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Last July, the OCC announced its decision to accept applications for special purpose national bank (SPNB) charters from fintech companies.  At that time we observed that, while not discussed in the materials released by the OCC, it appeared that a fintech company holding an SPNB charter would be required to be a member of the Federal Reserve System and be subject to oversight as a member bank.  As a Federal Reserve member, an SPNB would have access to the Federal Reserve discount window and other Federal Reserve services.

According to a Reuters article published today, Federal Reserve officials have expressed reservations about allowing such access to fintech companies.  Reuters reports that “many Fed officials fear that these firms lack robust risk-management controls and consumer protections that banks have in place.”  The article quotes the President of the St. Louis Fed as having expressed concern that “fintech will be the source of the next crisis.” The Atlanta Fed President is quoted as having said that “almost none of [the fintech entrepreneurs he has talked to] has risk at the top of what they’re thinking about, and that makes me nervous.”

Despite its reported reservations about the SPNB charter, the Federal Reserve has acknowledged the increasing role played by fintech in shaping financial and banking landscapes and indicated that it is interested in developing policy solutions that would result in greater efficiencies and benefits to all parties.  To that end, the Philadelphia Fed sponsored a conference last November on “Fintech and the New Financial Landscape.”  At the conference, Ballard Spahr partner Scott Pearson was a member of a panel that discussed “The Roles of Alternative Data in Expanding Credit Access and Bank/Fintech Partnership.”

 

 

 

On November 20, the Federal Reserve Board (FRB) and CFPB jointly proposed amendments to Reg. CC, which implements the Expedited Funds Availability Act (EFA Act), and also reopened for public comment various amendments that the FRB had proposed in March of 2011. This new proposal is in addition to the amendments to Reg. CC’s liability provisions that the FRB approved in September, which involved provisions that remain within the FRB’s sole rulemaking authority. In contrast, this more recent proposal relates to EFA Act sections for which the FRB and CFPB have joint rulemaking authority.

First, the FRB/CFPB Reg. CC proposal sets forth a methodology for adjusting a variety of dollar amounts in the EFA Act every five years by the aggregate annual percentage increase in the Consumer Price Index for Wage Earners and Clerical Workers rounded to the nearest multiple of $25. This would implement a statutory requirement under the EFA Act, which was introduced by section 1086(f) of the Dodd-Frank Act, and the proposed effective dates are April 1, 2020 for the first set of adjustments, April 1, 2025 for the next set, and then April 1 every fifth year thereafter. The change would affect various dollar amounts, including the minimum amount of deposited funds that banks must make available for withdrawal by opening of business on the next day, the amount of funds deposited by certain checks in a new account that are subject to next-day availability, and the civil liability amounts for failing to comply with the EFA Act, among others.

Second, the proposal seeks to implement the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) amendments to the EFA Act, which include extending coverage to American Samoa, the Commonwealth of the Northern Mariana Islands, and Guam. The EGRRCPA amendments subject banks in these jurisdictions to the EFA Act’s requirements related to funds availability, payment of interest, and disclosures. Among other things, the proposed amendments would treat each of these jurisdictions as “states” for purposes of Reg. CC.

Finally, the proposed amendments would make various other technical changes to Reg. CC, including a clarification in the regulation that the FRB and CFPB have joint rulemaking authority under certain provisions of the EFA Act.

As noted above, the FRB and CFPB are also reopening for public comment amendments that that the FRB proposed in 2011. That proposal included changes aimed at encouraging banks to clear and return checks electronically, new provisions governing electronic items cleared through the check-collection system, a shorter safe harbor period for exception holds on deposited funds, and new model disclosure forms. Last week’s announcement states that “there may have been important changes in markets, technology, or industry practice since the public submitted comments seven years ago in response to the Board’s 2011 Funds Availability Proposal,” and notes that now the FRB and CFPB have “assumed joint rulemaking authority with respect to some of those proposed amendments.” Previously submitted comments will remain part of the rulemaking docket.

The FDIC, Federal Reserve Board and Comptroller of the Currency are proposing a rule to implement a rural property appraisal exemption under the Economic Growth, Regulatory Relief, and Consumer Protection Act (the Act) and also increase the appraisal exemption based on transaction value from $250,000 to $400,000.

