Bank Lawyer's Blog

Sabbatical

Other than holidays and brief vacations, I have not taken a break from this blog in over a decade. It's time. This blog is going on summer vacation.

Have a great summer.

The Underbelly Of The Mt. Holly Settlement

The settlement of the Mt. Holly disparate impact case before it could be decided by the US Supreme Court were suspicious. At the time, it was thought by many that the US Justice Department had helped to engineer that settlement so that its (and HUD's and the CFPB's) use of that questionable doctrine in fair lending claims could continue for a while longer. The last thing the Feds wanted was for the SCOTUS to decide the matter, because they were worried (correctly) that it would strike down its use. At the same time, the banking industry wanted the SCOTUS to render a decision, because it thought that the court was more likely than not to strike down the doctrine's use in the fair lending context. The last thing that banks wanted was for the parties to the case to settle before the SCOTUS could render its decision (which is exactly what happened).

Recently, a rock has been overturned that has exposed a bunch of creepy-crawlers that work not for the federal government, but for the big banks that wanted the SCOTUS to rule in the Mt. Holly case. According to a former senior executive of Chase, that bank tried to get him to use his board position with a non-profit housing organization to "scuttle" the funding of the settlement. Moreover, the former executive, Wayne Trotman, at the time the mid-Atlantic market president of Chase, alleges that when he refused to breach his fiduciary duty as a member of the board of directors, the bank retaliated by firing him.

The fact that Mr. Trotman is an African-American adds not only to the radioactivity of the alleged wrongful conduct, but also substantial irony to those actions, if Mr. Trotman's allegations are true. While Chase counters that Trotman's claims are "baseless," Trotman's lawyers claim that they have "substantial evidence" to support them.

Obviously, the first thing that Trotman has to prove is that Chase pressured him to use his board position to scuttle the settlement. According to the linked article, which cites Trotman's Complaint, he claims that he was instructed to do so by Chase's Associate General Counsel, via email, even after he refused on the grounds that it would breach his fiduciary duty. The Complaint later states that another Chase attorney told him that he should not honor the request (which was also the position of his supervisor). Apparently, the ball started rolling in Jamie Dimon's office after he (and the heads of other large banks) received an email from Tim Pawlenty of the Financial Services Roundtable uirging the bankers to find ways to derail the settlement long enough for the SCOTUS to render a decision. There does not appear from the kinked article to be any order from Dimon that Trotman do anything, but, then, that's what subordinates are for: read the CEO's mind and "get 'er done" while retaining deniability for those residing at the top of Mt. Olympus.

The harder nut to crack for Mr. Trotman may likely be proving the causal connection between his decision to be an honorable man and not to breach his fiduciary duties, and his subsequent termination by Chase. It's impossible to determine that connection solely from the linked article, although I assume that the "substantial evidence" referenced by Trotman's lawyers indicates that they think that they can carry the water on that claim. The man worked for Chase for 19 years, received a "meets expectations" review shortly after the incident (although Chase substantially cut his bonus from the previous year, in which he received the same rating), then six months later received a mid-year performance rating of "poor" and was fired 14 days later without being provided an opportunity to improve. On its face, it looks like there might be fire with this smoke.

On the other hand, we haven't seen Chase's formal responsive pleading. In one press report, a Chase spokesperson told a reporter that Trotman 's position was eliminated in a "reorganization of markets." That spokesperson also claimed that Chase would "fight this in court." I guess that beats fighting it in the streets.

Obviously, it's too early to tell what the outcome of this lawsuit might be. The smart money in these situations is on a cash settlement with nondisparagement and confidentiality provisions in the settlement agreement, so that the "reputational risk" is mitigated and the whole sordid affair is swept under a rug.

Still. When it comes to picking a champion inducer of the gag reflex, it's often tough to choose between Big Banking and Big Government.

Releash The Hound

Calling the CFPB a "rogue agency," Georgia Senator David Perdue introduced a bill in the Senate last week to bring the rogue to heel. The Consumer Financial Protection Bureau Accountability Act of 2015 is a companion bill to one that passed the House with substantial bipartisan support.

