Financial Services Law -- Dec 06, 2013

more+
less-

In This Issue:

#Badidea: JPMorgan Chase Stumbles on Twitter

JPMorgan Chase’s recent activity on Twitter provides an example of the need for financial institutions to use caution when using social media.

The day before the company was scheduled to host an online discussion with executive Jimmy Lee, the JPMorgan Twitter account suggested that people should submit questions with the hashtag “#AskJPM.”

Although the bank received plenty of questions (and comments), they were likely not what JPMorgan had in mind.

As reported in the American Banker and other media, questions ranged from “Is your ‘Chief Compliance Officer’ alive? Has anyone checked to see if he’s in his office? #AskJPM” to a request for the bank to self-identify as one of the characters on Sex and the City (the questioner guessed the bank was likely a Samantha) to “What’s your favorite kind of whale? #AskJPM.”

One Twitter user asked, “Can I have my house back? #AskJPM” while the account for Occupy Wall Street shared the hashtag, writing “Ever wish you could give JPMorgan/Chase a piece of your mind? Check out the hashtag #AskJPM right now.”

Eventually, the company called for a truce. JPMorgan canceled the scheduled discussion and tweeted “#Badidea! Back to the drawing board.” During the roughly six hours before that tweet, the bank endured more than 6,000 responses to its request for questions; even after the event was canceled, the hashtag remained popular, with more than 24,000 posts.

Social media guidance for financial institutions may have benefited JPMorgan. In January, the Federal Financial Institutions Examination Council released proposed guidance for banks as they attempt to engage with customers on sites like Facebook, Twitter and YouTube.

Ably predicting the antagonism directed at JPMorgan via the Twitterverse, the proposed guidance noted that “the participatory nature of social media can expose a financial institution to reputational risks that may occur when users post critical or inaccurate statements.”

In addition to reputational risks such as JPMorgan’s embarrassing gaffe, the FFIEC “Social Media: Consumer Compliance Risk Management Guidance” explained that social media presents legal and operational risks for banks.

For example, banks must comply with Regulation Z’s advertising limits as well as avoid using illegal criteria when making lending decisions based on information found in social media (such as race or religion) in violation of the Equal Credit Opportunity Act.

The SEC in a report issued in April has also weighed in on companies’ use of social media, confirming that Twitter and similar social media channels can be use used to announce key information regarding a company, so long as investors have been informed regarding which social media will be used to disseminate such information.

Why it matters: JPMorgan’s efforts to start a conversation with customers backfired in a big way. Banks and other financial institutions should use caution when engaging on social media sites such as Twitter and consult the FFIEC’s and SEC’s guidance. Given the current antibank sentiment from many consumers and the record-breaking $13 billion settlement with the Justice Department over JPMorgan’s activities during the mortgage crisis, an uncensored exchange on Twitter was clearly not the best idea for the company.

OCC Releases Guidance on Banks’ Use of Independent Consultants for Enforcement Actions

With the release of a bulletin offering guidance on the use of independent consultants in the course of an enforcement action, the Office of the Comptroller of the Currency put banks of all sizes on notice about their expected due diligence of consultants.

The standards set forth in OCC 2013-33, “Use and Review of Independent Consultants in Enforcement Acts: Guidance for Bankers,” establish how the OCC assesses the need to require a bank to hire an independent consultant “as part of an enforcement action to address significant violations of law, fraud or harm to consumers.”

Consultants are often required by the agency when addressing significant deficiencies with bank programs related to the Bank Secrecy Act, the need to file or amend suspicious activity reports and significant consumer law violations of Section 5 of the Federal Trade Commission Act, which prohibits unfair or deceptive practices. Bank management and the board of directors are not absolved by the use of a consultant, the agency said, nor is the consultant considered a substitute for the final supervisory judgment of the OCC.

The determination to require a bank to engage an independent consultant is made on a case-by-case basis, the OCC said. Factors to be considered by the agency include the severity of the violations (including the impact on consumers), the agency’s confidence in the bank management’s ability to perform the necessary actions to identify and correct the violations, alternatives to the use of an independent consultant, the importance of the function to be addressed by the consultant, and the services to be provided by the consultant.

