On March 21, the U.S. Court of Appeals for the D.C. Circuit held that the Federal Reserve Board’s final rule imposing a 21-cent per transaction limit on debit card interchange fees (up from a 12-cent per transaction limit in its proposed rule) was based on a reasonable construction of a “poorly drafted” provision of the Dodd-Frank Act and that the Board acted reasonably in issuing a final rule requiring debit card issuers to process debit card transactions on at least two unaffiliated networks. NACS v. Bd. of Governors of the Fed. Reserve Sys., No. 13-5270, 2014 WL 1099633 (D.C. Cir. Mar. 21, 2014). The action was brought by a group of merchants challenging the increase to the interchange fee cap and implementation of anti-exclusivity rule for processing debit transactions that was less restrictive than other options. In support of their challenge, the merchants argued that in setting the cap at 21 cents the Board ignored Dodd-Frank’s command against consideration of “other costs incurred by an issuer which are not specific to a particular electronic debit transaction.” The court held, in a decision that hinged on discerning statutory intent from the omission of a comma, that when setting the fee cap the Board could consider both the incremental costs associated with the authorization, clearance, and settlement of debit card transactions (ACS costs) and other, additional, non-ACS costs associated with a particular transaction (such as software and equipment). The court further concluded that the Board could consider all ACS costs, network processing fees, and fraud losses. The court, however, remanded the question of whether the Board could also consider transaction-monitoring costs when setting the fee cap, given that monitoring costs are already accounted for in another portion of the statute. Finally, the court rejected the merchants’ argument that the Board’s final rule should have required the card issuers to allow their cards to be processed on at least two unaffiliated networks per method of authentication (i.e., PIN authentication or signature authentication) holding that the statute goes no further than preventing card issuers or networks from requiring the exclusive use of a particular network.
On April 15, the CFPB issued a proposed rule and request for comment to extend a temporary exception to Regulation E’s requirement that remittance transfer providers disclose certain fees and exchange rates to consumers. Pursuant to Regulation E, as amended to implement section 1073 of the Dodd-Frank Act, insured depository institutions are permitted to estimate certain third-party fees and exchange rates in connection with a remittance transfer until July 21, 2015, provided the transfer is sent from the sender’s account with the institution, and the institution is unable to determine the exact amount of the fees and rates due to circumstances outside of the institution’s control. The CFPB is proposing to exercise its statutory authority to extend this exception for an additional five years, until July 21, 2020. The agency explained that, based on its outreach to insured institutions and consumer groups, allowing the initial temporary exception to lapse would negatively affect the ability of insured institutions to send remittance transfers. Comments on the proposed rule are due within 30 days of its publication in the Federal Register. Read more…
On March 19, Illinois Attorney General (AG) Lisa Madigan announced a suit against a lender for allegedly offering a short-term credit product designed to evade the state’s usury cap. The AG claims the lender offers a revolving line of credit with advertised interest rates of 18 to 24%, and then adds on “account protection fees.” The AG characterizes those fees as interest substantially in excess of the state’s 36% usury cap. According to the AG, after a borrower takes out the short-term loan, the lender allegedly provides a payment schedule and instructs the borrower to make minimum payments, which consumers who filed complaints with the AG’s office believed was a timeline to pay off the full debt. The complaint is the AG’s first under the Dodd-Frank Act and claims that the lender’s practices take unreasonable advantage of consumers and constitute abusive practices. The complaint also alleges violations of the state Consumer Fraud and Deceptive Businesses Practice Act and seeks restitution, civil penalties, disgorgement, and an order nullifying all existing contracts with Illinois consumers and prohibiting the company from selling lines of credit and revolving credit in Illinois.
On March 5, the Federal Reserve Board, the OCC, and the FDIC issued final guidance for stress tests conducted by banking institutions with more than $10 billion but less than $50 billion in total consolidated assets. Under Dodd-Frank Act-mandated regulations adopted in October 2012, such firms are required to conduct annual stress tests. The guidance discusses (i) supervisory expectations for stress test practices, (ii) provides examples of practices that would be consistent with those expectations, and (iii) offers additional details about stress test methodologies. Covered institutions are required to perform their first stress tests under the Dodd-Frank Act by March 31, 2014.
