Financial Services Law

OCC Publishes Final Guidelines With Heightened Standards for Big Banks, Which All Banks Should Review

Risk management continues to be at the top of regulatory agendas, and the OCC has taken the opportunity to offer its heightened risk guidelines for large financial institutions of more than $50 billion in average consolidated assets (including national banks, federal savings associations, and federal branches of foreign banks supervised by the OCC). Initially proposed last January, the Guidelines address risk management and board governance weaknesses the OCC observed during the financial crisis and are issued pursuant to the OCC’s authority in Section 39 of the Federal Deposit Insurance Act to set safety and soundness standards.

The Guidelines follow and must be reconciled by national bank holding companies with the enterprise-wide risk management approach in the Federal Reserve’s post-Dodd-Frank “heightened prudential standards.” The Guidelines were not issued as interagency guidelines, and the FDIC likely will have its own approach for state nonmember banks to follow as will the state bank regulators.

While the OCC states that it does not intend to impose the Guidelines on community banks, it expressly reserves the right to apply the Guidelines to any national bank whose operations are “highly complex” or otherwise present a “heightened risk.” Neither term is defined in the Guidelines but derivatives activities and auto lending are mentioned in the discussion of comments received on the proposed rule.

The Guidelines mandate that a written risk governance framework be established encompassing “minimum” standards for a risk governance, including the role and responsibilities of both frontline management and internal control mechanisms. Key to this framework is the adoption by the board of a risk appetite statement for the institution, although the Guidelines provide no menu of risks which are or are not acceptable in a risk appetite statement. Instead, the board is called upon to establish and maintain “minimum” levels of oversight of this process.

The OCC identified “three lines of defense” that should together establish an appropriate system to control risk taking: frontline units, independent risk management and internal audit. Frontline management includes those departments involved in generating revenue for the bank, products or services to customers, or technology services – generally excluding back-office groups such as legal and human resources.

The Guidelines also permit a covered bank to use its parent company’s risk governance framework and internal audit function without modification if the risk profiles of the parent company and the covered bank are “substantially the same” as demonstrated through a documented assessment. Substantially, the same is defined to require that the bank’s total assets must be 95% of the parent holding company’s consolidated assets, thereby requiring bank holding companies to carefully consider conducting any significant activities outside of the subsidiary national bank if they want to avoid the costs of having a separate and independent risk governance framework at the bank.

The Guidelines make it clear that the board of the institution must play a major role in this process contemplated by the Guidelines. To that end, the board is expected to “ensure” an effective risk governance framework, provide “active oversight of management,” exercise independent judgment and make certain that independent directors are provided with ongoing formal training of the products, services and lines of businesses in addition to applicable laws and regulations.

While these concepts are not necessarily new to the world of board governance, they nevertheless highlight the increased participation expected of directors of the covered banks. Specifically, directors are encouraged to “question, challenge, and when necessary, oppose recommendations and decisions made by management that could cause the bank’s risk profile to exceed its risk appetite or jeopardize the safety and soundness of the bank.” Clearly, merely following the leader (usually the bank CEO) is not an acceptable course of conduct for a director.

To read the OCC Guidelines, click here.

Why it matters: The Guidelines are important to all OCC regulated institutions – and indeed to all banks – because they express an expectation that banks will need to do a better job than in the past of minimizing risk across the entire spectrum of the bank’s activities. As has been the case in the past in other situations, the framework embodied in the Guidelines will have a way of trickling down to smaller institutions, and regardless of their state or national charters, either through subsequent rules or through the safety and soundness examination process. To that end, all banks and their boards should play close attention to the specifics of the Guidelines and adopt the best-practices approach embodied within them, tailoring their specific practices to the bank’s own risk profile. Where deficiencies in meeting “minimum” standards and best practices are identified by examiners, enforcement actions focused at the board now inevitably follow.

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New York’s Attorney General Files Redlining Suit Against Bank

The New York Attorney General has charged a regional bank with engaging in illegal discrimination by intentionally ignoring predominantly African-American neighborhoods in Buffalo.