As we reported previously, the Act amends the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) to exclude a loan made by a bank or credit union from the FIRREA requirement to obtain an appraisal if certain conditions are met. The conditions are that the property is located in a rural area; the transaction value is less than $400,000; the institution retains the loan in portfolio, subject to exceptions, and; not later than three days after the Closing Disclosure is given to the consumer, the mortgage originator or its agent has contacted not fewer than three state-licensed or state-certified appraisers, as applicable, and documented that no such appraiser, as applicable, was available within five business days beyond customary and reasonable fee and timeliness standards for comparable appraisal assignments, as documented by the mortgage originator or its agent.

The federal banking agencies propose to implement the exemption under the Act by simply adding to the list of exempted transactions in their respective appraisal regulations a transaction that “is exempted from the appraisal requirement pursuant to the rural residential exemption under 12 U.S.C. 3356.”  In short, the agencies will implement the exemption by simply referencing the statutory provision.

Significantly, the agencies also propose to increase the exemption based on the value of a transaction from $250,000 to $400,000.  The agencies advise that the decision to propose an increase in the transaction value exemption is based on consideration of available information on real estate transactions secured by single 1-to-4 family residential property, supervisory experience, comments received from the public in connection with the Act, and rulemaking to increase the appraisal threshold for commercial real estate appraisals.  If this proposed exemption is adopted, it will significantly reduce the importance of the rural property exemption added by the Act.

With both proposed exemptions, banks still would need to obtain an appropriate evaluation of the real property collateral that is consistent with safe and sound banking practices.

The comment period will run 60 days from the publication of the proposal in the Federal Register.

The American Bankers Association and the Bank Policy Institute have sent a letter to the Board of Governors of the Federal Reserve System (Fed) to petition the Fed to engage in rulemaking to clarify the Fed’s September 2018 “Interagency Statement Clarifying the Role of Supervisory Guidance” (the “Interagency Statement”).  The Interagency Statement was issued jointly by the Fed, FDIC, NCUA, OCC and CFPB with the stated purpose of “explain[ing] the role of supervisory guidance and to describe the agencies’ approach to supervisory guidance.”

The letter states that the petition is made pursuant to section 553(e) of the Administrative Procedure Act.  That provision provides that each agency “shall give an interested person the right to petition for the issuance, amendment, or repeal of a rule.”  An agency must provide the grounds for the denial of a petition and a denial can be appealed to a court.

In their letter, the trade groups express concern that the Interagency Statement “may leave room for examiners to continue to base examination criticisms on matters not based in law.”  An example given is that “some examiners may continue to retain existing [matters requiring attention (MRAs) and matters requiring immediate attention (MRIAs)] based on agency guidance, on the theory that the Interagency Statement is not retroactive.”  They state that there is also “a concern that examiners might defeat the purpose of the Statement by replacing guidance-based examination criticisms with MRAs and MRIAs grounded in generic and conclusory assertions about ‘safety and soundness’ (as opposed to those that identify specific, demonstrably unsafe and unsound practices-the actual legal standard).

Finally, they observe that “the Interagency Statement’s general reference to a ‘criticism’ or ‘citation’ has engendered some confusion about whether MRAs, MRIAs, and other adverse supervisory actions are covered by the Statement.” (The Statement provided that ‘[e]xaminers will not criticize a supervised financial institution for a ‘violation’ of supervisory guidance.  Rather, any citations will be for violations of law, regulation, or non-compliance with enforcement orders or other enforceable conditions.”)

To address these concerns, the trade groups petition the Fed to take the following two specific rulemaking actions:

  • To propose and adopt, through notice and comment rulemaking, the content of the Agency Statement “as a formal expression and acknowledgment of the proper legal status of the guidance.”
  • To include in such a rulemaking “a clear statement that MRAs, MRIAs, examination rating downgrades, MOUs, and any other formal examination mandate or sanction will be based only on a violation of a statute, regulation or order—that is, that they are the types of ‘criticisms’ or ‘citations’ at which the guidance is directed.”  For this purpose, a “violation of a statute” would include the identification of a demonstrably unsafe and unsound practice pursuant to 12 U.S.C. Section 1818(b)(1) but would not include a generic or conclusory reference to “safety and soundness.”  (The groups call this “a critical distinction,” observing that “[i]t is essential that any examination criticisms adhere to the relevant legal standard: the statutory bar on ‘unsafe and unsound’ conduct, as interpreted and binding on the agencies under governing case law.”)

