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DOJ Alleges Community Bank's Unsecured Loan Pricing Violated ECOA
Last month, the DOJ announced a settlement with a three-branch, $78 million Texas bank to resolve allegations that the bank engaged in a pattern or practice of discrimination on the basis of national origin in the pricing of unsecured consumer loans. Based on its own investigation and an examination conducted by the FDIC, the DOJ alleged that the bank violated ECOA by allowing employees “broad subjective discretion” in setting interest rates for unsecured loans, which allegedly resulted in Hispanic borrowers being charged rates that, after accounting for relevant loan and borrower credit factors, were on average 100-228 basis points higher than rates charged to similarly situated non-Hispanic borrowers. The DOJ claimed that “[a]lthough information as to each applicant's national origin was not solicited or noted in loan applications, such information was known to the Bank's loan officers, who personally handled each loan transaction.”
The consent order requires the bank to establish a $159,000 fund to compensate borrowers who may have suffered harm as a result of the alleged ECOA violations. Prior to the settlement, the bank implemented uniform pricing policies that substantially reduced loan officer discretion to vary a loan’s interest rate. The agreement requires the bank to continue implementing the uniform pricing policy and to (i) create a compliance monitoring program, (ii) provide borrower notices of non-discrimination, (iii) conduct employee training, and (iv) establish a complaint resolution program to address consumer complaints alleging discrimination regarding loans originated by the bank. The requirements apply not only to unsecured consumer loans, but also to mortgage loans, automobile financing, and home improvement loans.
The action is similar to another fair lending matter referred by the FDIC and settled by the DOJ earlier in 2013, which also involved a Texas community bank that allegedly discriminated on the basis of national origin in its pricing of unsecured loans.
Prudential Regulators Announce Coordinated Action Against Technology Service Provider
Recently, the OCC released a formal agreement it entered with the FDIC, the Federal Reserve Bank of St. Louis, and a banking software company to resolve allegations of unsafe and unsound practices relating to the software company’s disaster recovery and business continuity planning and processes. The action reportedly resulted from the third-party service provider’s (TSP) delay in reestablishing full operations at a processing center in the wake of Hurricane Sandy. The agreement requires the TSP to continue to maintain a compliance committee, which must submit quarterly written reports to the TSP’s board. The agreement also details minimum requirements for (i) an enhanced disaster recovery and business continuity planning (DR/BCP) process; and (ii) a DR/BCP risk management program and audit process. The agreement also reaffirms the TSP board’s responsibility for proper and sound management of the TSP. The action demonstrates the OCC’s and other federal authorities’ continued focus on third-party service providers. While in this instance the regulators employed the Bank Services Company Act to directly address concerns about a TSP, recent Federal Reserve Board and OCC guidance also focuses on financial institutions’ responsibilities with regard to managing risks related to third parties’ disaster recovery and business continuity.
Federal Agencies Issue Statement On Subjecting TruPS CDOs To Volcker Rule
On December 27, in response to substantial criticism and legal action by banking trade groups, the Federal Reserve Board, the OCC, the FDIC, and the SEC stated that they are reviewing whether it is appropriate and consistent with the provisions of the Dodd-Frank Act (DFA) not to subject pooled investment vehicles for Trust Preferred Securities (TruPS), such as collateralized debt obligations backed by TruPS, to the prohibitions on ownership of covered funds in section 619 of the DFA, as implemented by the recently finalized Volcker Rule. Community banks and their trade group representatives state that the Volcker rule treatment of TruPS conflicts with a separate section of the DFA that requires TruPS issued by depository institution holding companies to be phased out of such companies’ calculation of Tier 1 capital, but provides for the permanent grandfathering of TruPS issued before May 19, 2010, by certain holding companies with total consolidated assets of less than $15 billion. The banks assert that banking entities investing in pooled TruPS are facing “unexpected and precipitous write-downs” that are not justified by any safety and soundness concern, and that the resulting write-downs are actually causing safety and soundness concerns. The agencies promised to address the matter by January 15, 2014.
