Regulator sounds alarm bells for Fannie Mae and Freddie Mac

By Andrew A. Turner, J.D.

Are declining capital buffers leading to future bailouts of Fannie Mae and Freddie Mac? That concern and the consequences that it could lead to were the focus when Federal Housing Finance Agency Director Mel Watt discussed the FHFA’s work as regulator and conservator of the government-sponsored enterprises at the Bipartisan Policy Center.

The most serious risk arising from the FHFA’s protracted conservatorships of Fannie Mae and Freddie Mac is the GSEs’ lack of capital, Watt warned. Favoring legislative action before we reach a crisis, Watt expressed concern over the lack of “discussion of housing finance reform in any of the presidential campaigns.”

Fannie and Freddie are unable to build capital under the terms of the Preferred Stock Purchase Agreements (PSPAs) set up to provide financial support from the Treasury Department in 2008 when the GSEs went into conservatorship. As a result, the capital buffer available to absorb potential losses, which reduces the need for the GSEs to draw additional funding from the Treasury, is decreasing each year. Watt said that the GSEs “are now over halfway down a five-year path toward eliminating the buffer completely,” at the beginning of 2018.

Watt feared that a number of non-credit related factors—interest rate volatility; accounting treatment of derivatives; reduced income from the Enterprises’ declining retained portfolios; and the increasing volume of credit risk transfer transactions—could lead to a loss and result in a draw against the remaining Treasury commitments under the PSPAs. A disruption in the housing market or a period of economic distress could also lead to credit-related losses and trigger a draw.

Watt worried over possible ramifications of future draws of funds from the PSPA commitments. “First, and most importantly, future draws that chip away at the backing available by the Treasury Department under the PSPAs could undermine confidence in the housing finance market,” he said. A second concern would be a hasty legislative response. Noting high stakes for the housing finance market and for the economy, Watt cautioned, “conservatorship is not a desirable end state and that Congress needs to tackle the important work of housing finance reform.”

Another challenge posed by a continuing conservatorship, noted Watt, is Fannie Mae and Freddie Mac’s insulation from market forces that would normally dictate operations and business practices.

Planning amidst an uncertain future was the final challenge that he discussed. Commenting on the reinstatement of prior CEO compensation limits by Congress, Watt did not want to “debate the wisdom of the decision that Congress made” although he did point out that “it was an easy political decision.” However, with reliance on a highly specialized and technically skilled workforce, Watt acknowledged that “retaining skilled employees will be an increasing challenge.”

Industry viewpoints. National Community Reinvestment Coalition’s President and CEO John Taylor agreed with Watt that the Fannie and Freddie conservatorship is unsustainable and that action must be taken to recapitalize the GSEs. "With a capital buffer declining to zero and with reduced income from the enterprises’ declining retained portfolios, the mission of the enterprises is in serious jeopardy," Taylor said.

A day before Watt’s speech, three national associations representing small mortgage lenders and community banks urged the FHFA to allow the GSEs to “build a capital buffer and avoid a Treasury draw under the GSEs’ Preferred Stock Purchase Agreements, out of a concern that the capital-deficient GSEs could further constrain credit to home buyers.” In their joint letter to Watt, the Community Home Lenders Association, Community Mortgage Lenders of America, and Independent Community Bankers of America recommended that the FHFA suspend the payment of dividends on the senior preferred stock held by the Treasury to “allow the GSEs to build a capital buffer to deal with potential earnings volatility driven by external economic developments rather than by actions or missteps by the GSEs.”

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California report details data breaches, recommends safeguards

By J. Preston Carter, J.D., LL.M.

As many as three in five Californians may have been data breach victims in 2015, according to a report released by the state’s Department of Justice. The report is accompanied by recommendations from the California Attorney General for organizations, businesses, and lawmakers on how to protect against data breaches and points to a specific set of actions that companies and organizations should start with to meet state and federal mandates of reasonable security.

Data breaches. The “California Data Breach Report 2012-2015” found that 657 data breaches compromised more than 49 million records of Californians’ personal information during that four-year period. In 2015, 178 breaches placed 24 million records of Californians at risk.

“Government and the private sector have a shared responsibility to safeguard consumers from threats to their privacy, finances, and personal security,” said state Attorney General Kamala D. Harris. “California is leading the nation with measures to prevent data breaches, but we can do better.”

The report reveals that Social Security numbers, payment card data, and medical information were the top three types of data breached over the past four years. The retail sector accounted for 24 percent of breaches and 42 percent of records breached. The financial sector came in second, with 18 percent of breaches and 26 percent of records, with SSNs being the most common breached data. Healthcare industry accounted for 16 percent of breaches, with small businesses representing 15 percent.

Recommendations for organizations. The report listed a number of recommendations for organizations to take to reduce the frequency of impact of future breaches. These include:

• adopting the Center for Internet Security’s Critical Security Controls as the start of a comprehensive information security program;
• making multi-factor authentication available on consumer-facing online accounts that contain sensitive personal information;
• consistently using strong encryption to protect personal information on laptops and other portable devices; and
• encouraging individuals affected by a breach of Social Security numbers or driver’s license numbers to place a fraud alert on their credit files.

Recommendations for state policy makers. Although data breach proposals in Congress would eliminate the states’ so-called “patchwork” of laws, the report states that those proposals would “lower the bar,” thereby providing less consumer protection for Californians. The report recommends that state legislators and attorneys general identify common patterns in their laws and reduce differences in order to simplify compliance, preserve consumer protections, and remain flexible in adapting to changing threats.