Once the decision to use an independent consultant has been made, the bank must submit information about the proposed consultant (such as qualifications and terms of engagement), document the due diligence conducted by the bank for review, and seek the OCC’s written “no objection” to its consultant choice and the proposed contract. The bulletin presented three areas of particular importance during the review process: the necessary due diligence, the independence of the consultant, and the engagement contract and work plan.

Due diligence must be conducted prior to proposal of an independent consultant, including consideration of issues such as expertise, capacity, reputation, information security and document custody practices, and the disclosure of any professional disciplinary actions, the bulletin advised.

The OCC placed great emphasis on the need for the consultant to maintain strict independence from bank management. Direct conflicts – like the use of a consultant who has previously reviewed the transactions at issue or the relevant policies and procedures – could cause the agency to disqualify the consultant, the bulletin cautioned, as could the appearance of a conflict of interest. A review of the consultant’s independence is intended to “establish that the consultant can perform its work with a high level of objectivity such that the results of the engagement are free of any potential bias and that the work is based on the consultant’s own independent and expert judgment,” the agency explained.

When submitting information to the OCC, banks should be aware that the agency will consider several factors. The independent consultant’s relationship with the bank, including prior work dating back three years, will be considered along with any specialized expertise of the consultant and the availability of other consultants. If potential conflicts do exist, the bank should provide information about possible means to mitigate the conflict. Financial, business and personal relationships should also be disclosed between the consultant and the bank and its executives and board members.

Finally, the OCC will review the engagement contract and work plan for the proposed independent consultant. The bank’s plan should establish compliance with all applicable laws and regulations, the bulletin noted, as well as the maintenance of complete records, an assurance that disagreements about material matters will be brought to the OCC’s attention, and that the conclusions and recommendations of the consultant will be based on his or her own independent judgment. Work papers, drafts and reports should all be available to the OCC upon request, and the agency should be able to meet privately with the consultant.

Oversight by the OCC continues throughout the enforcement action and therefore the length of the bank’s relationship with the independent consultant. The more serious the violations involved, the greater the oversight and more significant the monitoring of the consultant, the agency cautioned. Depending upon the action, periodic reports and meetings between the bank, consultant and the OCC may be necessary.

During the process, “if at any time the OCC determines that the work of the independent consultant is not consistent with the requirements of the enforcement action or the terms of the engagement, the OCC will asses whether to require the parties to modify or terminate the engagement or whether to take action,” according to the bulletin.

The agency will review the consultant’s final written report of findings and recommendations to the board of directors and management to ensure that the bank has appropriately addressed and corrected the violations and that corrective actions are sustainable. If not, the OCC may tell the bank or the independent consultant to get back to work.

The bulletin noted that independent consultants are also used by banks – particularly community banks – for more “functional” engagements, such as correcting operations and management deficiencies. Because the issues being addressed in those situations do not involve “significant” violations of law, fraud or harm to consumers, the OCC’s level of oversight is lower and the concern for independence “may not be as critical,” the agency said, adding that appropriate due diligence is still required.

To read OCC 2013-33, click here.

Why it matters: “Properly used, independent consultants can help further important supervisory objectives, particularly in the context of enforcement actions,” Comptroller Thomas J. Curry said in a press release about the bulletin. “However, while consultants can provide knowledge, expertise and additional resources, we must take care to ensure they maintain independence and are subject to appropriate oversight.” Banks not supervised by the OCC should consider this yet another “best practice” guidance that their regulators would endorse for all vendor selections. The guidance pillar requirements of expertise, resources and independence can make the selection of lower-cost and off-brand consultants risky for addressing significant violations such as anti-money laundering noncompliance, as well as awkward, as the limited number of qualified potential consultants for complex cases invariably includes many former senior examiners from the OCC and the other banking agencies.

FDIC Weighs in on Deposit Advance Products

Financial institutions that offer deposit advance products recently received supervisory guidance from the Federal Deposit Insurance Corporation with a warning about the “credit, reputational, operational and compliance risks” associated with the products.

Deposit advance products are akin to traditional payday loans as “a type of small-dollar, short-term credit product” for customers that have a deposit account or reloadable prepaid card, the FDIC explained, where the customer takes out a loan that is repaid from the proceeds of the next direct deposit.