"Right now, the CFPB is a rogue agency that dishes out malicious financial policy and creates new rules and regulations at whim without real Congressional oversight. The American people, through Congress, deserve a closer look at the CFPB and how its actions will impact consumers," he said. "Additionally, the agency itself has failed to operate within its own budget and proven it is more concerned with preserving its own power than protecting the public. Ultimately, I believe the CFPB should be eliminated, but an important first step is bringing it into the light for the American people."

As expected, financial institution trade groups supported the bill. In addition, taxpayer advocacy also voiced support.

A statement from the Taxpayers Protection Alliance charges that the CFPB operates outside of the jurisdiction of Congress that most agencies operate in and continues to be appropriated by taxpayer funds without the proper Congressional oversight. "This is an agency that demands scrutiny like any other federal agency and should be held accountable for their actions by moving into the proper process for Congressional appropriations," said David Williams, President of the Taxpayers Protection Alliance. "Any federal agency operating with the use of taxpayer funds must be subject to oversight by the elected officials that represent those taxpayers in Washington."

Expect Senators Darth Warren, Vladimir Ilyich Sanders, and their comrades in the Senate to fight tooth-and-nail to derail this bill. Even if it passes the Senate, expect the president to veto it. At that point, we'll see how extensive the "bipartisan" support for the law might be, because I would be surprised to see such a veto overridden this year or next. 

Still, a boy can dream.

Reality Check

While ideologues pontificating from ivory towers claim that community banks don't need regulatory relief, since they are doing just fine financially, boots on the ground tell a different story.

Community banks are drowning in a torrent of regulatory compliance costs, and Jack Barrett, president and CEO of First Citrus Bank, wants that to change.

Federal agencies that supervise financial institutions should focus on the largest institutions with the most complex transactions, Barrett wrote in a May 13 letter to Martin Gruenberg, chairman of the Federal Deposit Insurance Corp.

Barrett claims that the FDIC devotes three-quarters of its supervisory efforts to community banks that hold 13% of the industry's assets, while devoting only one-quarter to the largest banks.

“How is it sound for a soundness regulator to direct three times the amount of supervisor resources to 13 percent ($2.1 trillion) of industry assets, while 87 percent, $13.2 trillion of exposure, garners a mere 1/4th of supervisory resources?” Barrett’s letter said.

However, it's not the misallocation of FDIC resources, but the cost to First Citrus of managing all that regulatory scrutiny, that causes Barrett the most heartburn.

In 2014, First Citrus incurred $412,000 in expenses related to regulation, compared to less then $25,000 spent each year prior to 2008. The biggest chunk of regulatory expenses last year — $189,000 — was for personnel, as First Citrus, like many other community banks, has had to beef up compliance staff.

Regulatory costs equated to 72 percent of the bank’s net income of $662,000 in 2014.

"If we are too small to save, do the regulatory agencies know we are also small enough to drown in torrential compliance costs?” the letter said.

Yes, they know it. They'll pay lip service to the problem, then get about the business of consolidating the banking industry on the Canadian model favored by some. A few huge banks, working hand-in-glove with the central government to redistribute credit to those who most "deserve" it.

Banks: Targets of Opportunity

Conservative economist Larry Kudlow claims that while bank-bashing didn't work for the Labor party in the recent UK elections, banks in the US should gear up for a round of groin-kicking from both sides of the US political spectrum as the US presidential election race heats up late this year and next. According to Kudlow, the intellectual dishonesty inherent in this tactic is apparent.

Few will admit it, but unaffordable, undocumented mortgage quotas came out of Washington, not Wall Street. And Fanny and Freddie enforced them. And while the Fed’s ultra-easy money destroyed the dollar, it also caused a bubble in home prices.

 

Yes, banks made risk-management mistakes. But when will the firing squads stop? You know, you can’t have a decent economy without banks.

 

But when will you ever hear a politician say that?

Let me guess.