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‘Sloppy litigation tactics,’ false evidence don’t merit attorney fee award

By Richard Roth

Despite concluding that consumers and their attorney submitted evidence they knew or should have known was false, and their inclusion in a Fair Debt Collection Practices Act complaint of a clearly false allegation, a federal district court judge has refused to award the debt collector its attorney fees. The false statements were simply an extreme example of sloppy litigation tactics by the consumers’ attorney and did not merit the more than $75,000 fee award that was requested (Hamburger v. Northland Group, Inc.).

The suit arose from Northland Group’s efforts to collect a credit card debt apparently owed by a married couple’s son. According to the couple’s FDCPA complaint, Northland made multiple telephone calls to collect the debt from an individual named Henry. The consumers did not know anyone named Henry, their complaint alleged, and the calls continued even after they told Northland that no one named Henry lived with them.

Who’s Henry? Actually, Henry was their son.

Moreover, in an apparent effort to help his parents prove that the debt in question was a consumer debt—a requirement for a suit under the FDCPA—Henry later submitted what the judge termed an “artfully evasive affidavit” in response to a summary judgment motion. Essentially, the affidavit attempted to describe the account activity without admitting that Henry had incurred any of the debt. The judge noted that the affidavit was so deficient that its contents were excluded from use at the later trial.

Number of calls placed. The consumers’ evidence of the number of calls was lacking, the judge observed. While they claimed to have kept a log of Northland’s calls, they also said that the log had been lost. In the end, the only calls they could say with certainly had been made were those described in Northland’s own records, which they had obtained in discovery.

There were further problems, though. First, Northland’s records indicated that one of the described calls was an erroneous duplicate of a call earlier in the day and thus had not actually been placed. Nevertheless, that nonexistent call showed up in the consumers’ interrogatory answers.

Perhaps worse still, it turned out that the consumers lived in a different time zone than Northland’s office. However, the consumers’ list of calls in their interrogatory answer gave Northland’s time zone, not the time zone at the consumers’ residence where the calls would have been received.

Evidence presented at the trial did nothing to amplify the consumers’ claims, as they submitted nothing more than the consumers’ own recollections about the number of calls.

Demand for attorney fees. The jury returned a quick verdict in favor of Northland, and the company then filed a motion for an award of attorney fees. The motion gave three justifications for the fee demand:

1. The company was a prevailing defendant in an FDCPA suit that had been brought in bad faith and for purposes of harassment (15 U.S.C. §1692k(a)(3)).
2.  Federal law more generally allows an award of fees if proceedings in a suit were unreasonably and vexatiously multiplied (28 U.S.C. §1927).
3. The court has the inherent power to vindicate its own authority and punish fraud.

None of these were enough to justify deviating from the “American Rule” that parties should pay their own attorney fees, the judge decided.

FDCPA. The FDCPA says that a prevailing defendant is entitled to a fee award if the suit was “brought in bad faith or the purpose of harassment,” the judge said (emphasis added). As far as he could tell, this suit had been brought by the consumers simply to redress a perceived, legitimate grievance—illegal debt collection telephone calls. The FDCPA was not intended to penalize those “who litigate honest grievances but utterly fail to prove them.”

General federal law. The consumers’ attorney had not “multiplied the proceedings,” the judge said. The suit might have been unwarranted from the very beginning, but an attorney’s “incompetence in screening, investigating, and litigating” a case did not justify sanctions.

Even the use of the arguably fraudulent call history to prevent Northland’s summary judgment did not multiply the proceedings, according to the judge. Summary judgment was refused based on an affidavit by one of the consumers claiming to remember calls other than those Northland had logged, not based on the written call log.

Court’s inherent power. Northland’s best argument for a fee award was based on the court’s inherent power to control how participants behaved, the judge said. The evidence strongly suggested that the consumers and their attorney lied when they claimed the calls they described during discovery were recounted in the consumers’ subsequently misplaced log and that the attorneys knowingly submitted false evidence. Northland had proved that the consumers and their attorney submitted evidence they knew or reasonably should have known was untrue.

But that still was not enough.

The false evidence had no effect on the proceedings, the judge decided. The case would have gone to trial even if the false call log had not been submitted. Also, the false evidence had not prejudiced Northland because the jury rejected the consumers’ claims. The fraud was only a small exaggeration about the number of calls Northland had placed—perhaps seven or eight rather than five.

The judge characterized the situation as involving “clearly established fraud” that was limited in scope and did not affect the proceedings. A fee award would be disproportionate to the improper conduct. False statements made in a case that had been “litigated in a consistently poor manner” and that “lacked evidentiary support from its inception” demonstrated poor performance by the consumers’ attorney but did not justify a possible $75,000 fee award, the judge concluded.

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CFPB denies lack of jurisdiction claim: CID stands

By Katalina M. Bianco, J.D.

The Consumer Financial Protection Bureau has denied J.G. Wentworth, LLC’s, petition to modify or set aside a civil investigative demand issued by the bureau in 2014. The petitioner’s argument that the CFPB lacks jurisdiction over Wentworth because the company’s structured settlement and annuity payment purchasing activities that are the subject of the CID and outside the scope of the Consumer Financial Protection Act and Truth in Lending Act do not merit setting aside the CID, the bureau determined.

