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

Many community banks under pressure to raise capital are considering selling new shares of stock to investors; however, doing so may cause some banks to be required to register under Section 12(g) of the Securities Exchange Act of 1934. The Act provides that even if a company has never made a public offering of stock, it must register its stock with the SEC if has more than $10 million in assets and 500 shareholders of record. Once registered, the company must comply with the SEC’s costly periodic reporting requirements.

Even the smallest of banking organizations typically have more than $10 million in assets so the important requirement to avoid registration is to remain below 500 shareholders of record. As banks seek new investors, remaining below the threshold becomes difficult.

The American Bankers Association has long argued that the 500 shareholders threshold should be raised to somewhere between 1,500 and 3,000.  The ABA argues that when the 500 shareholders threshold was set in 1964, the number of investors in the marketplace and the market presence of 500 shareholders were 3-6 times smaller than they are now. Thus, the 500 shareholders threshold should be increased 3-6 times. The ABA laments that many community banks have had to redeem stock at the expense of capital to reduce the number of their shareholders of record to below 300, the requirement to deregister under the Exchange Act.

The SEC has considered updating the 500 shareholders threshold at various times since 1996 but has not yet done so. Community banks eager to raise capital without burdensome SEC reporting costs continue to push for change.
 

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Having your laptop or smartphone searched or detained by Customs on your way back from a business trip would be a nightmare for most travelers, including bankers and other finance professionals. However, this scenario is quite possible under new governmental policies. In 2009, Customs and Border Protection (“CBP”) and Immigration and Customs Enforcement (“ICE”) both issued their respective new policies on border searches of electronic devices. It was a coordinated effort of CBP and ICE to update and harmonize their border policies to detect an array of illegal activities, including terrorism, cash smuggling, contraband, child pornography, copyright, and export control violations.

With all the technology innovations that allow business travelers to carry massive amounts of information in small electronic devices, CBP and ICE are facing an enormous challenge. On the one hand, travelers have a legitimate right to carry information on electronic devices. In that respect, there are serious concerns regarding the traveler’s expectation of privacy. On the other hand, the government has a duty to combat illegal activities and to enforce U.S. law at the border. The difficulty is finding the right balance between the government’s duty to enforce the law and the rights of travelers.

The legal basis for ICE and CBP policies is the border search exception to the Fourth Amendment requirement that officers obtain a warrant before searching someone’s property. But, assuming that they have this power, another key issue is exactly what CBP and ICE are allowed to do with one’s laptop. In short, they have authority to search and share information on laptops, disks, drives, tapes, mobile phones, Blackberries, cameras, music players, and any other electronic or digital devices — with or without “reasonable suspicion1” of illegality. Detention of the devices and/or information requires probable cause that an illegal activity is underway or is about to occur.

Searches
CBP searches may be conducted with or without suspicion of an unlawful activity. To the extent practicable, CBP searches should be conducted in the presence of a supervisor. ICE searches should be conducted by an ICE Special Agent, CBP Officer, or Border Patrol Agent. The searches should be conducted in the presence of, or with the knowledge of, the traveler. Naturally, the guidelines provide for exceptions to the traveler’s presence under certain circumstances where national security or operational considerations are an issue. ICE guidelines specifically state that the traveler’s consent for the search is not needed.

Detention
CBP detention of a device should not exceed five days, but that period can be extended. ICE detention periods may be longer — up to 30 calendar days or longer — if circumstances warrant. CBP is required to issue a Custody Receipt to the owner of the device (CBP Form 6051D) at the time of detention. ICE will also give the owner of the device documentation regarding its custody. Detention of electronic devices requires probable cause to believe that the device, or its contents, contains evidence of illegality that CBP and ICE are authorized to enforce.

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Under the Gramm-Leach-Bliley Act (“GLB”), financial institutions are required to disclose their information-sharing practices to their customers and also to notify them of their right to opt out of certain practices. As amended by the Financial Services Regulatory Relief Act of 2006, GLB also requires that certain regulatory agencies develop a model privacy notice form. This form will assist consumers in comparing the different information and privacy practices of financial institutions by providing an inclusive form that is consistent across all institutions.

On November 17, 2009, the Board of Governors of the Federal Reserve System, the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation, the Federal Trade Commission, the National Credit Union Administration, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Securities and Exchange Commission jointly issued a final model privacy notice form under GLB. The final model privacy notice form comes in two versions: (1) a version containing opt-out language in a section titled “To limit our sharing,” and (2) a version without opt-out language.

