United States: Nutter Bank Report, May 2014

The Nutter Bank Report is a monthly electronic publication of the firm's Banking and Financial Services Group and contains regulatory and legal updates with expert commentary from our banking attorneys.

1. Banking Law Modernization Bill Progressing in Massachusetts Legislature
2. FDIC Recommends Strategies for Community Banks to Partner with CDFIs
3. Federal Reserve Amends the Identity Theft Red Flags Rule; Repeals Reg DD and Reg P
4. SEC Provides Guidance on Investment Adviser Due Diligence for Alternative Investments
5. Other Developments: Privacy, Thrifts and Mortgage Rules

1. Banking Law Modernization Bill Progressing in Massachusetts Legislature

The House Ways and Means Committee of the Massachusetts General Court has reported out the banking law modernization bill sponsored by the Massachusetts Bankers Association, House 3881, as a new draft. The bill, now House 4110, was ordered on May 27 to a third reading where it will be reviewed by House Counsel, a significant step for the bill in the legislative process. Among its more significant provisions, the bill would simplify corporate governance provisions for Massachusetts savings banks, co-operative banks and trust companies now contained in Chapters 168, 170 and 172 of the General Laws of Massachusetts into a single chapter, a new Chapter 167J. The bill would replace a number of statutory provisions that specify various reserve and surplus account requirements with a general requirement that a bank must at a minimum be adequately capitalized as determined by the FDIC or the Commissioner of Banks. The bill would also replace statutory provisions that specify the contents of periodic reports that bank management must submit to the full board of directors or board of trustees with a provision that would allow the board to focus on matters of general importance to banking regulators, such as financial soundness, policies, strategic planning, management oversight and oversight of certain regulatory compliance programs. While the statute would still mandate periodic management reports, it would allow the board to determine the information, trends and analysis the reports would contain.

     Nutter Notes: The bill would also address certain practical considerations for mutual banks. For example, it would allow the trustees of a mutual savings bank (rather than the corporators) to elect the president of the bank. The bill would also authorize a mutual savings or co-operative bank board to fill up to 2 vacancies on the board arising between annual meetings, and it would authorize a board of a mutual bank to appoint officers during the year (rather than waiting until the next annual meeting). The banking law modernization bill would also address several areas in which state and federal financial services laws overlap with potentially confusing and redundant regulatory compliance and reporting burdens. The bill would provide that a state-chartered bank is required to comply with certain Federal consumer financial protection laws, such as the Electronic Fund Transfers Act and the Fair Credit Billing Act, and would grant the Commissioner of Banks examination and enforcement authority with respect to those laws. Compliance in those areas would remain under the jurisdiction of the Commissioner, but state-chartered banks would no longer be subject to potentially conflicting state and federal reporting and compliance obligations. 

2. FDIC Recommends Strategies for Community Banks to Partner with CDFIs

The FDIC has issued guidance for community banks on strategies to meet community credit and development needs and receive consideration under the Community Reinvestment Act ("CRA") through collaboration with community development financial institutions ("CDFIs"). The guidance, published in FDIC Financial Institution Letter 26-2014 (May 8, 2014) provides information to help community banks identify and evaluate opportunities to collaborate with CDFIs to provide financial products and services to underserved markets. The guidance describes different types of partnership arrangements that banks can enter into with CDFIs. For example, the guidance notes that banks can make various types of equity investments to build the equity capital of CDFIs, such as stock purchases, grants, and ownership interests in CDFI venture capital funds, depending on the type of CDFI. According to the guidance, the Interagency Questions and Answers Regarding Community Reinvestment (the guidance on CRA issued by the federal banking agencies) explicitly recognize loans to and investments in CDFIs as examples of community development loans and qualified investments because CDFIs, which are certified by the U.S. Treasury Department's CDFI Fund, are required primarily to serve a community development purpose.