Earlier this month, the Federal Reserve invited comment on actions it can take “to promote ubiquitous, safe, and efficient faster payments in the United States by facilitating real-time interbank settlement of faster payments.”  Comments are due by December 14, 2018.

More specifically, the Fed is seeking comment on two potential actions.  One action is the Fed’s development of a service for real-time interbank settlement of faster payments 24 hours a day, seven days a week, 365 days a year.  The second action is the creation of a liquidity management tool that would enable transfers between Federal Reserve accounts on a 24x7x365 basis to support services for real-time interbank settlement of faster payments, regardless of whether those services are provided by the private sector or the Federal Reserve Banks.

According to a Federal Reserve Board Governor, there is a growing gap between the transaction capabilities in the digital economy for payments that are fast, convenient, and accessible to all and the underlying settlement capabilities.  There is a growing demand for payments to be as instantaneous as the apps on smartphones, but these payments currently rely on a patchwork of systems that can result in inefficiencies and delays, as well as uneven access.  Faster payments would allow consumers and businesses to send and immediately receive payments at any time of the day and on any day of the year, and provide funds recipients the ability to use the funds anywhere they choose.  In many circumstances, the underlying infrastructure cannot ensure that a fast payment is fully complete before the recipient seeks to use the funds.

Interbank settlements can be performed on a deferred basis or in real-time.  Most settlement arrangements for faster payments currently settle funds between banks on a deferred basis, a buildup of obligations results, presenting risks to the financial system in times of stress.  A 24/7 payment-by-payment interbank settlement in real-time, referred to as “real-time gross settlement,” offers clear benefits in minimizing risk and maximizing efficiency.  It would provide banks with access to a settlement system that settles each payment as soon as it is sent.  It would also provide important benefits to households and small business owners who face cash flow constraints.

While membership in a payment system can offer benefits to participating financial institutions such as meeting customer desires for faster, more convenient, or cross-border payment methods, it can also entail risks.  The OCC issued a 2017 interpretive letter that required a bank seeking to enter into membership in a payment system to submit a written notice to its examiner-in-charge providing relevant information regarding the proposed membership and engage in on going monitoring to ensure its involvement can be conducted in a safe and sound manner.

In addition to the Fed’s request for comment, there were two other recent noteworthy payments-related developments.  Last month, the Fed published final amendments to Regulation CC (Availability of Funds and Collections of Checks) to update the liability provisions of Reg. CC to address the nearly-complete conversion of the nation’s check collection system from a paper to an electronic environment. The amendments are effective on January 1, 2019.

Also last month, the National Automated Clearing House Association (NACHA) announced that its members has approved the following three new rules to expand the capabilities of Same Day ACH for all financial institutions and their customers:

  • Effective September 18, 2020, same-day ACH transactions can be submitted to the ACH Network for an additional two hours every business day.
  • Effective March 20, 2020, the same-day ACH per-transaction dollar limit is increased to $100,000.
  • Effective September 20, 2019, the speed of funds availability for certain same-day and next-day ACH credits is increased by making funds from same-day ACH credits processed in the existing first window available by 1:30 p.m. local time and funds from certain other ACH credits available by 9 a.m. local time by the receiving bank.

Last Wednesday the Federal Reserve published approved final amendments to Regulation CC (Availability of Funds and Collections of Checks) which update the liability provisions of Reg. CC to address the nearly-complete conversion of the nation’s check collection system from a paper to an electronic environment.

