Financial Services Law

Treasury Spends Ink on Regulatory Changes

By Richard Gottlieb, Partner, Financial Services | Charles E. Washburn Jr., Partner, Financial Services

The Treasury Department, in the first of four reports to President Trump detailing its review of financial regulations and its recommendations about potential changes to the depository system, proposed major changes in the Consumer Financial Protection Bureau (CFPB) structure as well as a “regulatory off-ramp” from capital and liquidity requirements, the Volcker Rule, and Dodd-Frank’s enhanced prudential standards, among other important changes.

What happened

Executive Order 13772 required the Treasury to detail laws, regulations and other government policies with regard to federal financial regulators. The 149-page “A Financial System That Creates Economic Opportunities” focuses on the depository system, including supervision and enforcement by federal regulators.

The report includes a background of the U.S. banking system and an overview of financial regulation, including the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Noting the goals of the current administration, the report identified several “Core Principles” that form the basis of President Trump’s policy with regard to the financial system (such as preventing taxpayer-funded bailouts and making regulation “efficient, effective, and appropriately tailored”).

With this in mind, the Treasury proposed several changes to federal financial regulatory oversight. To begin with, federal agencies need to increase their coordination and reduce overlap and duplication, the report stated. “This could include consolidating regulators with similar missions and more clearly defining regulatory mandates,” the agency suggested.

An interagency reassessment of Matters Requiring Attention, Matters Requiring Immediate Attention and Consent Orders should occur, and an improved approach for clearing regulatory entities of resolved supervisory findings should be developed. Federal financial regulators should be subject to cost-benefit analysis requirements like the executive agencies, the Treasury said, and a comprehensive review of the Community Reinvestment Act is needed to enhance the existing framework.

As part of the push to reduce the regulatory burden for banks and appropriately tailor applicable rules, the report proposed establishing a “regulatory off-ramp” from all capital and liquidity requirements, and enforcing the Volcker Rule (which prohibits banks from conducting certain investment activities using their own accounts) and nearly all aspects of Dodd-Frank’s enhanced prudential standards that apply to banks with assets of $50 billion or more. In order to take advantage of this option, such depository institutions would elect to maintain a sufficiently high level of capital, such as a 10 percent non-risk-weighted leverage ratio.

Specific to community financial institutions, the Treasury advised that modifications should be made to further streamline the process of forming de novo banks, the eligibility threshold for the 18-month examination cycle should be raised, and special consideration and tailoring should be applied by regulators to agricultural and rural banks.

High on the list of supposedly “necessary” changes, says the Treasury: reformation of the CFPB. “A significant restricting in the authority and execution of regulatory responsibilities by the CFPB is necessary,” according to the report. “The CFPB was created to pursue an important mission, but its unaccountable structure and unduly broad regulatory powers have led to predictable regulatory abuses and excesses.”

Similar to the proposed changes found in the Financial CHOICE Act, and consistent with court challenges on the same issue, the report recommends switching the CFPB’s director position to one that can be removed at will by the president or restructuring the agency as an independent multimember commission, subjecting the CFPB to the congressional appropriations process, repealing the authority to conduct examinations, requiring the CFPB to adopt regulations delineating unfair or deceptive acts and practices standards, and limiting the availability of detailed data in the CFPB’s complaint database to federal and state agencies rather than making it available to the general public—among many other suggestions.

The report also considered changes to mortgage lending requirements, advocating for tweaks to the Qualified Mortgage/Ability to Repay requirements (such as permitting a loan to attain Qualified Mortgage status if one underwriting criterion is met but compensating factors exist) and the TRID Rule (including additional rulemaking to reduce compliance uncertainty and permitting creditors to cure errors in the loan file within a reasonable period post-closing).

On a slightly different topic, the Treasury also recommends a specific review of regulatory expectations for board of director performance, expressing concern that the current burdens are excessive and could be better tailored to alleviate risk. Taking care of regulatory matters is taking up too much time for boards, the report said, leaving directors with less time to spend on core corporate governance issues and thereby increasing business risk.

To read the Treasury report, click here.

For the next three installments, the Treasury Department intends to focus on capital markets; asset management, insurance industries, and retail and institutional investment products; and nonbank financial institutions, financial technology and financial innovation. Importantly, many of the recommendations presented in the report could be achieved through regulatory agencies and do not require congressional action, improving the odds of change.

