Nutter Bank Report, April 2017

by Nutter McClennen & Fish LLP
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The Nutter Bank Report is a monthly publication of the firm's Banking and Financial Services Group.

Headlines
1. CSBS Seeks Federal Court Order to Block OCC Fintech Charter Proposal
2. New York’s New Data Security Rule for Financial Institutions Becomes Effective in August
3. Court Decision May Require CFPB to Change Its Approach to Investigations
4. OCC Issues New Supervisory Guidance on Retail Lending
5. Other Developments: Prepaid Accounts and SEC Guide 3

1. CSBS Seeks Federal Court Order to Block OCC Fintech Charter Proposal

The Conference of State Bank Supervisors (“CSBS”) has filed a complaint against the OCC in the U.S. District Court for the District of Columbia seeking to prevent the OCC from issuing special purpose national bank charters to fintech companies. The CSBS argues in its complaint and request for an injunction filed on April 26 that the OCC’s fintech charter proposal exceeds the limited chartering authority granted to the agency by Congress under the National Bank Act and other federal banking laws. Those laws authorize the OCC to charter institutions that engage in the “business of banking,” which requires an institution, at minimum, to receive deposits, the CSBS complaint argues. The CSBS complaint claims that because the OCC proposes to create a new special purpose charter for nonbank companies that do not take deposits, the OCC does not have the statutory authority to create such a charter without specific congressional approval. Among the arguments in the complaint, the CSBS states that the OCC’s fintech charter proposal would preempt state consumer protection laws, harm markets and innovation, and put taxpayers at risk of fintech failures. Click here for a copy of the complaint.

     Nutter Notes: The CSBS complaint also makes the argument that the OCC’s fintech charter proposal violates the federal Administrative Procedures Act because the OCC did not follow the regulatory notice and comment procedures required by that law. The OCC published a proposed supplement to the Comptroller’s Licensing Manual last month for public comment that describes how the OCC will apply the licensing standards and requirements in existing regulations and policies to a fintech company applying for a special purpose national bank charter. The proposed supplement also describes the factors that the OCC will consider in evaluating an application for a fintech charter, the OCC’s expectations for promoting fair access, fair treatment, and financial inclusion, and the OCC’s approach to supervising those fintech companies that become national banks. The proposed supplement provides that, as part of the chartering process, the OCC may impose supervisory conditions directly in an approval letter issued to a fintech charter applicant, or the OCC may require that the applicant enter into an operating agreement with the OCC specifying supervisory conditions. While the existence of such an operating agreement would be publicly disclosed in the OCC’s approval of a fintech charter, the CSBS complaint argues that the terms of such an agreement would not be publicly available and would therefore violate the Administrative Procedures Act.

2. New York’s New Data Security Rule for Financial Institutions Becomes Effective in August

The State of New York’s Department of Financial Services (“DFS”) adopted a new and potentially onerous cybersecurity rule last month that imposes minimum data security requirements on financial institutions licensed to do business in New York, including out-of-state banks, that will become effective starting on August 28, 2017. The final rule includes minimum requirements for a written cybersecurity program that must be adequately funded and staffed, overseen by qualified management, and reported on periodically to the most senior governing body of the institution. The rule also includes minimum standards for information technology systems security, including access controls, encryption and other data protection, and periodic penetration testing. The rule requires that each covered institution’s cybersecurity program address security breaches, including an incident response plan, preservation of data, and notice to the DFS of certain material cybersecurity events. The new rule also requires that a covered institution conduct a periodic risk assessment of its information systems and incorporate the results into its cybersecurity program. Click here for a copy of the new cybersecurity rule.

     Nutter Notes: New York’s new cybersecurity rule applies to any financial institution that is operating under or is required to operate under a license or other authorization issued by one of the agencies of the DFS, including banks, certain nonbank lenders, insurance companies and producers, and certain securities firms. The rule is relatively unique in that it applies minimum data security requirements not only to nonpublic personal information about consumers, but also to business-related information of the covered financial institution itself if unauthorized use of or access to such information would have a material adverse impact to the business, operations, or security of the institution. The rule also protects biometric data, such as fingerprints, and personal health information of the type protected by the federal Health Insurance Portability and Accountability Act (known as HIPAA). The rule requires covered institutions to oversee cybersecurity by their vendors, including initial due diligence and risk assessment, and periodic assessment of third party service provider cybersecurity practices. Compliance with various requirements of the rule will be phased in over a two-year period starting in August.