 

[Sound of crickets chirping]

 

Kudlow lists the usual suspects: Lizzie Warren, Bernie ("The proletarians have nothing to lose but their chains") Sanders, and, lately, Hilarity Clinton, but also notes that Republicans are also jumping on the anti-bank bandwagon.

Of all people, former Florida governor Jeb Bush bashed banks while in New Hampshire.

But wait, didn’t Jeb’s brother preside over the big bank bailout? Oops.

 

Former Texas governor Rick Perry is slamming the banks. So is former HP CEO Carly Fiorina. She actually said, “I agree fully with Elizabeth Warren.”

As Kudlow responds: "Huh?"

 

What's next for Carly? Is she coming out as 1/32 Huron? Will she change her last name to "Simon" and make her campaign song "Nobody Does It Better?"

 

Kudlow thinks that there are valid reasons for a politician to defend banks.

Banks do make business loans, which have picked up quite a bit. They do provide mortgages, though the terms are more difficult. They do offer credit cards, decent ATM machines, car loans, farm loans, and student loans. Even though the Fed has decimated interest rates, they do allow large savings accounts. And they do, after all, connect savings with investment. (I think that was their original purpose.)

Kudlow would get rid of the Ex-Im bank, as well as the "conserved" Aunt Fannie and Uncle Freddie. He doesn't say how he'd finance the US residential mortgage market without Fannie and Freddie, and I'd like to hear his ideas on that issue, because right now, those two broke (yet cash-generating) behemoths are pretty much all there is in the secondary mortgage market in this country, at least for conventional loans.

 

But I digress.

 

While sarcastically claiming that he'd never defend banks, he ends with a warning to pols.

Sometimes British politics leads our politics. And if bank-bashing didn’t work in the U.K., maybe politicians here should let it go, and instead focus on pro-growth measures like flat-tax reform, free trade, deregulation, and sound money. Just for a moment, why not leave banks alone?

Because they're easy scapegoats, Larry. Like lawyers, everybody loves to hate them, and for the cynics we have in D.C., who value power over truth (even those--or, perhaps, especially those--who claim to speak truth to power), they are low-hanging fruit.

Vendor Mismanagement

While banks have complained about the crushing burden of regulations in a post-Franken-Dodd world, in one area they could use a little more regulation. Not of the banks, but of third-party service providers to banks.

I have yapped repeatedly on this rag sheet about how banks need to treat regulatory guidance seriously. While some regulators send confusing signals about the legal enforceability of guidance, they have also made clear that they expect banks to comply with it. Period.

One piece of guidance that we have discussed is OCC Bulletin 2013-29 regarding third party relationships, which is a reworking and expansion of guidance first issued in in 2001 (OCC Bulletin 2001-47). Other federal financial institution regulators have issued similar guidance. One portion of that guidance deals with provisions that the OCC expects to be incorporated into written agreements between banks and their service providers. Banks who take regulatory guidance seriously attempt to ensure that their written agreements with their significant vendors meet the regulators' expectations.

If some technology service providers are to be believed, not many banks take the guidance seriously.

Repeatedly, attorneys who advise banks on such agreements will hear a common complaint: the bank asking for such a contractual provision is the only bank that has ever asked the vendor for the same. Putting aside my stock response ("You'll never be able to say that again, will you?"), let's take them at their word and see what this means.

Let's pick two provisions, access by the bank's regulators to the service provider's records concerning the services it provides to the bank, and a binding agreement by the vendor to provide the bank with a disaster recover plan and modifications to it. These aren't the only provisions. There are many more, but I don't make a living off this blog, so they'll have to do for now.

OCC Bulletin 2013-29 provides in part as follows:

In contracts with service providers, stipulate that the performance of activities by external parties for the bank is subject to OCC examination oversight, including access to all work papers, drafts, and other materials. The OCC treats as subject to 12 USC 1867(c) and 12 USC 1464(d)(7), situations in which a bank arranges, by contract or otherwise, for the performance of any applicable functions of its operations. Therefore, the OCC generally has the authority to examine and to regulate the functions or operations performed or provided by third parties to the same extent as if they were performed by the bank itself on its own premises.

