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04.30.2013 | Legal Update

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.

Headlines

1. Federal Court Rules that Bank Is Not Liable in Wire Transfer Fraud Case
2. Division of Banks Releases Revisions to Regulatory Bulletins
3. FDIC and OCC Propose Guidance on Payday Loans
4. Fed Proposes Annual Assessment Rule for Large Holding Companies
5. Other Developments: Retail Foreign Exchange and Mortgage Servicing

1. Federal Court Rules that Bank Is Not Liable in Wire Transfer Fraud Case

In a case decided last month, a federal district court ruled that the Uniform Commercial Code (“UCC”) allows a bank to shift the risk of loss arising from an incident of wire transfer fraud to its customer under certain circumstances. The March 18 decision by the U.S. District Court for the Western District of Missouri came in a dispute between a bank and a commercial customer that lost several hundred thousand dollars when criminals fraudulently initiated a wire transfer from the customer’s deposit account at the bank. The wire transfer was initiated via the internet using a username and password assigned to an authorized representative of the bank’s customer that had been obtained by a hacker who remotely accessed the computer of an employee of the customer. The bank had recommended on more than one occasion that its customer allow the bank to implement a dual-control system to authenticate wire transfer requests initiated via the internet on behalf of the customer. The dual-control system would have prevented any wire transfer request that was not separately initiated using two separate usernames and passwords assigned to two different authorized representatives of the customer. The bank’s customer repeatedly declined to allow the bank to implement such a dual-control system to authenticate wire transfer requests. The court held that the dual-control system was a commercially reasonable method of providing security against unauthorized transfers.

    Nutter Notes: The decision of the court in Missouri follows a number of recent wire transfer fraud cases that have been decided against banks. Those earlier rulings suggested that customers could be held liable under certain circumstances. In general, the UCC provides that a bank bears the risk of loss for unauthorized wire transfers. However, the UCC provides an exception if the bank can establish that its “security procedure is a commercially reasonable method of providing security against unauthorized payment orders,” and the bank “accepted the payment order in good faith and in compliance with the security procedure and any written agreement or instruction of the customer restricting acceptance of payment orders issued in the name of the customer.” Official UCC commentary cited by the court provides that when an informed customer declines a commercially reasonable security procedure and insists on a higher risk procedure for convenience, the customer has assumed the risk of the failure of the higher risk security procedure and cannot shift the risk of loss to the bank. According to the court, the experts called to testify in this case agreed that the fraud would not have occurred if a dual-control procedure had been implemented. However, banks should note that after the incident of fraud at issue in this case occurred, the FFIEC issued guidance recommending that banks consider multi-factor authentication procedures and a layered security approach to fraud prevention technologies.

2. Division of Banks Releases Revisions to Regulatory Bulletins

The Division of Banks has completed revisions to a number of regulatory bulletins applicable to state-chartered banks, including those related to fair lending and Community Reinvestment Act (“CRA”) assessments, insider transactions, investment policy requirements, deposit return item fees and branch office notice and application procedures. The revised regulatory bulletins released on March 29 represent the third phase of the Division’s comprehensive review of all bank and credit union regulatory bulletins and regulations to reduce regulatory burden and compliance redundancy by streamlining, updating or repealing requirements. For example, Regulatory Bulletin 2.1-102, Insider Transactions, has been revised to clarify that the threshold allowances for insider contracts or services refer to the annual aggregate amount of related insider contracts, outstanding extension(s) of credit, commissions, fees and or any other related compensation that meets or exceeds the minimum thresholds, which vary depending on the asset size of the institution. Regulatory Bulletin 2.2-101, Investment Policy Minimum Requirements, has been repealed in its entirety, though the Division cautions that, despite the repeal of this bulletin, all banks and credit unions must adhere to other existing guidance applicable to investment policy requirements. Regulatory Bulletin 2.1-104, Branch Office Notice and Application Procedures, was updated to allow filing of notices and applications using electronic media, such as through FDICconnect. The Division also combined its guidance for Fair Lending and CRA assessment criteria into one bulletin, Regulatory Bulletin 1.3-106, Community Reinvestment and Fair Lending Policy, and updated Regulatory Bulleting 2.3-106, Deposit Return Item Fees, to incorporate the Division’s methodology for calculating the fee.