By using the appropriate final model privacy notice form, financial institutions can comply with the GLB notice and disclosure requirements. Under the final rule promulgated by the regulatory agencies, use of the model form functions as a “safe harbor” such that any financial institution correctly using the appropriate model form will satisfy the notice and disclosure requirements.

While the model form provides a safe harbor, financial institutions can continue to use their own notice form so long as it complies with the final rule. If a financial institution elects to use the model form, that institution must determine whether or not their information-sharing practices necessitate the use of the opt-out model form. Accordingly, financial institutions should seek the advice of privacy personnel and legal counsel to determine if switching to the model form is the right decision for their business and, if so, which version applies.

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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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Earlier today the FTC announced it would delay enforcement of its Red Flags Rule until November 1, 2009.  Enforcement had been scheduled to begin August 1, 2009.  As previously discussed here, the Red Flags Rule is an FTC regulation that requires “creditors” and “financial institutions” with “covered accounts” to have a program in place to detect identity theft.  The term “creditor” is defined broadly to include any entity that regularly extends credit.  A “covered account” is essentially the extension of credit as part of a continuing relationship to purchase a product or service for personal, household, or business purposes.

The rule has garnered significant attention lately from lawyers following the FTC’s announcement in April that the FTC interprets the Red Flags Rule to apply to law firms because law firms bill for services already rendered.  The ABA disagrees and has threatened to sue should the FTC continue to assert that the Rule applies to lawyers.

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Promulgated under Sections 114 and 315 of the Fair and Accurate Credit Transactions Act (“FACTA”), the rules on Identity Theft Red Flags and Address Discrepancies have caused widespread confusion as to their coverage, application, and compliance requirements. In a coordinated response to this confusion, the Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, National Credit Union Administration, Office of the Comptroller of the Currency, Office of Thrift Supervision (each, a “Federal Banking Agency”), and the Federal Trade Commission (“FTC”) recently developed a set of frequently asked questions (“FAQs") to assist those that extend credit on covered accounts. 

The FAQs, 37 of them in all, cover the following range of topics:

• Red Flags Rule Scope
• Definitions
• Establishment of an Identity Theft Prevention Program (“Program”)
• Program Elements
• Program Administration
• Red Flags Examples
• Change of Address Validation
• Address Discrepancies Rule Scope
• Establishing a Reasonable Belief
• Furnishing Information to a Consumer Reporting Agency

For financial institutions regulated by a federal banking agency, the Identity Theft Red Flags and Address Discrepancies under FACTA went into effect on November 1, 2008. For all other consumer creditors, the FTC has delayed the effective date, first to May 1, 2009 and now to August 1, 2009. Please see the FTC’s Red Flags website for further information on the rules and for information and guidance for low-risk businesses on the development and implementation of a complying Program.

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In a response to public outcry in the midst of a recession, on April 21, 2009 the Board of Governors of the Federal Reserve System (“Board”), together with the Office of Thrift Supervision and the National Credit Union Administration, recently issued new rule clarifications under Regulation AA of the Federal Trade Commission Act in an effort to prevent unfair trade practices related to consumer credit cards. That same day, the Board also released clarifications under Regulation Z of the Truth in Lending Act in order to further regulate disclosures and solicitations related to consumer credit cards. The clarified rules take effect on July 1, 2010.

Taking this step toward tighter consumer credit card regulation and turning it into a giant leap, lawmakers passed the Credit Card Accountability Responsibility and Disclosure Act of 2009 (“CARD Act”), amending the Truth in Lending Act so as to ban certain credit card provider practices and augment required disclosures. President Obama signed the CARD Act into law on May 22, 2009. With the exception of two provisions that take effect on August 20, 2009, the CARD Act takes effect in February of 2010. With such short implementation timeframes for both the clarified rules and the CARD Act, consumer credit card providers must move quickly to revise policies and procedures to achieve timely compliance. 

Agency Rules 

As stated by Board Chairman Ben S. Bernanke at the adoption of the rules in December of last year, these “protections will allow consumers to access credit on terms that are fair and more easily understood.” These “protections” alter Regulations AA, Z, and DD as follows:

Regulation AA:

