Banking and Finance Law Report : Banking & Finance Lawyer & Attorney : Porter Wright Morris & Arthur Law Firm : Bankruptcy, Commercial Lending

Receiverships have gained in popularity in foreclosure cases and in other types of litigation in recent years. Orders appointing receivers and setting forth the receiver’s duties frequently include a provision allowing the receiver to market and sell real estate. However, the question of whether a receiver legally has the ability to convey title to real estate, free and clear of liens and encumbrances, appears to have been answered in the negative, at least by one appellate district in Ohio.

In 2008, the Eighth District Court of Appeals handed down its decision in the matter of Ohio Director of Transp. v. Eastlake Land Dev. Co., 177 Ohio App.3d 379, 2008-Ohio-3013, 894 N.E.2d 1255. In what appears to be a classic example of bad facts making bad law, the appellate court reversed the lower court’s approval of a receiver’s sale of real property free and clear of liens. In Eastlake, which was not a foreclosure, the court-appointed receiver sought authority to sell a parcel of real estate for the sum of $250,000, an amount which he stated he “believed” was a commercially reasonable price for the property. In connection with the motion, the receiver presented no evidence of his marketing and sale efforts, nor did he present any evidence regarding the value of the property. Notably, the receiver’s motion did not state that he intended to sell the property free and clear of AFF’s liens. The senior lienholder, American First Federal, Inc. (“AFF”) intervened in the case and filed an objection to the receiver’s motion to sell the property for less than what was owed to AFF. 

On January 20, 2007, the court issued two, inconsistent orders related to the receiver’s motion. In the first, the court set the receiver’s motion for hearing on February 13, 2007. In the second, the court “inexplicably” granted the receiver’s motion to sell, without vacating the order setting the hearing.   In its approval of the motion, the trial court specifically authorized the receiver’s sale free and clear of AFF’s liens. On February 2, 2007, (presumably unaware of the court’s 1/20/07 granting of the sale motion) AFF filed its objection to the receiver’s motion and in that objection (1) submitted a credit bid of $251,000 and (2) offered evidence to the court that the property in question was worth at least $600,000.

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 Ohio and federal courts continue to recognize an effective but seldom used preemption defense under the National Bank Act (“NBA”). This legal defense, available only to national banking associations, can be asserted against certain employment claims brought by terminated bank officers. 

Specifically, the NBA grants national banks the power: To elect or appoint directors, and by its board of directors to appoint ... officers, define their duties, require bonds of them and fix the penalty thereof, dismiss such officers or any of them at pleasure, and appoint others to fill their places.

Courts continue to hold that the NBA’s “at-pleasure” provision preempts state-law tort and contract wrongful discharge claims brought by terminated bank officers. For instance, recently in Schweikert v. Bank of America, Case No. 06-2137 (4^th Cir. April 1, 2008), Bank of America terminated Schweikert, a senior vice president in private banking, for failing to cooperate with the bank’s and the FBI’s investigation of a client for whom Schweikert had arranged several loans. Schweikert sued the bank for wrongful and abusive discharge under Maryland law. The trial court held the NBA’s “at-pleasure” provision preempted the claims and dismissed the complaint. The federal Court of Appeals for the 4^th Circuit upheld the trial court’s application of the NBA’s “at-pleasure” provision. In so ruling, the 4^th Circuit cited with approval the 9^th Circuit’s nearly twenty-year-old ruling in Mackey v. Peoria National Bank, 867 F.2d 520, 525-26 (9^th Cir. 1989), where the 9^th Circuit held that the NBA’s “at-pleasure” provision preempts a terminated bank officer’s state tort and contract claims.

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As if the specter of newly proposed SEC Rules and an investigation by the California Attorney General were not enough of a distraction for the battered credit-ratings industry, the Wall Street Journal reported that some state regulators are mounting a challenge to reduce or eliminate the role credit-ratings agencies play in evaluating the health of an insurer’s portfolio of investment-backed bonds. As one of the largest purchasers of bonds, insurers rely extensively on credit-ratings published by Standard & Poor’s, Moody’s, and Fitch and other SEC designated Nationally Recognized Statistical Rating Organizations (“NRSROs”). Insurance regulators rely on the same credit-ratings to value an insurers portfolio of mortgage backed bonds. The lower the rating the more capital regulators require an insurer hold in reserve to cover future loses.   

