community Bank. As receiver, the FDIC brought suit alleging the defendants were negligent with respect to the making of loans resulting in almost $22 million in losses.

Relying on the business judgment rule’s protection from liability for ordinary negligence, the officers moved to dismiss the suit. The FDIC countered that the rule was not a part of Georgia common law and even if it were, it would not apply to bank directors and officers who have a statutory duty in the state to exercise ordinary diligence and care.

Uncertain about the application of the rule in light of the statute, the federal court judge certified a question to the Georgia Supreme Court: “Does the business judgment rule in Georgia preclude as a matter of law a claim for ordinary negligence against the officers and directors of a bank in a lawsuit brought by the FDIC as receiver for the bank?”

With “an important qualification,” the court answered in the negative.

The unanimous court found “an implicit acknowledgement” of the business judgment rule in a number of prior decisions. But the court emphasized that case law “distinguished between claims of unreasoned and uninformed decisions and claims of unreasonable decisions. That is, we distinguished between cases in which a business decision was assailed for the way in which it was made – that the decision amounted to unthinking acquiescence, for instance, or was made without reasonable diligence to ascertain the relevant facts – and those in which the merit alone of the decision was disputed.” In other words, disputes about the wisdom of a business judgment “require something more than a mere want of ordinary care to establish liability,” but whether a business decision was in fact an exercise of judgment – “a product of deliberation, reasonably informed by due diligence, and made in good faith” – is open to judicial scrutiny.

A Georgia statute setting forth requirements for bank officers and directors did not supersede the common law business judgment rule, the court added.

The statute reads in part: “Directors and officers of a bank or trust company shall discharge the duties of their respective positions in good faith and with that diligence, care, and skill which ordinarily prudent men would exercise under similar circumstances in like positions. … A director or officer who so performs his duties shall have no liability by reason of being or having been a director or officer of the bank or trust company.”

Based on a review of statutory history and the underlying objective to allow financial institutions to exercise their business judgment, the statute should be understood as consistent with the common law, the court said.

“[T]hese provisions imply strongly that, if an officer or director fails to act in good faith or with such ordinary care, he is subject to liability,” the court wrote. “But taken in its legal context, the statutory reference to ordinary ‘diligence, care, and skill’ is most reasonably understood to refer to the care required with respect to the process by which a decision is made, most notably the diligence due to ascertain the relevant facts. So understood, the implication of liability means only that an officer or director who acts in bad faith or fails to exercise such ordinary care with respect to the process for making a decision is liable.”

The court rejected the defendants’ attempt to recognize a business judgment rule that would preclude all claims against officers and directors, settling on “a more modest business judgment rule.” Allowing some claims against bank officers and directors will not deter bank management from taking risks, the court said, underestimating the strength of the business judgment rule.

“[B]ank officers and directors are only expected to exercise the same diligence and care as would be exercised by ‘ordinarily prudent’ officers and directors of a similarly situated bank,” the court explained. Pursuant to the business judgment rule, a presumption exists that the officers and directors have acted in good faith and exercised ordinary care. “Although this presumption may be rebutted, the plaintiff bears the burden of putting forward proof sufficient to rebut it,” the court said. “All together, the limited standard of care, the conclusive presumptions as to reasonable reliance, and the rebuttable presumptions of good faith and ordinary care offer meaningful protection, we think, to officers and directors who serve in good faith and with due care.”

While the rule does not insulate “mere dummies or figureheads” from liability, it was never intended to, the court added. “[T]he business judgment rule precludes some, but not all claims, against bank officers and directors that sound in ordinary negligence,” the court concluded. “With that qualification, we answer the certified question in the negative.”

To read the court’s opinion in Federal Deposit Insurance Corporation v. Loudermilk, click here.

Why it matters: Courts have been faced with this issue in the wake of the financial crisis and FDIC suits against former directors and officers of failed banks. The Loudermilk decision presents a reasoned approach for Georgia, whose law, unlike California’s, specifically protects officers and directors. While the court declined to adopt the defendants’ more expansive interpretation of the law that would preclude all claims based on ordinary negligence, it did recognize that the protections of the business judgment rule generally apply to bank officers and directors who diligently inquire, engage and deliberate in a reasoned fashion. The wisdom of decisions taken with appropriate diligence and process will not be questioned by the courts.

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Payday Lender Settles With CFPB For $10 Million

Texas-based ACE Cash Express will pay a total of $10 million to settle an enforcement action brought by the Consumer Financial Protection Bureau (CFPB), predicated upon a finding by the CFPB that ACE had engaged in unfair, deceptive, and abusive practices in connection with its collection of payday loans in violation of the Dodd-Frank Wall Street Reform and Consumer Financial Protection Act of 2010 (Dodd-Frank).

One of the nation’s largest payday lenders, ACE operated a “culture of coercion,” CFPB director Richard Cordray said in a statement, which “drained millions of dollars from cash-strapped consumers who had few options to fight back.” Online or at one of approximately 1,500 retail storefronts located in 36 states and the District of Columbia, the company offers payday loans, check-cashing services, title loans, installment loans, and other financial products and services.