    Nutter Notes: In previous rounds of its regulatory review initiative, the Division has issued revisions to its regulatory bulletins related to fair lending examinations, information technology risk management, restrictive lease covenants, CRA ratings, and advertising guidelines for CDs and money market accounts. The Division revised Regulatory Bulletin 1.3-103, Consumer Protection and Fair Lending Examinations, to clarify the Division’s authority to enforce state and federal regulations. Regulatory Bulletin 2.3-102, CRA Ratings Policy, was revised to clarify the applicability of the Division’s guidance to large institutions. Regulatory Bulletin 2.3-103, Alternative CRA Examination Procedures, has been renumbered as Regulatory Bulletin 1.3-105 and updated to incorporate Mortgage Lender Community Investment examinations that are conducted by the Division at certain mortgage lenders. Regulatory Bulletin 2.2-102, Management Information Systems Examinations, has been repealed in its entirety. Certain guidance contained in the prior Regulatory Bulletin 2.2-102 addressing the need for information technology providers to provide a Letter of Assurance acknowledging that their services will be subject to regulation and examination by the Division to the same extent as if the services were being performed by the entity itself on its own premises has been updated and incorporated into Regulatory Bulletin 1.1-101, Examination Policies, which remains under review. Regulatory Bulletin 2.2-103, Exclusive Leases and Other Restrictive Agreements, has been updated to broaden the exemptions from its restrictions. Regulatory Bulletin 2.3-105, Certificate of Deposit and Money Market Account Advertising Guidelines, has been repealed in its entirety.

3. FDIC and OCC Propose Guidance on Payday Loans

The FDIC and OCC have issued proposed guidance to depository institutions that offer or may consider offering deposit advance credit products, commonly referred to as payday loans. The proposals released concurrently on April 15 would caution banks about a variety of safety and soundness, compliance and consumer protection risks posed by deposit advance loans. The proposed guidance describes the principles that the FDIC and OCC each expect depository institutions to follow in connection with deposit advance products in order to manage risks related to payday lending, including legal, reputational, consumer protection, compliance and credit risks. The proposal also discusses supervisory expectations for the use of deposit advance products, including underwriting and credit administration policies and practices. The proposal defines deposit advance products as a type of small-dollar, short-term credit product offered to consumers with a deposit account, reloadable prepaid card or similar deposit-related vehicle at a bank whereby the bank provides a credit feature that allows the consumer to take out a loan in advance of the consumer’s next direct deposit based on the consumer’s history of recurring deposits. The proposed guidance encourages banks to continue to offer these products, consistent with safety and soundness and other supervisory considerations. The proposal supplements existing FDIC and OCC guidance on payday loans and subprime lending. Comments on the proposed guidance are due by May 30, 2013.

    Nutter Notes: The proposed guidance notes that payday loans typically have high fees, are repaid in a lump sum in advance of the consumer’s other bills, and that lenders often do not employ fundamental and prudent banking practices to determine the consumer’s ability to repay the loan and meet other necessary financial obligations. The proposed guidance recognizes the need for safe, affordable and sustainable small-dollar credit products among consumers but warns banks to be aware that deposit advance loans can pose safety and soundness, compliance and consumer protection risks. Such loans should be underwritten with consideration of the consumer’s ability to repay the loan without needing to borrow repeatedly to meet necessary expenses, according to the proposed guidance. For example, the proposed guidance recommends that banks consider implementing repeat usage controls that provide a “cooling off” period during which the consumer cannot take out a deposit advance, or reduce the consumer’s credit limit. If structured properly, according to the proposed guidance, small-dollar loans should provide a safe and affordable means for borrowers to transition away from reliance on high-cost debt products. Examiners reviewing deposit advance lending activities will assess credit quality, including underwriting and credit administration policies and practices, and the adequacy of capital, reliance on fee income, and adequacy of the allowance for loan and lease losses, according to the proposed guidance. The FDIC and OCC said that they encourage banks to continue to offer these products, consistent with safety and soundness and other supervisory considerations.

4. Fed Proposes Annual Assessment Rule for Large Holding Companies

The Federal Reserve has issued a proposal to establish annual assessments of top-tier bank holding companies and savings and loan holding companies with $50 billion or greater in total consolidated assets and for nonbank financial companies designated by the Financial Stability Oversight Council (“FSOC”) for supervision by the Federal Reserve. The proposed rule released on April 15 describes how the Federal Reserve would determine which companies are assessed, estimate the total expenses that are necessary or appropriate to carry out its supervisory and regulatory responsibilities for such companies, determine the amount of each company’s assessment and bill for and collect the assessments. The proposed rule would implement Section 318 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), which requires the Federal Reserve to collect assessments sufficient to cover the total expenses the Federal Reserve estimates are necessary or appropriate to carry out its supervisory and regulatory responsibilities for large bank and savings and loan holding companies and nonbank financial companies designated by the FSOC. The Federal Reserve plans to collect assessments beginning with the 2012 assessment period. Comments on the proposed rule are due by June 15, 2013.