Petitioner’s arguments. Wentworth argued that its business activities are not covered activities under the CFPA because the company is not a covered person under the CFPA and its conduct does not fall within the scope of the Act’s provisions on unfair, deceptive, or abusive acts and practices. According to the petition, Wentworth provides liquidity to customers by purchasing future streams of income, such as structured settlement and annuity payments. Wentworth directly purchases these future fixed payments in exchange for a single up-front cash payment negotiated with each seller. When the company purchases the right to receive future settlement or annuity payments from a customer, no money is lent, no credit is extended, and no money is owed by the customer that must be repaid, the petitioner stated. Therefore, the conduct does not come within the meaning of consumer financial product or service as provided in the CFPA.

Further, because no money is lent to consumers and no credit is extended, Wentworth’s activities do not give rise to a TILA violation.
Finally, Wentworth argues that the CFPB has previously conducted discovery sufficient to determine that it lacks jurisdiction to issue the CID.

CFPB position. The bureau’s response, written by CFPB Director Richard Cordray, outlines the ways in which the petition is lacking in merit. First, the argument that Wentworth is not a covered person under the CFPA because it does not offer or provide a financial product or service is “misplaced.” The CFPA authorizes the bureau to issue CIDs to "any person" who may have information "relevant to a violation," Cordray noted. Because this authority extends to covered persons, service providers, or any other person who may possess relevant information, the company's argument does not relate to the scope of the CFPB's investigative authority. In addition, Cordray wrote, the company may well be engaging in conduct that brings it under the definition of covered person if the company is providing consumers with financial advisory services to assist in determining whether a structured settlement transaction is in their best interest. Wentworth acknowledged in its petition that the definition of financial product or service" under the CFPA includes "providing financial advisory services…to consumers on individual financial matters."

Wentworth’s argument that the CFPB lacks jurisdiction to issue the CID because the purchase of structured settlement and annuity payments does not constitute an extension of credit subject to TILA is a substantive defense that does not address the scope of the CFPB's investigative authority, according to Cordray. The director said that he did not need to address the merits of this argument “at this stage.”

As for the company’s argument that the CFPB has conducted discovery sufficient to determine that the bureau lacks jurisdiction to issue the COD, Cordray answered that because he had already concluded that the bureau does not lack jurisdiction to issue the CID, the point is moot.

Cordray ordered Wentworth to produce all responsive documents, items, and information to the bureau within 21 calendar days of the decision and order.

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Could FAST Act drive out member banks?

By John M. Pachkowski, J.D.

In light of recently-enacted legislation to fund transportation projects, the Federal Reserve Bank of Richmond has released an Economic Brief questioning whether the legislation could affect banks’ membership in the Federal Reserve System.

The legislation, the Fixing America’s Surface Transportation Act or FAST Act, contains a five-year, fully paid plan to broadly deal with U.S. roads and bridges, public transportation, car and truck safety, and railroads. In order to adequately fund transportation projects, the FAST Act looked at a number of revenue sources to close any funding gaps. Two of these new revenue sources encroach upon decades-old practices at the Federal Reserve Board. These revenue sources will total $35.7 billion over five years and account for more than 10 percent of the FAST Act’s total cost.

One source of revenue reduces the dividend paid on Federal Reserve Bank stock to member banks. Under section 32203 of the FAST Act, member banks with consolidated assets of $10 billion or less will continue to receive a 6-percent dividend on their Federal Reserve Bank stock, but the dividend is indexed to inflation. For member banks with consolidated assets greater than $10 billion, there is a floating dividend based on the smaller of: the rate equal to the high yield of the 10-year Treasury note auctioned at the last auction held prior to the payment of a dividend, and 6 percent.

The second revenue stream caps the Fed’s surplus account at $10 billion with any amounts exceeding the cap being remitted to the U.S. Treasury.

In the Economic Brief, “The Cost of Fed Membership,” the brief’s authors, Helen Fessenden and Gary Richardson, noted, “Given the relatively small sum of the dividend provision, it may be tempting to dismiss its significance. But a closer look at the history of the Fed-bank relationship shows that the value of these dividends is greater—and more complicated—than just the dollar amount.”

The authors also discussed the history of the Federal Reserve Bank stock requirement, how it contributed to the dual banking system, and responses to increase membership in the Federal Reserve System.

Fessenden and Richardson concluded, “There is no modern example to shed light on what might happen if banks decide Fed membership is no longer worth it. Nor is it clear what the consequences—intended as well as unintended—may be if member banks start leaving the System in substantial numbers. But what is clear is that a large decline in membership would directly challenge [Paul] Warburg’s [1916] prediction that ‘the future will belong to those banks—national or state—that are members of the Federal Reserve System.’”

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Bank entitled to foreclose on property via out-of-state reverse mortgage

By Thomas G. Wolfe, J.D.


Recently, the Supreme Court of the State of Washington was called to address an interesting legal issue involving a Washington deed-holder’s challenge to OneWest Bank’s attempted mortgage foreclosure of Washington real property, based on the bank's interest in the property via a reverse mortgage that was ordered by an Idaho state court. The deed-holder contended that her interest in the property took priority over the bank’s interest and that the Idaho court lacked any authority to affect the Washington property. Washington’s high court disagreed.

To provide some background for the court’s decision in OneWest Bank, FSB v. Erickson, in June 2007, Bill McKee, the Washington property owner, transferred his interest in his Washington home to his daughter, Maureen Erickson, through a quitclaim deed. However, Erickson did not record the deed until December 2011—over four years later. Meanwhile, in October 2007, as part of conservatorship proceedings in Idaho for McKee and his financial difficulties, an Idaho court directed the conservator to “facilitate a reverse mortgage” on the Washington property.