Eleventh Circuit Certifies Questions On Georgia Business Judgment Rule In Bank Officer Case, Declines To Apply "No Duty" Rule To Bar Affirmative Defenses
On December 23, the U.S. Court of Appeals for the 11th Circuit certified questions to the Georgia Supreme Court regarding whether bank directors and officers can be subject to claims for ordinary negligence under the state banking code. FDIC v. Skow, No.12-15878, 2013 WL 6726918 (11th Cir. Dec. 23, 2013). In this case, former directors and officers of a failed Georgia bank moved to dismiss a suit brought against them by the FDIC as receiver for the failed bank, asserting that the state’s business judgment rule blocked the FDIC’s ordinary negligence allegations. Specifically, the FDIC claimed that the former directors and officers were negligent in pursuing an unsustainable growth strategy that included approving high risk loans that resulted in substantial losses and contributed to the bank’s failure. The appeals court explained that state law appears to provide that a bank director or officer who acts in good faith might still be subject to a claim for ordinary negligence if he failed to act with ordinary diligence. However, given that its reading of the state statute conflicts with state intermediate appellate court holdings, the Eleventh Circuit asked the Supreme Court of Georgia to determine (i) whether a bank director or officer violates the standard of care established by state statute when he acts in good faith but fails to act with “ordinary diligence;” and (ii) whether, in a case applying Georgia’s business judgment rule, the bank officer or director defendants can be held individually liable if they are shown to have been ordinarily negligent or to have breached a fiduciary duty, based on ordinary negligence in performing professional duties. The court also affirmed the district court’s denial of the FDIC’s motion to strike certain affirmative defenses, rejecting the FDIC’s argument that under federal common law it owes “no duty” to bank officers or directors and it therefore is exempt from defenses under state law.
Prudential Regulators Address Impact Of QM Lending On CRA Ratings
On December 13, the Federal Reserve Board, the FDIC, the OCC, and the NCUA issued an interagency statement to clarify safety and soundness expectations and CRA considerations in light of the CFPB’s ability-to-repay/qualified mortgage rule. The statement emphasizes that institutions may originate both QM and non-QM loans based on their business strategies and risk appetites and that residential mortgage loans “will not be subject to safety-and-soundness criticism based solely on their status as QMs or non-QMs.” Acknowledging that some institutions may choose to originate only or predominantly QM loans, the agencies state that, consistent with recent guidance concerning the fair lending implications of QM-only lending, “the agencies that conduct CRA evaluations do not anticipate that institutions’ decision[s] to originate only QMs, absent other factors, would adversely affect their CRA evaluations.”
Banking Regulators Finalize Social Media Guidance
On December 11, the FFIEC, on behalf of the CFPB, the FDIC, the OCC, the Federal Reserve Board, the NCUA, and the State Liaison Committee, released final guidance on the applicability of consumer protection and compliance laws, regulations, and policies to activities conducted via social media by federally supervised financial institutions and nonbanks supervised by the CFPB. The guidance was finalized largely as proposed. However, in response to stakeholder comments, the regulators clarified certain provisions. For example, the final guidance clarifies that traditional emails and text messages, on their own, are not social media. The final guidance also explains that to the extent consistent with other applicable legal requirements, a financial institution may establish one or more specified channels that customers must use for submitting communications directly to the institution, and that a financial institution is not expected to monitor all Internet communications for complaints and inquiries, but should take into account the results of its own risk assessment in determining the appropriate approach regarding monitoring and responding to communications. The regulators also clarified that the guidance is not intended to provide a “one-size-fits-all” approach; rather financial institutions are expected to assess and manage the risks particular to the individual institution, taking into account factors such as the institution’s size, complexity, activities, and third party relationships. The final guidance also contains further discussion regarding the application of certain laws and regulations to social media activities, such as the Community Reinvestment Act. Finally, consistent with other recent regulatory initiatives, the final guidance clarifies that prior to engaging with a prospective third party an institution should evaluate and perform due diligence appropriate to the risks posed.
Agencies Finalize Exemptions To Higher-Priced Mortgage Loan Appraisal Requirements
On December 12, the Federal Reserve Board, the CFPB, the FDIC, the FHFA, the NCUA, and the OCC, issued a final rule supplementing their January 2013 interagency appraisal rule. As described in detail in our Special Alert, the January 2013 rule amended Regulation Z to require creditors to obtain appraisals for a subset of loans called Higher-Priced Mortgage Loans (HPMLs) and to notify consumers who apply for these loans of their right to a copy of the appraisal. Those new requirements take effect January 18, 2014.