Evans Bancorp, Inc., and Evans Bank, N.A., allegedly designated the bank’s “Trade Area” in the Buffalo area by taking a map and delineating the neighborhoods in which to market and sell the bank’s products and services. While the Trade Area encompassed the predominantly white areas of the city and suburbs, the neighborhoods composed of a majority of African-American residents were completely excluded.

“Our complaint alleges that Evans Bank has intentionally engaged in a systematic policy of illegal redlining that has had a disparate impact on the African-Americans it is supposed to serve,” AG Eric T. Schneiderman said at a press conference about the suit. “I honestly never thought I would have to bring a redlining case because this is a problem we thought we put behind us a couple of decades ago.”

Since at least 2009, federally chartered Evans engaged in intentional discrimination in violation of the Fair Housing Act as well as New York State human rights law and Buffalo City Code, according to the complaint filed in New York federal court. Evans refused to solicit customers, market loan products, and provide banking facilities in predominantly African-American neighborhoods, the AG alleged.

The bank is alleged to have adopted an explicit policy restricting eligibility for certain mortgage products to only certain geographic areas outside of the Trade Area, evaluating loan requests from outside the boundaries on “an individual case-by-case basis” while considering many factors including a policy of limiting the “concentration of loans outside of our trade area.” Borrowers with properties outside of the Trade Area were automatically disqualified from eligibility for certain mortgage products and services – regardless of their creditworthiness, the AG said.

Evans also located its branch offices and ATMs outside of African-American communities, limited its direct mail advertising campaigns to predominantly white communities, and placed the vast majority of its print media advertising in local newspapers with a circulation limited to the Trade Area, again excluding African Americans.

Further supporting the charges, the AG’s office noted a statistical analysis demonstrating that Evans drew mortgage applications from and originated mortgage loans to African-American borrowers at the lowest rate of all comparable banks (even banks lacking a presence in Buffalo). For example, according to Home Mortgage Disclosure Act data, Evans received 1,114 residential mortgage applications in the Buffalo area from 2009 to 2012. Only four of those applications came from applicants reporting as African American.

The suit seeks civil penalties, damages, punitives and injunctive relief halting future discrimination.

The bank responded with a statement: “We believe that the allegations being made by the New York State Attorney General are unfounded and without substance and we will vigorously defend this complaint through the legal system,” Evans CEO David J. Nasca said.

To read the complaint in New York v. Evans Bancorp, click here.

Why it matters: New York banks be warned. AG Schneiderman said the action was part of an ongoing, wider investigation by the Civil Rights Bureau into mortgage redlining by banks operating in New York, initiated after concerns were raised that in the wake of the financial crisis banks were lending at a decreased rate to minority communities.

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Bit Bites: Latest Legal Developments in Digital Currencies

When Is Bitcoin “Money” Versus a “Security”? In motions involving a high-profile criminal prosecution with ties to Silk Road and a Securities and Exchange Commission (SEC) enforcement action, two federal courts have clarified the circumstances in which Bitcoin will be considered money or a security. 

Bitcoin Is Money. U.S. District Court Judge Jed S. Rakoff denied in late August a motion to dismiss a pending indictment alleging money laundering by an “underground” Bitcoin exchanger. The defendant, Robert M. Faiella, argued, among other things, that Bitcoin is not “money” for purposes of federal law and that such a novel and unanticipated construction of the statute would operate like an ex post facto law, in violation of his due process rights. He also argued that operating a Bitcoin exchange does not constitute transmitting money under relevant U.S. law and that he was not a money transmitter.

But Judge Rakoff disagreed on the first argument, ruling that “Bitcoin clearly qualifies as ‘money’ or ‘funds,’” as the digital currency “can be easily purchased in exchange for ordinary currency, acts as a denominator of value, and is used to conduct financial transactions.” Congress likely “designed the statute to keep pace with evolving threats,” he added.

He also rejected the argument that the sale of Bitcoin was not transmitting money to another person or location because Bitcoin was transferred to and held under the control of Silk Road – and not the users – for a profit. Finally, he said that Faiella “clearly qualifies” as a money transmitter pursuant to guidance issued by the Financial Crimes Enforcement Network (FinCEN) in March 2013 clarifying when virtual currency exchangers constitute “money transmitters” under its regulations.