Through a series of assignments, OneWest Bank obtained a secured interest in the reverse mortgage. After McKee died and Erickson failed to make any payments under a repayment arrangement, OneWest Bank instituted foreclosure proceedings regarding the Washington property. Challenging the bank’s foreclosure, Erickson claimed that the reverse mortgage was void because she was the actual owner of the property and the Idaho court lacked jurisdiction to affect the Washington property.


Rejecting Erickson’s argument, the Supreme Court of Washington ruled that the Idaho court-ordered reverse mortgage, which encumbered the Washington property, was due “full faith and credit” under the U.S. Constitution. In determining that the Idaho court validly exercised personal and subject matter jurisdiction by directing the conservator to set up the reverse mortgage on the Washington property, the court reasoned that: (i) there was enough evidence to show that McKee had sufficient contacts with Idaho; (ii) Erickson had the opportunity to challenge that determination in Idaho; and (iii) the Idaho court did not directly transfer any title to the Washington property, but only indirectly determined “personal interests in the Washington property.”

Next, the court decided that, under Washington law governing the recording and priority of real property interests, Erickson took title to the Washington property “subject to” OneWest Bank’s interest in the reverse mortgage. Even though Erickson obtained her interest in the property before OneWest Bank’s predecessor did, the bank’s predecessor recorded its interest first, the court emphasized. Further, the court determined that Erickson failed to show that the bank’s predecessor had actual or constructive notice of her interest in the Washington property.

Concluding that OneWest Bank was a “bona fide mortgagee” whose interest took priority over Erickson’s interest, the court ruled that the bank was entitled to foreclose on the Washington property.

For more information about reverse mortgage issues and state banking laws, subscribe to the Banking and Finance Law Daily.

Elizabeth Warren report shines a light on failure in corporate enforcement

By Andrew A. Turner, J.D.

Senator Elizabeth Warren (D-Mass) has released a report, “Rigged Justice: How Weak Enforcement Lets Corporate Offenders Off Easy,” that lists examples in which the government caught big companies breaking the law and “let them off easy.” The report highlights 20 criminal and civil cases in 2015 in which “the federal government failed to require meaningful accountability from either large corporations or their executives involved in wrongdoing.” In most cases, the government just imposed fines without requiring an admission of guilt.

According to the report, these cases illustrate “problematic enforcement patterns” by federal agencies, from financial crimes to student loan rip-offs, from auto safety violations to environmental disasters. The report said that “putting a law on the books is only the first step. The second, and equally important, step is enforcing that law. A law that is not enforced—or weakly enforced—may as well not even be a law at all.”

Despite rhetoric and new policies, settlements and enforcement actions by the Department of Justice (DOJ) and other federal agencies continually fail to impose any serious threat of punishment on corporate offenders, according to the report. It argues that strong enforcement of corporate criminal laws serves to deter future criminal activity “by making would-be lawbreakers think twice before breaking the law and, sometimes, by helping victims recover from their injuries.” However, under the current approach to enforcement, the report states, corporate criminals routinely escape meaningful prosecution for their misconduct.

Financial crimes and offenses. As a past example, the report noted that banking regulatory agencies had the legal authority they needed to stop much of the fraudulent and high-risk conduct that led to the 2008 financial crisis, but the failure to act culminated in taxpayer bailouts.

One of the cases cited from the past year was “The Cartel”—Citigroup, JPMorgan Chase & Co, Barclays, UBS AG, and Royal Bank of Scotland”—a secret group which manipulated exchange rates for more than five years in a way that made the banks billions of dollars at the expense of clients and investors. Although the DOJ required admissions of guilt as part of the settlement, a reflection of the severity of the charges, not one single individual faced any criminal prosecution. Moreover, the Securities and Exchange Commission granted waivers to each bank so that the banks could avoid the collateral consequences that were supposed to accompany a guilty plea.

The report warns that the examples of feeble enforcement against corporate criminals in 2015, “raise the disturbing possibility that some giant corporations—and their executives—have decided that following the law is merely optional. For these companies, punishment for breaking the law is little more than a cost of doing business.”

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'The good, the bad, and the ugly' of Congressional response to the financial crisis

By J. Preston Carter, J.D., LL.M.

At the fifth anniversary of the Financial Crisis Inquiry Commission report, an American Action Forum article examines “the good, the bad, and the ugly” of Congressional response to the crisis and concludes that “[P]erhaps the best” response was greater capital reserves for financial companies. The article—FCIC Report: What have we learned since?—was written by Douglas Holtz-Eakin, AAF President and former Commissioner on the FCIC, which was formed to investigate and issue a report on the causes of the crisis, and Meghan Milloy, AAF Director of Financial Services Policy.

The good. Although capital mandates result in reduced lending activity and increased client fees, the authors write, “most can agree” that the benefits from “at least some increase” in bank’s capital cushions outweigh those costs. Other “good” responses are increased transparency of credit rating agencies’ decisions and “bailouts”—those that kept Fannie Mae and Freddie Mac from collapse, and those that came through the Troubled Assets Relief Program.

The bad. The Dodd-Frank Act’s “push out” rule, affecting non-credit derivatives, which, the authors say, had little to do with the financial crisis, has complicated bank customers’ one stop shopping for their financial needs, and has made banks more complex. Other “bad response” are: the Volcker Rule, premised on the false assumption that the crisis was caused by proprietary trading and set to cost banks $4.3 billion; and new Securities and Exchange disclosure rules, mandated by Dodd-Frank, even though, the authors contend, a lack of “certain disclosure requirements certainly didn’t cause the crisis.”