• Existing Balance Rate Increases: The proposed rules prohibit increasing the rate on existing balances unless the rate is tied to an index, a promotional rate expires, or the minimum due is not received within 30 days following the due date.
• Payment Times: Under the proposed rules, credit card payments may not be considered “late” unless the provider gives reasonable time to make payments (including a safe harbor provision for providers that send statements at least 21 days before the payment due date).
• Payment Allocation: Payments above the minimum due, made when multiple rates apply to multiple balances, would require allocation by one of three methods. Applying the entire payment to the lowest rate will no longer be permitted. Further, all payments above the minimum due must be allocated first to non-discounted-rate balances.
• Two-Cycle Billing: The proposed rules prohibit calculating finance charges in relation to days in billing cycles preceding the current billing cycle.
• Firm Offers of Credit: Financial institutions advertising offers of credit with multiple rates would be required to disclose the factors assessed to determine if the consumer qualifies for the lowest rate.
• Credit Card Holds: The proposed rules prohibit imposing fees when the credit limit is exceeded because of a hold on available credit.
• Subprime Credit Cards: The proposed rules prohibit financing security deposits and credit availability fees, if such charges over the first year would exceed 50 percent of the initial credit limit. Also, financed security deposits and credit availability fees exceeding 25 percent of the initial credit limit must be spread across the first year.
• Opt Out Rights: The new rules prohibit assessing overdraft fees, unless the consumer was given a chance to opt out of overdraft payment services and declined. Also, the financial institution must offer a partial opt out for ATM and point-of-sale.
• Debit Holds: No fees may be imposed when the account is overdrawn because of a hold on available funds.

Regulation Z:

• Payment Timeliness: Mailed credit card payments received by 5:00 p.m. be considered timely. Further, in cases when the due date falls on a weekend or holiday, payments received by mail the next business day must be considered timely.

Regulation DD – Account Disclosures:

• Overdraft Disclosures: Disclose month-to-date and year-to-date totals for overdraft and returned-item fees on periodic statements; and
• Availability Disclosures: Disclose available funds irrespective of funds to cover overdrafts, when using an automated information system.

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In a case decided at the end of this most recent term, the U.S. Supreme Court ruled that New York State prosecutors are permitted to investigate national banks for lending discrimination. The case opinion  in Cuomo v. Clearing House Association is contrary to what was the Office of the Comptroller of the Currency’s interpretation of federal banking regulations. The OCC had blocked an investigation by New York into lending practices of national banks, but the Court held that states have the power to enforce their banking-related laws against national banks.

At issue was an OCC regulation that expansively interpreted the National Bank Act’s preemption of a state’s visitorial powers to preclude states from enforcing national banks’ compliance with state and federal discrimination-in-lending laws. In a 5-4 opinion, the Court ruled that the OCC’s regulation preempting state law enforcement is not a reasonable interpretation of the NBA.

The case is potentially an affront to the OCC’s long-standing position in favor of preemption. As the bureau of the Department of Treasury charged with regulating national banks, the OCC has long argued for preemption of state banking law in what some have called an effort to make the national bank charter more attractive. The United States Supreme Court had previously endorsed the OCC’s position on preemption in the 2007 case of Watters v. Wachovia Bank, N.A.

In that opinion, the Court held that Wachovia Mortgage Corporation, a real estate lending business and wholly owned operating subsidiary of Wachovia, was subject to the superintendence of the OCC and not to the regulatory regimes of the several states in which the subsidiary operated.

The OCC’s victory in Watters was the culmination of years of opinion letters by the agency on the subject of preemption, each letter offering guidance on why various state laws are subject to preemption by federal law. The specific question of whether the OCC has the authority to preempt state law had, until Watters, remained unanswered by the Supreme Court, despite dissention on the issue among the circuit courts. The decision in the Watters case, which can be characterized as a clash between federal agency power and states’ rights, concludes that Congress has consistently supported the national banks’ right to avoid registration, inspection, and enforcement in every state in which they do business.

The decision indicates that the OCC, without authorization from Congress, does have the power to conclude that state banking law interferes with federal law and is therefore preempted. Surprisingly, a supreme court that has remained committed to states’ rights in other contexts supported the power of federal agencies in the context of banking law in the Watters decision.

Some commentators had thought the Watters decision, as the dissent states, “threatens the vitality of most state laws as applied to national banks.” In the realm of consumer protection laws, however, it seems the Watters decision has been significantly limited by the Cuomo decision.
 

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Private equity investment in banks remains stalled despite a 10-month-old Federal Reserve rule change that allows minority stakeholders in banks and bank holding companies to increase their investments without being subject to regulation under the Bank Holding Company Act of 1956 (the “BHC Act”).  The new rules are intended to encourage private equity funds to invest in banking organizations at a time when many banks require additional capital. Some news outlets report regulators will relax additional rules to encourage private buyouts, including the FDIC, which will soon issue “policy guidelines” regarding private equity investments.

