Bank Lawyer's Blog

Another Whistleblower Bites B of A

We don't mean to harp on the subject of what a lousy acquisition Countrywide was for Bank of America...ok, that was lie...we do intend to harp on it. A few days ago, Reuters ran a story of yet another example of how B of A shareholders are taking another blow to the solar plexus because of allegedly nefarious activities of Countrywide affiliates. This story dealt with an honest appraiser (no, that's not an oxymoron, although "honest lawyer" might be), Kyle Lagow, who was "coincidentally" fired by Countrywide not too long after he complained internally that a Countrywide affiliate was committing appraisal fraud. Oh, yeah: he was also fired while undergoing treatment for thyroid cancer, to add to the despicability factor of Countrywide's conduct.

What Lagow learned was that Countrywide wanted to make loans whatever the collateral was worth. LandSafe executives routinely pressed staff appraisers and independent appraisers to boost home values to ensure sales went through, according to a suit he filed in 2009.

Lagow also spotted trouble with a joint venture Countrywide had with homebuilder KB Home, according to his suit. The builder would only work with select appraisers, who were inflating home values to make sure sales went through, according to his suit. KB Home declined to comment.

[...]

In January 2008, after supervisors had repeatedly ignored his warnings, Lagow sent an email to Countrywide Chief Executive Officer Angelo Mozilo, according to the complaint. Mozilo responded that someone from his staff would get in touch, and Lagow later talked with Countrywide's chief operations officer, Jack Schakett, and its chief compliance officer, Richard Wentz.

Two weeks later, Lagow received an email from Wentz stating that his complaints had been investigated and there were no issues that needed to be addressed, according to the complaint.

[...]

In January 2008, Bank of America agreed to buy Countrywide as it verged on collapse. That November, Lagow was fired. At the time, he was undergoing treatment for thyroid cancer; he has since recovered.

Bank of America declined to comment on Lagow's case. "We have a strategy to put Countrywide and other legacy issues behind us as quickly as we can," bank spokesman Rick Simon said.

Putting a $40 billion "legacy issue" behind you is like Kim Kardashian putting on a skin-tight dress. There's absolutely no doubt that no matter how hard you try to cover it up, you've got a whale-load of junk in the trunk. Nice try by B of A's PR flacks, though.

Kyle later filed a whistle-blower lawsuit, but had to keep mum about it for three years, even from his family, so as not to impede ongoing government criminal and civil investigations of the "legacy issues" presented by Countrywide's pristine behavior in residential lending. Eventually, his suit was wrapped up in the global settlement with B of A and other large lenders and when the dust settled, Kyle walked off with $14.5 million. That almost makes up for the four years of emotional distress inflicted on him because...GASP...he tried to do the right thing.

He has bought a new home and has treated his family to a trip to Disney World, but he plans to leave most of the award to his kids.

"They are the ones," he said, "who suffered through this."

While some, like Kyle and his family, have "suffered through this" to a greater extent than other folks, the pain and misery of the most recent meltdown have been fairly widespread. Unless, of course, your name's Mazilo. That particular apex to a pyramid of greed walked away with a slap on the wrist of $47.5 million out-of-pocket out of over a half-billion dollars in income received from 2000 to 2008. Or, for that matter, unless you were a friend of Mazilio's and a member of the US House or Senate, in which case absolutely nothing bad will happen to you at all.

 

Wal-Mart and Monolines

Over four years ago, I observed that trying to get into the banking business with a "monoline" business plan was going to be more difficult than finding a bat-free belfry in the hallowed halls of Congress. I hadn't counted on the persuasive power of any business with the word "green" in it. 

A couple of weeks ago, the Federal Reserve Board approved the application of Green Dot Corp. to purchase a Utah bank.  The bank will be renamed "Green Dot Bank" (who woulda' figured!) and will start issuing all of Green Dot's pre-paid cards, which have been issued by Synovus Financial Corp. Green Dot's business plan is the marketing, selling, and servicing of prepaid cards through retailers, primarily Wal-Mart (which is also a shareholder). That's the plan, that's all there is to the plan, and it's a classic "monoline" business plan if I've ever seen one (and I've seen my share). That fact didn't bother a majority of the Board, but it sure bothered Governor Elizabeth Duke, who dissented.