Historically, when banks disputed which party should be responsible for the liability arising from an unauthorized check, the risks were split in two.  The paying bank (the bank that would pay on a check associated with an account it held) was responsible for forged checks; it would have a signature specimen from its customers, and be able to examine the signature of a presented check against the specimen signature; it would also know if the entire check was forged, since it was the bank’s check.  If the signatures didn’t match, or the check wasn’t an original check from the paying bank, yet the paying bank paid and there was a subsequent loss by the customer, the paying bank would be responsible for that loss, because it was in the best place to detect the forgery.

The depositary bank (the bank holding the account where check funds would be deposited) was responsible for altered checks; it was deemed to be in the best place to determine whether, for example, the amount of the check had been changed from $100 to $10,000.  This division of risk is old, originally established in 18th Century English law (in the case of Price v. Neal, 97 Eng. Rep. 871 (1762)), and enshrined in the U.S. under UCC Articles 3-407 and 3-417.  It also assumes the presentment and receipt of paper checks.

Virtually all checks presented in 2018 within the US are not presented in paper form.  Instead, an image of the check is taken, the original check is destroyed, and the depositary bank presents this check image (a truncated check) to the paying bank.  Notwithstanding the dramatic increase in settlement speed and dramatic reduction in processing costs, electronic images of checks create a potential problem in the event of a bank dispute over whether a check has been forged or altered.  The original check is destroyed, making it impossible to examine the original check to determine whether the check was altered, or whether it was a forgery.  Regulation CC currently does not provide any presumptions as to whether a check is altered or forged.

The new amendment provides this guidance, adding a new presumption of liability for substitute and electronic checks.  If there is a dispute between the paying bank and the depositary bank as to whether a substitute or electronic check is an altered or a forgery (now described as “derived from an original check that was issued with an unauthorized signature of the drawer”), the presumption is that the substitute/electronic check contains an alteration.  This generally shifts liability on fraudulent checks to depositary banks; this presumption may be overcome if a preponderance of the evidence proves the substitute or electronic check does not contain an alternation, or that it was a forgery.  The presumption does not apply if there is an original check to examine.

It’s a reasonable allocation of risk; the depositary bank is receiving, imaging and destroying the check, and then presenting the image to the paying bank.  If there is a later dispute over the fraudulent nature of the check, then the party that destroyed the original check, and was in the best place to preserve the check as evidence, should bear the risk associated with evidentiary questions.

The amendment goes into effect January 1, 2019.

On July 26, 2018, the Federal Reserve Board (“FRB“) announced the launch of the “Consumer Compliance Supervision Bulletin” (the “Bulletin“) and simultaneously published its first issue.  Aimed at “senior executives in banking organizations,” the Bulletin is published by the FRB’s Division of Consumer and Community Affairs with the intent to provide high-level summaries of various consumer protection issues and to enhance the transparency of the Federal Reserve’s consumer compliance supervisory program.  While the Bulletin is primarily focused on state-chartered banks that are members of the Federal Reserve System, it contains advice which will be applicable to all banks and even non-banks.   For example, it will highlight violations identified through supervision and examiner observations and provide practical steps for managing consumer compliance risks in coordination with similar FRB programs such as the Consumer Compliance Outlook and the Outlook Live webinar series.  In comparison to the Consumer Financial Protection Bureau’s publication of Supervisory Highlights, which notably has not been published since mid-2017, the initial issue of the Bulletin appears focused on providing high-level risk management guidance to institutions as opposed to a simple laundry list of violations identified through examinations.

With this in mind, the July 2018 Bulletin focuses on a wide-range of consumer protection issues, including:

