2010 CBA Regulatory and Litigation Summary
Leland Chan, CBA General Counsel
2010 will be remembered as the year that Congress enacted the single most significant piece of banking legislation since the Great Depression. By one count, the Dodd-Frank Wall Street Reform and Consumer Protection Act directs the issuance of 243 new regulations, many by the newly established Bureau of Consumer Financial Protection. The new independent agency will have primary jurisdiction over banks with over $10 billion in assets with respect to a myriad of consumer protection laws and regulations.
2010 will be remembered as the year that Congress enacted the single most significant piece of banking legislation since the Great Depression. By one count, the Dodd-Frank Wall Street Reform and Consumer Protection Act directs the issuance of 243 new regulations, many by the newly established Bureau of Consumer Financial Protection. The new independent agency will have primary jurisdiction over banks with over $10 billion in assets with respect to a myriad of consumer protection laws and regulations.
State and, presumably, local law enforcement agencies will share enforcement responsibilities with the new bureau, together with the existing cadre of federal banking agencies and others. The Dodd-Frank Act pares back the doctrine of preemption as applied to national banks, and eliminates the field preemption enjoyed by federal savings banks under the Home Owners Loan Act (national banks and federal thrifts will be subject to the same standards). This could result not just in more investigations and enforcement actions, but also in the development of inconsistent standards. One of the biggest challenges facing the industry in the next two years will be providing industry input in the rulemaking process so that the regulations to be written will be fair and workable.
Together with the proliferation of new laws and regulations inevitably come new grounds for litigation. Now more than ever it is imperative that the industry monitor and help shape the development of case law in the state and federal courts, which in practice carry the same weight as enacted legislation.
This Summary reviews the comment letters, friend-of-the-court briefs and letters, and Regulatory Compliance Bulletins prepared by CBA in 2010 on behalf of the California banking industry.
CBA comment letters and bulletins are available as links in the body of this Summary. Amicus briefs filed by CBA may be obtained by contacting Leland Chan at email@example.com.
The summaries listed in this section pertain to provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act irrespective of their subject matter. The full impact of the massive bill will not be manifested until the hundreds of regulations that the bill mandates are developed and become effective. The Bureau of Consumer Financial Protection is scheduled to assume its responsibilities over the enforcement a number of consumer protection laws as of July 21, 2011.
Debit Interchange Fee Regulation
Issue: A provision of the Dodd-Frank Act that could have among the biggest monetary impacts on banks mandates that the amount of any interchange transaction fee that an issuer may receive or charge with respect to an electronic debit transaction (EDT) must be “reasonable” and “proportional” to the cost incurred by the issuer with “respect to the transaction.” The Federal Reserve Board (“Board”) is directed to prescribe final regulations to implement this fee regulation no later than April 21, 2011, and the regulation will become effective July 20, 2011.
The Act exempts from any fee regulation the interchange fees charged by issuers that, together with affiliates, have less than $10 billion in assets. Merchants may not discriminate against specific issuers, but merchants will also be free to route EDTs for processing over any network and offer discounts or incentives for payment by cash, checks, debit cards, or credit cards. The Act also permits merchants to set a minimum dollar value for the acceptance of credit cards as long as the threshold does not differentiate between issuers or networks and the threshold is no greater than $10. See CBA Regulatory Compliance Bulletin, Analysis of Dodd-Frank Act: Durbin Amendment (Debit Card Interchange Fee Regulation), dated August 16, 2010.
Mortgage Lending: Steering and Ability To Repay
Issue: Title XIV of the Dodd-Frank Act, titled the “Mortgage Reform and Anti-Predatory Lending Act” essentially makes the payment of yield spread premiums to mortgage originators illegal. These are payments that result in a mortgage originator’s total compensation to vary based on the terms of the loan other than the amount of the principal. A mortgage originator may not receive any origination fee, whether or not a YSP, except from the consumer. But if the consumer pays no upfront discount points or origination points (however designated), then another person may pay an origination fee, subject to the restriction above.
The Act also includes a number of other provisions, to be implemented by regulation, prohibiting mortgage originators from engaging in a number of unfair and abusive practices. Mortgage originators may not steer a consumer to a loan that he or she lacks a reasonable ability to repay. Creditors are required to make a “reasonable and good faith” determination of the borrower’s ability to repay the obligations (including taxes, insurance, and assessments) based on verified and documented information, and taking into consideration other loans securing the same dwelling. Ability to repay must be based on a payment schedule that fully amortizes the loan.
A rather complicated safe harbor is provided in the event that a creditor is subject to liability. A creditor may assert a presumption of compliance if the loan is a “qualified mortgage.” A qualified mortgage is one that meets a number of criteria, including no increase or deferral of principal payments, no balloon payments, underwriting based on full amortization, reasonable debt load and fees (not to exceed 3% of the loan amount), and maximum 30 year term. Reverse mortgages and balloon payment loans are permitted under prescribed conditions. See CBA Regulatory Compliance Bulletins, Dodd-Frank Bill: Payments to Mortgage Originators and Steering, dated July 19, 2010, and Analysis of Dodd-Frank Act: Determining Ability to Repay, dated July 19, 2010.
Residential Real Estate Appraisals
Issue: Subtitle F of Title XIV of the Dodd-Frank Act, titled “Appraisal Activities” addresses a number of concerns over the perceived role that residential real estate appraisals have had in exacerbating the housing crisis. It puts into law existing regulations and guidance on appraiser independence, and establishes specific standards for appraisals related to “higher-risk mortgages.” Appraisal management companies (AMCs), whose prominence was elevated with the adoption of the Home Valuation Code of Conduct (HVCC), will be subject to heightened supervision.