Duke is bothered by the narrow focus of the business plan, which makes the bank susceptible to storms that can arise in that narrow business sector, which today appears to be prospering, but, as we have seen with subprime mortgage lending and commercial real estate, today's goldmine can turn into tomorrow's garbage heap in a hurry. Try walking into the Fed with a monoline business plan that's focused on making CRE loans and see how fast it takes the Fed to hand you your head. I mean, try walking in with an entity that's not partnered with Wal-Mart.

That partnership also caused Duke some heartburn. Duke worried that since "a single large retail partner" would account for a majority of Green Dot Bank's revenues, a loss of that "single large retail partner" could spell doom, and rather quickly. She also poo-pooed the conditions the majority placed on the Fed's approval (including maintaining a 15% leverage ratio for five years and restricting dividend payments), since they do not address her monoline concerns. These aren't unreasonable concerns and, again, you have to wonder whether the average financial business could wander in with such a game plan and not be shot down in flames. I wouldn't bet on it.

This is yet one more example (among many) of Wal-Mart's relentless drive to put the Sheila Bair era behind it and do whatever it can do to exploit (in a good way, of course) its street cred with The Peeps and sell the unbanked bank-like services without, of course, becoming a bank holding company, which would cause (and has caused) bankers throughout this country to break out with a severe case of shingles and to phone their mothers for chicken soup.

Love 'em or hate 'em, you have to respect 'em.

Rollin' Up The Op Subs

One of the advantages of a national bank or federal thrift charter used to be that for those banks or thrifts that engaged in mortgage lending on a multi-state scale, the mortgage operations could be housed in an operating subsidiary that had all the benefits of federal preemption that were afforded the parent bank or thrift (as confirmed by the Watters v. Wachovia ruling). The operating subsidiary could be exempt from state licensing and examination  requirements, as well as many other pesky state law requirements. For regulatory reporting purposes, the assets and liabilities of the operating subsidiary are consolidated with those of its parent; however, for liability purposes (as long as the bank and operating subsidiary avoid pitfalls that might allow a plaintiff to "pierce the corporate veil"), the parent's balance sheet can be isolated from the legal risks imposed by the subsidiary's business activities, which in the consumer lending area can be substantial. In addition, as Kate Berry observes in today's American Banker (paid subscription required), the operating subsidiaries are also sometimes set up as stand-alone operations that can be sold quickly when times got tough, which in a cyclical business like residential mortgage lending, they do on a regular basis (although usually not as rough as we've been seeing for the past several years).

With the passage of Dodd-Frank, which eliminates federal preemption for operating subsidiaries, Ms. Berry discusses the brave new world of mortgage banking, which may necessitate the wholesale "roll-up" of a lot of operating subsidiary mortgage lenders.

Industry lawyers expect most institutions to go the roll-up route, partly out of fear that sooner or later the states would try to force operating subsidiaries — and, potentially, their individual loan officers — to get state licenses. The burden of satisfying 50 state regulators would outweigh the cost in legal fees of restructuring.

The SAFE Act also comes into play.

The Secure and Fair Enforcement for Mortgage Licensing Act of 2008 required loan officers working at national banks and their operating subsidiaries to register with the Nationwide Mortgage Licensing System, a database run by the states.

Each loan officer gets a unique identifier (so all loans can be tracked) and undergoes a criminal background check under the SAFE Act.

The law has additional, more rigorous requirements for originators working at nonbanks: They must not only register but also be licensed in the states where they do business.

To do so, they must pass national and state exams and take at least 20 hours of continuing education a year.

Though most states probably would maintain the existing requirement that banks' operating subsidiaries only have to register with them, states have the authority to make operating subsidiaries meet the tougher licensing requirements, experts said.