That's pretty clear. Yet, we have repeatedly encountered service providers, including one of the major technology service providers in the United States, who have resisted such a contractual "stipulation". In one discussion, a service provider that was providing an online banking system and related customer-facing services asked the bank to cite the provision of the law that gave the OCC the right to have such access. When we gave it the citation to 12 USC 1867(c), it responded that its inside counsel did not agree with the OCC's interpretation of the Bank Service Company Act, and that examinations that it had permitted the OCC to make were purely voluntary and could be terminated at any time. We responded that we didn't give a flying fig in a rolling donut what its in-house counsel thought about the OCC's interpretation, since the law was clear on its face. In that case, we compromised on language that required such regulatory access "as is required by applicable law." However, we were told by that vendor that other banks did not insist on such a provision in the agreement.

With respect to business continuity plans, OCC Bulletin 2013-29 provides the following:

Ensure that the contract requires the third party to provide the bank with operating procedures to be carried out in the event business resumption and disaster recovery plans are implemented. Include specific time frames for business resumption and recovery that meet the bank’s requirements, and when appropriate, regulatory requirements. Stipulate whether and how often the bank and the third party will jointly practice business resumption and disaster recovery plans.

Recently, we have encountered a technology service provider who provides a critical online banking service that absolutely refuses to agree to any provision in the agreement that addresses business continuity plans or procedures. While it states that it has such a plan and that the bank can review it, it will not agree to put anything in the contract regarding such plans. Again, the bank was informed by the vendor that it has never agreed to provide such contractual protection to a financial institution, and that no other bank has insisted upon it. Again, this is a critical service provider whose service, if it went "offline" for any length of time, would cause intense heartburn to the bank.

These are only two examples. There are many, many more. It's as if not only are many vendors unaware of requirements that their bank clients must meet (and that have been required for over a decade), but that many banks do not care about complying with regulatory guidance. In the case of smaller institutions, there is also the problem that they lack the expertise to negotiate, or perhaps they believe that they do not have sufficient importance to the vendor to bargain effectively. Whatever the reasons, many of them are rolling over with their paws in the air instead of trotting in the other direction.

This leaves those banks that take regulatory guidance seriously in a tough position. Some of them are simply walking away and trying to find vendors who "get it," even if they are not the first choice from a purely business standpoint. Others end up negotiating with themselves to arrive at less-than-reasonable contractual compromises.

I have a couple of suggestions for the regulators. First, try enforcing the guidance across the board. There are financial institutions who are trying to "do it right," but who are being undercut by those who aren't. Moreover, use your authority under the Bank Service Company Act and otherwise to bring home to the vendors directly that if they want to play in this arena, they need to play by your rules. Some of them are not getting the message. Perhaps it would be helpful to start naming names on both ends of the spectrum. Perhaps that would get some attention.

In fairness, there are technology service providers who are doing it right. They understand the guidance, and while they are not willing to fall over and play dead, they are willing to make a reasonable attempt to accommodate what is essentially appropriate risk allocation between the parties, and appropriate accommodation to their customers' regulators' expectations. They "get it." Here's hoping that more of them eventually get the message, as well.

Study Contends Community Banks Need Relief

A recent study released by the University of New Orleans backs up what many have been contending: "Community banks in Louisiana and throughout the United States are rapidly disappearing, and federal laws meant to protect the country from another megabank bailout have saddled smaller financial institutions with disproportionately large costs."

The number of community bank charters plummeted 53.3 percent from 1993 to 2014, while the number of non-community banks jumped 17.6 percent, according to National and Regional Trends in Community Banking. The study was conducted by the University of New Orleans.

The causes include consolidation in the banking industry, competition from online banking and the crushing burden of “too big to fail” federal regulations, said Kabir Hassan, lead author of the study. The regulations are not working as intended to prevent the economy from being crippled if one of these megabanks fails.

“Actually in my reading, they have institutionalized it even further,” Hassan said. “And what it means is, when the law is made for a big bank, who suffers? The small, mom-and-pop community banks.”

[...]