The ugly. Finally, the authors list as “ugly” responses: (1) the Orderly Liquidation Authority and “Too Big To Fail” rules that, although intended to treat banks like “any other company,” have done “just the opposite,” with banks growing bigger; (2) the Financial Stability Oversight Council, which has “slapped” systemically important financial institution designations on companies that “pose no discernible systemic risk to the U.S. economy”; and (3) the “ugliest of all the uglies”—the absence of action on a core part of the actual causes of the crisis: Fannie Mae and Freddie Mac.

The American Action Forum describes itself as a 21st century center-right policy institute providing actionable research and analysis to solve America’s most pressing policy challenges.


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HSBC compliance report cannot be kept secret, federal judge says

By Richard A. Roth

A monitor’s report on HSBC Bank’s compliance with a deferred prosecution agreement is a judicial record that must be available to the public, according to a federal district court judge. A request by the bank and the federal government that the report remain secret has been rejected, although they have an opportunity to designate parts of the report that should remain confidential (U.S. v. HSBC Bank USA, N.A.).

The corporate compliance monitor was required under a 2012 settlement of Justice Department charges that HSBC violated Bank Secrecy Act regulation anti-money laundering program requirements and other federal laws. According to the charges, HSBC Bank USA failed to monitor more than $10 billion in transactions with HSBC Mexico between 2006 and 2009. The company also allowed the movement of hundreds of millions of dollars by nations that were subject to U.S. sanctions over a 10-year period. Unusually, HSBC admitted the violations as part of the settlement, and the company also agreed to pay more than $1.9 billion.

Confidential filing. The first annual report by the compliance monitor was issued in January 2015, but it was not filed with the court. Instead, the government filed a six-page document that it said summarized the more than 250-page report. The summary noted that HSBC has made significant progress but still needs to improve its compliance technology and corporate culture.

The judge, unsatisfied with the summary, ordered that the full report be filed. The report was filed under seal, and both HSBC and the government subsequently objected when a private individual asked that it be made public.

Judicial document. Both the common law and the First Amendment give the public a right of access to judicial documents, the judge noted, and that right applies even if the document does not contain any information that would be useful to the person seeking access. The first question to be answered was whether the monitor’s report is a judicial document.

A judicial document is one that is “relevant to the performance of the judicial function and useful in the judicial process,” the judge said. The compliance report meets that standard.

The report was needed to ensure that HSBC is in compliance with a DPA in an open criminal prosecution. The judge said he has an obligation to oversee the bank’s compliance, and he could not do so without some reports from both the bank and the government. In fact, the order that approved the settlement explicitly provided that the judge was to be kept informed of any significant developments.

The judge rejected the government’s assertion that he had no part in overseeing the monitor’s work, replying that his job was to oversee the entire criminal prosecution. “[I]t would demean this institution” for him to take no action if the monitor reported that HSBC continued to launder money for drug traffickers, the judge said.

The DPA provided that the charges against HSBC could be dismissed if the banks complied with the agreement’s terms. However, the prosecution could be dismissed only by a court order, and that order could not be entered unless the judge reviewed the monitor’s reports to ensure that the DPA had been fulfilled.

Right of access. On the other hand, the First Amendment right of access to judicial documents is not unlimited. It applies only if both experience and logic support access, the judge said. Both criteria supported public access to the monitor’s report.

Deciding whether HSBC is complying with the DPA is not comparable to deciding whether to file a case, the judge said in rejecting the government’s contrary argument. The DPA relates to “undoing” a case that already has been filed. A DPA is more akin to a plea agreement or a pretrial hearing, both of which commonly are subject to public access.

Logic also supports public access, the judge continued. The HSBC settlement was a matter of “great public interest,” he observed. The Justice Department and the court are public institutions, and HSBC is a vast international financial services institution. It is “appropriate and desirable” to allow the public to know what is going on.

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HSBC to pay $601 million for mortgage abuses

By Stephanie K. Mann, J.D.

HSBC North America Holdings Inc., and its affiliates, HSBC Bank USA, N.A., HSBC Finance Corporation, and HSBC Mortgage Services Inc., have entered into a consent order and will pay $470 million to address mortgage origination, servicing, and foreclosure abuses. The consent order is between HSBC North America Holdings Inc., its affiliates, the Department of Justice, Department of Housing and Urban Development, Consumer Financial Protection Bureau, 49 state attorneys general, and the District of Columbia. Oklahoma is the only state not a party to the consent order.

The Federal Reserve Board has also assessed a civil money penalty against HSBC for deficiencies in residential mortgage loan servicing and foreclosure processing. The $131 million penalty is the maximum amount allowed, according to the Fed.

The alleged mortgage origination, servicing, and foreclosure abuses are based on violations of: the various states’ unfair and deceptive acts and practices laws; the False Claims Act; the Financial Institutions Reform, Recovery, and Enforcement Act of 1989; the Bankruptcy Code; and the Federal Rules of Bankruptcy Procedure.

Mirrors 2012 settlement. The DOJ agreement’s mortgage servicing terms largely mirrors the 2012 National Mortgage Settlement (NMS) reached in February of 2012 between the federal government, 49 state attorneys general, and the five largest national mortgage servicers. That agreement provided consumers nationwide with more than $50 billion in direct relief, created new servicing standards, and implemented independent oversight. The NMS required the servicers to provide consumer relief, such as principal forgiveness and short sale assistance, for distressed borrowers who met the settlement’s eligibility criteria, and refinancing assistance for certain borrowers. The servicers’ performances under the settlement are evaluated by the use of a series of 33 metrics to assess how well each servicer is adhering to the 304 servicing standards, or rules, under the NMS.