That possibility could be the decisive factor in pushing national banks to restructure those entities.

"Right now, being a bank originator is a safe harbor," said Jeffrey Naiman, a partner at BuckleySandler. "Operating as a 50-state licensed entity has always been very difficult, but post-SAFE Act, it is becoming even harder."

As an added bonus, Dodd-Frank added to the house of horrors the dreaded Consumer Financial Protection Bureau.

Banks also are concerned that mortgage loan officers could ultimately face tougher standards when the job of umbrella enforcer for the SAFE Act is transferred from the Department of Housing and Urban Development to the planned Consumer Financial Protection Bureau in the Federal Reserve.

The CFPB may ultimately resolve the question of whether loan officers at bank subsidiaries need state licenses, said John Ryan, an executive vice president at the Conference of State Bank Supervisors.

"The line has already been drawn: Employees of federally regulated operating subsidiaries are registered; everybody else is licensed," said Ryan. "It might create a conflict with the SAFE Act to say that operating subsidiaries would have to be licensed when now they just have to be registered. So they might have to call in the CFPB."

If Elizabeth Warren is heading up the CFPB at the time it's "called in," bankers can expect the ultimate decision to be one that is not kind to their operating subsidiaries.If state banks have fumed for decades over the desire for Lebensraum shown by the preemption Nazis at the OCC and the OTS, wait until national banks and federal thrifts get a load of Reichsführer Warren and her ankle-biting storm troopers. National banks and federal thrifts will be rolling up op subs into the mother ship faster than Taylor Lautner sheds his shirt.

Sunday Night Scattershooting

I'm blogging on the fly while dodging arrows shot by Nouri lovers over last Thursday night's post. So, here are a few disconnected links to items that might be of interest to readers. If not, have a Supercalifragilisticexpialidocious start to your week.

First up is an article from Venable LLP partner Joe Lynyak entitled "The Failing Bank Scenario: An Explanation and Suggested Analysis for a Bank's Board of Directors and Management." It's a reprint of an article in The Banking Law Journal that's a must-read for management and directors of too-small-to-save community and regional banks that may be in danger of imitating The Titanic. In light of the FDIC's new additions to its troubled bank list, I assume that there's an audience out there for this information and that the audience is growing. The latest article by Joe is a companion piece to two other related articles, one on responding to enforcement actions and the other on liability considerations for directors and officers of FDIC-insured institutions (and "institution affiliated parties"). Earlier versions of the latter two articles have been previously discussed on this blog (here and here).

I realize that if there's one thing bankers hate to do, it's to pay a lawyer to do anything. On the other hand, I've seen so many bankers frozen in the glare of the headlights until the nanosecond prior to the collision, at which point they cry "Help!" Too late, Chicken Little, because by that time the lawyer is nothing more than a hospice caregiver. If you're at risk, read the linked articles and hire a knowledgeable counsel of your choice before the Eleventh Hour and Fifty-Ninth Minute.

On a completely unrelated matter, we noted in February that Fannie Mae and Freddie Mac were "in full put-back mode." According to Housing Wire, in the first quarter of 2010, the two broke mortgage giants "forced lenders to repurchase $3.1bn of mortgages out of their securities and off their books in Q110, up 64% from nearly $1.9bn one year earlier." They would have pushed back even more, but according to public filings, some lenders simply didn't have the financial ability to fund the buybacks. In other cases, one of the wards-of-the-state decided that future business considerations outweighed the need for immediate cash.

"Enforcing repurchase obligations with lender customers who have the financial capacity to perform those obligations could also negatively impact our relationships with such customers and ability to retain market share," Freddie said.

There's something odd about a company that is so insolvent, and whose business model is so broken, that its corporate motto ought to be "Epic Fail," worrying about "future market share." The resolution of Fannie and Freddie should have been part of the recent financial reform legislation. Of course, that might have forced the federal government to come even cleaner about its scheme to nationalize the nation's residential mortgage lending business, and goosed the American public out its eyes-glazed-over ennui with respect to the whole "bank bail out thing."