Hassan spoke at a community bank meeting organized by Gulf Coast Bank & Trust Co. Sen. David Vitter, chairman of the U.S. Senate Small Business and Entrepreneurship Committee, also spoke at the meeting in Baton Rouge.

Vitter said he hopes to distribute the study’s findings as widely as possible, starting with the Senate Banking Committee.

Although the downward trend in community banking is well-known, when these complaints are brought to Washington, D.C., there are typically two responses, Vitter said. The Washington-type experts deny it is happening or say it’s an unintended consequence.

“Well, it really doesn’t matter if it’s intended or not. That doesn’t change the reality,” Vitter said.

Obviously, Vitter is an ally of community banks in their quest for "regulatory relief." It will be interesting to see how his fellow members of the Senate Banking Committee, including everyone's favorite populist, Lizzie Warren, react to the study. With a yawn and a shrug, is my guess.

As the linked article points out, the loss of community banks has potentially serious consequences for small business lending. Traditionally, community banks have been the primary source of small business loans. While some commentators believe that alternative non-bank sources (including peer-to-peer lending) will eventually substantially supplant community banks, even if true (which I doubt), that's not going to happen overnight. I recall reading in the late 1990s prognostications that the internet would make soon branch banking obsolete. Several years later, the federal banking regulators were telling consultants and bank lawyers that they'd better not bring any more "internet-centric" bank charter applications for approval, because the bloom was off that rose. While the internet, and mobile, banking channels may one day replace brick-and-mortar branches, change happens more solely than many "true believers" expect, and severe dislocations for customers can result while the paradigm is shifting.

I think regulatory relief for community banks ought to be getting more "play" in Congress than we've seen thus far. More statistical support like the UNO study may help it gain traction. Let's hope so.

Going Unrogue

McGuire Woods attorneys Matthew Orso and Joshua Davey recently discussed the hypocrisy of the CFPB's public statements that it favors "transparency" and claims that it is not subject to "the Federal Advisory Committee Act (“FACA”), which, among other items, requires an agency to hold committee and subcommittee meetings in public."

Only three agencies are statutorily exempted from FACA – the Central Intelligence Agency, the Officer of the Director of National Intelligence, and the Federal Reserve.

Yet despite the fact that the CFPB is not involved in intelligence gathering or the setting of monetary policy, Director Richard Cordray has taken the position that it is not subject to FACA.

Unfortunately for the CFPB, Cordray made the claim to a Wisconsin Congressman, who wanted to attend a CFPB's Consumer Advisory Committee meetings in February, at the time that the CFPB denied his request. That Congressman turned around and introduced a bill to peel back the curtain on whatever the CFPB is trying to hide. We hope that it's not a wizard.

Congressman Sean Duffy claims that his bill, the Bureau Advisory Transparency Act, "mandates that FACA must apply to all of the CFPB's advisory committees. The people have a right to know what their government is up to, and the government has a responsibility to provide that transparency." In addition to that act, Orso and Davey note that "a budget amendment has been proposed by Senator Perdue to subject the CFPB to the Congressional appropriations process, rather than allowing its continued operation under the Federal Reserve with no accountability to Congress. The amendment seeks to allow Congressional oversight of the CFPB’s functions in light of its roughly $600 million budget."

Transparency and accountability. For the CFPB? Expect the Massachusetts Mohican to go on the warpath against these heinous concepts. They're fine when they apply to the rest of the world, but not when they try to impede the "justice for all" that can only be provided by the benevolent despots whose ideology is pure and must remain unsullied by the low-lives who inhabit the opposing realms of the universe (i.e., the other 99%). After all, what will happen to the fog-brained poor without Aunt Lizzie and her cadre of true believers to tell them what they ought to want?

Davey and Orso close with a dash of hope and a dollop of reality.

The days of the CFPB’s clandestine policymaking and unbridled activities may be coming to a close. Don’t expect it to happen without a fight.

The following is rare footage of Senator Warren sending the Adjustment Bureau's famous "Flying Squad" of litigation lawyers after a transparency-seeking waif and her little dog. Those offended by the sight of chimps with wings, or scarecrow stomping, should shield their eyes.