Why it matters

This report is part of a full frontal attack on Obama-era structural changes as a result of the recent economic recession that began in 2007–08. This report and the possibility of significant changes under the House-passed Financial CHOICE Act suggest an administration aligned with the House of Representatives on core structural changes that would have a dramatic impact on financial regulation and supervision. Whether or not these changes have the support of the Senate is an entirely different question.

back to top

New Federal Bills Feature MLA Requirements, AML Obligations

By Charles E. Washburn Jr., Partner, Financial Services

New legislation recently introduced in Congress impacting the financial services industry would amend the Military Lending Act (MLA) and impose additional requirements with regard to anti-money laundering (AML) obligations.

What happened

The first bill, the “Transparency in Military Lending Act of 2017,” was introduced in the House of Representatives by Rep. Dan Kildee (D-Mich.) in June, proposing an expansion of current MLA disclosure requirements. Enacted in 2006, the MLA caps the interest rate on covered loans to active-duty service members at 36 percent per annum, prohibits the use of arbitration clauses, and requires disclosures to inform service members and their families of their rights, among other provisions.

H.R. 2697 would tack on additional disclosures, including a statement from lenders that the Department of Defense and each service branch offer a variety of financial counseling services, along with contact information for the nearest office.

Lenders would also be required to make a statement that other, lower-interest-rate loans (including potentially 0 percent interest loans) may be available through other financial institutions and military relief societies, and inform potential borrowers about the actual cost of the extension of credit, prepared as an amortization table showing what the cost to the borrower will be if the extension of credit is paid off at different points in time.

All disclosures would need to be provided on a single sheet of paper in bold, 14-point font, and lenders would need to obtain separate, signed acknowledgment for each of the disclosures.

The bill is currently being considered by the House Armed Services Subcommittee on Military Personnel.

A second measure, the “Combating Money Laundering, Terrorist Financing, and Counterfeiting Act of 2017,” was presented to the Senate by Sens. Chuck Grassley (R-Iowa) and Dianne Feinstein (D-Calif.), with the goal of modernizing and strengthening criminal laws against money laundering, “a critical source of funding for terrorist organizations, drug cartels and other organized crime syndicates,” the lawmakers said in a statement, estimating that trillions of dollars in cash are involved in money laundering worldwide on an annual basis.

The proposal would increase the penalties for bulk cash smuggling (a “common method” of transporting illegal proceeds between the United States and Mexico, the senators said), allow the government to apply for a restraining order to temporarily freeze the bank accounts of defendants arrested for offenses involving the movement of funds into or out of the United States, and clarify that a defendant need not know the purpose and plan behind the transportation of criminal proceeds across the border under the concealment money laundering statute.

Existing laws that permit law enforcement to obtain foreign bank records by subpoenaing banks in the United States with which the foreign banks have a correspondent account would be strengthened pursuant to S. 1241, and the current AML requirements would be updated to include prepaid access devices such as stored value cards. In addition, the act would bring hawalas and other informal value transfer systems within its reach.

Also covered by the bill are a restoration of wiretapping authority to investigate currency reporting, bulk cash smuggling, illegal money services businesses and counterfeiting offenses, and the establishment of a new money laundering violation that prohibits the transfer of funds into or out of the country with the intent to violate U.S. income tax laws.

Counterfeiting laws would be updated by the act to prohibit “state of the art” methods, and two new offenses would be created to criminalize knowingly concealing from or falsifying or misrepresenting to a financial institution important information concerning ownership or control of an account or assets held in an account.

The proposal addresses commingled criminal proceeds with a clarification that the withdrawal of funds in excess of $10,000 from an account containing more than $10,000 in criminal proceeds commingled with other funds constitutes a transaction involving more than $10,000 in criminally derived property. The bill also permits the government, in order to meet the $10,000 threshold, to aggregate individual transactions that are closely related in time, the identities of the parties, the nature of the transactions or the manner in which they are conducted.

After being introduced, S. 1241 was referred to the Senate Judiciary Committee.

To read S. 1241, click here.

Why it matters

Both pieces of legislation would have a potentially significant impact on financial institutions. The amendments to the MLA would expand the already extensive disclosure requirements found in the statute, while the bill focused on combating terrorism with a crackdown on money laundering would make a host of changes to AML requirements for banks.

back to top

CFPB Proposes Changes to Prepaid Card Rule

By Anita L. Boomstein, Partner, Global Payments

The Consumer Financial Protection Bureau (CFPB) has requested comment on proposed changes to its prepaid rule, including the potential for another extension of the effective date of the rule. The proposed rule changes are being made as a result of industry feedback of unanticipated complexities in complying with the rule based on industry practices and business models.

What happened

Initially proposed in November 2014, the prepaid rule was finalized in October 2016, imposing significant new requirements for prepaid accounts under Regulation E issued under the Electronic Funds Transfer Act as well as Regulation Z, implementing the Truth in Lending Act. The rule was meant to “fill key gaps” for consumers with regard to prepaid products, the CFPB said.