According to Paul Muolo of National Mortgage News, the repurchase "hit" taken during the first quarter by the "Big Four" commercial banks that dominate residential mortgage production in this country was much larger than a paltry $3.1 billion.

...[A]ccording to the latest figures, the "Big Four," combined, were forced to repurchase $8.7 billion of residential loans during the first quarter.

[...]

The buyback issue is now so white hot that the Mortgage Bankers Association is planning a series of seminars around the nation to educate lenders about their rights as seller/servicers. "Our seminars focus on different things," said MBA chief economist Jay Brinkmann. "One key thing we talk about is what type of buybacks are worth fighting for and which ones aren't. There's some lenders out there that have three different repurchase requests on the same loan-all for different reasons."

What's bad news for banks can be great news for lawyers, however (and what else is new).

Law firms are now getting into the buyback game as well. The key question for seller/servicers is how often can they win their buyback battles. One mortgage banker close to the buyback situation said he knows of a lender that recently won 52 out of 55 repurchase disputes. "He had to resubmit documents and it took a lot of time but he won," said the official, requesting his name not be used.

He noted, however, that at some point seller/servicers have to cut their losses. "Rep and warranties can be fought to a degree," he said. "But fraud lives forever. If it's discovered that fraud was involved there's nothing the originator can do."

Yeah, "fraud lives forever." However, some people suffer the consequences and some people don't. For example, how many directors and officers of too-big-to-fail banks will be pursued by the FDIC (or any other federal banking agency) for bad business decisions that have morphed into breaches of fiduciary duty, as opposed to directors and officers of many, if not most, of the too-small-to-save community banks that have failed and will fail? What's your guess?

Throwing Gas On The Fire

When you're a bank, it's hard to lend money when you have to hoard capital because the regulators keep forcing you to write down the value of your assets. While we've been focusing on commercial real estate loans and REO, the regulators have been throwing other assets into the write-down pile.

According to Columbus (Ohio) BusinessFirst, community bank Delaware County Bank & Trust recently disclosed that what it, and its outside auditors, thought were adequate valuations of trust preferred securities weren't conservative enough to satisfy "you-can-never-go-too-low" FDIC examiners.

Bank parent DCB Financial Corp.has disclosed that regulators told the bank the assumptions it was using to value an investment portfolio weren’t conservative enough and that it needed to reflect a greater likelihood of future problems. The new assumptions led to a bigger write-down on the value of the securities than bank executives reported in quarterly financial roundups.

“It is awkward for us to have our auditors sign off on our methodology and assumptions and then have the regulators come in later on and say, ‘No, we don’t agree with that,’ ” said CEO Jeff Benton.

The change accounted for substantially all of a $1.2 million increase in the bank’s 2009 loss to $4.2 million, from $3 million originally. The bank ended up taking $2.6 million in charges related to the securities last year, leaving the $8 million investment with a value of $2.1 million, said CFO John Ustaszewski.

[...]

The disagreement centers on the bank’s portfolio of trust preferred securities, which were issued by small banks to raise capital. Classified as collateralized debt obligations, they were popular before the mortgage crisis, when bank failures were rare and finances for most lenders were strong.

But such investments increasingly have soured as the conditions of small banks responsible for paying dividends and principal on the securities have weakened.

Delaware County Bank wrote down the value of the investments without prompting. But regulators during an examination last spring disagreed with projections the bank used to determine how deeply those investments were in trouble, Benton said.

Guess who won that "disagreement"? That was an easy question to answer, right?

According to one expert quoted in the article, trust preferred securities are "risky."

It’s no surprise regulators are taking a close look at holdings of trust preferred securities because their provisions often allow banks backing them to defer making payments for years if they get into financial trouble, said John Shaffer, a principal at Dublin-based bank consultant Keller & Company Inc.

And the odds that banks will go under have increased, raising the potential for further problems with the securities, Shaffer said.

“That’s why (the investments) are risky,” he said.