The Act makes it unlawful to engage in conduct that violates appraisal independence in the context of extending credit or providing services related to a consumer credit transaction secured by the consumer’s principal dwelling. Acts or practices that violate appraisal independence are very similar to existing provisions in the HVCC and the banking agencies’ appraisal regulation and guidance. Persons involved in a covered transaction are required to report to the applicable state agency (in California, the Office of Real Estate Appraisers) any illegal, unethical, or unprofessional conduct by any appraiser. If a creditor knows at or before consummation of the loan of a violation of the independence or conflict of interest standards, it may not extend the credit unless it first documents that the appraisal does not materially misstate or misrepresent the value of the secured dwelling. With the Board’s issuance of an interim final regulation in October 2010, per the Act the HVCC was invalidated. Other provisions address the portability of appraisals, heightened regulation of appraisal management companies, fair compensation of independent appraisers, and specific requirements applicable to appraisals in connection with “higher-risk mortgages.” See CBA Regulatory Compliance Bulletin, Analysis of Dodd-Frank Act: Appraisers, Dated September 12, 2010.
Executive Compensation Limits/Corporate Governance
Issue: The Dodd-Frank Act included a number of provisions aimed at the regulation of executive compensation at public companies and improvement of corporate governance. Shareholders are given opportunities to cast non-binding votes on the compensation of senior executives (“say on pay”) and (“golden parachute”) compensation in the context of mergers and acquisitions. The compensation committees of boards and their consultants and attorneys must adhere to independence standards. If the financial statements of a company are restated after an earlier disclosure, then executive compensation is to be recovered to the extent based on the financial information that is required to be restated. Any hedging that is used by employees or directors to protect against the drop in value of equity stocks given as compensation must be disclosed in any annual proxy or material soliciting shareholder consent. Other provisions in the bill pertain to proxy access, broker voting, separation of the chairman and CEO roles, and establishment of a risk committee for banks. Many of these statutory provisions become effective after the SEC, the stock exchanges, or the federal banking agencies, as applicable, issue final rules. See CBA Regulatory Compliance Bulletin, Dodd-Frank: Executive Compensation and Corporate Governance, dated November 29, 2010.
Mortgage Securitization: Risk Retention
Issue: Section 941 of the Dodd-Frank Act seeks to protect investors by creating incentives for issuers and sponsors of asset-backed securities to focus more on collateral quality. It does so by requiring securitizers and originators to retain an interest in transferred securities generally in the amount of 5% and to provide certain disclosures. The Act delegates broad authority to the FDIC, Federal Reserve Board, OCC, and the SEC to develop regulations implementing the risk retention rule. A separate rulemaking is mandated specifically for securities backed by residential mortgage assets (ABS’s), and these regulations are to be developed jointly by the agencies together with HUD and the Federal Housing Finance Agency. The regulations must be issued in final form within 270 days of the Act’s enactment, and become effective one year after publication of the final rules for securitizers and originators of ABS’s backed by residential mortgages, and two years after publication for all others. See CBA Regulatory Compliance Bulletin, Analysis of Dodd-Frank Act: Risk Retention For Securitizers, dated September 3, 2010.
Anti-Deficiency: Short Sales
Issue: The California legislature enacted SB 931 to facilitate “short sales” of distressed residential property and avoid the burdens of foreclosure sales while preserving for the borrower the anti-deficiency protections that are already set forth in Code of Civil Procedure (hereafter “CCP”) Sections 580b and 580d.
SB 931 adopts new CCP 580e which provides that no judgment shall be rendered for any deficiency on a note secured by a first deed of trust encumbering a dwelling of not more than four units where the trustor, with the beneficiary’s consent, sells the dwelling for less than the remaining balance of the secured indebtedness. The beneficiary’s written consent to the sale will obligate the beneficiary to accept the sale proceeds as full payment of the secured obligation.
The legislation will not limit the ability of the beneficiary to seek damages and enforce existing rights if the trustor commits fraud with respect to the sale of the property or waste with respect to the property.
While the intent of SB 931 is to protect individuals in connection with the short sale of their residences, the language of the bill is broad enough potentially to apply to a person or entity who is a borrower on a commercial loan secured by one or more consumer residences. CBA is considering changes to the legislation. See CBA Regulatory Compliance Bulletin, New California Law Prohibits Deficiencies On Short Sales, dated October 25, 2010.
Issue: A number of suits were filed against creditors or their agents in California violating Civil Code section 2923.5, which was codified by SB1137 in 2008. The primary purpose of the statute was to require mortgagees, trustees, beneficiaries, or their authorized agents (hereafter, “lenders”) to explore alternatives to foreclosure with their borrowers before filing a notice of default. One of the cases, Mabry v. Aurora Loan Services, resolved a number of questions raised by the statute. The plaintiffs in this case sued a loan servicing company to prevent foreclosure on the grounds that it failed to describe specifically how it attempted to contact the borrowers, and and that it failed to certify that the declaration was made under penalty of perjury.
The court held that Section 2923.5 allows a remedy for violation in the form of postponement of foreclosure. However, a suit may not be brought as a class action because the question of the adequacy of the attempted or actual contacts is fact-specific.
The court held that the declaration that creditors are to include with the notice of default need only track the language of Section 2923.5(b) and need not delineate precisely how the borrower was contacted. This is an important ruling because it is consistent with the reality that those who prepare the declaration are not necessarily the same persons who made the attempted contacts. The Court also held that the declaration is not required to be prepared under penalty of perjury. Importantly, the decision states that noncompliance with Section 2923.5 does not cloud title after sale.
CBA Action: CBA filed an amicus curiae brief in support of the servicer. As CBA worked closely with the legislature on the bill, we were able to offer an insider’s perspective on the bill’s intent. We noted that it was never contemplated that creditors or servicers would be required to prepare the declaration under penalty of perjury, or that anything more than a recitation of the statutory language was required.
Mortgage Debt Relief
Issue: Congress enacted the Mortgage Forgiveness Debt Relief Act of 2007 in order to give federal tax relief to individuals who have had residential mortgage debt cancelled or forgiven by a lender and who otherwise would be subject to income tax on the cancelled amount. Consumers who have had their residential mortgage debt cancelled were complaining to banks that financial institutions were improperly completing IRS Form 1099C (Cancellation of Debt) by indicating that the borrower is personally liable on the debt. It turns out that the consumers erroneously believed that if they were personally liable, then the debt is not mortgage debt, and therefore they would not qualify for the tax forgiveness. Banks on the other hand were uncertain whether to characterize the forgiven debt as recourse or non-recourse, which is partly a legal question and partly a question of intent.