The supplemental final rule, which takes effect on the same date, exempts certain transactions from the HPML appraisal requirements. First, all loans secured in whole or in part by a manufactured home are fully exempt until July 18, 2015. After that date: (i) transactions secured by a new manufactured home and land are exempt only from the requirement that the appraisal include a physical review of the interior of the property; (ii) transactions secured by an existing manufactured home and land are not exempt from any HPML appraisal requirements; and (iii) transactions secured by a manufactured home but not land are exempt from all HPML appraisal requirements, provided the creditor provides the consumer with certain specified information about the home’s value. Second, the supplemental final rule exempts streamlined refinances—i.e. refinancing transactions where the holder of the successor credit risk also held the credit risk of the original credit obligation—so long as the consumer does not take any cash out and the new loan does have negative amortization, interest only, or balloon payments. Third, the supplemental final rule exempts “small dollar” transactions of $25,000 or less, indexed annually for inflation.
Federal Agencies Finalize Volcker Rule
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.
Federal, State Authorities Announce Largest RMBS Settlement To Date
On November 19, the DOJ, other federal authorities, and state authorities in California, Delaware, Illinois, and Massachusetts, announced a $13 billion settlement of federal and state RMBS civil claims, which were being pursued as part of the state-federal RMBS Working Group, part of the Obama Administration’s Financial Fraud Enforcement Task Force. The DOJ described the settlement as the largest it has ever entered with a single entity. Federal and state law enforcement authorities and financial regulators alleged that the bank and certain institutions it acquired mislead investors in connection with the packaging, marketing, sale and issuance of certain RMBS. They claimed the institutions’ employees knew that loans backing certain RMBS did not comply with underwriting guidelines and were not otherwise appropriate for securitization, yet allowed the loans to be securitized and sold without disclosing the alleged underwriting failures to investors.The agreement includes $9 billion in civil penalties and $4 billion in consumer relief. Of the civil penalty amount, $2 billion resolves DOJ’s claims under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), $1.4 billion resolves federal and state securities claims by the NCUA, $515.4 million resolves federal and state securities claims by the FDIC, $4 billion settles federal and state claims by the FHFA, while the remaining amount resolves claims brought by California ($298.9 million), Delaware ($19.7 million) Illinois ($100.0 million), Massachusetts ($34.4 million), and New York ($613.0 million). The bank also was required to acknowledge it made “serious misrepresentations.” The agreement does not prevent authorities from continuing to pursue any possible related criminal charges.
OCC, FDIC Finalize Deposit Advance Guidance
On November 21, the OCC and the FDIC separately issued guidance that establishes numerous expectations for institutions offering deposit advance products, including with regard to consumer eligibility, capital adequacy, fees, compliance, management oversight, and third-party relationships. For example, under the guidance the agencies expect banks to offer a deposit advance product only to customers who (i) have at least a six month relationship with the bank; (ii) do not have any delinquent or adversely classified credits; and (iii) meet specific financial capacity standards. The guidance also establishes, among other things, that (i) each deposit advance loan be repaid in full before the extension of a subsequent loan; (ii) banks refrain from offering more than one loan per monthly statement cycle and provide a “cooling-off period” of at least one monthly statement cycle after the repayment of a loan before another advance is extended; and (iii) banks reevaluate customer eligibility every six months. The final guidance is substantially the same as the versions proposed in April. However, the agencies added language to clarify that eligibility and underwriting expectations do not require the use of credit reports, and to emphasize that the guidance applies to all deposit advance products regardless of how the extension of credit is offered. Acknowledging the demand for short-term, small-dollar credit products, and dismissing the concerns that the guidance might restrict such credit, the FDIC encouraged banks to continue to offer “properly structured products” and to develop new or innovative programs to effectively meet the need for small-dollar credit. As a reminder, the Federal Reserve Board did not propose similar guidance, but instead issued a policy statement.