Consumer relief. Of the $470 million that the HSBC parties agreed to pay in the DOJ settlement, $370 million will be used for consumer relief in the form of reducing the principal on mortgages for borrowers who are at risk of default, reducing mortgage interest rates, forgiving forbearance and other forms of relief. The remaining $100 million is to be split between the states and the federal government. The states are set to receive $59.5 million and the federal government $40.5 million.

Compliance. Besides the payments, the HSBC parties also required to fulfill other obligations under the terms of the consent order. These various obligations, set forth in numerous exhibits, relate to servicing standards, consumer relief, and compliance metrics.

To ensure compliance, the terms of the consent order will be overseen by an independent monitor, Joseph A. Smith Jr., who is also the monitor for the NMS. Smith will oversee implementation of the servicing standards required by the agreement, will certify that HSBC has satisfied its consumer relief obligations, and will file regular public reports that identify any quarter in which HSBC fell short of the standards imposed in the settlement.

HSBC statement. HSBC issued a statement about the DOJ settlement and the Fed consent order. In its statement, HSBC said that in addition to civil money penalties, HSBC has agreed to adhere to the national mortgage servicing standards outlined in prior NMS agreements reached with other U.S. mortgage servicers. According to HSBC, the settlement will not cause HSBC to take any additional charges to income beyond those recorded in prior years.

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CFPB fears lack of account options sidelining consumers

By Katalina M. Bianco, J.D.

The Consumer Financial Protection Bureau has taken steps intended to boost checking account options for consumers. The bureau says it fears that lack of access to lower-risk accounts is keeping consumers out of the banking system. To address this issue, the bureau sent a letter to the CEOs of the 25 largest retail banks urging them to make available, and widely marketed, lower-risk deposit accounts that help consumers avoid overdrafts.

 “Consumers should not be sidelined out of the basic banking services they need because of the flaws and limitations in a murky system,” said CFPB Director Richard Cordray. “People deserve to have more options for access to lower-risk deposit accounts that can better fit their needs.”

In his prepared remarks for a field hearing on checking account access, Cordray said that there are nearly 10 million unbanked households that have no checking or savings accounts. Some consumers may have been rejected when they tried to open an account before, or they might have lost an account after it became overdrawn and they were unable to recover, Cordray said. He noted that overdraft protections for checks and electronic transactions, offered more regularly since the 1980s, have allowed institutions to collect more fees and are a “significant reason why many consumers incur negative balances.” Too many overdraft problems is another reason why consumers have given up on accounts, the director said.

Letter to banks. The CFPB noted in its letter to the bank CEOs that currently either an applicant passes a standard screening process to obtain an account after identifying any credit risks posed by the applicant’s history of misuse or mishandling of some prior account, or the applicant is blocked from accessing the banking system altogether. The bureau suggested a third possibility—offering all applicants a lower-risk account, whether a checking account or a prepaid account. Because the account is lower-risk, applicants would not pose the same level of risk to the institution. Further, applicants need not be screened out of the banking system by applying the same risk thresholds that are used to determine eligibility for a standard checking account.

The bureau also urged banks and credit unions that do not currently offer transaction accounts designed to help consumers avoid overdrafts to do so. Institutions that already offer such accounts should feature them among their standard account offerings both in their branches and online. The CFPB said that the lack of marketing for these products has lessened their visibility and undermined their rate of uptake among consumers who might otherwise benefit from their availability.

Screening inaccuracies. The CFPB also is concerned with inaccuracies that can occur when institutions screen potential customers. CFPB Compliance Bulletin 2016-01 warns banks and credit unions that “failure to meet accuracy obligations when they report negative account histories to credit reporting companies could result in Bureau action.”

For more information about the CFPB and checking accounts, subscribe to the Banking and Finance Law Daily.

Discriminatory loan pricing leads to CFPB/DOJ settlement with Toyota Motor Credit

By Katalina M. Bianco, J.D.

The Consumer Financial Protection Bureau and Department of Justice have resolved an action with Toyota Motor Credit Corporation for allegedly charging thousands of minority buyers higher rates for auto loans regardless of the borrower’s creditworthiness. Under the agreement, affected borrowers will receive up to $21.9 million. Toyota also agreed to change its pricing and compensation system to substantially reduce dealer discretion and accompanying financial incentives to mark up interest rates.

 “We are dedicated to promoting fair and equal access to credit in the auto finance marketplace,” said CFPB Director Richard Cordray. “Toyota Motor Credit is among the largest indirect auto lenders, and we commend its industry leadership in shifting to reduced discretion to address the significant fair lending risks.”

“Toyota’s reforms will level the playing field to ensure that all eligible borrowers—regardless of their race or national origin—can sign auto loans with fair terms and reasonable interest rates,” said Principal Deputy Assistant Attorney General Vanita Gupta, head of the DOJ’s Civil Rights Division. “While dealerships deserve fair compensation for the valuable customer service they provide, federal law protects consumers against higher price markups simply because of what they look like or where they come from.”

This joint action marks the fourth in a series of joint CFPB and DOJ public resolutions that address the fair lending risks in dealer discretion and financial incentives. The action also marks the third resolution that minimizes fair lending risks by substantially reducing dealer discretion and financial incentives.

According to the CFPB, auto loans are the third-largest source of outstanding household debt in the United States, after mortgages and student loans. As an indirect auto lender, Toyota Motor Credit sets interest rates, or “buy rates,” for consumers based on credit scores and other risk criteria. Those rates are conveyed to auto dealers. The bureau said that indirect auto lenders like Toyota Motor Credit allow auto dealers to charge a higher interest rate when they finalize the deal with the consumer, an action typically called “dealer markup.”