CBA Action: CBA prepared a bulletin explaining the law and summarizing IRS guidance on the use of Form 1099C in order to assist banks in explaining the rules to their customers. See CBA issued a Regulatory Compliance Bulletin, Consumer Confusion Over Debt Cancellation Relief, dated March 15, 2010.
Issue: Last year this publication reported that the federal Ninth Circuit Court of Appeal denied a petition, which CBA supported with an amicus brief, to review a case that held that a furnisher of credit information may be sued directly by the subject of a report for making an allegedly erroneous report. In 2010 CBA supported an appeal to the U.S. Supreme Court, and that petition was also denied. The case is Gorman v. Wolpoff & Abramson and MBNA.
Issue: The City of San Francisco filed a law suit against FIA Card Services alleging that consumer arbitrations to settle credit card disputes conducted through the National Arbitration Forum (NAF) are unfair and unlawful business practices under Business & Professions Code Section 17200. According to the City’s complaint, these violations warrant civil penalties and a wide-ranging injunction subjecting future NAF arbitrations to state regulation and control. Arbitration is a relatively cost effective method to resolve consumer disputes compared to litigation, and the Federal Arbitration Act specifically prohibits state policies that discriminate against arbitrations.
CBA Action: CBA filed an amicus letter with the California Supreme Court supporting FIA’s petition for review. The Court denied review.
Translation of Mortgage Documents
Issue: The enactment of AB 1160, the 2008 bill that requires mortgage lenders to provide translations of residential mortgage documents if loan negotiations are conducted in one of the specified foreign languages (Spanish, Chinese, Korean, Vietnamese, and Tagalog), left questions about the applicability of the requirement to business loans that are secured by residential mortgages and to home equity lines of credit (HELOCs). AB 1160 requires the Department of Financial Institutions and the Department of Corporations to develop translated forms that lenders and originators may use to satisfy the statute.
In accordance with the statute, the translations are based on the HUD-1 Good Faith Estimate (GFE) form. CBA noted to the agencies that the GFE form is not used in connection with business purpose loans or with HELOCs, and the purpose of the statute is not advanced by its application to these transactions. The agencies have taken CBA’s request under consideration.
Regulation Z: Default Rate of Interest
Issue: The issue in McCoy v. Chase Manhattan Bank is whether the notice requirements of the Truth in Lending Act and Regulation Z apply to discretionary interest rate increases imposed upon a consumer default. The Ninth Circuit Court of Appeal ruled that TILA/Regulation Z requires the bank to give consumers notice of an interest rate increase in such situation if the agreement permits the creditor to increase the rate at its discretion but does not include the specific terms for an increase. The Federal Reserve’s Official Staff Commentary interprets Regulation Z to require no notice to a cardholder where the agreement permits the bank to increase the interest rate. The bank filed a Petition for a Writ of Certiorari with the United States Supreme Court, which was granted. CBA did not participate in this case.
FTC/State Enforcement of TILA
Issue: A provision in a federal appropriations bill (H.R. 1105) would grant broad authority to the Federal Trade Commission and the 50 state attorneys general to enforce residential lending laws, including the Truth in Lending Act. TILA is already enforced by the federal banking agencies and in some instances by state banking officials. The legislative provision is a less than thoughtful ad hoc attempt to multiply enforcement authority that would only increase liability and compliance costs for all mortgage lenders. CBA opposed the provision and it was not included in the bill. Since then, the Dodd-Frank Act was enacted, which broadens enforcement authority over consumer protection laws such as TILA.
Automobile Financing: Negative Equity
Issue: Previously, CBA had reported on a bankruptcy case that considers whether credit granted in part to finance “negative equity” on a trade-in vehicle is considered part of the secured purchase money debt or unsecured debt. The portion of the creditor’s claim allowed as secured debt would be paid in full with interest, while the unsecured portion would be paid pro-rata with other general unsecured claims, i.e., “crammed down.”
CBA filed a brief to the Ninth Circuit Court of Appeals to argue that the negative equity advance is secured purchase-money debt since the transaction cannot be completed unless the existing indebtedness on the trade-in vehicle is discharged. On July 21, 2010, the Ninth Circuit upheld the Bankruptcy ruling that bifurcated the credit (most of the other federal appellate courts that addressed this issue held that negative equity should be treated as integral to the secured credit). The Ninth Circuit court focused on the vehicle’s “price,” which it did not consider to be affected by the negative equity financing. The creditor in the case petitioned the Ninth Circuit for a re-hearing. The case is In re: Marlene A. Penrod (Americredit Financial Services v. Marlene A. Penrod).
FDIC Deposit Insurance
Issue: The FDIC issued final rules implementing Section 343 of the Dodd-Frank Act, which makes the core of the Transaction Account Guarantee Program (TAG Program) non-optional beginning December 31, 2010 and ending December 31, 2012. As of December 31, 2010 all banks, including those that had opted out of the TAG Program, will provide unlimited FDIC coverage for noninterest-bearing transaction accounts. The Act also makes the $250,000 per account coverage ceiling permanent. Unlike the TAG Program, the Act does not extend insurance to NOW accounts and Interest on Lawyers Trust Accounts (IOLTAs). (However, in late December President Obama signed into law a federal bill that would cover IOLTA accounts). Banks must provide customer notices of the changes and also post a prescribed notice in bank locations and, as applicable, on bank websites. See CBA Regulatory Compliance Bulletin, Summary of Final Rule on Unlimited Insurance Coverage For Noninterest-Bearing Transaction Accounts, dated November 22, 2010.
