Bank Lawyer's Blog

Yes, It Does Flow Downhill

I occasionally receive mail from colleagues who occupy the opposite side of the fence from my piece of the political and professional pasture, but whose views I respect. I received one of those emails recently from an attorney who thinks that MERS is the spawn of Satan. Well, that characterization of his comments is a little over-the-top, but that's the style I prefer. What he actually said was:

MERS while laudable in its goals completely disenfranchises the ordinary citizen (all of us) from appropriate legal transparency in real property matters.  We used to be able to go to the County Recorder’s office and figure things out.  No more.  To my chagrin MERS has been wining cases around the US, but an enterprising state, Connecticut, is hitting back and extracting some blood from this turnip.  Go states!

He included a copy of a recent Connecticut law that raised the recording fee for the first page of any document affecting a residential real estate mortgage held in the name of a nominee like MERS (other than assignments and releases) from $53.00 to $116.00. Now, that high fee may give MERS-haters a momentary thrill, until they realize that all MERS does is pass it along to the borrowers whenever possible. Thus, the blood that's squeezed is from a vampire, not a turnip, which sinks its fangs into the necks of consumers and replenishes its blood supply quickly.

Business principles are a bitch, aren't they?

I'm out of town all week and away from the blog until the week of July 7th. I hope that all the readers, even the trolls, have a happy 4th.

Cybersecurity: It's Not Just For Banks

I wonder whether this is an aberration or a trend?

Under pressure from federal regulators, who are concerned about lax cybersecurity at law firms, the Bank of America Merrill Lynch has begun conducting audits on the law firms it does business with, to verify what they are doing to protect sensitive information.

Although experts have been warning for some time that such audits were looming, a number of law firms have been caught flat-footed, assistant B of A general counsel Richard Borden told attendees at a recent conference for top in-house lawyers, Corporate Counsel reports.

[...]

"It’s been really interesting dealing with the law firms, because they’re not ready,” said Borden, an in-house cybersecurity lawyer who has been helping the group that's auditing the Bank of America's outside counsel. “Some of them are, I should say, but there are many that aren’t. And it actually does pose a threat.”

Auditors are looking to see if the law firm has a cybersecurity plan, he told Corporate Counsel, and, if so, whether it is followed. Since mobile electronic devices are a likely weak area, one issue is whether confidential information sent to them is encrypted. Additionally, unwary employees clicking on malicious links in email remains a common cause of problems, just as it has been for years.

"Unwary employees clicking on malicious links" has been a problem for businesses of all kinds and sizes, not merely law firms and banks. It's often the root cause of the eventual theft of money from many small business bank accounts, as we've been discussing here for years. Much good would be accomplished by surfing the internet for porn on a different computer that the business uses for banking, but then you have the problem of the sole proprietorship that consists of "one consultant, one laptop." In those cases, using a separate computer solely for banking is likely not a practical solution, anymore than it is to ask people to refrain from clicking on links on their favorite "make love to my wicked shoes" web site.

Getting back to attorneys for banks: how many of you encrypt any firm email sent to your cell phone, tablet, or other portable device? Yeah, that's what I thought.

This isn't going to be a problem merely for the brother-in-law of the chairman who has an office above the corner drug store and gets thrown the occasional foreclosure, lease, or other "bone" by a small-town bank. According to Mr. Borden, this is going to something that firms large and small will have to address.

Welcome to the 21st Century.

War Without End

I have a brother who is sixteen months younger than I am, and when we were growing up, we used to screw with each other in a way that only close siblings understand. We instinctively knew how to annoy one another, and we never hesitated to employ our best efforts to dig at each other, until my father, The Hairy Thunderer, intervened to restore peace and quite to our large, Irish-Catholic household, "peace" being a relative term in a family of five kids with an age span of a mere ten years. I recall my father once telling my brother and me that he if he left us alone with the Pope for five minutes, he'd return to find the Swiss Guards kicking the living crap out of both of us.

I was reminded of that observation while reading the latest back-and-forth between the trade groups representing community banks and credit unions.

[I]n a recent letter to the Senate Finance Committee and the House Ways and Means Committee, the Independent Community Bankers of America urged the government to eliminate the credit unions' tax exemption, arguing the firms are virtually indistinguishable from tax-paying community banks.