Charges. The bureau’s stipulation, filed in an administrative action, alleges that Toyota Motor Credit violated the Equal Credit Opportunity Act (15 U.S.C. §§1691-1691f) and its implementing Regulation B (12 CFR Part 2002) for permitting dealers to charge higher interest rates to consumer auto loan borrowers on the basis of race and national origin. The DOJ has alleged the same violations in a civil action filed in the United States District Court for the Central District of California styled United States of America v. Toyota Motor Credit Corporation, filed on or about Feb. 2, 2016.

Consent orders. Under the CFPB’s consent order, and the DOJ’s proposed consent order, in addition to requiring Toyota Motor Credit to pay $21.0 million in remediation, the settlement requires Toyota to improve its monitoring and compliance systems. The settlement allows Toyota to experiment with different approaches toward lessening discrimination and requires it to regularly report to the CFPB and DOJ on the results of its efforts as well as discuss potential ways to improve results.

Further, the settlement provides for an administrator to locate victims and distribute payments of compensation at no cost to borrowers whom the CFPB and DOJ identify as victims of Toyota Motor Credit’s discrimination. The DOJ and CFPB will make a public announcement and post information on their websites once more details about the compensation process become available.

For more information about CFPB enforcement actions, subscribe to the Banking and Finance Law Daily.

Will the Fed’s TLAC requirement be a cure all?

By John M. Pachkowski, J.D.

Although the time to provide comments was extended by the Federal Reserve Board, a number of stakeholders have weighed in on a November 2015 proposed rulemaking by the Fed that would require a small number of bank holding companies (BHCs), considered to be global systemically important banking organizations (GSIBs) to take a number of steps to enhance their resolvability under the U.S. Bankruptcy Code.

Specifically, the Fed’s proposal would:

• require covered BHCs to establish an external long-term debt requirement (external LTD requirement), an external total loss-absorbing capacity requirement (external TLAC requirement), and a related external TLAC buffer;
• impose restrictions on the operations of covered BHCs to be known as “clean holding company requirements”; and
• impose regulatory deductions for investments in the unsecured debt of covered BHCs by requiring an institution with a non-significant investment in a covered BHC to deduct any investment in unsecured debt issued by the covered BHC in the same manner as if the unsecured debt were tier 2 capital using the “corresponding deduction approach.”

To meet the external TLAC requirement, covered BHCs would be required to maintain outstanding eligible external TLAC equal to the greater of: 18 percent of risk-weighted assets (RWAs) and 9.5 percent of total leverage exposure. The external LTD requirement would be met if a covered BHC maintains outstanding eligible external LTD equal to the greater of: 6 percent of RWAs, plus the applicable GSIB capital surcharge, and 4.5 percent of total leverage exposure. Finally, the external TLAC buffer would equal the sum of 2.5 percent, any applicable countercyclical capital buffer, and the GSIB surcharge applicable under method 1 of the Fed’s GSIB surcharge rule.

Right direction. Stephen Matteo Miller, PhD, a Senior Research Fellow at the Mercatus Center, called the proposed rule’s emphasis on higher capital, using debt and equity, as a “step in the right direction” for mitigating future crises, but the holding company is not necessarily the correct entity to rely on to mitigate future crises. He also noted that it was “unclear” as to whether the continued use of risk-based capital could create problems in the future.

Benefit-cost analysis. Miller also raised concerns regarding the Fed’s benefit-cost analysis for the proposed rule. He noted that although the Fed chose a “detailed and well-reasoned framework to estimate the inputs used to conduct the benefit-cost analysis,” one aim of economic analysis “should be to justify a new rulemaking compared to alternatives, not merely to examine whether the proposed rule’s estimated benefits exceed its costs.”

No end to TBTF. In his analysis of the TLAC proposal, Paul Kupiec, Resident Scholar at the American Enterprise Institute, suggested that the proposal will not remove the risk of “too big to fail” and that the largest financial institutions may require future taxpayer assistance should the country face another financial crisis. He added, “the uncertainties associated with using TLAC in a Dodd-Frank Title II resolution are likely to create a new important source of systemic risk—uncertainty about which investors bear losses in a GSIB resolution—a risk that did not exist in the prior financial crisis.”

Kupiec also raised a number of concerns associated with the proposal. These concerns were:

1. The alleged benefits of TLAC are only available in a Dodd-Frank Title II Resolution. If the GSIB parent holding company is not eligible for a Title II resolution, TLAC investors will not be required to bear the loss of a failing bank subsidiary.
2. The “clean” parent holding company provisions of the proposed TLAC rule will make it more difficult to use a Title II resolution.
3. The proposed TLAC rule extends trillions of dollars in new implied government guarantees for the liabilities issued by GSIB subsidiaries.
4. Requiring TLAC debt at the parent holding company does not necessarily remove large institution TBTF interest rate subsidies.
5. The proposed TLAC regulation adds complexity to a regulatory system already plagued by overly complex capital and other prudential regulations. There is a simpler, more transparent way to satisfy TLAC regulatory goals.

Addresses TBTF. The Independent Community Bankers of America generally supported the proposal to impose an external TLAC requirement and an external LTD requirement on covered BHCs and agreed with the Fed that “there is a need for both requirements and that the LTD requirement will specifically help address the too-big-to-fail problem.”

