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Nutter Bank Report, November 2011

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11.30.2011 | Legal Update

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1. CFPB Proposes Alternative Prototypes of New Home Mortgage Disclosure Forms
2. OCC Proposes to Remove Credit Ratings from Eligible Investment Securities Criteria
3. Agencies Clarify Supervisory Responsibilities for Federal Consumer Financial Laws
4. Court Rules that Consumers May Sue to Recover Costs of Payment Card Data Breach
5. Other Developments: CFPB Enforcement Actions and Investment Adviser Exemptions

1. CFPB Proposes Alternative Prototypes of New Home Mortgage Disclosure Forms
The Consumer Financial Protection Bureau (“CFPB”) has released two alternative prototypes of a mortgage disclosure form that would combine the two forms consumers get before finalizing a home loan—the Truth in Lending disclosure statement and HUD-1 Settlement Statement—into a single mortgage closing document. The CFPB has requested public feedback on the two prototypes which marks the second phase of its Know Before You Owe mortgage project. The project began in May with the release of two alternate prototype forms designed to replace the Truth in Lending disclosure statement and Good Faith Estimate form given to consumers when they apply for a mortgage loan. The CFPB said that its most recent mortgage closing document prototypes released on November 8 reflect the feedback received from five rounds of testing different prototypes of the loan estimate disclosure forms in the first phase of the Know Before You Owe mortgage project. The prototypes include some new disclosures that are not included on either of the current disclosure documents that the combined form would replace. The additions are new disclosures required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The CFPB announced that it will accept public feedback on the two alternative prototype forms of closing disclosures while it conducts four rounds of testing and revisions through February 2012. The CFPB said that it plans to issue draft forms as part of a formal notice and comment rulemaking procedure in July 2012.

      Nutter Notes:  Section 1032 of the Dodd-Frank Act requires the CFPB to propose for public comment by July 21, 2012 rules and model disclosures that combine the disclosures required under the Truth in Lending Act (“TILA”) and Sections 4 and 5 of the Real Estate Settlement Procedures Act (“RESPA”) into a single, integrated disclosure for mortgage loan transactions, unless the CFPB determines that any proposal issued by the Federal Reserve and HUD carries out the same purpose. Responsibility for issuing these new disclosure forms under TILA and RESPA was transferred from other federal agencies to the CFPB when the agency officially launched on July 21, 2011. Changes from the current Truth in Lending disclosure statement and HUD-1 settlement statement include top-of-form sections where any possible monthly payment changes during the life of the mortgage would be noted. The first prototype disclosure form, called “Hornbeam” by the CFPB, is five pages and the second prototype, known as “Ironwood,” is six pages. The differences between the two prototypes primarily relate to the manner of presentation of certain loan information at the end of the forms. Hornbeam presents summaries of closing costs, lender’s cost of funds, originator fees, total interest as a percentage of the loan amount and total loan payments. Ironwood presents similar information in a tabular format and provides other disclosures using a larger typeface. Copies of the prototype disclosure documents are available on the CFPB’s website.

2. OCC Proposes to Remove Credit Ratings from Eligible Investment Securities Criteria
The OCC issued a proposed rule to remove references to credit ratings from various OCC regulations, including the reference to credit ratings in the definition of “investment grade” in its investment securities regulations at 12 C.F.R. Part 1. The OCC also issued proposed related guidance on November 29 to clarify steps national banks and federal savings associations should take to meet due diligence requirements when purchasing investment securities and conducting ongoing reviews of their investments. The OCC’s investment securities regulations at 12 C.F.R. Part 1 use credit ratings as a factor in determining the credit quality, marketability, and appropriate concentration levels of investment securities purchased and held by national banks. Under the OCC rules, an investment security must not be “predominantly speculative in nature.” The OCC rules currently provide that an obligation is not “predominantly speculative in nature” if it is rated investment grade or, if unrated, is the credit equivalent of investment grade. The term “investment grade” is currently defined to include a security rated in one of the four highest rating categories by 2 or more nationally recognized statistical rating organizations (“NRSROs”) (or one NRSRO if the security has been rated by only one NRSRO). The OCC has proposed corresponding changes to the investment securities regulations applicable to federal savings associations, now codified at 12 C.F.R. Part 160. The proposed amendments would generally require national banks and federal savings associations to make their own assessments of a security’s creditworthiness, similar to the assessments currently required for the purchase of unrated securities. Comments on the proposed rules and guidance are due by December 29.