  • Redlining. The Bulletin reminds institutions that redlining risk may arise from failure to market products or locate branches in the minority prevalent locations or as a result of institutional changes such as mergers, acquisitions and new lending patterns and describes the key risk factors Federal Reserve examiners may consider, including whether a bank’s (i) Community Reinvestment Act (“CRA“) assessment area appears to inappropriately exclude majority minority census tracts; (ii) record of Home Mortgage Disclosure Act and/or CRA small business lending shows statistical disparities in majority minority census tracts; (iii) branch, product and marketing strategies have an impact on minority census tracts; and (iv) consumer complaints.  It also provides guidance as to redlining risk management techniques such as (i) the regular review of assessment areas and credit market areas; (ii) evaluation of fair lending risk arising from the opening, acquiring or closing of branches and offices; (iii) evaluation through marketing and outreach programs; and (iv) complaints monitoring.
  • Mortgage Target Pricing. The Federal Reserve details risk management insights related to “target prices” for mortgage loan originators, particularly where a higher target price is set for originators that serve minority areas, including:  (i) reviewing financial incentives for compliance with Regulation Z; (ii) implementing policies and procedures to control for fair lending risks; (iii) managing risks for loan originators with higher target prices that serve minority neighborhoods; (iv) monitoring pricing by race and ethnicity across mortgage loan originators; and (v) mapping loans by target price.
  • Small Dollar Loan Pricing. It details fair lending issues associated with small dollar loan pricing such as (i) a lack of rate sheets or other pricing guidelines; (ii) broad pricing discretion at the loan officer level; (iii) lack of clear documentation for pricing decisions; and (iv) lack of monitoring for pricing disparities, and it suggests managing these risks through detailed rate sheets and documentation and the monitoring of pricing exceptions.
  • Disability Discrimination. The Federal Reserve notes that some bank practices related to disability benefits, such as requiring applicants receiving disability income to provide proof of disability through a doctor’s letter, may raise fair lending concerns, and suggests addressing these risks by reviewing policies and procedures and training employees to ensure compliance.
  • Maternity Leave Discrimination. Similarly, it indicates that some bank practices related to applicants on maternity leave, such as treating such applicants as unemployed, may raise fair lending risks and also suggests managing this risk through policy and procedure reviews and training.
  • UDAP Issues Related to Student Loans. While noting previous enforcement with respect to deceptive practices surrounding student loan deposit accounts, the Bulletin stresses the increased UDAP risk associated with third-party student loan servicers and suggests that such risks can be managed through (i) evaluating the financial condition and experience of the third party before onboarding; (ii) monitoring third party complaints; and (iii) ensuring oversight of the third party through monitoring and assessment.
  • UDAP Issues with Overdraft Fees. The Federal Reserve reiterates assessing overdraft fees on transactions with sufficient funds at the time of the transaction but not at posting is a UDAP and details risk management techniques for overdraft fee practices that include: (i) vendor management; (ii) analysis of the overdraft processing methodology and accurate disclosure of same to consumers; (iii) prohibiting overdraft fees where there are sufficient funds at the time of the transaction; and (iv) review of overdraft fee guidance and implementation of best practices.
  • UDAP Issues Related to Loan Officer Misrepresentations. The Bulletin describes potential UDAP violations that may occur when loan officers make misrepresentations, particularly with respect to eligibility for loan programs or qualifications for a loan.  It notes that these misrepresentations are typically identified through consumer complaints and highlights related risk management strategies such as (i) consumer complaint monitoring; (ii) refraining from definitive statements when qualifications are uncertain; (iii) clear and accurate disclosure of qualification requirements; (iv) review and modification of internal policies; (v) adoption of automated underwriting criteria; and (v) appropriate employee training.
  • Other Topics of Note. The Bulletin concludes with a brief discussion of the Uniform Interagency Consumer Compliance Rating System and changes to the Military Lending Act’s implementing regulation.

The federal banking agencies (the Federal Reserve Board, OCC, and FDIC (FBAs)), recently issued a “Policy Statement on Interagency Notification of Formal Enforcement Actions” that is intended “to promote notification of, and coordination on, formal enforcement actions among the FBAs at the earliest practicable date.”  The issuance of the policy statement follows the DOJ’s announcement last month of a new policy to encourage coordination among the DOJ and other enforcement agencies when imposing multiple penalties for the same conduct to discourage “piling on.”

The new policy statement recites that it is not intended as a substitute for routine informal communications among FBAs in advance of an enforcement action, including verbal notification of pending enforcement actions “to officials and staff with supervisory  and enforcement responsibility for the affected institution.”