TLAC and LTD requirements. As for the external TLAC and LTD requirements, the ICBA noted that the proposed TLAC capital measure closely reflects the “historical loss experience of major financial institutions during the recent financial crisis.” It added that the proposed LTD requirement was “vital if the single point of entry (SPOE) resolution process is to work.”

Capital deduction. Commenting on the proposed requirement that there be a regulatory capital deduction for investments in the unsecured debt of covered BHCs, the ICBA noted that the deduction was necessary to address the potential contagion stemming from the failure of a GSIB.

Although the ICBA agreed that the capital deduction was necessary, it raised concerns regarding the effects that “corresponding deduction approach” would have on community banks. It recommended that the banking agencies issue specific guidance to community banks on this issue prior to the TLAC rules becoming effective in 2019. The ICBA noted, “The guidance should explain how the ‘corresponding deduction’ rules work under Basel III and the consequences to an institution’s regulatory capital if covered BHC debt is purchased.”

For more information about financial stability and GSIBs, subscribe to the Banking and Finance Law Daily.

Were insolvent bank’s due process rights violated by state banking officials?

By Thomas G. Wolfe, J.D.

Recently, the U.S. Court of Appeals for the Tenth Circuit was called to address whether certain Kansas banking officials were entitled to qualified immunity in connection with a civil rights lawsuit brought against them by Columbian Financial Corporation on behalf of Columbian Bank & Trust Company, an insolvent bank under a Federal Deposit Insurance Corporation receivership.

In August 2008, the Office of the State Bank Commissioner of Kansas declared Columbian Bank to be insolvent, seized the bank’s assets, and appointed the FDIC as receiver. On the same day it was appointed receiver, the FDIC sold many of the bank’s assets to a third party in a prearranged sale.

Among other things, Columbian Financial alleged that the Office of the State Bank Commissioner of Kansas and four commission officials violated the procedural due process protections afforded Columbian Bank by the Fourteenth Amendment to the U.S. Constitution because: (1) the bank’s assets were seized and placed under the FDIC receivership in August 2008 without any pre-deprivation hearing; and (2) the bank’s post-deprivation hearing was not concluded until April 2012—a delay of about three years and eight months.

In Columbian Financial Corporation v. Stork, the Tenth Circuit was called to ascertain whether two Kansas bank commission officials, Judi Stork and J. Thomas Thull, were entitled to qualified immunity from Columbian’s claims. Ultimately, the Tenth Circuit ruled that the two Kansas banking officials were entitled to qualified immunity on the due process claims because they did not violate “clearly established constitutional rights” of Columbian. Moreover, in taking their actions, the commissioners reasonably relied on precedents and principles enunciated under both federal and Kansas law, the court determined.

The Tenth Circuit noted, “Our precedents have not squarely addressed the need for a predeprivation hearing when a bank’s assets are placed in the control of a receiver (rather than a conservator).” Columbian argued that even if the appointment of a conservator did not trigger the right to a pre-deprivation hearing, the appointment of a receiver did. In rejecting the bank’s argument, the Tenth Circuit underscored that any distinction between a conservatorship and a receivership “would have been hazy, to say the least,” from the perspective of the state officials, Stork and Thull.

Moreover, the court decided that the Kansas officials were entitled to qualified immunity because: (i) Columbian did not plead facts showing the violation of a clearly established constitutional right; (ii) in forgoing any pre-deprivation hearing, the Kansas officials could reasonably rely on the precedents and analytical framework set forth by the U.S. Supreme Court, other federal circuit courts, and a tangential Kansas case; (iii) contrary to the bank’s argument, Kansas law supported the officials’ actions; (iv) Stork and Hull reasonably concluded that they needed to move quickly once the bank was declared insolvent; and (v) given the fogginess of the issue, the denial of a pre-deprivation hearing did not violate a clearly established constitutional right.

Similarly, the Tenth Circuit rejected Columbian’s contention that the delay between the bank’s seizure in August 2008 and the conclusion of the post-deprivation hearing in April 2012 violated Columbian’s right to procedural due process.

In applying a three-part test as part of a “fact-intensive analysis” to determine whether the delay was excessive and unconstitutional, the Tenth Circuit concluded that the three factors of the test “do not clearly cut in favor of Columbian Financial.” Furthermore, the court asserted, the two Kansas officials did not have the benefit of any “precedent sufficiently on point … to put [them] on notice that the delay was unconstitutional.” In addition, because there was inherent uncertainty about how the Tenth Circuit or the U.S. Supreme Court would apply any fact-intensive balancing test, “the delay in the post-deprivation hearing did not violate a clearly established constitutional right.”

For more information about state banking issues, subscribe to the Banking and Finance Law Daily.

Wolters Kluwer News: Publication opportunity for current law students

The Wolters Kluwer Legal Scholar program, in its third year, allows current law students to compete for the chance to have their work published in a Wolters Kluwer publication. Wolters Kluwer will accept submissions through Friday, April 1, 2016.

 

One submission per category may be submitted by any student currently enrolled in an ABA-accredited law school. Categories for submission are:

• Health law (including Medicare, Medicaid, life sciences, and health reform)
• Cybersecurity (including banking and financial privacy, securities, health care, and insurance)
• Products liability and consumer safety
• Employment law (including wage/hour, labor, and discrimination)

Depending on the number of entries, one to two winners per category will be selected and published in a Wolters Kluwer publication, to be determined based on the submission’s topic.

 

Winners will be notified by April 22, 2016. The winning submissions will be featured in a Wolters Kluwer publication the week of April 25, 2016, along with a biographical paragraph about the author.

 

For for information and full contest rules, visit Legal Scholars.