The agency alleged that the payday lender “pushed borrowers into a cycle of debt” using illegal debt collection tactics such as harassment by making an excessive number of calls and in some cases, calling employers or relatives of borrowers and sharing details about the debt. Despite the fact that ACE did not actually sue consumers, collectors used legal jargon and threatened lawsuits as well as extra fees, according to the CFPB.

Collection agents – both third-party and ACE employees – pressured borrowers into taking out additional loans by creating a “false sense of urgency,” the CFPB said, encouraging borrowers to pay off an existing loan and then quickly take out a new loan, incurring more fees.

ACE even used a graphic in its 2011 training manual to illustrate the cycle of debt, the agency said. First, ACE approves a loan; if the consumer exhausts the cash and cannot repay, ACE offers the option to refinance or extend the loan; when the consumer fails to make a payment and the loan enters collections, the cycle renews with the borrower applying for another payday loan.

ACE’s actions constituted unfair, deceptive, and abusive practices, the CFPB said.

In addition to the $10 million – $5 million of which will go to borrowers as refunds with the other $5 million a penalty to be paid to the agency – ACE agreed to change its practices. Collectors will no longer (i) pressure delinquent borrowers to pay off a loan and then quickly take out a new one; (ii) disclose debts to unauthorized third parties; (iii) directly contact consumers who are represented by an attorney; or (iv) falsely threaten to sue a consumer, report him to the credit bureau, or charge collection fees.

The enforcement action came as a result of an examination of ACE conducted by the CFPB in coordination with the Texas Office of Consumer Credit Commissioner.

ACE also issued its own press release about the settlement, which shed additional light on the case.

The company said it retained an outside independent financial expert in response to the CFPB investigation. After reviewing a statistically significant, random sample of ACE collection calls, the expert found that more than 96 percent of the calls during the period met relevant collection standards. A study of company data from March 2011 through February 2012 revealed that 99.5 percent of customers with a loan in collections for more than 90 days did not take out a new loan with ACE within two days of paying off their existing loan, the company added, and 99.1 percent of customers did not take out a new loan within 14 days of paying off their existing loan.

“We settled this matter in order to focus on serving our customers and providing the products and services they count on,” ACE’s CEO Jay B. Shipowitz said in the release.

To read the consent order in In the Matter of ACE Cash Express, click here.

To read ACE’s press release, click here.

Why it matters: On a call to discuss the consent order, Director Cordray said the agency remains “concerned that short-term payday loans can turn into long-term debt traps that leave consumers worse off,” citing the CFPB’s study on payday loans released earlier this year. The action against ACE reiterates the CFPB’s focus on – and limited patience for – payday lenders. In addition, the CFPB used its UDAAP authority under Dodd-Frank to effectively subject ACE, a first-party debt collector, to the requirements of the Fair Debt Collection Practices Act, even though the FDCPA excludes parties collecting on their own debts from the definition of “debt collectors.”

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Citigroup To Pay $7 Billion To Settle Mortgage Claims

To settle charges related to the packaging, marketing, sale, and issuance of residential mortgage-backed securities (RMBS), Citigroup will pay a total of $7 billion, including a record $4 billion fine to the Department of Justice (DOJ).

The deal was reached after months of negotiations – Citi’s first offer to settle was reportedly $363 million, a fraction of the final total – between the bank and the RMBS Working Group, a division of the Financial Fraud Enforcement Task Force consisting of state and federal authorities and financial regulators, and reported preparation by the DOJ to file a civil suit if a satisfactory settlement was not reached.

According to the settlement’s statement of facts, Citigroup securitized and sold RMBS with underlying mortgage loans that it knew had material defects between 2003 and 2008. Citi employees had knowledge that “significant percentages” of the loans reviewed in due diligence had material defects and yet the company securitized the loan pools with the defective loans and sold the resulting RMBS to investors for billions of dollars.

The DOJ highlighted internal company e-mails that documented both awareness of the problem and a failure to heed warnings. In one message, a trader wrote that he “went thru Diligence Reports and think that we should start praying … I would not be surprised if half of these loans went down,” adding, “It’s amazing that some of these loans were closed at all.”

The consent decree with the DOJ includes a record-setting $4 billion penalty based on the agency’s allegations that Citi violated the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) as well as $208.25 million to the Federal Deposit Insurance Corporation (FDIC) for securities claims. Five states will also receive funds: Citi agreed to pay $102.7 million to California, $92 million to New York, $45.7 million to Massachusetts, $44 million to Illinois, and $7.35 to Delaware.

The remaining $2.5 billion was promised to consumers. Citi will modify loan terms for struggling borrowers, provide donations to legal aid groups, and offer assistance with down payments. Because the bank does not service enough troubled loans to meet the settlement’s terms, it also agreed to pay $180 million to finance affordable rental housing in “high cost of living areas,” a move the DOJ said was intended to fill a gap in locations where cities and states cut funding for affordable housing in the wake of the financial crisis.

Citigroup’s required consumer relief must be completed by 2018.

To read the Statement of Facts, click here.

To read the settlement agreement, click here.