With all due respect, pools of trust preferred securities were not considered exceptionally risky a few years ago. In fact, when the FDIC authorized state banks to invest in such securities in 1999, it did so under its authority "to designate other kinds of hybrid securities as permissible investments, subject to the same 15 percent cumulative limit, if the securities have the character of debt securities and do not represent a significant risk to the deposit insurance funds." Neither the issuers nor the purchasers expected the bottom to fall out of the US economy and to plummet into the worst recession since the 1930s, anymore than the regulators did. Now that the economy has done just that, the FDIC has had second thoughts.

A spokesman for the Federal Deposit Insurance Corp. said the agency does not comment on specific banks, but provided a guidance letter the FDIC sent to banks last April imploring them to carefully evaluate trust preferred and other securities.

“Management due diligence regarding purchases of these products was often lacking,” the letter said, warning bankers that FDIC examiners could force impairments even if the securities had investment-grade credit ratings.

Yes, well after the economy crashed, the FDIC sent a letter warning banks to be careful about investing in trust preferred securities. Like similar "guidance" (such as the commercial real estate guidance we discussed yesterday), it served no practical purpose other than covering the regulators' backsides, because by the time it was issued, the critical problem was not the acquisition of new assets but the problem of dealing with the legacy assets purchased long before such guidance was issued. As has become typical, the response of the FDIC to the problem of legacy assets is to deplete capital by being more conservative than either bank management or outside auditors, which exacerbates the problems of the banks that hold the assets.

It would be interesting to see how many of the bank and thrift holding companies that issued trust preferred securities have been subjected to vigorous write downs and loss reserve requirements by regulators, which actions have led, in turn, to deterioration in the financial condition and performance of the issuers, which deterioration was used as a basis for writing down the value of the securities on the books of the banks that hold them. Obviously, the root cause of the economic problems of community banks is the economy, not the regulators' reaction to it; however, has anyone in the regulatory realm heard of the term "self-fulfilling prophecy"?

Just checking.

And You Don't Even Own Clubs

Great news: "[T]op investment banks are now intending to hire one-third more graduates this year than last. Their remarkable resilience to the downturn, and this year's strong recovery in the financial markets, mean that opportunities still exist in banking for those with the skill and tenacity to get them."

That sure warms the cockles of my heart. How about you?

What they don't tell recruits, however, is that the world of investment banking is full of hidden perils, not the least of which is the risk of a broken heart. From Columbia Business School's Follies of 2006 comes a trailer for a movie about the dangers of office romance in a business that broke the back of the American economy.

Note to politically correct hypersensitive readers: if you're offended, take it up with CBS. Don't hate the playa, hate the game.

For Whom The Toll Bells

Erin Toll, a BLB fave, is back in the trade news again, and, as might be expected, it's not because she's shilling for businesses. Ms. Toll, the Director of Real Estate for the State of Colorado, was last seen running scofflaws out of the mortgage brokerage business, following her death match with the title insurance industry during her stint as Deputy Insurance Commissioner.

These days, she smells a RESPA rat in Colorado, and she’s about to go DEFCON 1 on it.

Speaking in New Orleans to more than 100 members of the Real Estate Services Providers Council, Inc. –or RESPRO — Toll said that real estate marketing agreements “look a lot like captive reinsurance agreements, which looked a lot like sham affiliated business arrangements.” Toll also suggested that such agreements violate the Real Estate Settlement Procedures Act.

Toll said she first became aware of these agreements, most of which are closely guarded confidential arrangements, when a disagreement between two parties led to a suit in Colorado court. Seeing the previously secret agreement in the court documents led Toll to begin investigating the increasingly popular arrangements. What she saw, the former litigator said, appears to her — and, just as importantly, appears to HUD — to be an illegal arrangement.

“First, the exclusivity spelled out in the agreements I have seen is very troubling,” said Toll. “Next, the fluctuating fees based on monthly reports with capture rates sure looks like a referral fee.” Fees given or received for referrals are illegal under RESPA. Also troubling, Toll said, is the secrecy spelled out in many such documents, along with the very high fees paid — as much as $1,000,000 per year.