But NAFCU released a study suggesting an elimination of the benefit would reduce the credit union market share by 50%.

Brad Thaler, vice president of legislative affairs with NAFCU, said, "Everything found in the study is not only a benefit to credit unions, but it also serves as a check on bank rates. Not only would you loose the money that would go to members, but also bank members would see their rates and fees creep up."

We've heard these same arguments ad nauseum,from both sides. No matter how much I urge it, the two industry segments can't seem to make like the late, great, Rodney King and just "get along." Instead, they are destined to bite and kick each other like two stallions in a fenced pasture until The Second Coming.

And the really telling comment as to the uselessness of this exercise comes from the NAFCU's Thaler.

[D]espite the ICBA’s request, NAFCU's Thaler said that no member of Congress is proposing to eliminate it and the proposal has never gained traction in the past.

He's right. But that won't stop the war, will it? Of course not.

Liz Warren's Epiphany

If this story is true, and The Pocahontas Princess is serious, and not merely shining us on, this story needs more "pop" in the trade press than it's received thus far.

Community banks represented 95% of all banking organizations in 2011 but represented only 14% of all the banking assets in the nation. However, community banks held 46% of all the small loans to businesses, according to a study done by the Federal Deposit Insurance Corp.

In light of this, Elizabeth Warren, D-Mass., said in a hearing with the Senate committee on Banking, Housing and Urban Affairs, "Are we reaching a point where we should have a two-tiered regulatory system?"

Small banks are subject to many regulations that were written for larger institutions, so now there is a regulation system that will in effect crush the smaller institutions, Warren explained.

Except in St. Louis, the news that the Dr. Frankenstein of the soul-crushing CFPB is urging in Senate hearings that her fellow solons join her in lessening the regulatory burden that threatens to flatten the community banking business was met by the trade and main stream media with a yawn the size of the Grand Canyon. However, in "The Rome of the West," the local business press (via reporter Greg Edwards) stood up, took notice, and cheered on The Cherokee Chickadee, albeit with a tone of amazement.

Community bankers have been saying for years that they shouldn’t be saddled with the same regulations designed for big banks. However, Warren is a bit of a surprise as an ally. Since joining the Senate Banking Committee this year, the freshman senator has been critical of banks in many respects.

"Critical of banks in many respects." That's a nice way of saying "Comparing bankers to something so foul that if you find it adhering to the sole of your shoe, you don't scrape it off, you buy a new pair."

Liz styles herself as a populist, which, in this day and age, means she drinks her Pinot Grigio with her mitt wrapped firmly around the glass, rather than with the pinky finger extended. Championing the "little guy" she's done so much to beat down is a smart play, at least from a PR standpoint. On the remote chance that she actually might be willing to follow through along this line, I think community bank trade groups should be all over her on this topic like they would be if Lindsay Lohan showed up on time for a court hearing. In other words, this is an opportunity that is worth a further effort, if for no other reason than to see if there's any there, there.

This may be one issue where Richard Shelby and Elizabeth Warren can agree on something related to banking, or at least discuss it face-to-face without each having the suppress the urge to beat the other senseless with a tire iron.

NY Fed Official: Let's "Facilitate" The Seizure Of Underwater Loans

As we discussed in April, the scheme to have municipalities seize mortgages from lenders through the use of the power of eminent domain refuses to die. It continues to stalk the nightmares of loan owners and servicers alike.

According to Housing Wire, North Las Vegas, Nevada, and Richmond, California are the latest desperate localities to consider buying into years of litigation that will inevitably follow the first attempt to exercise such a power. Industry groups are warning those cities that they are walking on thin ice.

In response to such actions, industry groups sent joint letters to these municipalities voicing their concerns, according to a recent note by the law firm Dechert.

[...]

In response to the growing acceptance of this practices, groups such as American Securitization Forum, American Bankers Association and National Association of Real Estate Brokers have gone on the offensive, appealing to lawmakers and policymakers to explain why such practices may be illegal and detrimental to the local housing markets.

For example, the joint industry letters argue that in both California and Nevada, the eminent domain power of local municipalities "only permits them to take the property of private owners who are domiciled within that municipality, and certainly not from owners who are not even within that state."