“The final supervisory guidance released today aims to alert financial institutions to the risks posed by certain deposit advance products and to encourage institutions to meet the demand for small-dollar loans through affordable products that are prudently underwritten and designed,” FDIC Chairman Martin J. Gruenberg said in a statement. The “Guidance on Supervisory Concerns and Expectations Regarding Deposit Advance Products” is intended to supplement the agency’s existing guidance on payday loans and subprime lending.

The FDIC said the design of deposit advance products coupled with weak underwriting can raise issues under the Truth in Lending Act, the Equal Credit Opportunity Act, as well as potential UDAAP violations.

Pursuant to the guidance, banks must assess a customer’s ability to repay the loan by analyzing recurring deposits and outflows over a six-month period to ensure that the individual can “continue to meet typical recurring and other necessary expenses such as food, housing, transportation and healthcare, as well as other outstanding debt obligations.”

In addition to financial capacity, the underwriting process should also consider the length of the customer’s relationship with the bank and undertake ongoing customer eligibility review no less than every six months, to check for risks such as repeated overdrafts.

The guidance also outlines a “cooling off” period of at least one monthly statement cycle after an advance loan has been repaid before another advance can be extended.

“[A]ppropriate supervisory action to address any unsafe or unsound banking practices associated with these products, to prevent harm to consumers, and to ensure compliance with all applicable laws,” will be taken by the FDIC, the agency said.

Examinations will include an assessment of credit quality, underwriting and credit administration policies and practices, as well as an evaluation of compliance with applicable federal statutes and management oversight. Banks with repetitive deposit advance borrowings could be criticized in the Report of Examination, which could be factored into a bank’s ratings, the guidance noted.

To read the FDIC guidance, click here.

Why it matters: The FDIC reported that it received more than 100 comments on the proposed guidance, with many commenters expressing concern that the agency is overreaching by promulgating new regulations in the area of consumer protection. In response, the FDIC said the guidance is intended to “highlight[] supervisory expectations based on applicable laws and regulations.” Further, the guidance – and specifically the determination of a consumer’s financial capacity – will not prove overly burdensome for banks. Recognizing the need for small-dollar credit products, the agency said that if structured properly, the products “can provide a safe and affordable means for customers to transition from reliance on high-cost debt products.” The FDIC also urged banks “to develop new or innovative programs” to meet the need for small-dollar credit, however, “that do not exhibit the risks associated with deposit advance products and payday loans.”

FDCPA Can Apply to Creditors, 2nd Circuit Holds

Ruling in a class action suit brought against The Money Store and two affiliates, a Federal Court of Appeals in New York broadened the “false name” exception under the Fair Debt Collection Practices Act to broaden the circumstances under which a defendant could be held liable under the statute.

“[W]here a creditor that is collecting its own debts hires a law firm to mail thousands of letters to debtors that misleadingly indicate that the law firm has been retained to collect the creditor’s debts, and where the law firm has not engaged in any other bona fide efforts to collect those debts, the creditor can be held liable for violating the FDCPA pursuant to the statute’s false name exception to creditor immunity,” the court held.

Four plaintiffs filed suit against The Money Store. Each had obtained a mortgage through a different original lender, each mortgage was purchased by The Money Store, and each plaintiff eventually defaulted on his or her mortgage, triggering collection. The defendants violated the FDCPA by allegedly charging improper fees on their accounts, such as excessive late fees and vague and unwarranted fees for “file reviews.”

To handle its collection efforts, The Money Store retained the law firm of Moss, Codilis, Stawiarski, Morris, Schneider & Prior LLP (Moss Codilis). For a flat fee of $50 per letter, the law firm sent debt collection letters to debtors as directed by The Money Store.

The letters stated that “this law firm” has been “retained” in order to “collect a debt for our client,” and that “this firm has been authorized by [The Money Store] to contact you” and “provide[] notice that you are in default” on the mortgage. The letters also stated that, with limited exceptions, “[a]ll communication about this matter must be made through [The Money Store].” Over a five-year period, Moss Codilis sent 88,937 such letters on The Money Store’s behalf for the “Breach Letter Program.”

The extent of the law firm’s involvement remained in dispute: Moss Codilis argued that the program was an exercise in mass processing and essentially sold the services of its letterhead, while The Money Store said the law firm was more actively involved, engaging in communications with some of the debtors and functioning as the primary drafter of the breach letters.