Pursuant to the rule, providers of prepaid products—broadly defined to include payroll card accounts, government benefit accounts, student financial aid disbursement cards and tax refund cards, among others—must protect consumers against fraud and theft, with liability limited to $50 when a consumer promptly notifies the institution of theft.

In addition, providers must give consumers free and easy access to product information (by phone, online or in writing upon request), work with consumers to investigate any errors on covered products (with provisional credit for the dispute during the course of the investigation), and add “Know Before You Owe” prepaid disclosures to highlight key costs associated with the product prior to use, including periodic fees, balance inquiry fees or inactivity fees.

Prepaid cards must also adopt certain protections provided to credit cards—such as monthly account statements, consideration of whether a consumer has the ability to repay the debt before offering credit, and limits on late fees—to achieve compliance with the rule.

While the rule was originally set to take effect on Oct. 1, 2017, in April the CFPB formally delayed implementation of the rule for six months, making the new effective date April 1, 2018. That action was taken after discussions with industry stakeholders revealed potential difficulties in meeting the Oct. 1 compliance date—in particular, constrained production capacity of the manufacturers of the prepaid card packaging due to the increased demand from the industry, as well as concerns about legal exposure.

Also in its effort to support industry implementation of the rule, the CFPB noted that industry participants revealed they have become aware of unanticipated complexities in compliance with the rule based on the current industry business models and practices.Because the industry did not discuss these concerns in previous comment letters, the CFPB indicated it would use the extension period to consider the need for and desirability of amendments to the rule.

On June 15, the CFPB announced that it was seeking public comment on proposed updates to the prepaid rule in light of the industry feedback it received. Two primary changes to the rule have been proposed.

The first applies to the requirement that financial institutions and issuers provide fraud protection and error resolution rights to customers whose cards are unregistered or whose identities could not be or have not been verified. Under the proposal, the error resolution obligations applicable to the issuer, and the limitation on consumers’ liability, would not apply to unregistered prepaid cards or to prepaid cards where the consumer’s identity was not or could not be verified. These protections would apply, however, if the consumer’s identity was later verified.

The second proposed amendment applies to digital wallets that are linked to credit cards and that are prepaid cards because they are capable of storing funds. The proposed changes would provide a limited exception to the credit-related provisions of Regulation Z for certain business arrangements between digital wallet issuers and issuers of the linked credit cards if certain conditions are met. To qualify, the consumer would have to have authorized the linkage of the accounts, and the linkage could not be a condition imposed on the consumer or subject to varying terms.

In addition to other minor amendments, the CFPB is also seeking comment on whether an additional delay in the effective date of the rule is necessary and whether a safe harbor for early compliance should be added.

To read the CFPB’s proposal with request for comment, click here.

Why it matters

CFPB Director Richard Cordray remains bullish on the rule. “We know that effective implementation helps our rules deliver their intended value to consumers,” Cordray said in a statement. “Today’s request for comment shows we are listening closely to feedback on our rules to decide whether certain adjustments will help achieve that goal.”

back to top

Bank Holding Company Execs Not Entitled to Insurance Coverage

By Ivan L. Kallick, Partner, Bankruptcy

Is a bank holding company that owns and operates banks the same entity both pre- and postbankruptcy filing for the purposes of pursuing directors and officers (D&O) insurance coverage? Yes, the U.S. Court of Appeals, Sixth Circuit, has ruled, finding that because the liquidating trustee of a bank holding company held essentially the same legal status, it was unable to tap into D&O insurance coverage for former executives facing liability for its financial problems.

What happened

A holding company incorporated in Michigan, Capitol Bancorp owned community banks in 17 states. Joseph Reid founded Capitol and served as its chairman and chief executive officer, his daughter Cristin Reid served as president, and her husband, Brian English, served as general counsel.

Hit hard by the financial crisis, Capitol accepted oversight by the Federal Reserve in 2009 and entered Chapter 11 bankruptcy proceedings in 2012. With the filing, Capitol’s assets (including its ownership interests in the subsidiary banks) became the property of the bankruptcy estate, with Capitol the debtor in possession under the direction of the Reids. Reorganization efforts failed and Capitol was subject to a liquidating plan in 2013.

Capitol reached an agreement with the creditor’s committee that required Capitol to assign all of the company’s causes of action to a liquidating trust, which could pursue those claims on behalf of creditors. Another provision stated that the executives had no liability for any conduct after they filed the bankruptcy petition and limited any prepetition liability to amounts recovered from Capitol’s liability insurance policy.