Furthermore, most residential mortgages are primarily held in securitization trusts, which are likely not California entities. Additionally, the beneficiaries of these securitizations are nation and international investors who are based all over the country and the world.

The letters also reiterated the destructive power the use of eminent domain would have on housing in those local markets and on the overall economic recovery.

"The letters caution that this will inevitably lead to complicated and costly legal battles over whether these municipalities had the right to seize the mortgages in the first place, which will only hinder the ability of individual homeowners and local housing markets to recover," the law firm explained.

While some municipalities that have considered the idea have decided that it's a bad idea, others will continue to take it seriously as long as people like the NY Fed's Robert Hockett think that the use of eminent domain is a dandy way of getting around the unfortunate necessity of having to get an agreement to write down the balances of loans from all those dastardly investors who own the loans.

"Specifically, such loans are subject to pooling and servicing agreements that require collective action by a large majority of security holders before a loan can be modified," said Robert Hockett of the Federal Reserve Bank of New York.

He added, "As a result, carrying out write-downs is challenging and sometimes impossible."

How do we turn a program that is seemingly impossible into the possible?

Hockett argues that one possible way to sidestep this problem is by having governments buy and restructure under water mortgages.

"By utilizing their eminent domain authority, state and municipal governments could bypass the coordination problems posed by the pooling and servicing agreements," Hockett explained.

He added, "They could then reduce the principal on underwater loans, lowering the amount owed by borrowers and thereby reducing the risk of default."

He added that in getting this process off the ground and into the stratosphere, "federal agencies could be helpful facilitators for all."

"Facilitator." We used to call it an "aider and abettor," but, then, we live in Orwellian times. By "all," I assume he means the municipalities and the borrowers. The owners of the loans would be getting something less than the remaining balance of their loans, which is perfectly fine in a land where private contracts are negated whenever the government decides that a small subset of people need some help in getting more than they bargained for. Since in many instances, the residential real estate markets, even the lousiest of them, are bound to recover before the end of the loan terms, who benefits from the rise in the value of the collateral when the property is eventually sold? The borrowers? The municipalities? Certainly, it isn't going to be the lenders.

That pesky right to own private property, and the resulting need to require the consent of the owner to give it up. It simply stands in the way of doing good as those in political power in a small slice of the country see the good. Therefore, it must yield.

Misguided Guidance?

While engaged in a "myth busting" exercise via the myth busters preferred venue, Source Media, FDIC senior policy analyst Elizabeth Khalil responded to one "myth" with an answer that, while it may be technically correct, may also fly in the face of recent "boots on the ground" experience.

Ms. Khalil, one of the authors of the FFIEC's proposed guidance on social media use by financial institutions, was responding to various negative comments and alleged concerns expressed by critics of the proposed guidance. One of the "myths" allegedly floated by critics is that the proposed guidance is a "regulation." Obviously, it's not a "regulation," it's "guidance." Ms. Kahlil, however, seems to negate the impact of the guidance as an embodiment of "safe and sound banking practices" that most of us in the private sector and, we assumed, most of those in the regulatory agencies, thought such guidance was intended to be.

"It doesn't create any new obligations or burdens," Khalil says. "To create any new obligations we would have to issue a regulation. We can't impose new obligations through the guidance. That's important to emphasize, because a lot of people have been referring to this document as a regulation or as rules, and that is not correct."

A bank's examiners could not cite violations of the guidance, she says. "You can't technically violate guidance. You can violate the laws and regulation referred to in the guidance, but not the guidance itself."

She then goes on to state that the guidance was intended to be some sort of public service announcement, designed, at the request of ignorant bankers, to clue them in on the risks of social media that they could not get from other sources, such as consultants and lawyers in the private sector who are paid to tell bankers what the risks might be and how to mitigate those risks. In other words, FFIEC guidance is some sort of an educational tool but not the basis for the assertion of regulatory enforcement action if a financial institution doesn't follow it.

