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01.29.2009 | Legal Update

Headlines

1.  Treasury Amends CPP Rules on Executive Compensation
2.  Court Upholds State Tax on Out-of-State Credit Card Bank
3.  Guidance on Risk Management of Remote Deposit Capture
4.  FDIC Proposes Changes to Interest Rate Restrictions
5.  Other Developments: TLGP Debt Reporting and Credit Union Mergers

Full Reports

1.  Treasury Amends CPP Rules on Executive Compensation

The Treasury Department has issued amendments to its interim final rules addressing reporting and recordkeeping requirements under the Capital Purchase Program (CPP) executive compensation standards. The amendments released on January 16 require the chief executive officer to certify annually, within 135 days after the financial institution’s fiscal year end, that the financial institution and its compensation committee have complied with the CPP executive compensation standards. In addition, within 120 days of the closing date of the CPP investment, the CEO is required to certify that the compensation committee has reviewed the senior executive officers’ incentive compensation arrangements with the senior risk officers to ensure that the arrangements do not encourage senior executives to take unnecessary and excessive risks that could threaten the value of the financial institution. The annual and 120-day certifications must be delivered to the Treasury’s Chief Compliance Officer for the Troubled Asset Relief Program (TARP). The amended rule also requires the financial institution to keep records to substantiate those and other CPP certifications for at least six years following each certification.  Finally, the amendments clarify that bonus and incentive compensation will be considered paid to a senior executive officer during the period when Treasury holds an equity or debt position under the CPP, and therefore will be subject to clawback, if the officer obtains a legally binding right to that payment during that period.

Nutter Notes:  Update on other recent TARP developments:

• The FDIC issued Financial Institution Letter FIL-1-2009 on January 12, which directs state nonmember banks to document their use of capital injections, liquidity support and financing guarantees obtained through federal financial stability programs, including the CPP. The FDIC expects institutions to monitor how participation in these federal programs has assisted them in supporting prudent lending and foreclosure mitigation. The FDIC expects banks to describe their use of the funds during examinations, and encourages banks to summarize the information in published annual reports and financial statements.
• The Treasury Department issued a term sheet for qualifying financial institutions that are S corporations applying for CPP funds.  The term sheet released on January 14 provides for the issuance of debt rather than the preferred stock that public and private C corporations are required to issue under the CPP.  S corporations will issue subordinated debentures to Treasury that are similar in many respects to trust preferred securities. The CPP funds provided in return for the debentures will qualify as Tier 2 capital for banks and savings associations, and Tier 1 capital for holding companies, subject to additional rulemaking by the federal holding company regulators.  Interest will be payable at a rate of 7.7% per annum until the fifth anniversary of the date of the investment and thereafter at a rate of 13.8%. S Corporations will have until February 13 to apply using forms on the Treasury’s TARP web site.
• Because mutual institutions are unable to issue equity securities, the terms Treasury is expected to issue for participation in the CPP by mutual banks and mutual holding companies are likely to be similar to those for S corporations.

2.  Court Upholds State Tax on Out-of-State Credit Card Bank

In a recent decision, the Massachusetts Supreme Judicial Court ruled that Massachusetts may impose its financial institution excise tax (FIET) on an out-of-state bank that does not have any offices in Massachusetts. The court’s January 8 opinion involved two affiliated banks that issued credit cards to hundreds of thousands of Massachusetts residents. The banks had no physical presence in Massachusetts, did not own or lease any property in Massachusetts, and had no agent, employee or independent contractor located in Massachusetts during the tax years in question.  As credit card issuers, the banks filed quarterly credit card issuers reports with the Division of Banks. The Massachusetts Commissioner of Revenue issued an assessment of the FIET to the banks for the tax years at issue and the banks applied for abatement of the FIET, which was denied.  In upholding the denial of the banks’ applications for abatement of the FIET, the court found that the banks had a “substantial nexus” with Massachusetts that justified imposition of the FIET. The nexus was established not only by the banks’ issuance of credit cards to Massachusetts residents, but also because the banks used the Massachusetts court system to collect delinquent accounts, working with collection agencies and Massachusetts attorneys.

Nutter Notes:  The banks challenged the imposition of the FIET only on constitutional grounds. The United States Supreme Court has held that the Federal commerce clause of the United States Constitution precludes a state from imposing sales or use tax obligations on a company that has no physical presence in that state.  The Supreme Court has held that a state’s assessment of a sales or use tax on a business with no physical presence in the state creates an unconstitutional burden on interstate commerce. The banks in this case argued that the commerce clause should be held to apply the physical presence requirement equally to income-based tax assessments, like the FIET. In another line of cases, the Supreme Court has affirmed the right of a state to impose a tax on a business engaged in interstate commerce if the tax is applied to an activity with a “substantial nexus” with that state. The Massachusetts court held that nothing in the line of Supreme Court cases on the subject suggests that a physical presence is required to establish a “substantial nexus” with the state to justify the imposition of other types of taxes, such as income-based taxes. In a more recent decision, the U.S. Supreme Court agreed with another state court’s assessment that recent rulings under the commerce clause indicated a retreat from the stringent physical presence test in favor of a more flexible substantive approach, at least for taxes other than sales or use taxes. Citing a similar conclusion by West Virginia’s highest court involving a credit card bank, the Massachusetts court concluded that the “substantial nexus” test does not require a physical presence in the taxing state for the assessment of an income-based tax.