“Each discrete piece of the marketing agreements real estate services companies are entering into may be legal,” said Toll. “But that doesn’t mean that the arrangement as a whole is legal.”

“The bottom line is, I don’t like these agreements,” said Toll, who said that HUD officials share her concern over possible RESPA violations tied to the agreements. “If participants were to get rid of the secrecy and eliminate the anti-competitive nature of these agreements, there might be a way to develop an agreement that does not violate RESPA,” she said.

It never ceases to amaze me, how clear is the “spirit” of the anti-referral provisions of RESPA and how impure is the spirit of the industry participants who think they’ve found the next-best-thing to circumvent those provisions. As I’ve reiterated repeatedly, all these schemes are nothing more than invitations for civil money penalties. Not that such worries will stop the flow of them. No matter how many times HUD and/or state regulators like Ms. Toll slap the hands of offenders for one discredited scheme or another, a new one pops up. HUD must feel like it’s playing regulatory “Whack-A-Mole.”

Ms. Toll’s parting comment, in answer to an audience member’s question, is one near and dear to my heart, being a line I’ve used so many times over the years that I was beginning to wonder if I, like Denny Crane, might have “the Mad Cow.”

When questioned by a member of the audience as to why these agreements are illegal when many other industries utilize similar arrangements, Toll said it all relates to RESPA. “I get this question on a regular basis,” said Toll. “The answer is, other industries aren’t covered by RESPA. The real estate industry is.”

She diplomatically refused to add: “This law's been around for over thirty years, for crying out loud! If this is news to you, get a job in the fast food industry, Bozo!”

I'll bet she wanted to, though.

Red Flags In Place?

Occasionally, I like to point those readers who are in-house counsel or private practitioners and who represent financial institutions to a useful publication that's available on-line from another law firm. Ordinarily, I'd make a snarky, self-deprecating comment at this point; however, my e-mail lately indicates that there are some readers who not only don't "get" the snark, but take it on face value and begin to froth at the mouth with politically correct apoplexy. So, just for today, I'll play it straight. Tasteless, low-brow sarcasm will resume tomorrow.

Today's resource is the Proskauer Rose LLP Privacy Law Blog, which has good material on, of all things, privacy law. Of particular interest to many businesses is a recent post on the suspension of enforcement by the FTC of the of the "Identity Theft Red Flag and Address Discrepancies Rules" until May 1, 2009. Unfortunately, the suspension applies only to those business subject to FTC enforcement of the rules, not to financial institutions governed by the Red Flag rules that are enforced by the federal bank regulatory agencies. As to the latter, you banks better be in compliance by the end of this week!

The reasons for the FTC action are interesting.

The rules apply to financial institutions and creditors.  But, according to the FTC, many companies “indicated that they were not aware that they were engaged in activities that would cause them to fall under the FACT Act’s definition of creditor or financial institution.”Moreover, the FTC said that companies not traditionally subject to the jurisdiction of the FTC did not follow the FTC’s rulemaking, and consequently did not become aware of their obligations under the Red Flag Rules until very recently.  The FTC also expressed concern that covered entities, to meet the fast approaching November 1 deadline, were not taking the appropriate care necessary to do a proper risk assessment and craft a meaningful red flags program.

As the FTC stated, “[g]iven the confusion and uncertainty within major industries under the FTC’s jurisdiction about the applicability of the rule, and the fact that there is no longer sufficient time for members of those industries to develop their programs and meet the November 1 compliance date, the Commission believes that immediate enforcement of the rule on November 1 would be neither equitable for the covered entities nor beneficial for the public.”  Therefore, the FTC will delay enforcement of the new rules for six months.  Considering this generous extension, covered entities should be on notice that they will need to have a written identity theft prevention program in place by the May 1, 2009 deadline.

So, this time around, being a clueless ignoramus turned out to be a good thing, unless you were a financial institution regulated by one of the federal bank regulatory agencies.