FDIC Overdraft Fee Guidance
Issue: Independently of the other federal banking agencies, the FDIC issued guidance on overdraft protection programs for the stated purposes of reducing over-use of costly overdraft protection by some consumers and reducing risks to banks arising from inappropriate practices. A bank’s board of directors must provide “appropriate oversight” of the bank’s overdraft protection program. Banks are also required to ensure that the overdraft protection program and how it is communicated to customers minimize potential consumer confusion and promote responsible use. Staff must be trained to explain program features and alternatives to customers and monitor for “excessive or chronic customer use.” If a customer overdraws an account more than six times in a 12-month period, the bank is expected to contact the customer to discuss less costly alternatives. Banks are to institute “appropriate daily limits” on customer costs such as by limiting the number of transactions subject to a fee or limiting the total amount of fees charged per day, and to “consider” eliminating overdraft fees on de minimus overdrafts. If de minimus exceptions are not adopted, fees should be reasonable and proportional to the amount of the original transaction. Check-clearing procedures must avoid the effect of maximizing fees by means of the clearing order. Banks are precluded from using the Regulation E opt-in process to steer customers who frequently overdraw their accounts toward fee-based products and away from alternatives. The Guidance states that banks “should” allow customers to opt out of overdraft coverage on transactions not covered by Regulation E, such as ACH and check transactions. See CBA Regulatory Compliance Bulletin, Analysis of FDIC’s Overdraft Practices Guidance, dated December 13, 2010.
Overdraft Litigation: Posting Order
Issue: Several major banks are the targets of litigation over their item processing policies, in particular for processing items from high value to low. One such suit is a federal district court action in California, Gutierrez v. Wells Fargo Bank, involving the processing of debit card transactions from high value to low. California has a unique comment in its Commercial Code that explicitly imposes a good faith requirement with respect to check order processing. A bank may not establish a practice of maximizing the number of returned checks for the sole purpose of increasing the amount of returned check fees charged to the customer. Processing items from high to low is likely to result in more transactions potentially being subject to fees, but increasing fees may not be the “sole purpose” of such a practice. The Gutierrez court considered, and rejected, the common argument that bank customers benefit when their high dollar items are paid before low dollar items. Among other things, the court noted, most debit card transactions are “must pay” items owing to the nature of the debit card clearing process.
The court also looked disapprovingly upon the bank’s internal documents showing a reliance on generating overdraft fees to meet revenue goals. This evidence, from the court’s perspective, undermined the bank’s argument that it promoted responsible account usage through its customer communications materials. Other factors affecting the court’s decision include the bank’s commingling of other types of items with debit card transactions for posting purposes, and its adoption of a “shadow line,” which is an informal line of credit to support debit card transactions. These practices were seen as contributing to the inflation of transactions going into overdraft. The bank’s liability was based on California Business and Professions Code Section 17200 et seq. Wells Fargo Bank also raised a defense based on federal preemption, but the Court held that the bank had not complied with the conditions of invoking preemption under 12 CFR 7.4002. See CBA Regulatory Compliance Bulletin, Analysis of Gutierrez v. Wells Fargo Posting Order Decision, dated November 9, 2010.
Local Agency Deposits
Issue: In 2006 the California legislature enacted a law (AB 2011) permitting banks to use a deposit placement service to satisfy collateralization requirements associated with taking local agency deposits. Under its terms, that law was due to expire as of January 1, 2012. Under SB 1344 enacted this legislative session, the sunset provision was removed and the law was thereby made permanent. SB 1344 also clarifies that only local agencies that are permitted under law to invest funds may avail themselves of this provision of law. See CBA Regulatory Compliance Bulletin, Local Agency Deposits Law Made Permanent, dated October 18, 2010.
Overdraft Fee Disclosure: Regulations DD and E Clarifications
Issue: The Federal Reserve Board released a final rule clarifying its previously issued revisions to Regulation DD (finalized in January 2009) related to the disclosure of overdraft fees in periodic account statements. Regulation DD and the official staff commentary are revised to address the application of the rule to retail sweep programs, clarify the terminology for overdraft fee disclosures, and to make conforming amendments. See CBA Regulatory Compliance Bulletin, Federal Reserve Clarifies Regulation DD Overdraft Disclosure Rule, dated June 2, 2010.
CBA had sent comments to the Federal Reserve Board on the proposed Regulation DD changes. Regulation DD provides that if funds other than those contained in the subject account are available to cover transactions when there are insufficient funds, such as under an arrangement to transfer funds from a line of credit or another account, the additional funds may not be shown as part of the “available balance” when a consumer inquires, but the other funds may be included in a separate balance disclosure. The Board had proposed a new comment 11(c)-2 illustrating the appropriate disclosure of funds available through retail sweep programs. Among other things, funds in the linked account are to be disclosed as “overdraft funds.” Some linked accounts do not come within this description, particularly deposit accounts linked with investment accounts used to achieve higher rates of return.
CBA submitted a letter to the Board requesting the addition of another exception describing investment sweeps and indicating that funds in those accounts may be included as available in an account balance inquiry. In the final rule the language was broadened to cover any bank service to transfer funds from another account of the consumer. See CBA’s comment letter to the Federal Reserve Board dated March 31, 2010.
The Board also released a final rule clarifying its Regulation E opt-in requirement for overdraft services related to ATM and one-time debit card transactions. Institutions that have a policy and practice of declining ATM and one-time debit card transactions that would overdraw an account are subject to the fee prohibition of the rule. Also, an institution may not assess any overdraft fee until it has sent the required written confirmation. Several staff comments are also added or amended. See CBA Regulatory Compliance Bulletin, Federal Reserve Board Clarifies Regulation E Opt-In Rule, dated June 2, 2010.
Here too, CBA sent a letter to the Board during the notice and comment process regarding a number of issues, including electronic and telephonic delivery of written confirmation of a consumer’s opt in decision, the model form, and consent for multiple accounts. See CBA’s comment letter to the Federal Reserve Board dated May 31, 2010.
Restriction on Garnishment of Federal Payments
Issue: The U.S. Department of Treasury issued a proposed rule establishing various restrictions against the garnishment of certain federal benefit payments. Several of the restrictions are not workable, such as a response time of one business day following receipt of a garnishment order to perform an account review.