The policy statement’s key instructions are:

  • When an FBA determines that it will take formal enforcement action against a federally-insured depository institution, depository institution holding company, non-bank affiliate, or institution-affiliated party, it should evaluate whether the action involves the interests of another FBA.  By way of example, the policy statement notes that an entity targeted by an FBA for unlawful practices might have significant connections with an institution regulated by another FBA.
  • If it is determined that one or more other FBAs have an interest in an enforcement action, the FBA proposing the action should notify the other FBA(s) at the earlier of the FBA’s written notification to the targeted entity or when the responsible agency official or group of officials determines that enforcement action is expected to be taken.
  • The information shared should be appropriate to allow the other FBA(s) to take necessary action in examining or investigating the entity over which they have jurisdiction
  • If two or more FBAs is considering bringing a complementary action, such as an action involving a bank and its parent holding company, those FBAs should coordinate the preparation, processing, presentation, potential penalties, service, and follow-up of the enforcement action.

We view the new policy statement as a very positive development.

On Tuesday the Federal Reserve published proposed amendments to Regulation J (Collection of Checks and Other Items by Federal Reserve Banks and Funds Transfers through Fedwire) which are intended to clarify and simplify certain provisions of Regulation J that no longer aligned with Regulation CC (Availability of Funds and Collections of Checks) following its amendments, after it was amended in 2017.

The proposed Regulation J amendments align the regulation with the distinction made in the Regulation CC amendments, and established in Article 3 of the UCC, between checks (which by definition must be reduced to writing) and electronically-created items, or ECIs.  Under the proposed amendments, the Reserve Banks would require senders of ECIs to provide certain warranties and indemnities, in an effort to shift liability to the sending parties who are in a position to know whether they are sending an electronic check (which enjoys standard check warranties) or an electronically created item (which does not).

The proposed amendments additionally smooth out some bumpiness financial institutions may have experienced in moving Fedwire payments to the ISO 20022 financial messaging standard.  ISO 20022 is the global financial messaging standard for SWIFT (the Society for Worldwide Interbank Financial Telecommunication), and its adoption for Fedwires is necessary for “straight through processing” of a payer instruction from a non-US bank to a US bank. Put another way, unified financial messaging standards don’t require translation, and are therefore faster.  Concerns were raised that certain terms used in the ISO 20022 standards (such as “agent”, “creditor”, and “debtor”) would create certain legal obligations. The proposed amendments clarify that usage of any term in the financial messaging standard does not confer or connote any specific legal status, or responsibilities.

On November 28, 2017, the Federal Reserve Board announced a Consent Order with Peoples Bank (Peoples) in Lawrence, Kansas.  The Order charges Peoples with violating Section 5 of the Federal Trade Commission Act (FTCA) by engaging in deceptive mortgage origination practices between January 2011 and March 2015.  According to the Order, Peoples “often” gave prospective borrowers the option of paying discount points (an amount calculated as a percentage of the loan amount) at the time of closing, in order to obtain a lower interest rate.  According to the Fed, this “regularly” led borrowers to pay thousands of dollars for discount points, but did not always result in a lower interest rate.  Peoples denies the charges, but has agreed to pay $2.8 million to a settlement fund for the purpose of making restitution to the affected borrowers.  Also, while not a part of the Order, Peoples has ceased taking new mortgage applications, and is in the process of winding down its mortgage lending operation.

Section 5 of the FTCA proscribes “unfair or deceptive acts or practices in or affecting commerce.”  Here, the Federal Reserve found that Peoples’ misrepresentations were deceptive because they were likely to mislead borrowers to reasonably conclude that they obtained a lower interest rate through the payment of discount points, when in fact, many did not receive a reduced interest rate, or received a rate that was not reduced commensurate with the price they paid for the discount points.  This was found to be material because it “relate[s] to the cost of the loan paid by the borrowers.

The Consent Order notes that Peoples’ loan disclosures “gave an accurate quantitative picture of the loans’ costs.”  But according to the Fed, Peoples (which had no written policy regarding discount points) misrepresented and/or omitted the nature of the discount points, which led many reasonable consumers to incorrectly assume they were receiving a rate based on the discount points they paid, when they actually received no benefit (or not the full benefit) from their payment.  This illustrates the need for mortgage lenders to ensure they are painting an accurate picture of their mortgage products at all stages of the origination process – including advertising, loan disclosures, and communications with prospective borrowers.