While no state insurance regulators have presented any firm proposals, regulators are reportedly considering whether to expand the number of firms allowed to provide securities evaluation analysis. This expansion would be a marked departure from the insurance industry’s exclusive reliance on credit-ratings provided by NRSROs. The potential break-up of the de facto ratings oligopoly will likely foster increased competition among rating agencies, which seems to be a key goal of insurance regulators and NRSROs’ critics.

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As credit-rating agencies, including Standard & Poor’s, Moody’s and Fitch try to rebuild their image and credibility in the wake of the U.S. financial Crisis, the SEC proposed new rules to promote transparency and eliminate conflicts of interest. The proposed rules target a select group of credit-rating agencies called Nationally Recognized Statistical Rating Organizations (“NRSROs”). NRSROs have been under intense scrutiny since regulators and other industry watchers began examining their role in the sub-prime mortgage crisis. Critics argue that NRSROs provided

AAA bond ratings on mortgage backed securities and other collateralized debt obligations that should have received significantly lower credit-ratings.  Historically, NRSROs have served as “financial gatekeepers” that assess the risks associated with certain public and private bonds and other securities. NRSROs are primarily funded in two ways: (i) by issuers, sponsors, or underwriters of securities (commonly known as “arrangers”) that seek ratings to sell securities; or (ii) subscribers (e.g bond purchasers) who pay to have access to and rely upon NRSROs credit rating data. NRSROs, however, have several other sources of revenue. Many NRSROs are also paid to advise arrangers on how to structure complex financial products that are later rated by the same NRSROs. The structuring of these complex financial products often lead to lucrative commissions for the NRSRO’s, which creates an inherent conflict of interest. Some critics also accuse arrangers of seeking undisclosed “preliminary ratings” from NRSROs in an effort to “shop” for the most favorable credit-rating. Among other goals, the SEC’s proposals seek to address concerns about conflicts of interest and “ratings shopping.” The key proposals are as follows:

• Disclosure of Conflicts of Interest: Require NRSROs to disclose (i) their net revenue attributable to the 20 largest users of credit rating services; and (ii) the percentage of their net revenue attributable to other services and products. In addition, the NRSROs would have to post a consolidated report at the end of each fiscal year that discloses the name of any person (or company or institution) that purchased services and products other than credit-rating services from the NRSRO and disclose the relative percentage of net revenue earned by the NRSRO from that person (to 10%, top 25%, top 50%, bottom 25%).
• Annual Compliance Reviews: Require NRSROs provide to the SEC an annual report describing their compliance reviews for the most recently completed fiscal year. The reports will outline the steps the NRSROs have taken to comply with securities laws and describe any material compliance issues.
• Disclosure of Credit Rating Reviews: Require NRSROs disclose to all other NRSROs when they are in the process of determining the credit rating of a structured financial product for an arranger. The rule would also require NRSROs to obtain a representation from the arranger that the arranger will provide the same information to other NRSROs seeking to rate the product.
• NRSRO liability under the Securities Act: Require that if an issuer or registrant includes a credit-rating issued by an NRSRO in a registration statement then the issuer or registrant would be required to file the consent of the NRSRO, which would subject the NRSRO to potential liability as an expert under the Securities Act.

The SEC’s proposals come on the heels of the California Attorney General’s announced investigation of credit-rating agencies’ role in fueling the financial crisis and a federal court ruling that held credit-rating agencies can’t use a “free speech” defense to avoid liability for faulty ratings reports. On September 17, 2009, California Attorney General, Jerry Brown, launched an investigation of whether Standard & Poor’s, Moody’s, and Fitch broke state consumer protection or unfair business practice laws in connection with the ratings they issued on mortgage backed securities. NRSROs typically claim that their ratings are protected “opinions” under the First Amendment, but a federal judge recently ruled in a case against several NRSROs that such a defense is not available to an NRSRO due to the widely disseminated nature of the opinions and the reliance on the opinions by investors. The federal court ruling was in a case brought by investors that lost millions of dollars in a structured investment product containing over valued highly rated mortgage backed securities.

 The NRSROs are expected to survive this latest round of regulations, investigations and lawsuits, but the question remains—will they ever retain their unquestioned credibility? Many industry observers believe that the industry titans Standard & Poor’s, Moody’s, and Fitch are going to be the ultimate losers. The new SEC regulations are targeted to promote competition and reduce their industry leading market share. Moreover, the mounting investigations and lawsuits against Standard & Poor’s, Moody’s, and Fitch continue to erode their remaining credibility.

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As a follow up to our recent post on e-Verify [link], many of our financial institution clients have been asking whether they are required to comply with the new federal e-Verify requirements for federal contractors.