3. Court Decision May Require CFPB to Change Its Approach to Investigations

A recent ruling by the U.S. Court of Appeals for the District of Columbia Circuit has invalidated a civil investigative demand (“CID”) issued by the CFPB in a case that may affect other CFPB investigations. The April 21 ruling involved a CID issued to a nonbank institution in connection with a student loan investigation in which the “Notification of Purpose” on the CID stated that the CFPB was seeking information about “unlawful acts and practices in connection with accrediting for-profit colleges.” The lower court invalidated the CID because it concluded that the CFPB does not have the legal authority to investigate the process for accrediting schools. On appeal, the circuit court held that the CID was invalid because its Notification of Purpose did not adequately describe the unlawful conduct under investigation or the applicable law. The circuit court said that it did not, therefore, need to determine whether the CFPB had the legal authority to investigate the accrediting process because the CID was invalid for failure to adequately specify the purpose of the investigation. While the court’s ruling is limited to that particular CID, it suggests that any CID that does not adequately describe what violation of law the CFPB is investigating may be invalid or unenforceable. Click here for a copy of the decision.

     Nutter Notes: The language used in the CID’s statement of purpose—that the CFPB was investigating “unlawful acts and practices” generally—is considered standard language that the CFPB uses in other CIDs. In holding that this language does not satisfy the requirement under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) that each CID “state the nature of the conduct constituting the alleged violation which is under investigation and the provision of law applicable to such violation,” the ruling questions the validity of any other CID using the same language without specifying the conduct being investigated and the applicable legal requirement that may have been violated. The practical effect of the ruling is that the CFPB will have to give the targets of its investigations more information about what the CFPB is investigating. The CFPB has exclusive federal supervisory authority and primary enforcement authority for compliance with federal consumer financial law over banks with total assets over $10 billion. The CFPB has more limited direct authority over banks with total assets of $10 billion or less, though CFPB examiners may accompany federal bank examiners to assess consumer compliance during community bank examinations.

4. OCC Issues New Supervisory Guidance on Retail Lending

The OCC has issued guidance in the form of a new “Retail Lending” booklet of the Comptroller’s Handbook, which discusses the risks associated with retail lending and provides a framework for evaluating retail credit risk management activities. The new booklet published on April 12 is part of the “Safety and Soundness” category of the Comptroller’s Handbook and supplements the core assessment sections of the “Large Bank Supervision,” “Community Bank Supervision,” and “Federal Branches and Agency Supervision” booklets. The new “Retail Lending” booklet describes the criteria examiners will consider when evaluating retail credit originations, account management, collections, and portfolio management activities and processes. The booklet also describes the OCC’s expectations for the objectives of control functions commonly used in a retail lending business to measure performance, make decisions about risk, and assess the effectiveness of processes and personnel. Click here for a copy of the new Retail Lending booklet.

     Nutter Notes: According to the OCC, banks should expect the principles described in the new Retail Lending booklet to be applied by examiners when specific retail lending products, services, activities, or risks “warrant review beyond the core assessment because they have a material impact on the risk profile and financial condition of national banks and federal savings associations.” The OCC defines retail lending as closed- and open-end credit extended to individuals for household, family, and other personal expenditures. Retail lending generally includes consumer loans, credit cards, auto loans, student loans, and home mortgage loans, including first mortgages, home equity loans and lines of credit, and home improvement loans. The booklet focuses on eight categories of risk implicated in retail lending: credit, interest rate, liquidity, price, operational, compliance, strategic, and reputation. According to the booklet, examiners will expect risk management for retail lending activities to correspond to the bank’s size, complexity, and risk profile.

5. Other Developments: Prepaid Accounts and SEC Guide 3

  • CFPB Delays the Effective Date of New Prepaid Accounts Rule

The CFPB adopted a final rule on April 20 that delays the general effective date of its rule governing prepaid accounts by six months. The rule will now take effect on April 1, 2018. The CFPB also announced that it will revisit at least two substantive issues in the prepaid accounts rule through a separate notice and comment rulemaking process.

     Nutter Notes: The CFPB issued a final rule to amend Regulation E to provide comprehensive consumer protections for prepaid accounts on October 5, 2016, including a requirement that issuers of prepaid accounts submit prepaid account agreements to the CFPB. The CFPB said that, as a result of discussions with various industry participants, it learned that some financial institutions would have difficulty coming into compliance with the new rule. Click here for a copy of the final rule extending the compliance deadline.

  • SEC Requests Proposals for Changes to Public Disclosure Requirements for Banks

The SEC is seeking public input about possible changes to the disclosures required for publicly traded banking organizations under Industry Guide 3, Statistical Disclosure by Bank Holding Companies. The request was issued last month and the SEC announced on April 17 that it is extending the public comment period until July 7, 2017.

     Nutter Notes: The SEC stated that it is seeking input about new or revised disclosure or the elimination of what may be duplicative or overlapping disclosures in Guide 3. The SEC also asked for input on whether any of the Guide 3 disclosures, which are not SEC rules or requirements, should be codified as SEC rules. Click here for a copy of the request for comments.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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