Don't believe it. While it is true that guidance is not regulation, and a "violation" of "guidance" should not have the same effect as the violation of a formally adopted "regulation," a number of bank lawyers who have reviewed a client's report of examination in the years 2007 through 2012 and saw a Matter Requiring Attention, or reviewed a "15-day Letter" from a regulatory agency threatening a potential enforcement action against a bank's current or former officers and directors, saw among the laundry list of alleged "violations" an item that alleged that the bank violated the Statement of Policy on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practice. That "Statement of Policy" specifically states that it is "guidance," yet alleged violations of it are cited as forming the basis for regulatory sanctions, including enforcement action. If violations of guidance can't be cited by an examiner in a report of examination, then what are citations of such violations that I and others have seen with our own eyes in examination reports doing there? I'm speaking of examinations done by the FDIC, by the way.

I have always understood such guidance as providing "rules of the road" that financial institutions should follow if they want to be in conformance with safety and soundness principles. Violating "safety and soundness" standards is a basis for regulatory action against the institution. Thus, I think that, notwithstanding Ms. Khalil's dismissal of the guidance as not rising to level of a "regulation," any financial institution would be foolish not to treat it seriously.

Banks Hire Hagglers

A few weeks ago, the American Bankers ran a story about how community banks were hiring outside consultants to negotiate major IT contracts with vendors.

Hiring consultants, including those who once worked at tech vendors, can make a difference, industry observers say. Vendors have an advantage because they are constantly negotiating deals, while bankers only visit the issue every few years, says Greg Schratwieser, president and CEO of International Consulting.

Paladin [an IT consulting firm] collects data tied to the processing contracts of financial institutions with less than $5 billion of assets. It then uses its database to determine whether a bank is overpaying for its services.

Not surprisingly, some IT service providers aren't happy to see the "hagglers" appear on the scene. My response would be "Tough." Then again, some IT service providers go with the flow.

Despite the head-to-head competition, consultants and core processors have a good relationship, says Stephen Ward, senior vice president of the global sales organization at Fiserv.

The presence of a third-party negotiator shows that a bank is serious about the contract, and it "instills a process that has a start time and end time," he says.

"If the bank is paying for that service, it is more likely to follow the timetable," Ward adds.

Spoken like a man who, when handed lemons, can whip up a gallon of tasty lemonade in no time flat.

Nowhere in the article is made the very important point that the consultant is only one member (albeit, a potentially valuable member) of the financial institution's negotiating team. Another critical player is the bank's IT counsel. The consultants who are described in the article are focused on the business terms, including pricing, add-on services, and term. Knowledgeable lawyers would be focused on other issues, such as legal risk allocation, including warranties, remedies, limitations, disclaimers, and indemnifications. As OCC Bulletin 2001-47 states, concerning risk assessment:

The risk assessment phase should include the identification of performance criteria, internal controls, reporting needs, and contractual requirements. Internal auditors, compliance officers, and legal counsel could help to analyze the risks associated with the third-party relationship and to establish the necessary control and reporting structures.

There is also contained in that bulletin and other guidance issued by the federal banking regulators, a laundry list of contract issues that should be considered and negotiated in third party service agreements. Again, input from legal and other areas of the bank is advisable to ensure that these issues are properly assessed and addressed in the written agreement between the bank and the service provider.

Hagglers may be a valuable add-on to the bank's other resources, but they're not the only necessary player on the evaluation and negotiation team of a financial institution's technology service agreement.

Can't Get No Relief?

The NAFCU's Steve Van Beek discussed in a recent post the Regulatory Accountability Act of 2013. Steve explains what the bill would do, if enacted.

1. Require regulators to consider their existing rules when writing new regulations;
2. Issue an advanced notice of proposed rulemaking (ANPR) prior to proposing a major rule; and
3. Require regulators to avoid regulations that are inconsistent or incompatible with other regulations and draft regulations in simple and easy to understand language.

Look, it's not a panacea by any means, but it's a start. Moreover, it's an act that would assist businesses of all types, not merely financial institutions. As Steve notes, 87 trade associations in addition to the NAFCU sent letters of support to Congress. From the NAFCU's letters, the following statements were excerpted by Steve:

"Our regulatory process has not been updated in more than six decades, and as a result we are seeing a rising number of massive, costly rules that breed uncertainty, drive up costs, and stifle hiring and investment. This legislation, which would modernize the 66-year old Administrative Procedure Act, would improve the process by which federal agencies promulgate regulations to improve accountability and the integrity of the rulemaking process.