      Nutter Notes:  These proposed rules, if adopted, would also indirectly affect investments made by state chartered banks since state chartered banks are generally barred by Section 24 of the Federal Deposit Insurance Act from making any investment not permissible for a national bank, with certain exceptions identified in Part 362 of the FDIC’s regulations. Section 939A of the Dodd-Frank Act requires the OCC and other agencies to review any regulation that requires the use of an assessment of creditworthiness of a security or money market instrument and any requirements in such regulations related to credit ratings. Section 939A also requires the agencies to remove references to, or requirements of reliance on, credit ratings and substitute a standard of creditworthiness that each agency determines to be appropriate. The statute requires each agency to seek to establish, to the extent feasible, uniform standards of creditworthiness, taking into account the entities the agency regulates and the purposes for which those entities would rely on those standards. The OCC’s proposed guidance accompanying its proposed rule to implement Section 939A would clarify steps national banks ordinarily should take to demonstrate that they have properly verified that their investments meet the new credit quality standards under 12 C.F.R. Part 1 and steps national banks and federal savings associations should take to demonstrate that they met due diligence requirements when purchasing investment securities and conducting ongoing reviews of their investment portfolios. According to the proposed guidance, federal savings associations will need to follow FDIC requirements when the FDIC issues its credit quality standards pursuant to Section 939A. The proposed guidance would also reiterate the supervisory risk management expectations associated with permissible investment portfolio holdings for national banks and federal savings associations under 12 C.F.R. Part 1 and Part 160.

3. Agencies Clarify Supervisory Responsibilities for Federal Consumer Financial Laws
The federal banking agencies along with the CFPB and the NCUA issued an interagency statement that explains how the total assets of an insured bank, thrift or credit union will be measured for purposes of determining supervisory and enforcement responsibilities under the Dodd-Frank Act. The CFPB has exclusive supervisory authority and primary enforcement authority over depository institutions classified as “Large Institutions” under the Dodd-Frank Act, and any of their affiliates, for purposes of federal consumer financial laws. The statement issued on November 17 explains that the agencies will use June 30, 2011 call report data to determine a depository institution’s asset size for purposes of the Dodd-Frank Act initially. Thereafter, an institution will not become classified as a “Large Institution” under the Dodd-Frank Act unless it has reported total assets of greater than $10 billion in its quarterly call report for 4 consecutive quarters. Similarly, an institution will not cease to be a classified as a “Large Institution” unless it has reported total assets of $10 billion or less in its quarterly call report for 4 consecutive quarters.  

      Nutter Notes:  Under Section 1025 of the Dodd-Frank Act, the CFPB has exclusive authority to require reports and conduct examinations on a periodic basis of any insured depository institution with total assets of more than $10 billion and any affiliate, and any insured credit union with total assets of more than $10 billion and any affiliate. The CFPB is required to coordinate its supervisory activities with the supervisory activities conducted by prudential regulators and state bank regulatory authorities, including scheduling examinations. Section 1026 of the Dodd-Frank Act provides that the Director of the CFPB may require reports from an insured depository institution with total assets of $10 billion or less, or an insured credit union with total assets of $10 billion or less to support the role of the CFPB in implementing federal consumer financial law and to detect and assess risks to consumers and consumer financial markets. The CFPB is required to use otherwise available reports to the extent possible. The Federal Reserve, the FDIC, the OCC and the NCUA will retain supervisory and enforcement authority over federal consumer financial laws for depository institutions with total assets of $10 billion or less.