Under federal affirmative action laws, many banks are considered federal contractors because they are issuing and paying agents for U.S. savings bonds or they are insured by FDIC. However, as explained below, issuance and payment of U.S. savings bonds and FDIC insurance do not trigger e-Verify obligations.

Clarifying language in the e-Verify regulations states that:

Agreements or activities performed by financial institutions that are not subject to the FAR (Federal Acquisition Regulation) are not required to comply with the e-Verify provisions and clauses of the FAR.

This statement in the e-Verify regulations is given in response to a specific question about whether banks and other financial institutions whose federal contracts are limited to serving as issuing and paying agents for U.S. savings bonds or being insured by the FDIC should be excluded from e-Verify requirements. Since issuance of or payment on U.S. savings bonds and FDIC insurance are not covered by FAR, they do not trigger e-Verify obligations. Similarly, the clarification notes that financial agency agreements (FAAs) between banks and the federal government are not subject to FAR and, therefore, do not trigger e-Verify obligations.

For all of these reasons, so long as the only federal contracts for your bank are of the sort described above, you can rest assured that you do not have to comply with the federal e-Verify requirements. 

The e-Verify regulations do not address specifically federal share insurance of the sort that credit unions have under the National Credit Union Insurance Fund. However, the rationale for concluding that FDIC insurance does not trigger e-Verify requirements would apply also to federal share insurance for credit unions. 

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 Litigation regarding 401(k) plans is on the rise, and while the Employee Retirement Income Security Act (ERISA) is probably not the first thing on your mind these days, we hope you will take a few moments to consider whether you may have exposure in this area. Any company, including banking companies, that sponsors a 401(k) plan, and any company that handles 401(k) plan assets for clients, needs to be familiar with ERISA fiduciary responsibilities. 

A plan has “named fiduciaries,” and ERISA also broadly defines a “fiduciary” as a person who:

1. Exercises discretionary authority or control in the management of the plan or exercises any authority or control respecting the plan’s assets;
2. Renders investment advisement for compensation, direct or indirect, concerning any money or property of the plan, or has authority or responsibility to do so; or
3. Has any discretionary authority or responsibility in the administration of the plan. 

A fiduciary has the duty to follow plan terms, to act solely in the interests of participants and beneficiaries for the exclusive purpose of providing benefits and paying only reasonable expenses of the plan, to act prudently, and to diversify plan investments.

Fiduciaries can be held liable to make the plan whole for any losses that occurred as the result of a breach of fiduciary duty, and may be assessed penalties.

The Department of Labor (DOL) may investigate and bring an action against persons it believes are fiduciaries. Delinquent contributions are a topic for the DOL. The regulations regarding the timeframe for deposit of 401(k) deferrals and loan repayments withheld from pay into trust are rather vague, but the DOL is initiating investigations and asserting that breaches of fiduciary duty and “prohibited transactions” have occurred for failure to deposit within days.

The boom in ERISA fiduciary litigation by plan participants started with the “stock drop” cases. Plaintiffs seeking class certification alleged (among other things) that it was imprudent to offer employer stock as an investment in the 401(k) plan, and that fiduciary breaches caused losses to the plan assets. The collapse of the subprime mortgage market and economic downturn resulted in a new round of these cases.

Plan participants have also brought suits seeking class certification against plan fiduciaries and financial institutions regarding other alleged harm to their investments, such as undisclosed revenue sharing, and failure to negotiate lower fees. This is anticipated to result in greater disclosure requirements, including renewed interest in potential conflicts of interest.

Anyone who may be an ERISA fiduciary needs to evaluate whether the necessary steps have been taken to fulfill duties, prevent the likelihood of litigation, and minimize exposure.

The position of federal banking regulators on these matters is clear. Banking companies should carefully consider the implications of status of a fiduciary under ERISA. For example, Appendix E of the FDIC Trust Examination Manual, titled Employee Benefit Law sets forth a fairly in-depth explanation of ERISA matters. The Appendix begin with this Interagency Agreement: http://www.fdic.gov/regulations/examinations/trustmanual/appendix_e/appendix_e.html.

Additional information from the Department of Labor is available at http://www.dol.gov/ebsa/.

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Under Ohio law, a person may reserve a name for a proposed new corporation or limited liability company, or an existing corporation or limited liability company intending to change its name may reserve a name for 180 days. Once filed, a name reservation form grants the registrant the exclusive right to use the specified name in the State of Ohio for the 180 day time period.