Capitol took out a one-year management liability insurance policy from Indian Harbor Insurance Co. in 2011, twice extending the policy after the bankruptcy proceedings began. Pursuant to the policy, Indian Harbor agreed to pay for any “Loss resulting from a Claim first made against the Insured Persons”—a group that included Capitol’s directors, officers and employees—“during the Policy Period … for a Wrongful Act.” A policy exclusion covered “any claim made against an Insured Person … by, on behalf of, or in the name or right of, the Company or any Insured Person.”

In 2014, Capitol’s liquidating trustee sued English and the Reids for $18.8 million, alleging they breached their fiduciary duties to Capitol through a number of improper actions. The liquidating trustee notified Indian Harbor of the lawsuit, and the insurer responded with a declaratory judgment action that it owed no obligation to cover any damages from the lawsuit because the trust’s claim fell within the insured v. insured exclusion.

A district court judge agreed, and the Sixth Circuit affirmed.

The appellate panel was not persuaded by the argument that when Capitol and Indian Harbor formed the insurance contract, “the Company” referred to the financial institution in its prebankruptcy form and that, as a result of the bankruptcy filing, it underwent a transformation, with Capitol as debtor in possession administering the estate for the benefit of the creditors. Because a debtor in possession is legally distinct from the prebankruptcy “Company,” the insured v. insured exclusion was inapplicable, the executives told the court.

“But this new-entity argument surely would not work before bankruptcy,” the appellate panel said. “Capitol could not have dodged the exclusion by transferring a mismanagement claim to a new company—call it Capitol II—for the purpose of filing a mismanagement claim against the Reids. No matter how legally distinct Capitol II might be, the claim would still be ‘by, on behalf of, or in the name or right of’ Capitol.”

The same conclusion applied to a claim filed after bankruptcy, the court said. “Here too the voluntarily transferred claim would be filed ‘on behalf of’ or ‘in … the right of’ Capitol,” the panel said. “The exclusion remains applicable by its terms.”

Other terms of the contract similarly resisted the reading proposed by the executives, the court added, such as a “Change in Control” clause contemplating that coverage would continue uninterrupted during bankruptcy, even after the company became a debtor in possession. And the parties’ actions were consistent with this reading of the contract, as Capitol paid more than $3 million in total premiums to extend the policy—twice—after filing for bankruptcy.

Further, the Supreme Court has rejected the argument that a debtor in possession is a “wholly new entity” unbound by the prebankruptcy company’s contracts, the Sixth Circuit noted, writing that it was “sensible to view the debtor-in-possession as the same ‘entity’ which existed before the filing of the bankruptcy petition.”

The Bankruptcy Code itself supported this understanding, the court said, as the animating purpose of a Chapter 11 filing is to keep the prebankruptcy company up and running, giving the debtor in possession all the statutory powers and duties of a trustee.

“If Capitol had successfully emerged from Chapter 11 bankruptcy … it would once again be the same ‘Company’ covered by the contract,” the panel wrote. “How strange then to treat the debtor in possession as an entirely distinct entity for purposes of this insurance contract.”

Although the court recognized that the debtor in possession and the prebankruptcy debtor are legally distinct, it characterized the situation as one and the same person, wearing two hats. The panel left open the question of whether a court-appointed trustee or creditor’s committee could collect on the policy.

One member of the panel dissented, writing that the majority ignored the fundamental principles of bankruptcy law, as “a new entity is in fact formed” upon the filing of a bankruptcy case.

To read the opinion in Indian Harbor Insurance Company v. Zucker, click here.

Why it matters

The decision provides an important reminder for the management and boards of financial institutions and, where applicable, their holding companies to consider the scope of insurance coverage, particularly with regard to the impact of a bankruptcy filing. It also left open the question of whether a court-appointed trustee, liquidating trustee or creditor’s committee could collect on the policy, potentially signaling that creditors will be required to seek the appointment of a trustee in order to pursue insurance proceeds.

back to top

CFPB and Stakeholders Weigh In on the Credit Card Market

By Anita L. Boomstein, Partner, Global Payments

As required by law, the Consumer Financial Protection Bureau (CFPB) has once again asked for public comment on a variety of topics related to the credit card market. The comment period has ended for the most recent request for information (RFI), with 32 entities, ranging from financial services organizations to consumer groups, weighing in.

What happened

The Credit Card Accountability Responsibility and Disclosure Act of 2009 (CARD Act) requires the CFPB to conduct a review of the consumer credit card market every two years. Following reviews in October 2013 and December 2015, the CFPB submitted an RFI in March 2017 requesting public feedback on 13 topics that are indicative of how the credit card market is functioning. The topics include credit card terms, disclosures and issuer practices, consumer protections, the cost of credit, deferred interest products, innovation, secured cards, and rewards products, among others.

