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Nutter Bank Report, April 2012

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1. DOR Eases Restrictions on Pledges of Security Corporation Stock
2. CFPB Provides Guidance on Compensation to Mortgage Loan Originators
3. Massachusetts Debt Collection Rules Impose New Burdens on Creditors
4. Federal Reserve Issues Guidance on the Rental of Residential OREO
5. Other Developments: Liability for Vendor Acts and Reserves Administration

1. DOR Eases Restrictions on Pledges of Security Corporation Stock
The Massachusetts Department of Revenue (DOR) has issued a revised draft of a regulatory directive addressing the ability of a shareholder of a Massachusetts security corporation to pledge its stock in the security corporation as collateral for a loan to the shareholder. The DOR has removed from the revised draft of the directive released on April 6 certain restrictions on pledges of the stock of a security corporation that appeared in the original draft of the directive released on September 30, 2011. In the original draft of the directive, the DOR announced that it would revoke a security corporation’s classification if the shareholder pledged stock representing more than 50% of the value or total voting power of the security corporation, or if the pledge included covenants that restricted the scope of the security corporation’s permitted assets, liabilities or activities. The revised draft of the directive includes examples of restrictive covenants that the DOR says would result in revocation of security corporation classification, such as a covenant requiring the shareholder to withdraw securities from the security corporation and pledge those securities to the lender or a covenant directing the security corporation’s investments to securities of the shareholder, the pledgee or their respective affiliates.

    Nutter Notes: A corporation that qualifies and is classified by the DOR as a Massachusetts security corporation receives beneficial tax treatment. A security corporation must restrict its activities to buying, selling, dealing in or holding securities on its own behalf and not as a broker, and the securities it holds must be acquired and held for investment purposes. In addition to the discussion of impermissible restrictive covenants in connection with a pledge of security corporation stock, the revised directive addresses the circumstances in which a security corporation may acquire appreciated securities from an affiliate and subsequently sell those securities to a third party without resulting in revocation of security corporation classification. For example, a security corporation may acquire appreciated securities from an affiliate and subsequently sell those securities to a third party in cases where the securities acquired from the affiliate were initially acquired by the affiliate through a public exchange or other arm’s-length secondary market transaction. However, according to the revised directive, in general a security corporation may not be used as a conduit for the sale of appreciated securities for the purpose of sheltering the gain on the sale from the general corporate excise tax rate.

2. CFPB Provides Guidance on Compensation to Mortgage Loan Originators
The Bureau of Consumer Financial Protection (CFPB) has issued guidance clarifying the Truth in Lending rules that restrict the payment of incentive compensation to mortgage loan originators. The guidance, CFPB Bulletin 2012-02 issued on April 2, addresses questions about whether and how those restrictions under Regulation Z apply to employer contributions to qualified profit-sharing, 401(k) and employee stock ownership plans (Qualified Plans). Subject to certain exceptions, Regulation Z prohibits the payment of incentive compensation to a loan originator that is based on any terms or conditions of a mortgage transaction. The CFPB said that it has been asked whether a financial institution can, consistent with the restrictions on incentive compensation to mortgage loan originators, contribute to Qualified Plans for employees, including loan originators, if the employer contributions are derived from profits generated by mortgage loan originations. According to the guidance, the CFPB takes the position that Regulation Z permits employers to contribute to Qualified Plans out of a profit pool derived from loan originations. The CFPB’s guidance did not address how the Regulation Z compensation restrictions apply to profit-sharing plans that are not Qualified Plans, but did say that it plans to address profit-sharing plans in a forthcoming proposed rule on the loan origination provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).

    Nutter Notes: Amendments to Regulation Z implementing the loan originator compensation restrictions were originally adopted by the Federal Reserve in September 2010, and compliance with the restrictions became mandatory on April 6, 2011. Rulemaking authority for Regulation Z was transferred to the CFPB pursuant to Title X of the Dodd-Frank Act. The official staff commentary to Regulation Z explains that the terms or conditions of a mortgage loan transaction that trigger the loan originator compensation restrictions include the interest rate, loan-to-value ratio or prepayment penalty. The commentary clarifies that compensation may not be based on a factor, such as a credit score, that is a proxy for one of those terms or conditions. The commentary also provides examples of when compensation is not based on a term or condition of the loan, such as basing compensation on the long-term performance of the loan or whether the consumer is an existing customer or a new customer. Section 1403 of the Dodd-Frank Act contains provisions that also address loan originator compensation. The Dodd-Frank Act requires the CFPB to adopt final loan originator compensation rules by January 21, 2013. The CFPB said that it plans to issue a proposed rule to implement the loan origination provisions of the Dodd-Frank Act in the near future.