On February 21, the U.S. District Court for the Southern District of New York held that the Dodd-Frank Act’s whistleblower protection provisions could not be applied retroactively to an alleged retaliation that occurred before the effective date of the statute. Ahmad v. Morgan Stanley & Co., Inc., No. 13-6394, 2014 WL 700339 (S.D.N.Y. Feb. 21, 2014). A former employee of a financial institution filed suit against his former employer under Dodd-Frank, alleging that he had been harassed and intimidated for his attempts to raise concerns during audits of loans made by the institution. Although the alleged retaliation occurred before the effective date of Dodd-Frank, the employee argued that the statute’s whistleblower provisions—which broadly prohibit employers from discriminating, harassing, terminating or otherwise punishing employee whistleblowers for their lawful conduct—were merely technical revisions to whistleblower protections that already existed under the Sarbanes-Oxley Act of 2002, and therefore the Dodd-Frank act protections apply retroactively. The court disagreed and held that the Dodd-Frank created an “entirely new whistleblower cause of action,” distinct from that provided by Sarbanes-Oxley. In particular, the court pointed to the plain text of Dodd-Frank, which identifies the relevant provisions as a “cause of action,” and allows plaintiffs to seek double back-pay for retaliation, a remedy not available under Sarbanes-Oxley. The court dismissed the former employee’s suit with prejudice.
On December 10, the Federal Reserve Board, the OCC, the FDIC, the SEC, and the CFTC issued a final rule to implement Section 619 of the Dodd-Frank Act, the so-called Volcker Rule. Section 619 was a central component of the Dodd-Frank Act reforms, and the final rule and its preamble are lengthy and complex. The Federal Reserve Board released a fact sheet, as well as a guide for community banks. Generally, the final rule implements statutory requirements prohibiting certain banking entities from (i) engaging in short-term proprietary trading of any security, derivative, and certain other financial instruments for a banking entity’s own account, (ii) owning, sponsoring, or having certain relationships with a hedge fund or private equity fund, (iii) engaging in an exempted transaction or activity if it would involve or result in a material conflict of interest between the banking entity and its clients, customers, or counterparties, or that would result in a material exposure to high-risk assets or trading strategies, and (iv) engaging in an exempted transaction or activity if it would pose a threat to the safety and soundness of the banking entity or to the financial stability of the U.S. Exempted activities include: (i) market making; (ii) underwriting; (iii) risk-mitigating hedging; (iv) trading in certain government obligations; (v) certain trading activities of foreign banking entities; and (vi) certain other permitted activities. The compliance requirements under the final rules vary based on the size of the institution and the scope of activities conducted. Those with significant trading operations will be required to establish a detailed compliance program, which will be subject to independent testing and analysis, and their CEOs will be required to attest that the program is reasonably designed to achieve compliance with the final rule. The regulators state that the final rules reduce the burden on smaller, less-complex, institutions by limiting their compliance and reporting requirements. The rule takes effect on April 1 2014; however, the Federal Reserve Board announced that banking organizations covered by section 619 will not be required to fully conform their activities and investments until July 21, 2015.
On September 3, the Federal Reserve Board and the FDIC released an optional model template for firms to use when preparing the tailored resolution plans required from some bank and nonbank entities under Dodd-Frank. Entities impacted by these requirements include (i) bank holding companies with total consolidated assets of $50 billion or more and (ii) nonbank financial companies designated for enhanced prudential supervision by the Financial Stability Oversight Counsel.