    Nutter Notes: Under the proposed rule, each calendar year would be an assessment period. The Federal Reserve would make the determination for each assessment period in which a company is a bank holding company or savings and loan holding company with total consolidated assets greater than or equal to $50 billion, or a nonbank financial company designated by the FSOC, and therefore subject to assessment, based on information reported by the company on regulatory or other reports to the Federal Reserve. Total assessable assets would include total assets for all activities subject to the Federal Reserve supervisory authority as the consolidated supervisor. For a U.S. company, total assessable assets would be the company’s total consolidated assets of its entire worldwide operations, determined by using an average of the total consolidated assets reported in applicable regulatory reports for the assessment period. The Federal Reserve would notify the companies of the amount of their assessment no later than by July 15 of the year following each assessment period. After an opportunity for appeal, assessed companies would be required to pay their assessments by September 30 of the year following the assessment period. The Federal Reserve announced that it has completed the development of a framework for the estimation of its regulatory oversight expenses and the collection of assessments. The 2012 assessment period would be the first full calendar-year assessment period subsequent to the effective date of Section 318 of the Dodd-Frank Act.

5. Other Developments: Retail Foreign Exchange and Mortgage Servicing

• Federal Reserve Approves Final Retail Foreign Exchange Rule

The Federal Reserve on April 4 issued a final rule that sets standards for bank and savings and loan holding companies and Federal Reserve member banks that engage in certain types of foreign exchange transactions with retail customers. The rule, issued pursuant to the Dodd-Frank Act, establishes requirements for risk disclosures to customers, recordkeeping, business conduct and documentation for retail foreign exchange transactions. The rule will become effective on May 13, 2013.

    Nutter Notes: Institutions regulated by the Federal Reserve that are engaging in retail foreign exchange transactions will be required to notify the Federal Reserve and to be well capitalized. Such institutions will also be required to collect margin for retail foreign exchange transactions. The types of transactions covered by the rule include foreign exchange transactions that are futures or options on futures, over-the-counter options on foreign currency and so-called rolling spot transactions.

• CFPB Proposes Amendments to Clarify or Correct Recent Mortgage Rules

The Consumer Financial Protection Bureau (“CFPB”) announced on April 19 proposals to amend some of its recently issued mortgage rules. The proposed amendments would clarify provisions on the relation of Regulation X’s servicing provisions to state law under the Real Estate Settlement Procedures Act (“RESPA”), and clarify the small servicer exemption from certain mortgage servicing rules, among other proposed changes. Comments on the proposed amendments will be due within 30 days after publication in the Federal Register, which is expected shortly.

    Nutter Notes: One of the CFPB’s proposals would amend the commentary to Regulation X to clarify that for purposes of preemption of state law, RESPA and Regulation X do not occupy the field of the regulation of mortgage servicers or mortgage servicing covered by RESPA or Regulation X, meaning that state laws in those areas are not necessarily preempted. The proposal would also clarify which mortgage loans may be considered in determining the availability of the small servicer exemption.

Nutter Bank Report

Nutter Bank Report is a monthly electronic publication of the Banking and Financial Services Group of the law firm of Nutter McClennen & Fish LLP. Chambers and Partners, the international law firm rating service, has ranked Nutter’s Banking and Financial Services practice among the top banking practices in the nation. The 2012 Chambers and Partners review says that a “broad platform of legal expertise and experience” in the practice “helps clients manage challenges and balance risks while delivering strategic solutions.” Clients praised Nutter banking lawyers as “very responsive and detail-oriented.” Visit the U.S. rankings at ChambersandPartners.com. The Nutter Bank Report is edited by Matthew D. Hanaghan. Assistance in the preparation of this issue was provided by Melissa Maichle. The information in this publication is not legal advice. For further information, contact:

Kenneth F. Ehrlich
kehrlich@nutter.com
Tel: (617) 439-2989

Michael K. Krebs
mkrebs@nutter.com 
Tel: (617) 439-2288

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.