Small and large businesses alike consistently cite growing regulatory burdens and the uncertainty that occurs when badly-written regulations must be corrected through years of litigation as the most significant obstacles to new hiring."

I urge all of you bankers out there who write to complain about the crushing burden of all the new regulations that have been launched in past few years to support this proposed legislation by contacting your senators and congress persons and letting them know that you're serious about this piece of legislation and they should "get with the program" if they're not already "with it."

More FDIC D&O; Lawsuits

In his latest post on the status of FDIC lawsuits against former officers and directors of failed banks, Kevin LaCroix makes a couple of observations. One is the fact that in the latest two lawsuits, filed during the last two  weeks of May, the FDIC doesn't bother pleading ordinary negligence, instead pleading only gross negligence. As a commenter to that post points out, that may be because the FDIC is allowed to recover on the theory of ordinary negligence only where applicable state law so provides, but is always allowed, by federal law, to recover if it can prove gross negligence. In other words, gross negligence is the floor of the standard of conduct for officers and directors of federally-insured financial institutions, even if greater protection for the officers and directors is afforded by state law. 

In many previous cases, the FDIC has routinely pleaded both ordinary and gross negligence, regardless of state law. LaCroix speculates that the FDIC may have decided not to waste time and money on attorneys fees slugging it out on the standard of negligence. I think that makes sense, since it has lost on that issue in some states. Pleading only gross negligence (although, theoretically, a higher hurdle to jump) should, in most cases where the complaint or petition is properly composed, survive a motion to dismiss, at least in the early stages of the litigation. By the time the FDIC has softened up the defendants and their professional liability carrier with many, many months of expensive discovery and motion hand-fighting, the chances of extracting a settlement have increased.

Kevin's other observation has to do with the location of the real estate securing the "loss loans" on which the FDIC is basing its damages.

The other thing about these cases is that they both are based primarily on loans made in the deteriorating Las Vegas real estate market five or more years ago. The collapse of the Las Vegas real estate market, as well as the collapse of other regional real estate markets that had surged during the boom years last decade, contributed to the closure of many banks. Although the agency’s filing of these lawsuits apparently met the strict requirements of the statute of limitations, there does seem to be a sense in which the agency’s lawsuits increasingly involve stale allegations. As time goes by, questions about loans made into the real estate bubble a long time seem increasingly pointless. The events from that time are starting to seem like ancient history.

To the extent that his problem with the FDIC allegations is that when the loans were made many years ago, during flush times, no one could have reasonably foreseen the crash, nor, certainly, its depth, breadth, and length, I agree with him. Otherwise, I think the loans seem "stale," in large part, because the FDIC has spent the last few years since these two banks failed, trying to squeeze a settlement out of reluctant defendants and, more likely, reluctant insurers who are tired of writing checks. You've got a three-year statute of limitations (which can be extended with a tolling agreement), and the FDIC doesn't want to sue until it has to sue. Therefore, I don't see "staleness" as an issue, at least not one that is objectionable solely on the basis of the age of the loss loans.

The wheels of "justice" grind slowly, but exceedingly fine. In addition, so do the wheels of FDIC litigation.

Kevin's analysis is that there are 49 lawsuits yet-to-be-filed in the FDIC's pipeline. It will be interesting to see if the FDIC continues to stick with gross negligence claims, except in those few states whose legal standard allows it.

Much Ado About Something

I don't think I've ever received as much comment via email and telephone to any trade press article as I did to one in last Friday's American Banker with the totally biased headline "The Myth of the All Powerful CFPB" (paid subscription required), nor comment that contained so much personal invective. Those who comment on my writing usually save the personal invective for me.

The article's editorial writer (although it isn't labeled as an opinion piece), Victoria Finkle, is described as the paper's Capitol Hill reporter. Whatever her actual job description might be, as commenter "George Bailey" observed on the paper's web site, Ms. Finkle is clearly "not a banker."

It is easy for those who do not work in the industry to sit back and applaud the CFPB. They are clueless as to what is actually happening compared to us who work in the industry.