CBA Action: CBA filed a comment letter with the Treasury Department with a number of recommendations that would ease compliance for banks. See CBA’s comment letter to the Treasury Department dated June 18, 2010.
Reclamation Claims: Treasury Checks
Issue: The U.S. Treasury Department proposed to allow its Fiscal Management Service (FMS) to direct the Federal Reserve Bank to debit a financial institution’s Federal Reserve account as a means of resolving a reclamation claim. Banks will have 30 calendar days from the date that the FMS sends a reclamation notice to pay the claim or challenge it.
CBA Action: CBA submitted comments to the Treasury Department stating that, generally, banks need more than 30 days to take the necessary steps to determine the appropriate course of action. The bank has to debit the affected customer’s account, notify the customer, and possibly conduct an investigation if there is a dispute. The monthly statement cycle that banks follow makes it unlikely that most customers will even become aware of the debit within the 30 day period. CBA requested that the FMS allow 60 days from the date of the notice to respond. See CBA’s comments to the FMS within the U.S. Treasury dated March 5, 2010.
Deposit Operations: Fiduciary Duty
Issue: In 2009 CBA filed an amicus brief in support of the bank in Brown Family Trust v. Wells Fargo Bank. The bank had been held to a fiduciary duty toward a deposit account customer because of the high degree of personalized services given to the customer. The general rule is that the bank-depository relationship is governed strictly by contract. The appellate court in the case upheld the trial court decision; therefore, the decision is final.
The unusual facts of this case render the decision not much of a threat to ordinary bank-customer relationships. But it does highlight the balancing act that banks face when serving high net worth individuals, particularly those who experience some form of physical or mental impairment. See CBA Regulatory Compliance Bulletin, California Ruling Raises Risk of Heightened Legal Duty, dated February 8, 2010.
Bonded Stop Notices
Issue: In 1989 a California Court of Appeal, in a decision called Familian v. Imperial Bank, incorrectly held that a stop notice claim reaches interest payments previously made to a construction lender from general construction loan funds. The purpose of the state’s stop notice law is to protect contractors who perform work on projects but are not paid for their work by the general contractor. It allows them to obtain access to the general contractor’s construction funds held by the construction lender upon presentation of a bonded stop notice claim. When served with a bonded stop notice, a lender is obligated to withhold from the unexpended balance of the loan fund an amount sufficient to pay the claimant. The Familian court had misconstrued the statute by holding that the corpus of loan funds to which a stop notice applies includes prior payments of interest made to the lender as they came due.
After Familian, lenders have attempted to find ways to work around the risk of exposing their earnings to stop notice claims. One way is to avoid making the entire loan proceeds accessible to the borrower through a loan fund, but rather make a credit line available for drawdown as construction progresses.
In 2000, a case (Steiny v. Citicorp Real Estate Inc.) arose in the appellate court that offered an opportunity for the California Supreme Court to review the Familian case. CBA filed an amicus brief asking the Supreme Court to overturn Familian. Unfortunately, the court denied the request.
In 2010, East West Bank defended an action by a contractor that had presented it with a bonded stop notice. When the notice was presented, the bank was not holding any undisbursed construction funds; the last advance to the borrower was made seven months before service of the stop notice. Nevertheless the trial court, following Familian, held that the interest and loan fees paid to the bank from the loans were improper “assignments” within the meaning of California Civil Code § 3166.
CBA Action: CBA will support the bank’s appeal of the decision. The Familian decision, and this case that follows it, are based on only a partially correct theory. The stop notice statute acknowledges the value that contractors add to construction projects and protects their right to payment to the extent of the developer’s funds that remain undisbursed with the lender. However, the decision places no value on the provision of credit, without which practically no construction projects are possible. Loan interest is how lenders are compensated, and if their earnings are to be exposed to claims for work performed during any stage of a construction project, then their very incentive to make such loans is undermined. At the very least lenders would be compelled to raise the cost of credit to account for the added risk.
Bonded Stop Notice: Preliminary Notice
Issue: Until the decision in Force Framing, Inc. v. Chinatrust Bank (U.S.A.) most California lenders have relied on their timely recorded construction deeds of trust to give subcontractors and material suppliers notice of the lender’s identity for such purposes as delivering stop notices. In this case a contractor delivered a mandatory preliminary notice to file a stop notice to the wrong lender, and on these grounds the actual construction lender did not honor the stop notice claim. The California statute allows for delivery of a preliminary notice to the “reputed construction lender,” but in this case the actual construction lender had properly recorded its construction deed of trust. Nevertheless, the bank was held responsible to pay. As a result of the decision, lenders would be compelled to treat wild bonded stop notices as valid until proven otherwise. Banks would not be able to rely on preliminary notices for construction loan management purposes such as estimating the price of subcontractors’ work and monitoring loan budgets.
CBA Action: CBA filed an amicus letter with the California Supreme Court supporting the bank’s petition for review. We argued that when the actual construction lender has recorded its construction deed of trust, that fact negates the existence of a different “reputed construction lender.” To hold otherwise is to make a nullity of the whole concept of public recordation as the established means of furnishing constructive notice. That a person could be considered to be acting in good faith when failing to consult public records, in light of a statute providing for the recordation of the very record in question, makes a nullity of the concept of good faith. The petition was denied.
Issue: The Small Business Association published a notice seeking comments on the impact that FAS 166 will have on SBA lenders under the 7(a) loan program. FAS 166 provides that, in order to obtain sales treatment for the sale of a portion of a loan, the revised definition of “participation” must be met. As a result, any gain on sale of the guaranteed portion of an SBA loan must be deferred until the warranty period set forth in SBA Form 1086 expires. Also, if the lender sells the loan and retains cash flow in excess of the minimum servicing fee, the transaction is considered a borrowing and the lender must continue to retain capital to support the loan. The financial consequence to lenders of deferring recognition of income is the loss of at least 90 days of gain in 2010.