Dozens of stakeholders took the opportunity to share their thoughts. For example, the comments from the American Bankers Association (ABA) focused on the increase in cost and the decline in the availability of credit since the CARD Act was implemented, writing that issuers are “more inclined to deny credit to applicants seen as potentially high-risk” because of the legislation, and to impose “higher interest rates at the outset of the lending relationship than they would otherwise in an effort to manage risk.” Consumers, particularly lower-income individuals, have been hit hard by the statute’s ability-to-pay requirement, the ABA told the CFPB, with many turning to other short-term lending options (such as payday loans) as a result.

Responding to some of the CFPB’s questions, the group said rewards products are priced competitively and are well understood by consumers, demonstrated by the growing volume of rewards accounts. The ABA urged the CFPB to facilitate a process for companies to obtain reliable advisory opinions to spur innovation in the market, which would “provide a means for innovators to engage in a dialogue with the Bureau and other regulators before a product reaches consumers to avoid potential violation of consumer protection laws.”

The group also took the position that deferred interest products “are popular and beneficial to consumers and retailers,” and there is “little evidence” that users do not understand how the products function. Small and midsize retailers find the products useful, the ABA noted, and “merchants do not stay in business by alienating their customers with defective products, financial or otherwise.”

Similarly, the Consumer Bankers Association (CBA) and the Financial Services Roundtable (FSR) jointly authored a letter that praised rewards products as “an example of effective self-regulation that negates the need for regulatory intervention” and deferred interest products as “valuable to consumers and small businesses alike.” Specifically, the groups said no additional action by the CFPB in connection with deferred interest promotional offers was necessary. Consumers appear to understand deferred interest offers and continue to benefit from them, they wrote, with no CFPB action needed.

Turning to rewards products, the groups described them as “a key driver for consumer product selection, continued engagement with their credit cards, and overall product satisfaction.” Credit card issuers have enhanced their disclosures to inform consumers of key terms at the right time, the CBA and FSR told the CFPB, with the members of their groups making real progress in simplifying the terms governing how rewards are earned and may be redeemed, making any limitations “readily apparent” to consumers.

“Such effective self-regulation and focus on positive consumer experiences with reward programs negates the need for regulatory intervention from the Bureau,” the groups wrote. “Introducing regulations to govern reward programs will make these programs more difficult to operate and stifle further innovation.”

Commenting from the perspective of retail merchants, the National Retail Federation (NRF), the world’s largest retail trade organization, devoted its comment letter exclusively to deferred interest products—programs that are “a longstanding practice within the retail industry.”

“A significant number of NRF members have long offered deferred interest purchase plans for their customers,” according to the group’s comment. “The plans are valued by consumers, and by the retailers who offer them. For retailers, they meet customer needs and are a valuable competitive tool. For many consumers, they are a money-saving option for large ticket purchases.”

The NRF noted that while there are risks inherent in deferred interest products, the CFPB’s own statistics demonstrate that the majority of consumers follow the terms and pay no interest. Significantly, however, the NRF commented that in some cases, the CARD Act has made it difficult for consumers to avoid paying a finance charge because it requires “creditors to apply the maximum amount of a customer’s payment to the highest interest open account immediately due.” This denies the consumer the ability to control his or her payment allocations. The NRF suggested that the CFPB encourage Congress to address this concern.

On the other end of the spectrum, Consumer Action (CA) wrote that “retailers and cards that offer deferred interest not be allowed to apply interest until the end of the deferral period,” a proposal similar to that of letters recently sent by the CFPB itself.

The group also noted an overall improvement in card disclosures, sharing examples from credit card offers it found clear as well as those that it declared vague and misleading, or that used “vast” rate ranges, which it said are not helpful when consumers are comparison shopping for a card.

Transfer fees for using a credit card for overdraft protection are in need of scrutiny, the CA told the CFPB, while some new marketing approaches concern the group, which suggested the CFPB conduct a review for signs of disparate impact. The comment closed with support for the planned prohibition on class action bans in arbitration clauses, hoping to see a final rule on arbitration from the CFPB in the near future.

Why it matters

Credit cards are the most commonly used form of consumer credit. Reflecting their constituents, the industry groups that provided comments presented a variety of perspectives on the consumer credit market to enable the CFPB to access whether, and to what degree, the CARD Act is effective.

back to top



pursuant to New York DR 2-101(f)

© 2024 Manatt, Phelps & Phillips, LLP.

All rights reserved