Many banks were well on their way to compliance with the Red Flag rules as part of their information security and customer identification programs, long prior to November 1. Red Flag and address discrepancies compliance has been more a matter of documenting the program and having it approved by the board of directors.

Incidentally, the OTS released last Friday revised examination procedures, which were developed jointly with the other agencies, for examinations after November 1, 2008. The revised procedures incorporate procedures to test compliance with the Red Flag rules. The OCC released its revised examination procedures on October 15, 2008, which also addressed affiliate marketing and opt-out notices.

Preemption Creep

When the US Sixth Circuit Court of Appeals recently overturned a district court decision, and held that State Farm's federal saving bank's "exclusive agents" who act as mortgage loan originators are not subject to state licensing by the state of Ohio, it came as no surprise to us. We never bought the district court's allegation that an opinion letter of the OTS that interpreted federal law was a "legislative rule" that required the OTS to follow the Administrative Procedures Act. The OTS was merely interpreting the law as it applied to a specific set of facts, not issuing a new regulation. The Court rejected that approach and decide that Ohio law was preempted by federal law based upon the Court's de novo of applicable law and regulation.

While the Court observes in a footnote that State Farm's agents may eventually be subject to state licensing in accordance with the requirements of the recently enacted Housing and Economic Recovery Act of 2008 (“the HERA”), the extent of state regulation will have to await the enactment of the necessary Ohio implementing legislation, which may be a year off. In the meantime, the exclusive agents need to eat and the federal savings bank needs to make loans (although, we hope, only the most fair and balanced mortgage loans). In addition, the Court apparently wanted to state in no uncertain terms that the march of federal preemption slogs onward, grinding the rights of the states beneath its jackboot heel. Or. something like that.

Actually. the Sixth Circuit panel relied heavily upon the approach of the US Supreme Court in Watters v. Wachovia. As did the SCOTUS with respect to national banks, the Sixth Circuit focused on the effect of state law on the exercise of a federal savings powers, not on the corporate structure through which the bank exercised those powers.

Properly understood, Watters stands for the proposition that when considering whether a state law is preempted by federal banking law, the courts should focus on whether the state law is regulating “the exercise of a national bank’s power” not on whether the entity exercising that power is the bank itself. Id. at 1570.

The federal savings bank was exercising its power to originate mortgage loans through exclusive agents. The Ohio licensing law impeded the bank in the exercise of those powers. Therefore, the Ohio law was preempted. It was as simple as that.

The Court also observes in a footnote that it's not deciding the question of whether or not the Ohio law might apply to non-exclusive agents of federal savings banks. Although the sweep of the Court's opinion (and of the Wachovia opinion, for that matter) is broad, it's logical to conclude that a non-exclusive agent that is not working exclusively for federal savings banks and/or national banks, but for non-federal loan originators, as well, would be subject to licensing by the state. It would be a Rubik's cube of "parsing the nuances" to try to allocate the extent of preemption and non-preemption where such "non-exclusive agents" were involved, and it would be tough to argue preemption in such a case (although I could do it with a straight face if paid a sufficient hourly rate).

Nevertheless, this latest decision gives more ammunition to those states rights advocates who legitimately ask, as did a correspondent whose plaintive cry was noted in a previous post: "Where does this all end?"

I think we all know the answer to that question, don't we? 

Regulatory Flexibility

Rooting around, searching for something totally unrelated, I recently unearthed a recent Office of Thrift Supervision Approval of Rebuttal of Control granted to Legg Mason Inc. and certain related entities in January.

The rebuttal was filed in connection with the proposed acquisition by Legg Mason and various of its subsidiaries to acquire more than ten percent of Countrywide Financial Corporation's voting stock. Obviously, Legg Mason doesn't want the group of related companies or any of its members to be classified as a savings and loan holding company, for a number of very sound reasons. Legg Mason had been granted approval by the OTS in 2003 to acquire more than ten percent but less than twenty-five percent of the stock of Countrywide's voting stock, but was required by the OTS to obtain prior OTS approval for any "subgroup" to acquire more than ten percent of any class of voting stock of a savings association in the future. The Legg Mason companies now proposing to acquire the additional voting stock of Countrywide are such a "subgroup."