The Business Services Division of the Ohio Secretary of State recently changed their policy regarding the renewal of name reservations with their office. Effective immediately, they will no longer accept name reservation renewal forms, stating that such renewals are not permitted by Ohio law. If a registrant desires to reserve a name longer than the 180 day period, they may file a new name reservation form after the current reservation has expired. The Secretary of State’s office has said that they will reject a name reservation form if it is received by them before the name has expired. In the past, the Secretary of State had permitted a registrant to file name reservation renewal forms prior to the expiration of their name reservation, allowing a registrant to continuously keep a name exclusively reserved for as long as they desired. 

This raises the question of what would happen if multiple parties attempted to reserve the same name the day following its expiration. The Secretary of State has indicated that multiple reservations will be taken on a first come, first served basis as soon as the name has expired so it is to your advantage to file a name reservation early in the morning the day following its expiration if you wish to reserve a name for longer than 180 days.

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The Higher Education Opportunity Act (“HEOA”), signed into law on August 14, 2008, regulates private education loans and the relationships between postsecondary education institutions and private education lenders. The Board of Governors of the Federal Reserve (the “Fed”) recently issued a Final Rule amending Regulation Z, which implements the disclosure requirements of HEOA and imposes a number of substantive restrictions on lenders. Compliance with these requirements becomes mandatory on February 14, 2010.  

The Final Rule also sets forth a fairly regimented process for the application, approval and disbursement of private student loans. In connection with loan applications or solicitations, lenders must provide general information about loan rates, fees and terms, including an example of the total cost of the loan based on the highest interest rate permitted under the loan. The initial disclosures must also inform the student of the possibility of obtaining federal student aid.

Once the application has been submitted and the loan approved, the lender must provide a second set of disclosures, this time based on the specific terms of that consumer’s loan. Once the consumer has received the approval and disclosures, he or she will have 30 days during which to decide whether to accept the loan offer. Other than changes to the variable interest rate brought about by changes in the index to which it is tied, the lender may not change the terms of the loan during this period. 

After the borrower accepts the loan and delivers to the lender a student self-certification, the lender must send out yet another set of disclosures, which should reflect the terms and conditions of the prior set of disclosures. After the loan has been accepted and all disclosures and certifications have been delivered, the student has another three business days during which he or she may terminate the loan transaction. Only after this three day period has expired may the lender finally disburse funds.  

Because the disclosure requirements for private education loans differ from those for other loans, lenders that offer private education loans will have to implement specific procedures to ensure compliance.

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For bankers, November 2, 2009, is a key date to remember in conjunction with unlimited FDIC deposit insurance on noninterest-bearing transaction accounts. By that date, bankers must decide to opt out of the program, or not. For bank customers, November 16, 2009, is a key date because by that date banks that opt out must post notices to that effect.

You will remember the origins of this program: The Transaction Account Guarantee (TAG) program was established in October 2008 in the midst of a severe disruption in the credit market. The TAG program is one of two elements of the FDIC’s Temporary Liquidity Guarantee Program. The other element is the Debt Guarantee Program that provides a guarantee for bank-issued senior debt. The ability to issue debt under that program was scheduled to expire on June 30, 2009 and has been generally extended for four months.

On August 26, 2009, the Board of Directors of FDIC approved its Final Rule on the extension of unlimited deposit insurance for transaction accounts under TAG, and the rule is effective October 1, 2009. The program has been extended to June 30, 2010 (from December 31, 2009). 

Each financial institution that participates will be subject to certain FDIC fees during the extension. The Final Rule provides that financial institutions can opt out of the program by November 2, 2009, and it describes the procedures required for a financial institution to make an election to opt out. The fees to be paid by participating institutions are based on the entity’s Risk Category under the FDIC’s risk-based premium system and range from 15 basis points to 25 basis points (annualized) multiplied by the amounts held in noninterest-bearing accounts that exceed the current deposit insurance limit of $250,000.

The rule also contains requirements for financial institutions to provide notices to customers with respect to the financial institution’s participation in TAG. In summary, the notices must be prominent and must be posted in the lobby of the main office, in each branch office and on the financial institution’s website if it offers internet deposit services. The notice must state whether the institution is participating in the transaction guarantee program and, if so, that the funds held in noninterest-bearing transaction accounts are guaranteed in full by the FDIC. 

In addition, the rule requires certain disclosures of institutions that use sweep arrangements or other actions that result in funds being transferred or reclassified to an account that is not guaranteed under TAG. For example, funds swept into an interest bearing account would not be covered. These disclosures must advise customers that such arrangements would void the FDIC’s insurance guarantee with respect to the swept, transferred, or reclassified funds.

The FDIC’s Final Rule is available here.

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