Why it matters: The settlement arguably is the product of a hard-line approach taken by the DOJ, providing the largest civil penalty ever. U.S. Attorney General Eric Holder characterized Citi’s conduct as “egregious,” adding that “the bank’s activities contributed mightily to the financial crisis that devastated our economy in 2008.” Holder also stated that the deal does not absolve Citi or its employees of possible criminal charges.

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NY Regulator Releases First Regulatory Framework For Virtual Currency

It happened: Benjamin Lawsky, Superintendent of New York’s Department of Financial Services (DFS) announced the release of the DFS’s much-anticipated proposal for a BitLicense, stating “We have sought to strike an appropriate balance that helps protect consumers and root out illegal activity – without stifling beneficial innovation.” However, many were surprised by the complexity of the proposal – a comprehensive framework for licensing and regulating virtual currencies, the first of its kind in the United States.

Beginning July 23, the public will have 45 days to comment on the proposal which requires a person to seek a BitLicense before engaging in any one of five different types of activities in New York or involving New York residents: (1) receiving or transmitting virtual currency; (2) securing, storing, holding, or maintaining custody or control of virtual currency on behalf of others; (3) buying or selling virtual currency as a customer business – distinct from personal use; (4) performing retail conversion services (including the conversion of fiat currency or other value into virtual currency and vice versa and the conversion of one form of virtual currency into another); and (5) controlling, administering, or issuing a virtual currency (excepting virtual currency miners).

The New York regulator laid out a myriad of requirements both for the BitLicense application as well as ongoing compliance, including a robust anti-money laundering compliance program, certain Bank Secrecy Act reporting and recordkeeping requirements such as reports that must be filed with the departments, advertising and marketing requirements, cybersecurity program, business continuity and disaster recovery plan, and a customer complaint process and consumer protections intended, among other things, to ensure that customers are provided with “clear and concise” disclosures about the risks of virtual currency. Key requirements include:

  • Customer asset safeguards. The DFS will set appropriate capital levels for each licensee based on a number of factors. Also, a licensee must hold virtual currency of the same type and amount as any currency owed or obligated to a third party as well as maintain a bond or trust account in USD “in such form and amount as is acceptable to DFS” for the protection of customers.
  • Customer receipts. A licensee must provide detailed receipts to customers that include the name and contact information for the business, including a telephone number; the type, value, date, and precise time of the transaction; the fee charged; if applicable, the exchange rate; a state of the liability of the licensee for nondelivery; and a statement about the licensee’s refund policy.
  • Anti-money laundering compliance. The DFS is proposing that licensees conduct both initial and annual risk assessments and establish, maintain and enforce risk-based anti-money laundering compliance programs, including customer identification programs. The DFS is also proposing the retention of certain information on each transaction and notification of any transaction or series of transactions involving virtual currency of more than USD 10,000 in one day, by one person within 24 hours of the transaction. Customer identities must be verified at account opening and checked against OFAC’s Specially Designated Nationals list. Enhanced due diligence is required for foreign entities and may be required for others based on certain factors, including high-risk customers, high-volume accounts, or accounts where a suspicious activity report has been filed. Without the exceptions provided under federal law, accounts for foreign shell entities are prohibited. Also going beyond federal requirements, the DFS is proposing that licensees monitor for and immediately report transactions that could indicate tax evasion, money laundering, or other illegal activity. In addition, any company not subject to the federal suspicious activity reporting requirement will be required.
  • Recordkeeping and official roles. Every licensee must designate a qualified employee to serve as a Chief Information Security Officer, responsible for overseeing and implementing the cybersecurity policy. Licensees must also designate another person as the compliance officer to coordinate and monitor compliance obligations. Records and books must be kept, demonstrating compliance, documenting transaction information and details related to the investigation of consumer complaints. Financial statements will be due to the DFS on a quarterly and annual basis.
  • Grandfathered activities. The proposal appears to grandfather activities conducted as of the effective date of the regulation as long as the entity applies for a license within 45 days of the effective date.

Licensees will be subject to examination by the DFS “whenever the superintendent deems necessary” but no less than once every two calendar years. Exams will assess the licensee’s financial condition, safety and soundness, management policies, and compliance with laws and regulations.

The proposed regulations may be revised by the DFS following the public comment period.

Why it matters: This proposal is the promised next step in a process begun more than a year ago when a number of entities received DFS subpoenas. The public hearings that followed in January were part of the effort to strike the right balance. Superintendent Lawsky said, “Setting up common sense rules of the road is vital to the long-term future of the virtual currency industry, as well as the safety and soundness of customer assets.”

This proposal could be viewed as creating parity with money transmitters, although it goes a bit further by addressing in regulation a number of issues that have become regulatory best practices or that have fallen into regulatory gaps.

The Bitcoin community generally has not received this proposal well. As proposed, only the best capitalized firms will be able to obtain licenses – at least in the short term – and it will stifle too much of the entrepreneurial zeal in the community. It is also likely the DFS will receive an overwhelming response to kill the proposal. However, at this point, the proposal represents the best option for the Bitcoin community to move forward in New York.

In the end, the DFS and the community need to work together to strike that right balance if virtual currencies are to gain broader acceptance and be allowed in New York.

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