On August 28, the FDIC, OCC, Federal Reserve Board, FHFA, SEC, and HUD released a revised rule to implement the credit risk retention requirements of the Dodd-Frank Act, including provisions defining “qualified residential mortgages” (QRMs). A memorandum prepared by FDIC staff in connection with the re-proposal highlights certain substantial changes from the rule as originally proposed, including, among others: (i) generally defining a QRM as a mortgage meeting the requirements for a “qualified mortgage” as defined by the CFPB; (ii) calculating the 5% risk retention requirement for non-QRM mortgages and other non-exempt assets based on fair value (rather than par value) of the securitization transaction; (iii) eliminating the premium capture cash reserve account requirements; (iv) permitting the sale and hedging of required risk retention after specified time periods; (v) permitting a sponsor to hold any combination of vertical and horizontal first-loss interests that together represent 5% of the fair value of a securitization; (vi) providing that commercial, commercial real estate and automobile loans satisfying underwriting requirements for exemption from risk retention could be blended in asset pools with non-qualifying loans of the same asset class and remain eligible for reduced risk retention; and (vii) adding a new risk retention option for open market collateralized loan obligations (CLOs), available if the lead arrangers of the loans purchased by the CLO retain the required risk. The agencies also seek comment on an alternative QRM definition called QM-plus, which would encapsulate the core QM requirements but add additional conditions, including a 70% cap on LTV at closing, certain evaluation criteria with respect to credit history, and other product limitations. Comments on the re-proposed rule are due by October 30, 2013.
On August 20, the CFPB announced an enforcement action against a debt settlement company for violations of the Telemarketing Sales Rule and the Dodd-Frank Act. The complaint alleges that the company disguised illegal upfront fees charged for debt-relief services as bankruptcy-related charges and deceived consumers into believing they would become debt free when only “a tiny fraction” of its customers actually do. The enforcement action follows a lawsuit filed against the CFPB on July 22, in which the same debt settlement company and an attorney jointly accused the CFPB of “grossly overreaching its authority” in the investigation on which the enforcement action is based.
On August 16, the Federal Reserve Board issued a final rule establishing the process by which it will assess annual fees for its supervision and regulation of large financial companies. The Dodd-Frank Act directed the Board to collect assessment fees equal to the expenses it estimates are necessary or appropriate to supervise and regulate bank holding companies and savings and loan holding companies with $50 billion or more in total consolidated assets and nonbank financial companies designated by the Financial Stability Oversight Council. The final rule outlines how the Board will (i) determine which companies are assessed, (ii) estimate the total anticipated expenses, (iii) determine the assessment for each of the covered companies, and (iv) bill for and collect the assessment from the companies. For the 2012 assessment period, the first year for which assessment fees will be collected, the Board will notify each company of the amount of its assessment when the rule becomes effective in late October. Payments for the 2012 assessment period will be due no later than December 15, 2013. The Board estimates it will collect about $440 million for the 2012 assessment period. Beginning with the 2013 assessment period, the Federal Reserve will notify each company of the amount of its assessment fee no later than June 30 of the year following the assessment period. Payments will be due by September 15.
On August 15, the OCC issued bulletin OCC 2013-17 regarding its final lending limits rule. In June 2012, the OCC promulgated an interim final rule to apply its existing lending limits rule to certain credit exposures arising from derivative transactions and securities financing transactions, as required by the Dodd-Frank Act. With the interim final rule and subsequent actions, the OCC extended the compliance date while it accepted comments and prepared a final rule. As explained in the bulletin, the final rule outlines permissible methods available to banks to measure credit exposures arising from derivative transactions and securities financing transactions. For derivative transactions, banks can generally choose to measure credit exposure through (i) the Conversion Factor Matrix Method, which uses a lookup table that locks in the attributable exposure at the execution of the transaction, (ii) the Current Exposure Method, which replaces the Remaining Maturity Method included in the interim final rule and provides a more precise calculation of credit exposure, or (iii) an OCC-approved internal model. For securities financing transactions, the final rule specifically exempts securities financing transactions relating to Type I securities and for other securities financing transactions allows banks to (i) lock in the attributable exposure based on the type of transaction, (ii) use an OCC-approved internal model, or (iii) use the Basel Collateral Haircut Method, which applies standard supervisory haircuts for measuring counterparty credit risk for such transactions under the capital rules’ Basel II Advanced Internal Ratings-Based Approach or the Basel III Advanced Approaches. The final rule also extends the compliance period through October 1, 2013.