Although creditors are generally not considered debt collectors subject to the FDCPA, the plaintiffs turned to an exception found at 15 U.S.C. § 1692(a)(6). That provision opens the door to potential liability where the creditor “in the process of collecting [its] own debts, uses any name other than [its] own which would indicate that a third person is collecting or attempting to collect such debts.” By using the law firm’s name to send out debt collection letters for debts The Money Store was in fact collecting itself, the defendants falsely used a name other than their own, the plaintiffs contended.

A federal lower court dismissed the suit, refusing to apply the false name exception. But the Second Circuit reversed, finding that The Money Store exposed itself to liability by representing to debtors that the law firm was collecting its debts when in fact the law firm made no bona fide efforts to do so.

Applying an objective standard of whether the “least sophisticated consumer would have the false impression that a third party was collecting the debt,” the federal appellate panel emphasized that the FDCPA was intended to protect consumers from abusive and deceptive debt collection practices.

Three requirements must be met under the statutory language of Section 1692(a)(6), the court said: the creditor must be collecting its own debts, the creditor “uses” a name other than its own, and the creditor’s use of that name falsely indicates that a third person is “collecting or attempting to collect” the debts that the creditor is collecting.

All three elements were satisfied, the court said. Although The Money Store did not utilize a pseudonym or alias (as occurred in the only other false name case decided by the Second Circuit), the court found it was enough that the defendants implied that a third party was collecting its debts.

“When a creditor that is collecting its own debts hires a third party for the purpose of sending letters that represent that the third party is collecting the debts, that is sufficient to show the ‘use’ of a name by the creditor other than its own,” the panel said, satisfying the requirement that creditors “actively engaged” in misrepresenting its identity in some way.

The Money Store also misrepresented the law firm’s role in the collection efforts, meeting the third requirement, the court wrote. Although the law firm generated the breach letters and mailed them to the debtors, those acts alone did not constitute “collecting or attempting to collect” the defendant’s debts. Collecting debts “must mean something more than any role, no matter how tangential, in the collection process,” the court said. “Merely changing the return address from The Money Store to Moss Codilis . . . does not change whether the letter misleads consumers, which . . . is the statutory touchstone for all aspects of the FDCPA, including the false name exception.”

“We therefore hold that, when determining whether a representation to a debtor indicates that a third party is collecting or attempting to collect a creditor’s debts, the appropriate inquiry is whether the third party is making bona fide attempts to collect the debts of the creditor or whether it is merely operating as a ‘conduit’ for a collection process that the creditor controls,” the Second Circuit panel wrote.

At the summary judgment stage, the panel said it could not find that Moss Codilis was engaged in such bona fide efforts. “[T]he jury could conclude that the letters received by plaintiffs appear to be ‘from’ The Money Store in every meaningful sense of the word,” as The Money Store reviewed and maintained possession over its debtors’ files while the law firm simply received spreadsheets with debtors’ names and addresses and added that information to the form letter on Moss Codilis letterhead, sending it out.

“Notwithstanding its limited involvement, Moss Codilis sent out letters to plaintiffs stating that ‘this law firm’ has been ‘retained’ in order to ‘collect a debt for our client.’ The jury could find that this falsely implied that Moss Codilis was attempting to collect The Money Store’s debts and would institute legal action against debtors on behalf of The Money Store if the debtors did not resolve the delinquency,” the court said.

The court did uphold dismissal of the plaintiffs’ Truth in Lending Act (TILA) claims, finding that because The Money Store was the assignee of the plaintiffs’ mortgages, the defendants were therefore not the persons to whom the mortgages were initially payable as reflected on the face of the loan documents, as required by the statute. Therefore – even though some of the plaintiffs actually made their first payment on the mortgage to The Money Store – the defendants were not “creditors” under TILA and could not be liable for violating the statute, the panel wrote.

To read the decision in Vincent v. The Money Store, click here.