Ms. Finkle allegedly points out some of the concerns that opponents have about the structure of the bureau, including "the fact that the agency runs under a director, not a commission, and that its budget is not subject to congressional appropriations as evidence that it is able to act as it pleases, unbeholden to lawmakers, taxpayers or anyone else." Note the straw man argument that critics purportedly assert that the CFPB can "act as it pleases...unbeholden to anyone else." Serious critics do not believe that the CFPB could violate the U.S. Constitution without, ultimately having the U.S. federal court system intervene, or that, ultimately, an out-of-control bureau wouldn't offend Congress sufficiently to prompt some legislative response. Yet, critics are concerned that the structure of the bureau makes the risks of abusive behavior more likely than would be the case with a board, rather than a single director, controlling the bureau. They are also concerned that as structured, the CFPB could do a lot of damage to the banking industry and other segments of the financial system before its abuses could be reigned in by Congress or the court system.

These objections are based upon the same skeptical views of human weakness and the corrupting influence of great executive power as "The Founders" possessed when they established a political system of checks and balances, especially at the federal level. To the bureau's critics, the structural problems pose unacceptable risks of abuse that should be addressed by changes to that structure. Lord Action's assertion that power corrupts, and that absolute power corrupts absolutely, still has believers. At least, it does outside of the pages of the American Banker.

Even disbelievers in traditional rationales for checks-and-balances on federal executive power ought to listen to the father of the modern political monstrosities of both the right and the left, Friedrich Nietzsche.

[Anything which] is a living and not a dying body... will have to be an incarnate will to power, it will strive to grow, spread, seize, become predominant - not from any morality or immorality but because it is living and because life simply is will to power... 'Exploitation'... belongs to the essence of what lives, as a basic organic function; it is a consequence of the will to power, which is after all the will to life.

The CFPB isn't run by angels, it's run by mortals. Just a reminder.

Ms. Finkle's response to these concerns is to argue that because the former acting Director and the current Director of the CFPB haven't abused their power during the first two year's of the CFPB's existence, the critics' concerns are baseless.

Yet time and again the CFPB acts much like other regulators, including listening to Congressional and industry concerns and compromising on key issues.

[...]

So far, however, the agency has made deliberate efforts to incorporate multiple points of view into its rules. For example, the CFPB announced several amendments to its controversial qualified mortgage rule last week, winning praise from industry officials and consumer advocates alike. The revisions also reflected feedback from lawmakers, who had raised concerns the qualified mortgage rule was too narrowly defined and would stifle access to credit.

"So far." Yes, that's a decisive rebuttal to the legitimate concerns of the bureau's critics. "So far."

The article mentions that the CFPB is attempting to define "abusive" through enforcement actions rather than the rule-making process. That puts a chink in the armor worn by former CFPB big-wig Raj Date, who argues that the CFPB is restrained by the necessity to follow the APA in formulating its rules. In addition, as was recently pointed out, federal statutory requirements haven't been an impediment to the CFPB in turning public meetings into private ones and barring financial industry representatives from attending.

Toward the back of the article, The Cato Institute's Mark Calabria is allowed to express a view with which many agree, albeit the "many" do not, apparently, include the article's author.

"The first few years were always going to be a question about their long-term viability," said Mark Calabria, director of financial regulation studies at the Cato Institute. "They always wanted to get themselves to a spot where they weren't a target anymore. How they have behaved so far is not in my opinion the best indicator of how they will behave in the future."

I happen to agree with Mark, but it doesn't matter to me how they have acted thus far from the standpoint of the structure of the bureau or how they might intend to act following the end of the honeymoon period. The structure of the bureau is flawed. The actions of its representatives are irrelevant.

After a brief nod to the opposition, Ms. Finkle finishes with a rehash of her main theme.

In the meantime, however, many in Washington are likely to keep arguing that the CFPB is out-of-control, despite its behavior to date.

"It truly feels to me that the concerns on Capitol Hill have their own life force beyond the concerns of financial lobbyists," said [policy analyst Isaac] Boltansky. "Once the talking points are learned and are committed to memory, then it's easier to retrieve them. This fight has been going on for so long that it's very easy for lawmakers to continue it without any catalysts in the covered financial sectors."

Again, the framing of the main argument of the CFPB's critics is stated falsely ("out of control") and the main counter-argument presented (the CFPB has not yet acted like it is out of control) is both unresponsive and unpersuasive to rebut the legitimate argument that its structure lacks sufficient restraints to mitigate the opportunity for it to abuse its power.