The BHC Act applies to any company that controls a bank or bank holding company. Minority investors in banking organizations commonly structure their investments to ensure that they do not obtain “control” of the banking organization, a status that triggers regulation under the BHC Act. “Control” is defined by the BHC Act to include the exercise of a controlling influence over the management or policies of the bank. The Federal Reserve’s latest policy statement on this subject offers further guidance on what constitutes a “controlling influence.”

The Federal Reserve policy statement institutes the following changes to allow a minority investor to avoid having a controlling influence:

• A minority investor is permitted to have a representative on a banking organization’s board of directors and may have two representatives if there are at least eight board members. There are limitations on the investor’s representative serving as board chairman or on specific committees. Previously, an investor with 10 percent or more of the voting stock of a bank was not permitted to have representation on the board of directors unless it owned less than 15 percent of the voting stock and another investor owned a larger block.

• An investor does not have a controlling influence if it owns less than one-third of the total equity of the bank and less than 15 percent of any class of voting stock. Previously, equity investments could not exceed 25 percent of the total equity of the bank and the investor was required to own less than 10 percent of the voting stock.

• A minority investor may now advocate a variety of positions, including changes in the bank’s policies and operations, strategies for raising capital, new business lines, sales of subsidiaries and other assets, mergers, and changes in management, as long as the decision to act on such discussions remains with the shareholders as a group or the board of directors, as appropriate. Communications by minority shareholders should not contain threats to sell shares or to solicit proxies as a way of influencing management.

• Under the new policy statement, business relationships between minority investors and the bank may be allowed depending on the ownership percentage of the investor, and whether the business relationship is non-exclusive, on market terms, and terminable without penalty to the bank.

• The Federal Reserve continues to look unfavorably on contractual restrictions that inhibit a banking organization’s ability to make decisions on hiring, firing, executive compensation, operations, raising capital, sales and acquisitions of major assets, and mergers and acquisitions. However, investment agreements that restrict issuing senior securities, borrowing on a senior basis, modifying the investor’s security, or liquidating the bank are no longer discouraged.

At a time when banking organizations are seeking capital from all available sources, these changes have not necessarily encouraged much-needed investment by private equity funds.
 

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On November 12, 2008, the U.S. Department of Housing and Urban Development ("HUD") issued a long-anticipated Final Rule amending the regulatory framework of the Real Estate Settlement Procedures Act ("RESPA").  In conjunction with the Final Rule, HUD also issued a standardized Good Faith Estimate form and a revised HUD-1 Settlement Statement form.  Compliance with the Final Rule and use of these standardized forms will become mandatory on January 1, 2010.

Industry groups maintain that the Final Rule is deficient in many respects, arguing that because it may overlap with regulations issued by the Fed under the Truth in Lending Act, it creates the possibility of conflicting and ambiguous requirements for lenders and brokers.  Consumer advocates also maintain the Final Rule is deficient, arguing that it falls short of stopping certain incentives, such as yield-spread premiums, that contributed heavily to the current problems in the mortgage market, and fails in a broader sense in that it does not help consumers answer the basic question:  Can I afford this loan?

Key to these regulations is the requirement that lenders or brokers issue a Good Faith Estimate at the outset of the loan process.  Lenders must prepare the estimate with a minimum of information from the borrower, such as the borrower's name, Social Security number, gross monthly income, address and value of the property, and the amount of the proposed mortgage loan.  Lenders can request additional information, but cannot expect the borrower to go into the detail otherwise reserved for the formal loan application process. 

Once the lender has the necessary information, it must provide the borrower with a Good Faith Estimate (at no charge to the borrower) within three days.  The Good Faith Estimate will contain information needed to help consumers shop for the lowest-cost loan, such as the interest rate, timing and cost of the interest rate lock, estimated cost of all settlement charges (including title insurance and recording fees), and the general terms of the loan, such as the amount, term, origination fees, estimated monthly payment, and the fixed or variable nature of the interest rate. 

Because the purpose of this estimate is to help consumers make informed decisions, loan originators have an express obligation to provide accurate information up front.  As a result, the final cost and terms of the loan and closing process must reflect the original Good Faith Estimate, except under certain specific circumstances. 

This Final Rule represents a substantial changes in the regulatory environment surrounding residential mortgage loans and the settlement process.  In addition to the significant changes that lenders and brokers will need to make to their loan application process in order to ensure full compliance with the Good Faith Estimate requirements, there will be many practical business arrangements that will have to be made to ensure that disclosed costs (such as a title company's settlement costs) are accurate. 

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