CBA Action: CBA provided comments to the SBA. We stressed the impact to the banking industry of having to continue to carry a transferred loan as a loan after a secondary market sale and to retain capital against it. We supported elimination of the warranty period, as only a small percentage of SBA loans defaults or is repaid during the warranty period each year. See CBA’s letter to the Small Business Administration dated April 19, 2010.
Credit Report Fees/ECOA
Issue: The FDIC in some examinations considers it a violation of the Equal Credit Opportunity Act (ECOA) if married applicants were charged one price for a credit report and unmarried joint applicants were charged another price. The issue arises when a credit reporting agency furnishes single, merged reports only for married couples who share the same home address and, for all others, multiple individual reports. The FDIC takes the position that all joint applicants are entitled to credit report price parity, not just couples—married, unmarried, domestic partners, or otherwise. The surprise comes when scrutiny is given to the fees charged to, say, a father and daughter applying jointly for an auto loan, or to two unrelated business partners. CBA alerted the membership of the FDIC’s unstated position through a Regulatory Compliance Bulletin, New FDIC Focus On ECOA: Credit Report Fees, dated March 1, 2010.
Issue: In 2009 CBA filed a brief in support of a bank on the issue of whether California’s Unruh Civil Rights Act prevents a bank from refusing to grant credit if the applicant has a criminal record. The statute does not list criminal conviction as a protected characteristic, but the plaintiff argued that a conviction is an indelible trait not unlike other traits that are protected. CBA argued that a court should not be legally exposed for taking into account for purposes of credit underwriting the voluntary actions of an applicant that have a direct bearing on his creditworthiness and likelihood of repayment. Moreover, from a creditor’s perspective, there is no practical distinction between two individuals who engaged in the same dishonest act, where one was convicted and the other was not. In 2010 the California Appellate Court upheld the trial court’s denial of the plaintiff’s novel claim. The case is Semler v. Wells Fargo Bank.
Issue: A month before the Dodd-Frank Act was enacted, the federal banking agencies issued joint guidance on bank incentive compensation policies and practices. These guidelines, the development of which did not directly involve the SEC, are not limited to public companies. Incentive compensation is defined as the portion of compensation where the amount varies with and is tied to a metric such as sales. The purpose of the guidance is to ensure that such policies do not encourage imprudent risk-taking and that they are consistent with principles of safety and soundness. It does not apply to banks that do not use incentive compensation.
The guidance adopts a principles-based approach to regulation: incentive compensation arrangements (1) should provide incentives that balance risk and financial results without encouraging imprudent risk-taking; (2) should be subject to effective controls and risk-management; and (3) should be supported by strong corporate governance, including board oversight. It applies to executive and non-executive employees “who, either individually or as part of a group, have the ability to expose the organization to material amounts of risk.”
Much of the guidance is targeted at “large banking organizations,” or LBO’s, as defined. An incentive compensation arrangement must appropriately balance revenue generation and risk to the organization. Deferred incentive compensation for senior executives should focus on longer term, multiple-year periods rather than short term results. The guidance specifically warns against golden parachute arrangements that fail to consider the effect on risk-taking behavior of employees during their tenure at the bank. Risk management personnel and, as appropriate, the bank’s board are expected to be involved in all aspects of incentive compensation arrangements. See CBA Regulatory Compliance Bulletin, Federal Banking Agencies Issue Final Guidance on Incentive Compensation Arrangements, dated June 28, 2010.
Leave Benefit: Organ Donation
Issue: SB 1304 requires employers in California with at least 15 employees to permit employees to take up to 30 days’ leave of absence with pay to donate an organ or up to 5 days’ leave to donate bone marrow. The leave in either instance may be taken once per year. Employers are required to restore an employee returning from such leave to the same or equivalent position held when the leave began in terms of seniority, benefits, pay, and other terms and conditions of employment. An employer may decline to restore an employee as required for reasons unrelated to the employee’s exercise of these rights. Time taken during such leave may not be treated as a break in continuous service for purposes of salary adjustments, or accrual of sick leave, vacation time, annual leave, or seniority. Any group health benefits must be maintained during the leave. However, an employer may require the employee to take up to five days of earned but unused sick or vacation leave for a bone marrow donation and up to two weeks of earned but unused sick or vacation leave for an organ donation. See CBA Regulatory Compliance Bulletin, New Employee Right To Paid Leave: Organ Donation, dated October 25, 2010.
DOL Regulation: Mortgage Loan Officers Non-Exempt
Issue: In March this year the U.S. DOL issued an Administrator’s Interpretation which concludes that employees who perform the typical job duties of a mortgage loan officer do not qualify as bona fide “administrative” employees exempt under the Fair Labor Standards Act. The interpretation represents a change of policy at the DOL regarding mortgage loan officers. In a prior Wage and Hour Opinion Letter (FLSA 2006-31 dated September 8, 2006), such employees were deemed to meet the duties requirements for the administrative exemption.
The issue of whether personnel who perform sales type work can be exempt administrative employees is the subject of current litigation, including an important case pending before the California Supreme Court (see Harris v. Liberty Mutual Insurance discussed below). In some of these cases and under the DOL’s interpretation, the inquiry centers on the so-called “administrative-production dichotomy.” Strict application of this test is detrimental to banks and other employers because it generally precludes inclusion within the category persons having high levels of skills and independence, but who are nevertheless engaged in creating or selling the employer’s products and services. See Regulatory Compliance Bulletin, DOL Reverses Course: “Typical” Mortgage Loan Officers Not Exempt, dated June 7, 2010.
CBA filed amicus briefs with both the appellate court and Supreme Court opposing the appellate court’s narrow interpretation of the administrative exemption in the Harris case. We noted that commercial loan officers are examples of why the administrative-production dichotomy, a throw-back to America’s industrial era, is inappropriate in a complex office and sales economy. See also CBA’s Regulatory Compliance Bulletin, Supreme Court to Decide Key Overtime Case, dated February 1, 2010.