3.  Guidance on Risk Management of Remote Deposit Capture

The member agencies of the Federal Financial Institutions Examination Council (FFIEC) have issued guidance addressing risk management in the use of remote deposit capture (RDC) systems by financial institutions. The guidance, Risk Management of Remote Deposit Capture, issued on January 14 encourages financial institutions to carefully identify the legal, compliance, reputation and operational risks associated with RDC particular to that financial institution, considering the institution’s existing risk management practices, before implementing RDC and periodically thereafter. RDC is a system that allows bank customers, including merchants, to scan checks and deliver the checks for deposit electronically from remote locations. The remote locations may be locations owned and controlled by the financial institution, such as its branches or ATMs, locations owned and controlled by customers of the financial institution or both. The checks may be settled either through the check collection system or as Automated Clearing House (ACH) Network transactions. The RDC guidance highlights the additional risks inherent in RDC, and focuses on the associated controls and risk management practices needed to operate RDC safely and effectively. Risks and risk management practices will vary significantly depending on how checks are cleared, whether the institution controls the remote locations and whether RDC is used to process foreign checks. The guidance also directs financial institutions to consider technology and process controls and risk management processes at customer locations. 

Nutter Notes:  The RDC guidance lists customer and vendor contract provisions that financial institutions should consider to clarify, assign responsibility for and minimize risks related to RDC. Some of these include the roles and responsibilities of the parties, including those related to the sale or lease of equipment and software needed for RDC at a customer location, handling and record retention procedures for information, including security expectations for access, transmission, storage, and disposal of deposit items containing nonpublic personal information, and the types of items that may be transmitted. The guidance recommends that customer contracts address the processes and procedures that the customer must follow, including those related to image quality, what imaged documents (or original documents, if available) RDC customers must provide to facilitate investigations related to unusual transactions or poor quality transmissions, or to resolve disputes, and funds availability. The guidance also suggests that contracts provide for periodic audits of the RDC process (including the IT infrastructure), performance standards, allocation of liability, warranties, indemnification, and dispute resolution, collateral, and collected funds requirements, and the authority of the financial institution to mandate specific internal controls at the customer’s locations. Interagency RDC examination procedures will be published in an updated FFIEC Retail Payment Systems handbook scheduled for release in early 2009.

4.  FDIC Proposes Changes to Interest Rate Restrictions

The FDIC has proposed to amend its regulation restricting the deposit interest rates paid by banks that are less than well capitalized. The proposed amendments approved on January 27 would redefine nationally prevailing deposit rates for deposits of similar size and maturity to be the average of rates paid by all insured depository institutions and branches, as computed and published by the FDIC based on data available to it. The FDIC proposes to post the national rate for deposits of a particular size and maturity and also post the “rate cap” for such deposits on its web site and update it weekly. The “rate cap” would be the national rate plus 75 basis points. Reliance on Treasury security yields in the current regulation to determine nationally prevailing rates would be discontinued. The proposal would also establish a presumption that locally prevailing deposit rates equal the national rates published by the FDIC. A bank would be able to rebut this presumption by presenting evidence that the prevailing rates of interest in its normal market ara exceed the nationally prevailing deposit rates calculated by the FDIC. For those cases in which the national rate does not represent the prevailing rate in a particular market area, as determined by available evidence, the bank would be permitted to offer deposits bearing a rate of interest equal to the prevailing rate plus up to 75 basis points. Comments on the proposed amendments are due 60 days after it is published in the Federal Register.

Nutter Notes:  Section 29 of the Federal Deposit Insurance Act (FDI Act) generally prohibits an insured depository institution that is not well capitalized from accepting funds obtained, directly or indirectly, by or through any deposit broker for deposit, roll over or renewal. The FDIC may, on a case-by-case basis and upon application by an adequately capitalized institution, grant a waiver allowing such an institution to accept, renew or roll over brokered deposits. Section 29 of the FDI Act prohibits such an institution from paying a rate of interest on such funds which exceeds the rate paid on deposits of comparable maturity in the institution’s normal market area for deposits accepted in that market area or the national rate paid for deposits accepted outside the institution’s normal market area.  Institutions that are less than well capitalized are also prohibited from soliciting deposits by offering rates that are significantly higher than the local or national prevailing rates, as applicable. The FDIC’s current regulation implementing Section 29 of the FDI Act ties permissible interest rates nationally to the comparable Treasury yield, and ties permissible interest rates locally to undefined prevailing local interest rates.  The current low yields on Treasury securities are compressing the “national rates” computed under the FDIC’s regulation, causing the “national rates” for regulatory purposes to fall well short of the national average of rates actually paid by depository institutions.

5.  Other Developments: TLGP Debt Reporting and Credit Union Mergers

• FDIC Issues Guidance for TLGP Debt Reporting

The FDIC issued Financial Institution Letter FIL-2-2009 on January 12, which provides guidance on the debt reporting requirements under the Temporary Liquidity Guarantee Program. All participating institutions must report their outstanding debt balances within 30 calendar days after the last day of the month.

Nutter Notes:  Participating institutions must report outstanding balances of guaranteed debt using FDICconnect. The debt reporting function is available within the TLG Program transaction in FDICconnect (which is the same transaction used to submit the TLG Program Election Form).

• Approval Requirements Reduced for Credit Union Mergers

The Massachusetts legislature has approved amendments to the banking statutes that modify the number of votes of a Massachusetts credit union’s members necessary to approve a merger with a Massachusetts savings bank or a co-operative bank from two-thirds to a simple majority. On December 23, 2008, Governor Patrick signed the amendments, Chapter 423 of the Acts of 2008, into law.

Nutter Notes:  Such mergers still require approval by a vote of two-thirds of the corporators of a savings bank or two-thirds of the shareholders of a co-operative bank present, qualified and voting at a meeting, as applicable. Mergers among savings banks and co-operative banks also remain subject to the two-thirds vote approval requirements.

Nutter Bank Report

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Tel: (617) 439-2288