Financial Services Alert

The U.S. Court of Appeals for the Third Circuit (the "Court of Appeals") held that a bank may deduct from Federal taxes the full amount of expenses the bank incurs for marketing, researching, and originating loans (the "Loan Origination Expenses") in the year the loan is made. PNC Bancorp., Inc. ("PNC") v. Commissioner of Internal Revenue, 3rd Cir. No. 99-6020, May 19, 2000. Two banks which were subsequently acquired by PNC treated Loan Origination Expenses as deductible for Federal tax purposes in the year incurred on the basis that such expenses are ordinary and necessary expenses pursuant to Section 162 of the Internal Revenue Code ("IRC"). The IRS disallowed the deductions and declared that Loan Origination Expenses must be capitalized and amortized over the life of the applicable loan pursuant to Section 263 of the IRC. In 1998, the U.S. Tax Court held that Loan Origination Expenses must be capitalized by PNC pursuant to Section 263. PNC appealed to the Court of Appeals which reversed the Tax Court and held that Loan Origination Expenses are a routine part of a bank's daily business and are deductible under Section 162 and are not within the purview of Section 263. The issue is not necessarily resolved, however, as the IRS could ask the Court of Appeals to reconsider its ruling, seek a ruling with a different taxpayer in another circuit court of appeals, or file a petition seeking a writ of certiorari from the U.S. Supreme Court.

The OCC issued a bulletin (2000-14) providing guidance to national banks on how to prevent, detect and respond to intrusions into bank computer systems. The bulletin notes that the risk and prevalence of computer intrusions is increasing as information systems become more interconnected and as banks make greater use of Internet banking services and other remote access devices. The guidance declares that senior management and the board of directors of a bank are responsible for overseeing the development and implementation of a security strategic plan, key elements of which should include an intrusion risk assessment plan, risk mitigation controls, intrusion response policies and procedures, and testing processes, and sets forth many of the necessary components of these systems. The OCC further notes that national banks are required to report intrusions and other computer crimes to the OCC and law enforcement by filing a Suspicious Activity Report. Management also should ensure that information system networks are tested regularly, with the nature, extent, and frequency of tests used proportionate to the risks of intrusion from external and internal sources. Moreover, management should ensure that an objective, qualified source conducts a penetration test of Internet banking systems at least annually. Furthermore, the bulletin encourages information sharing among institutions in an effort to detect and respond to intrusions and vulnerabilities on a collective basis.

Collective Funds. The OCC released an Interpretive Letter 884 (the "Letter") which concludes that a national bank (the "Bank") may invest tax-exempt, employee benefit plan assets (the "Assets") which the Bank holds as a directed agent or a non-discretionary custodian (and with respect to which it does not make investment decisions) in a part 9 collective investment fund (the "CIF"), provided that the CIF itself qualifies for an exemption from Federal tax. The Letter states that 12 C.F.R. §9.18(a)(2)(ii) explicitly permits the Bank to invest tax exempt employee benefit plan assets, such as the Assets, that the Bank holds "in any capacity (including agent)," in the CIF so long as the CIF is tax exempt, and thus the Bank need not have a fiduciary relationship (such as investment manager) with respect to the Assets.

Credit Insurance. The OCC issued Interpretive Letter 883 (the "Letter") which concludes that despite the Gramm-Leach-Bliley Act of 1999's (the "Act") general prohibition against the underwriting of insurance by national banks or their subsidiaries, the "authorized product exception" contained in Section 302 of the Act preserves the authority of national banks and their subsidiaries to underwrite credit-related insurance with respect to loans originated by both affiliates and nonaffiliates. A subsidiary (the "Subsidiary") of the bank (the "Bank") which is the subject of the Letter underwrites credit life, accident, disability and health insurance products ("Credit-Related Insurance") in connection with loans originated by the Bank, the Bank's other affiliates and unaffiliated financial institutions. Credit-Related Insurance protects both the borrower and the lender by causing the loan to be repaid in the event the borrower dies, becomes disabled or becomes unemployed. The Letter states that the various types of Credit-Related Insurance are each a "product" for purposes of Section 302 of the Act and that the OCC had, prior to January 1, 1999, authorized national banks and their subsidiaries to provide Credit-Related Insurance products as principal to both affiliates and nonaffiliates. The OCC has determined that the underwriting of Credit-Related Insurance products is a permissible activity for national banks and their subsidiaries because such products: (1) are functionally equivalent to or a logical outgrowth of a recognized banking activity; (2) benefit the national bank or its customers; and (3) involve risks similar to those already assumed by banks.

The U.S. Court of Appeals for the District of Columbia Circuit (the "Court of Appeals") held that the OCC lacks the authority to allow national banks to sell crop insurance on the basis of the "incidental powers clause" of the National Bank Act. Independent Insurance Agents of America, Inc. v. Hawke. D.C. Cir. No. 98 cv 00562, May 16, 2000. In 1997, the OCC issued a letter ruling which stated that a national bank may offer, as agent, crop insurance, which insures against unavoidable losses on crops, because, the OCC stated, crop insurance is a product incidental to the business of banking as contemplated by 12 U.S.C. §24 (Seventh). The Court of Appeals distinguished bank sales of crop insurance from bank sales of credit insurance products, which the Court of Appeals has held are authorized under the "incidental powers clause," because the beneficiary of credit insurance is the bank and the insurance policy secures consumer loans whereas the beneficiary of crop insurance is the farmer and the insurance proceeds do not directly secure an agricultural loan. The Court of Appeals notes that its ruling may "have little practical effect" because the Act now allows national banks to sell insurance, including crop insurance, through financial subsidiaries, provided that the bank which files the application is "well capitalized and well managed" and meet the other requirements of the Act.

Regulation Z, implementing the Federal Truth in Lending Act, requires that certain direct mail and other solicitations and applications to open credit and charge card accounts include disclosures in the form of a table, commonly known as the "Schumer Box." The terms required to be disclosed in the Schumer Box are: the method used for calculating finance charges on the outstanding balance, any minimum finance charge per billing cycle, transaction fee, annual fee, grace period and the annual percentage rate ("APR") for purchase transactions. Other disclosures regarding any cash advance fee, late payment fee, or overlimit fee may either be included in the Schumer Box or given elsewhere.

The FRB has proposed amendments to Regulation Z (Docket No. R-1070, May 18, 2000) (the "Proposal") which would add a requirement that the APR for purchase transactions be provided in no less than 18-point type and appear under a separate heading from other APRs, such as penalty rates. In addition, under the Proposal, the existing requirement that disclosures be "clear and conspicuous" would be more strictly construed for purposes of the Schumer Box. The Schumer Box disclosures would have to be "readily noticeable," meaning in at least "12-point type," and in a "reasonably understandable form." The Proposal also includes new commentary on satisfying the current requirement that the Schumer Box be prominently located. Additionally, in the interest of reducing clutter in the Schumer Box, proposed new guidance would limit the additional information which could be included inside the table to disclose penalty APRs. Other currently required disclosures, such as the events which would trigger an increased penalty rate, would have to be given outside of the Schumer Box. Comments to the Proposal are due by July 18, 2000.