On August 12, the U.S. Court of Appeals for the District of Columbia Circuit agreed to hear appeals filed by several state Attorneys General (AGs) and certain private plaintiffs regarding the U.S. District Court for D.C.’s dismissal of a suit in which the AGs and the private plaintiffs challenged the Orderly Liquidation Authority (OLA) created by the Dodd-Frank Act, and in which the private plaintiffs challenged the constitutionality of Title X, which created the CFPB, and the Financial Stability Oversight Council (FSOC) created by Title I. The parties separately appealed, but the court consolidated the appeals for its review.
The use of outside vendors by financial services companies is far from new, but the role of these service providers and the adequacy of their work have drawn increasing regulatory scrutiny over the past few years. Effective management and oversight of third-party service providers is key to minimizing the likelihood of derivative liability. Companies must use adequate due diligence to select and engage vendors, consistently monitor the quality of their work, and timely mitigate any problems identified.
Institutions using third-parties service providers should consider taking steps which include the following:
- Establishing written guidelines and clear criteria for the selection of service providers;
- Establishing detailed, written record-keeping protocols for work performed by service providers and monitoring adherence to their implementation;
- Establishing an appropriately robust quality assurance monitoring and testing program together with timely reporting;
- Conducting periodic on-site reviews of service providers for compliance including periodic review of the service provider’s policies, procedures, internal controls and training materials; and
- Carefully analyzing customer complaints related to service provider, in order to remediate any consumer harm and identify broader trends that may need to be addressed.
We encourage you to review some of our recent writing on issues relating to third-party service providers. In “Mortgage Crisis Triggers Stronger Focus on Vendors,” BuckleySandler attorneys Jonice Gray Tucker and Kendra Kinnaird discuss regulatory scrutiny on the use of vendors by mortgage servicers. Another recent article by Valerie Hletko and Sarah Hager provides an overview of supervisory issues related to third-party service providers post-enactment of the Dodd-Frank Act.
On July 30, the OCC, the FDIC, and the Federal Reserve Board proposed guidance for stress tests conducted by institutions with more than $10 billion but less than $50 billion in total consolidated assets. Under Dodd-Frank Act mandated regulations adopted by the regulators last October, such firms are required to conduct annual company-run stress tests starting in October 2013. The guidance discusses supervisory expectations for stress test practices, provides examples of practices that would be consistent with those expectations, and offers additional details about stress test methodologies. It also underscores the importance of stress testing as an ongoing risk management practice that supports a company’s forward-looking assessment of its risks and better equips the company to address a range of macroeconomic and financial outcomes. Comments on the proposed guidance are due by September 25, 2013.
On August 1, the U.S. District Court for the District of Columbia dismissed in its entirety a lawsuit that challenged Titles I, II, and X of the Dodd-Frank Act as unconstitutional. The lawsuit was brought originally by three private parties and later joined by several state attorneys general. The court determined that that the plaintiffs lacked standing and had not demonstrated injury sufficient to permit a challenge of the law on any of their claims.
The private plaintiffs’ challenge to Title X, which created the CFPB, was based on “financial injuries directly caused by the unconstitutional formation and operation of the [CFPB,]” including substantial compliance costs, increased costs of doing business, and forced discontinuance of profitable and legitimate business practices in order to avoid risk of prosecution. The court concluded that such “self-inflicted” harm could not confer standing to challenge Title X. With respect to the private plaintiffs’ challenge to the Financial Stability Oversight Council (FSOC) created by Title I, the court concluded that while an unregulated party is not precluded from establishing standing to challenge the creation and operation of FSOC, standing is “substantially more difficult to establish” under such circumstances and the theories asserted by the plaintiffs were too remote to confer standing.
Both the private plaintiffs and the state attorneys general challenged Title II, claiming that the “orderly liquidation authority” (OLA) provisions violate the separation of powers, deny due process to creditors of a liquidated firm, and violate the requirement for uniformity in bankruptcy. The court again concluded that none of the plaintiffs established either present or future injury sufficient to confer standing to challenge the OLA.
According to media reports, an appeal of the ruling by at least one of the private plaintiffs is anticipated.