Employee Rights Posting Requirement
Issue: The U.S. Department of Labor issued a final rule requiring certain federal departments and agencies to include in their government contracts provisions requiring contractors and subcontractors with whom they do business to post notices informing their employees of their federal labor rights. Banks are covered by the rule by virtue of the provision of deposit insurance through the FDIC. The notice is a reminder to employees of their rights protected under the National Labor Relations Act pertaining to the right to organize. Contractors also have a duty to ensure compliance by any subcontractor that the contractor engages to perform all or part of a covered federal contract. See CBA Bulletin, New Employee Rights Posting Requirement Applicable to All Banks, dated June 21, 2010.
Responsible Banking Ordinance: Los Angeles
Issue: The City of Los Angeles is considering an ordinance imposing CRA and foreclosure mitigation requirements on any bank that provides financial services to any city agency. As with a prior proposal, the proposal’s proponent Los Angeles City Councilman Richard Alarcón sought to have the League of California Cities, a statewide advocacy group, adopt a similar proposal for its members, which are municipalities throughout California.
CBA Action: CBA is assisting its members with research and communications support. CBA does not oppose the imposition of standards as conditions for any customer doing business with a bank. However, the proposed ordinance would impose considerable and unnecessary reporting burdens on banks. We are seeking to meet the legitimate expectations of this, and potentially other, cities partly by leveraging data that banks already report, including under HMDA, CRA, federal modification programs, and CALL/TFR reports. See CBA letter to the League of California Cities dated August 26, 2010 and letter to LA Councilmembers dated October 22, 2010.
Investment Ordinance: San Francisco
Issue: The City of San Francisco revised its investment regulation to incorporate standards for financial institutions partners for the purpose of promoting responsible banking practices. CBA supported its members by meeting with City officials to discuss banks’ efforts and submitting a letter on behalf of the industry. See CBA’s letter to the San Francisco Board of Supervisors dated April 23, 2010.
Foreclosures: Public Entities
Issue: A new California bill, AB 2347, was enacted for the purpose of mitigating the impact of the foreclosure crisis on the availability of affordable housing in California. When a lender forecloses on residential property that is subject to a regulatory agreement or deed restriction in favor of a public entity (in exchange for providing financial assistance to multifamily properties in exchange for preserving affordable housing units), the subordinate entity’s interest is wiped out. AB 2347 allows a public entity to request postponement of the sale date by no more than 60 days. The delay is intended to give the entity an opportunity to intervene so that it could, for example, purchase the property or find a purchaser that will preserve the affordable units. AB 2347 becomes effective on January 1, 2011 and sunsets after January 1, 2013. See CBA Regulatory Compliance Bulletin, Foreclosure Delay: Public Entities, dated October 25, 2010.
Issue: Pursuant to a federal law (the Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010 or “Federal Act”) California enacted AB 1650 to prevent state and local agency investments in companies operating in Iran’s energy sector that, in turn, support the government of Iran’s efforts to achieve nuclear weapons capability. AB 1650 prohibits any person or entity that provides goods or services of $20 million or more in the energy sector of Iran, or a financial institution that extends $20 million or more in credit to such a person, from bidding for, entering into, or renewing a contract for goods or services of $1 million or more with a public entity. CBA was able to insert a provision in AB 1650 to require the California Department of General Services (“DGS”) to publish a list of persons who provide goods or services of $20 million or more in the energy sector of Iran. The DGS must do so by June 1, 2011 and update the list every 180 days. Thus, financial institutions will not be required to engage in due diligence efforts to determine who is engaged in Iran energy sector investments. See CBA Regulatory Compliance Bulletin, New State Restrictions Against Iraq Investing and Lending, dated October 18, 2010.
Fair Value Accounting
Issue: The Financial Accounting Standards Board issued a proposal to apply fair value accounting to, among other things, debt instruments not intended for sale or trading. Its proposal, No. 1810-100, also covers accounting for derivative instruments and hedging activities. The proposal represents another in a series intended to apply fair value accounting to banking activities, believed to be necessary to improve valuation of assets and transparency of financial disclosures.
CBA Action: CBA questioned the appropriateness of applying fair value accounting outside of circumstances in which assets are held for sale or trading. The proposal does not reflect the way that banks do business, as instruments managed for long-term investment in order to collect the contractual cash flows should be accounted for at amortized cost. Fair value accounting as applied to loans does not fairly account for how a bank manages the credit risk of customers, but may be appropriate where a bank resorts to selling a loan following foreclosure. CBA also offered comments on developing an accounting model for impairment that is meaningful to investors, depositors, and other users of financial statements. Regarding derivatives and hedging activities, CBA urged FASB to ensure that its standards are coordinated with those of the International Financial Reporting Standards and to consider additional considerations. See CBA’s comment letter to FASB dated September 30, 2010.
Issue: An individual trustee was found liable for breach of fiduciary duty, and a trial court imposed extraordinary damages inconsistent with existing law. This complicated case involved the disputed sale of a portion of the trust’s pre-IPO shares of Qualcomm stock nearly ten years before they rocketed in value. While the sale of the shares still yielded the trust a substantial gain at the time, the trustee was held to have acted for his own benefit (by liquidating assets in order to borrow cash from the trust). The court held the trustee liable to pay to the trust all of the appreciation of the sold shares had they been held until the trust was terminated, which was post IPO.
The court did not accept the trustee’s argument that the damages calculation would entail the trustee holding a substantial amount of speculative stocks for nearly ten years, probably in violation of his duty of prudent investment. The Court of Appeal “conclude[d] that the fact that the sale might have been in the best interests of the trust, or even compelled by the duty to invest prudently, if true, does not excuse [the trustee] from liability for his breach of the duty of loyalty.” The trustee is appealing the decision.
CBA Action: CBA filed a brief with the California Court of Appeal supporting review of the decision, focusing only on the proper measure of damages. The opinion suggests that the trust was harmed because the trustee violated his duty of loyalty, but expects him to violate the duty of prudent investment in furtherance of complying with his duty of loyalty. The opinion thus places trustees in a position of conflict between the two duties. We also argued that the award of compensatory damages is inappropriate since no pecuniary loss resulted from the alleged breach and, indeed, the transaction was consistent with the duty of prudent investment. The purpose of compensatory damages is to make a plaintiff whole, not to deter or to penalize. The case, Uzyel, et al. v. Kadisha, is pending.