     Nutter Notes: The guidance recommends that community banks interested in partnering with a CDFI take certain steps to identify and evaluate CDFIs, and mitigate risks associated with CDFI partnership activities. The guidance recommends that a community bank consider whether a proposed partnership with a CDFI will be valuable to the bank in the context of the bank's business strategy and target geographic area. A bank can consult the list of certified CDFIs by type and state that is available on the CDFI Fund's website to help identify CDFIs serving the bank's CRA assessment area or the broader statewide or regional area that includes the assessment area. The guidance suggests that a bank consider a partnership with a CDFI that can support the bank's business lines. For example, a commercial bank may partner with a CDFI that specializes in microloans with the expectation that the CDFI may help to grow businesses that could later become commercial customers of the bank. The guidance recommends that a bank's evaluation of a CDFI include traditional credit and financial performance reviews of the CDFI. The guidance also recommends that banks consider information provided by one or more CDFI technical assistance providers, such as the National Community Investment Fund or the Opportunity Finance Network. According to the guidance, community banks should consider risks associated with a CDFI partnership and how to mitigate them, such as through traditional credit enhancements or by investing through an intermediary like a CDFI technical assistance provider. 

3. Federal Reserve Amends the Identity Theft Red Flags Rule; Repeals Reg DD and Reg P

The Federal Reserve has adopted final amendments to provisions of its Regulation V, the identity theft red flags rule (the "Red Flags rule"), and has repealed Regulation DD (Truth in Savings) and Regulation P (Privacy of Consumer Financial Information). The final amendments to the Red Flags rule announced on May 22 reflect legislation that amended the Fair Credit Reporting Act ("FCRA") to clarify that these provisions apply only to creditors that regularly extend credit or obtain consumer reports in the ordinary course of their business. The amendments to the FCRA were intended to narrow the scope of the law so that it would not be applied to certain professionals, such as doctors or lawyers, who sometimes allow consumers to defer payments, which can be considered an extension of credit to consumers. The final amendments modify the definition of "creditor" in the Red Flags rule to reflect the amended definition of that term under FCRA. The Federal Reserve repealed Regulations DD and P on May 22 because the CFPB has issued interim final rules that are substantially identical to those regulations. Title X of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") transferred rulemaking authority for Truth in Savings and Privacy of Consumer Financial Information to the CFPB.

     Nutter Notes: The Red Flags rule requires each financial institution and creditor that holds any consumer account, or other account for which there is a reasonably foreseeable risk of identity theft, to develop and implement an identity theft prevention program in connection with new and existing consumer accounts. The rule requires identity theft prevention programs to include reasonable policies and procedures for detecting, preventing, and mitigating identity theft. The rule also requires financial institutions and creditors to exercise appropriate and effective oversight of vendors who have access to consumer account information. Under certain circumstances, the vendor oversight requirement may apply to banks servicing other creditors who are subject to the Red Flags rule. The federal banking agencies have also issued guidelines to assist banks in developing and implementing an identity theft prevention program, including a supplement that provides examples of identity theft red flags. 

4. SEC Provides Guidance on Investment Adviser Due Diligence for Alternative Investments

The SEC has issued examination guidance for investment advisers that manage or recommend alternative investments to their clients on due diligence practices that should be followed for alternative investments. The guidance, a National Examination Program Risk Alert titled Investment Adviser Due Diligence Processes for Selecting Alternative Investments and Their Respective Managers, recommends certain due diligence practices that may provide greater transparency regarding portfolio holdings and that independently support the information provided by underlying managers of alternative investments, including the use of separate accounts to gain full transparency and control and the use of transparency reports issued by independent fund administrators and risk aggregators. The guidance also recommends that investment advisers verify relationships with critical service providers, confirm the existence of assets, routinely conduct onsite reviews, emphasize operational due diligence and have independent providers conduct comprehensive background checks. The types of alternative investments considered by the guidance include private funds, such as hedge funds, private equity, venture capital, real estate, and funds of private funds. The guidance is based on recent SEC staff examinations of the due diligence and related investment advisory processes of advisers to pension plans and funds of private funds in which examiners evaluated how the advisers performed their due diligence and identified, disclosed, and mitigated conflicts of interest, among other things. The guidance noted that many of the recently examined investment advisers had written due diligence policies and procedures in place, but typically did not incorporate those policies and procedures into the advisers' compliance manuals.