In support of the subgroup's Rebuttal of Control, it filed a Rebuttal of Control Agreement. The form of those agreements is set forth in 12 CFR 574.100. To rebut a presumption of control, the acquirors are supposed to submit an agreement that "materially complies" with the form set forth in 12 CFR 574.100, although the OTS has the authority to "otherwise agree in writing." The Legg Mason "subgroup" requested a number of changes from the standard form, and the OTS agreed to them.

A number of the changes were made to conform to the OTS' 2003 ruling, and others made to ensure that the acquirors did not control Countrywide. However, the  OTS also  approved some additional changes to engage in certain advisory services with Countrywide and its affiliates, something that the standard agreement prohibits. In fact, the standard agreement prohibits the acquirors from engaging in any intercompany transactions with the thrift or holding company. The OTS doesn't believe that in this case, the ban on intercompany transactions is warranted because the nature of the services to be provided by the subgroup to Countrywide, and by Countrywide to the subgroup, would not "enable the Acquirors  to influence or control " Countrywide or its affiliates. Those services are (1) banking and financial services to be provided by Countrywide and (2) investment advisory services to be provided by the Legg Mason "subgroup."  The services are to be provided on market rates and terms.

The OTS merely states that with respect to Countrywide providing banking and financial services services to Legg Mason, the OTS "does not believe" that such services would permit Legg Mason to control or influence Countrywide. That's the end of the discussion. The advisory services to be provided by the Legg Mason entities to Countrywide merits a paragraph, the crux of which is that since there's plenty of market competition for such advisory services, the danger of influence or control is not present.

The OTS may or may not be correct in the conclusions it reached. Unfortunately, without more discussion of its analysis, it's impossible to challenge its reasoning. In other words, the OTS just breezed through the issues and reached a conclusion favorable to Legg Mason's subgroup being able to acquire more voting stock of Countrywide.

Not that a bank regulator would have done whatever it took to let Legg Mason pump badly needed capital into troubled Countrywide. The fact that Legg Mason upped its stake in Countrywide to 15% a couple of weeks after the OTS gave its approval and that Countrywide desperately needed the "scratch" was likely coincidental. Not that the OTS might have looked the other way when, in September 2007, the "subgroup" publicly announced that they had increased their voting stock from 8.76% to 10.04%, which should have required a prior approval of the Rebuttal of Control at that time, not four months later. I'm also sure that the OTS' decision being released one week to the day following the announcement by Bank of America that it was acquiring Countrywide is pure serendipity.

A CEO of a federal thrift recounted to me how he once listened to an OTS minion, looking especially arrogant with half-closed eyelids and a barely-concealed Elvis-like sneer, blather about the OTS' "unwritten rule" concerning savings and loan holding company capital requirements (find those "unwritten" rules in the regulations, I dare you), and about how the savings and loan executive should have known about these "unwritten rules" that the executive unwittingly "violated." With 30+ years of such experiences under my belt, I tend to take a jaundiced view of these matters. When a regulator wants to serve his agency's self-interest, the "What, Me Worry?" style of analysis can quickly replace the "tortures-of-the-damned-drowning-in-a-river-of-red-tape-and-nitpickers" style in which many financial thrift employees find themselves floundering when they want an interpretation on an issue on which the regulators have no skin in the game.

Perhaps Legg Mason hasn't been directly trying to influence Countrywide. On the other hand, the public statements that Legg Mason fund manager Bill Miller has made criticizing Bank of America's offer price and demanding that Countrywide drop its poisoned pills, might lead a skeptic to think otherwise. It won't make any difference to the OTS. The need to keep Countrywide afloat pending the consummation its acquisition by Bank of America  will keep its views of regulatory compliance "elastic."