4. Court Rules that Consumers May Sue to Recover Costs of Payment Card Data Breach
A federal appeals court has held in a recent case that consumers whose credit and debit card data was allegedly stolen when a national grocery store chain’s electronic payment processing system was breached may move forward with a lawsuit against the grocery store chain. The October 20 ruling from the U.S. Court of Appeals for the First Circuit held that the consumers have adequately stated claims under Maine law based on negligence and implied contract to move forward with the case. The court affirmed a lower court ruling that the grocery store chain did not owe a fiduciary duty to maintain the confidentiality of payment card data and that the consumers failed to adequately state a claim under a state consumer protection law. The lower court had also held that the consumers did adequately state claims that the grocery store chain negligently failed to take reasonable care to protect the payment card data and that a jury could find an implied contract between the consumers and the grocery store chain that the grocer would take reasonable measures to protect the payment card data. However, while the lower court had held that the consumers’ alleged injuries for negligence and breach of implied contract were too unforeseeable, the appeals court disagreed and held that it was reasonably foreseeable that consumers who found out that their payment card data had been stolen would replace the cards in order to mitigate the risk of misuse of the data, thereby incurring replacement costs, and purchase credit monitoring services and identity theft insurance.

    Nutter Notes: The case is significant because, among other reasons, many banks’ agreements with data processing vendors obligate the bank to indemnify the vendor for liability the vendor may suffer to third parties including the bank’s customers (for example, arising out of a data security breach by the vendor) even in circumstances where the vendor is negligent and the bank is not. If a consumer action were brought against a data processing company following a data security breach similar to the one at issue in this case, banks could be exposed to liability even though the banks themselves might not be at fault. It was widely reported that the data security breach at issue in this case affected up to 4.2 million cards used at the grocery store chain in New England and in Florida, and that many financial institutions reissued credit and debit cards to affected consumers whether or not there was evidence of actual fraudulent use of the payment card data. The fact that many financial institutions reissued payment cards to affected customers to mitigate losses in the absence of evidence of actual fraud was viewed by the appeals court as evidence that it was reasonable for consumers to replace compromised payment cards even if the card issuer did not immediately do so. In this case, over 1,800 fraudulent charges had been identified by the time the grocery store chain publicly disclosed the breach, and the court found that consumers could reasonably expect that more fraudulent charges would follow.

5. Other Developments: CFPB Enforcement Actions and Investment Adviser Exemptions

  • CFPB Issues Policy Statement on Early Warning Prior to Enforcement Actions

The CFPB announced on November 7 that it would provide advance notice of potential enforcement actions to individuals and firms under investigation by the new federal agency. The CFPB’s Early Warning Notice process will allow the subject of an investigation to respond to any potential legal violations before the CFPB ultimately decides to take formal action.

      Nutter Notes: The CFPB Early Warning Notice process would begin with the CFPB’s Office of Enforcement explaining to an individual or firm that evidence gathered in a CFPB investigation indicates that the individual or firm appears to have violated a consumer financial protection law. The recipient of the notice would then have 14 days to submit a response in writing to the CFPB’s allegations.

  • Massachusetts Securities Division Proposes Revisions to Investment Adviser Exemptions

The Massachusetts Securities Division on November 2 issued proposed amendments to its investment adviser registration requirements that would phase out the registration exemption for those who serve as advisers only to institutional buyers but would also create a new private fund adviser registration exemption. Comments on the proposed amendments are due by January 6, 2012.

    Nutter Notes: The proposed amendments would narrow the definition of “institutional buyer” that currently includes an investing entity that accepts only “accredited investors,” each of which has invested at least $50,000, by making that category available only to advisers of funds that existed prior to March 30, 2012 (the date the SEC’s new rules regarding investment adviser exemptions take effect) and that have not accepted new investors since that date.

Nutter Bank Report

Nutter Bank Report is a monthly electronic publication of the Banking and Financial Services Group of the law firm of Nutter McClennen & Fish LLP. Chambers and Partners, the international law firm rating service, has ranked Nutter’s Banking and Financial Services practice among the top banking practices in the nation. The 2009 Chambers and Partners review says that a “real strength of this practice is its strong partners and . . . excellent team work.” Clients praised Nutter banking lawyers as “practical, efficient and smart.” Visit the U.S. rankings at ChambersandPartners.com. The Nutter Bank Report is edited by Matthew D. Hanaghan. Assistance in the preparation of this issue was provided by Lisa M. Jentzen. The information in this publication is not legal advice. For further information, contact:

Kenneth F. Ehrlich
kerlich@nutter.com                      
Tel: (617) 439-2989

Michael K. Krebs 
mkrebs@nutter.com
Tel: (617) 439-2288

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