     Nutter Notes: Investment advisers are required by the SEC's Rule 206(4)-7 under the Investment Advisers Act of 1940 (the "Advisers Act") to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and to annually review the adequacy of those policies and procedures and the effectiveness of their implementation. These requirements include adopting compliance policies and procedures and completing annual reviews of the effectiveness of their compliance policies and procedures. According to the guidance, the SEC staff identified a number of material deficiencies or control weaknesses in examinations of advisers who recommended alternative investments, including failure to include due diligence for alternative investments in the annual compliance review when these types of investments are a "key portion" of an adviser's business. The SEC staff also found discrepancies between the disclosures regarding due diligence practices made to clients and prospective clients and the due diligence actually performed, and failure to comply with the requirement under Advisers Act Rule 204 2(a)(13)(iii) to maintain a record of decisions to permit advisory personnel to acquire securities in a limited offering and the reasons supporting those decisions. The guidance notes that an adviser that exercises discretion to purchase alternative investments on behalf of its clients, or that relies on an underlying manager of an alternative investment to perform due diligence, must determine whether such investments meet the client investment objectives and are consistent with the investment principles and strategies that were disclosed by the underlying manager to the adviser. 

5. Other Developments: Privacy, Federal Thrifts and Mortgage Rules 

  • CFPB Proposes Amendments to Privacy Rule

The CFPB on May 6 proposed amendments to its Regulation P (Privacy of Consumer Financial Information) that would allow companies, including banks, that limit their consumer data-sharing and meet other requirements to post their annual privacy notices online rather than delivering them individually. Comments on the proposed amendments are due by July 14, 2014.

     Nutter Notes: The Gramm-Leach-Bliley Act and its implementing rules generally require that financial institutions send annual privacy notices to customers. These notices must describe whether and how each financial institution shares consumers' nonpublic personal information. If an institution shares this information with an unaffiliated third party, it typically must notify consumers of their right to opt out of the sharing and inform them of how to do so. 

  • OCC Integrates Thrift Rules with National Bank Rules 

The OCC issued a final rule on May 23 that integrates rules relating to consumer protection in insurance sales, Bank Secrecy Act compliance, management interlocks, appraisals, disclosure and reporting of agreements related to CRA, and FCRA by amending the national bank rule to include federal savings associations (and when appropriate, state savings associations). The amendments will become effective on June 16, 2014.

     Nutter Notes: The final rule does not result in any substantive changes for national banks or federal savings associations. The OCC also announced that it will soon publish a proposed rule that would integrate the rules for national banks and federal savings associations relating to policies and procedures for corporate activities and transactions. 

  • CFPB Proposes Amendment of Qualified Mortgage Rule

The CFPB on April 30 issued a proposed amendment to its home mortgage loan rules that would, in limited circumstances, allow lenders that have exceeded the applicable points and fees cap to refund the excess amount to consumer borrowers in order to classify the loan as a Qualified Mortgage. Comments on the proposed amendment are due by July 7, 2014.

     Nutter Notes: Under the CFPB's Ability-to-Repay rule, the points and fees charged to a consumer on a Qualified Mortgage generally cannot exceed 3% of the loan principal. The amendment would allow a lender which believes it has offered a Qualified Mortgage but afterwards discovers that it has exceeded the cap to refund the excess and still meet the legal requirements of a Qualified Mortgage, provided the refund occurs within 120 days after the loan is made. 

Originally published May 30, 2014

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.

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