Why it matters: The Second Circuit decision opens the door to liability for creditors under the FDCPA by broadening the “false name” exception of the statute, and, as the dissenting opinion noted, the ruling could deter creditors from overseeing collection efforts for fear of coming under the purview of the FDCPA and discourage them from remaining involved in the operations of the debt collection agencies they hire. The “bona fide” test established by the majority “will over time sow ambiguity into an otherwise straightforward statutory scheme, auguring both difficult line-drawing exercises for future courts and uncertain liability for creditors who contract with debt collectors to collect those creditors’ debts,” Circuit Judge Debra Ann Livingston wrote in her dissent. Although the majority disagreed,”[w]e repeat, for emphasis: the exception does not create backdoor vicarious liability for creditors,” the decision could, at the very least, inspire future actions from consumer class action attorneys.

CFPB Releases New Mortgage Disclosure Forms, Rule

With tweaks to an earlier proposal, the Consumer Financial Protection Bureau released a final rule on mortgage disclosures and issued two new forms to replace the existing disclosures required by the Real Estate Settlement Procedures Act and the Truth in Lending Act.

Creditors have until August 1, 2015, to begin using the new “Know Before You Owe” forms after more than 30 years of using the old disclosure forms. The rule applies to most closed-end consumer mortgages; home equity lines of credit and reverse mortgages are not covered. The new rule – which runs to 1,888 pages – was mandated by the Dodd-Frank Wall Street Reform Act, which required the CFPB to integrate and combine the existing RESPA and TILA disclosures.

The CFPB released preliminary disclosures for public comment in May 2011; the agency released additional prototypes over the following months and issued a proposed rule in July 2012.

Pursuant to the final rule, when it becomes effective in 2015, the three-page Loan Estimate will have to be provided to the consumer within three business days after a loan application is submitted. In the proposed rule, the CFPB wanted to change the definition of “business day” to include Saturdays. Based on feedback from industry members, the final rule instead allows a company-specific definition of “business day.” Under that definition, the three-day period will be based on the days that the given company’s offices are open to the public for conducting substantially all of its business.

Lenders may not charge any fees until after the Loan Estimate form has been provided and the consumer goes forward with the loan. The form combines requirements of several statutes, featuring disclosures from the current Truth in Lending (TIL) statement with some from the RESPA Good Faith Estimate, as well as additional disclosures required by the Dodd-Frank Act and the appraisal notice mandated by the Equal Credit Opportunity Act.

The borrower must receive the five-page Closing Disclosure at least three business days before the loan closes. If a “significant change” to the loan terms occurs after the Closing Disclosure is delivered, then a new Closing Disclosure must be given, and another three business days must elapse before the closing can occur. “Significant changes” are defined by the rule to mean only (i) a rate (APR) change of 1/8th of 1% or more (or 1/4th of 1% for loans with irregular payments or periods), (ii) a change in the product type, or (iii) addition of a prepayment penalty. The final rule has fewer such situations where an additional three-day waiting period will be required, compared to the proposed rule.

The CFPB provided detailed guidance to creditors for both forms, including a variety of samples for different mortgages, such as an interest-only adjustable rate, fixed-rate, balloon-payment, and negative amortization purchase loans, as well as a refinancing sample.

The agency made other tweaks to the rule as proposed last year. After pushback from the industry, the CFPB chose not to require “additional costs” to be added to the finance charge. Items like title-agent charges, credit life insurance premiums, voluntary debt cancellation fees, closing agent charges, and security interest charges all would have been included. Industry representatives successfully argued that including those items would have significantly raised APRs, increasing the number of loans considered to be “high-cost” and therefore limiting the availability of relying upon the safe harbor for Qualified Mortgages that are not “high-cost.”

The industry dodged another blow from the proposed rule, with the agency tossing a requirement that creditors maintain evidence of their compliance in an “electronic, machine readable format.” Under the final rule, records may be retained in paper or scanned forms.

Finally, industry efforts to provide a sufficient time period for lenders to come into compliance proved successful. With the release of the final rule in November 2013, a roughly 20-month implementation period will exist before the new forms must be used in August 2015.

To read the final rule, click here.

To see the Loan Estimate form, click here.

To see the Closing Disclosure form, click here.

Why it matters: Although there is substantial lead time until the effective date of August 1, 2015, there is immediate work to be done to prepare for this dramatic change. Forms and systems will have to be conformed to the new physical format. Some disclosure items are not on the old forms at all, and others are newly redefined. Systems will need to be modified to perform the new calculations. Banks, mortgage companies and other loan originators should start working with their vendors now to be prepared for the changes.