Bitcoin Is a Security. Similarly, in the now long-running Shavers case, a federal court granted in part and rejected in part the defendant’s motion for reconsideration of a civil action accusing him of violating federal securities laws in his operation of Bitcoin Savings and Trust (BTCST).

Trendon T. Shavers, who was charged in 2013 by the SEC with scamming consumers out of 263,104 Bitcoin by offering investors a specific percentage in interest daily, sought to dismiss the charges, telling the court that all of his transactions involved Bitcoin, so that no money ever changed hands.

The SEC took the position that the BTCST investments met the definition of a “security” because they were both investment contracts and notes.

U.S. District Court Judge Amos L. Mazzant said the SEC established that the BTCST investments constituted an “investment contract” under the statute as a transaction involving an investment of money in a common enterprise with the expectations that profits will be derived from the efforts of the promoter or a third party. The court added that Bitcoin did not need to be cash, as the “investment of money” is understood to take the form of “goods and services” or other “exchange of value.”

Judge Mazzant was not swayed by the Internal Revenue Service’s declaration that Bitcoin is property, not money. “[T]he IRS Notice did not make any determinations about whether Bitcoins are money or not, only that for federal tax purposes, Bitcoins are to be treated as property,” the court said, adding that FinCEN’s guidance further “demonstrates that virtual currencies, like Bitcoin, are being treated like money for purposes of federal regulation.”

“Even if the court accepts defendant’s contention that Bitcoin is more akin to property rather than money, Bitcoin still satisfies the ‘investment of money’” requirement, the court wrote. “For example, in order to participate in defendant’s investment scheme, investors were required to give up a specific consideration, Bitcoin, in return for the promised consideration, which was the 7 percent return on their investment brought about by the efforts of Shavers.”

Note: The court subsequently issued a permanent injunction against Mr. Shavers and BTCST from violating federal securities, ordered disgorgement of more than $40 million and imposed a civil fine of $150,000 on both parties.

Is the Shrem Plea a New Way to Prosecute Bitcoin Ventures? Following the determination that Bitcoin is money for purposes of federal criminal statutes, former BitInstant CEO and 24-year-old Charlie Shrem pleaded guilty in New York federal court to one count of aiding and abetting his codefendant in the operation of a money transmitting business that was (a) unregistered and (b) involved in the transportation and transmission of funds intended to be used to promote and support the unlawful activity of narcotic trafficking on the Silk Road website. His codefendant Robert Faiella pleaded guilty to one count of operating an unregistered money transmitting business.

According to documents filed by the Department of Justice, Shrem allowed Faiella to use BitInstant to buy Bitcoin that Faiella’s customers could use to buy illegal drugs on the “sprawling and anonymous black market bazaar” Silk Road website, shuttered last year by the federal government. The original complaint, which had been sealed, was filed in January 2013. Shrem and Faiella – high-profile members of the Bitcoin community – were arrested and charged in January 2014.

FTC Acts to Close Manufacture of Bitcoin Mining Equipment. At the request of the Federal Trade Commission, a federal court has granted a temporary restraining order and asset freeze against BF Labs, Inc., a manufacturer of equipment used in mining Bitcoin, and several individuals. The lengthy order states that the company, commonly known as Butterfly Labs, must stop immediately representing how much Bitcoin can be mined using the equipment and when the equipment will be delivered. The order also appoints a temporary receiver with extraordinary powers over every aspect of the company and permits the FTC and the temporary receiver to repatriate assets outside the U.S. The company had been the subject of numerous consumer complaints in recent months.

To read the order in United States v. Faiella, click here.

To read the order in United States of America v. Shrem, click here.

To read the order in Federal Trade Commission v. BF Labs, Inc., click here.

To read the order in Securities and Exchange Commission v. Shavers, click here.

Why it matters: As the adoption of digital currencies expands, regulatory agencies and the courts are confronted with interpreting existing laws in the context of the new technology. The courts are not shying away from their duties in this regard. The stakes are high–criminal convictions, court orders to shut down businesses and freeze assets, substantial fines and orders to disgorge. For both businesses and investors in the digital currency community, these stakes increasingly make imperative the task of ensuring that they properly understand how existing laws and regulations may apply to the business models and take the necessary actions to protect the enterprise.

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