Libel Against Banks
Issue: A former senior employee of a bank posted derogatory and false statements about the bank on an internet site, including that the bank will imminently be closed and that customers should move their accounts as soon as they can. The bank filed suit and the defendant countered with a claim that the state’s anti-SLAPP statute applies (“Strategic Lawsuit Against Public Participation”). A SLAPP suit seeks to chill or punish a party’s constitutionally protected right to free speech and to petition the government for redress of grievances. In considering whether the anti-SLAPP statute applies, a court determines whether the defendant’s disputed action arises out of an exercise of a protected activity, and whether the plaintiff (here the bank) has demonstrated a probability of prevailing on the claim. The defendant’s statements are not only false under the laws against libel but they also violate Financial Code Section 756, which makes it a misdemeanor to make false public statements about a bank. An activity that is illegal in this state cannot be a protected activity.
CBA Action: CBA is committed to support the bank in the appeals process as friend of the court. The case is Summit Bank v. Rogers.
Issue: The federal Ninth Circuit Court of Appeals ruled in a 2008 case that the National Bank Act preempts California law regarding the disclosures that are required to accompany “convenience checks.” However, a California court of appeals, considering the identical issue in Parks v. MBNA, came to the opposite conclusion. In this class action case, the plaintiffs argued that the non-conforming disclosures were “unlawful” under California’s Unfair Competition Law (Business & Professions Code Section 17200 et seq). OCC regulations provide that state laws that require “specific statements, information, or other content” in connection with credit solicitations do not apply to national banks.
CBA Action: CBA and ABA jointly filed an amicus letter with the California Supreme Court in support of the bank’s petition for review. The Court granted review on September 1, 2010.
LIST OF COMMENT LETTERS, AMICUS BRIEFS, AND BULLETINS
Comment letters and bulletins are linked within the body of the Summary where discussed. Amicus briefs may be obtained by contacting Leland Chan at firstname.lastname@example.org.
Comment Letters Filed by CBA
Letter to Treasury Department on Garnishment of Federal Benefits
Letter to Department of Financial Institutions on Coverage of AB 1160
Letter to Federal Reserve Board on Regulation E Amendments
Letter to Financial Management Service on Reclamation Claims
Letter to Federal Reserve Board on Regulation DD Amendments
Letter to San Francisco Board of Supervisors on Investment Criteria
Letter to FASB on Accounting of Derivatives and Hedging Activities
Letter to League of California Cities on Responsible Banking Proposal
Letter to City of Los Angeles on Responsible Banking Proposal
Letter to SBA on Effect of Financial Accounting Standard 166 on Small Business Lending
Active Friend of the Court Case List
Gutierrez v. Wells Fargo Bank (Order of Processing Items as
Paveco v. East West Bank (Stop Notice Claim Reaching Bank’s Earned Interest)
Force Framing Inc. v. China Trust Bank (Stop Notice—Preliminary Notice)
Uzyel, et al. v. Kadisha (Measure of Damages For Trustee Breach of Duty)
Harris v. Superior Court (Liberty Mutual Insurance) (Administrative Exemption Criteria)
Gorman v.Wolpoff & Abramson, MBNA (Consumer Report Furnisher Liability)
Summit Bank v Rogers (Whether anti-SLAPP Statute Prevails Against Bank Libel Claim)
People v. Liberty Tax Services, Inc. (TILA Coverage of Deposit Operation Fees)
Semler v. Wells Fargo Bank (Criminal Conviction as Protected Class)
Parks v. MBNA (Federal Preemption)
Brown Family Trust v. Wells Fargo Bank (Fiduciary Duty Toward Deposit Customers)
In re: Marlene A. Penrod (Whether Negative Equity is Secured Credit in Bankruptcy)
Regulatory Compliance Bulletins
Supreme Court To Decide Key Overtime Case,
February 1, 2010
California Ruling Raises Risk of Heightened Legal Duty, February 8, 2010
New FDIC Focus On ECOA: Credit Report Fees, March 1, 2010
Consumer Confusion Over Debt Cancellation Relief, March 15, 2010
Federal Reserve Board Clarifies Regulation E Opt-In Rule, June 2, 2010
Federal Reserve Clarifies Regulation DD Overdraft Disclosure Rule, June 2, 2010
DOL Reverses Course: “Typical” Mortgage Loan Officers Not Exempt, June 7, 2010
Partial Victory in SB 1137 Case, June 7, 2010
New Employee Rights Posting Requirement Applicable to All Banks, June 21, 2010
Federal Banking Agencies Issue Final Guidance on Incentive Compensation Arrangements, June 28, 2010
Analysis of Dodd-Frank Act: Determining Ability to Repay, July 19, 2010
Dodd-Frank Bill: Payments to Mortgage Originators And Steering, July 19, 2010
Analysis of Dodd-Frank Act: Durbin Amendment, August 16, 2010
Analysis of Dodd-Frank Act: Risk Retention For Securitizers, September 3, 2010
Analysis of Dodd-Frank Act: Appraisers, September 12, 2010
New State Restrictions Against Iraq Investing and Lending, October 18, 2010
Local Agency Deposits Law Made Permanent, October 18, 2010
New California Law Prohibits Deficiencies On Short Sales, October 25, 2010
New Employee Right To Paid Leave: Organ Donation, October 25, 2010
Foreclosure Delay: Public Entities, October 25, 2010
Analysis of Gutierrez v. Wells Fargo Posting Order Decision, November 9, 2010
Summary of Final Rule on Unlimited Insurance Coverage For Noninterest-Bearing Transaction Accounts, November 22, 2010
Dodd-Frank: Executive Compensation and Corporate Governance, November 29, 2010
Analysis of FDIC’s Overdraft Practices Guidance, December 13, 2010