3. Massachusetts Debt Collection Rules Impose New Burdens on Creditors
Recent amendments to the Massachusetts Attorney General’s debt collection regulations expand the scope of the regulations to cover debt collection activities involving cell phone and text messaging and make first mortgage loans and consumer loans in excess of $25,000 subject to the rules. The amendments, which went into effect on March 2, include a requirement that a creditor cease collection of a debt under certain circumstances until the creditor has provided the debtor or an attorney for the debtor with certain information and documentation in the event that the debtor disputes the validity of the debt. Under that requirement, a creditor must deliver to the debtor copies of all documents relating to the debt and bearing the debtor’s signature, a ledger or statement reflecting payment history and certain charges relating to the debt (such as interest, fees, charges and amounts collected for escrow), the name and address of the original creditor, if different from the creditor collecting the debt, and a copy of any judgment against the debtor. Lenders, including banks, which collect their own debts should establish policies and procedures to comply with the new disclosure and documentation requirements, and to respond to a notice of dispute of a debt in the manner required by the amended regulations.

    Nutter Notes: Other changes to the debt collection regulations made by the recent amendments include the expansion of the term “creditor” to cover both active and passive debt buyers, whether they collect a debt for themselves or hire a third party or attorney to collect it for them, and, as noted above, the expansion of the definition of “debt” by removing the exclusions for residential first mortgage loans and consumer loans in an amount in excess of $25,000. Other provisions of the regulations were modernized to reflect newer communications technologies, such as cell phones and text messaging and usage fees related to electronic communications. Amendments to the general prohibitions on unfair or deceptive acts or practices now incorporate certain prohibited practices from Division of Banks debt collection rules. The amended regulation also requires any person collecting a debt to determine, in good faith, whether the debt is time-barred, and to make a specific disclosure to consumers with respect to any debt the collector knows or has reason to know is time-barred.

4. Federal Reserve Issues Guidance on the Rental of Residential OREO
The Federal Reserve has issued new guidance that addresses the circumstances in which banking organizations may rent residential OREO properties as part of an orderly disposition strategy. The guidance, entitled Policy Statement on Rental of Residential Other Real Estate Owned (OREO) Properties (see Supervision and Regulation Letter no. SR 12-5) issued on April 5, advises banking organizations that they may rent 1- to 4-family residential OREO properties without having to demonstrate continuous active marketing of the properties, provided that the institution has appropriate policies and procedures in place. The guidance acknowledges that the general policy of the Federal Reserve is that banking organizations should make good-faith efforts to dispose of OREO properties at the earliest practicable date, but that extraordinary market conditions currently prevail that may merit renting OREO properties more often than in the past. In addition, the guidance indicates that the Federal Reserve will give favorable CRA consideration to institutions it supervises to the extent that OREO properties rented by such institutions meet the definition of community development under the Community Reinvestment Act regulations. The guidance also addresses key risk management considerations for the rental of residential OREO, including compliance with holding-period requirements, compliance with landlord-tenant and associated requirements, and accounting considerations.

    Nutter Notes: The Federal Reserve’s policy statement establishes specific supervisory expectations for banking organizations that undertake large-scale residential OREO rental operations. The Federal Reserve considers residential OREO rental activities involving 50 or more properties available for rent or rented to be large-scale. According to the guidance, banking organizations with large-scale residential OREO rental operations should have formal policies and procedures governing the operation and administration of OREO rental activities, including property-specific rental plans, policies and procedures for compliance with applicable laws and regulations, a risk management framework, and oversight of third-party property managers. Regardless of the size of an institution’s OREO rental operations, the Federal Reserve said that it expects each banking organization considering such rentals to evaluate the overall costs, benefits and risks of renting. The guidance advises banking organizations to pursue a clear and credible approach for ultimate sale of OREO rental properties within applicable holding-period limitations. The guidance suggests that institutions consider exit strategies that include special transaction features to facilitate the sale of OREO properties, such as seller-assisted financing or rent-to-own arrangements with tenants.

5. Other Developments: Liability for Vendor Acts and Reserves Administration

  • CFPB Warns that Financial Institutions May Be Liable for Acts of Vendors

The CFPB released a bulletin on April 13 indicating that financial institutions subject to CFPB supervision may be held responsible for violations of consumer protection laws by companies with which they contract under certain circumstances. According to the bulletin, the CFPB expects that supervised financial institutions have effective processes for managing the risks of service provider relationships.

    Nutter Notes: The bulletin includes the CFPB’s recommendations for steps that institutions should take to ensure that service provider relationships do not present unwarranted risks to consumers, such as conducting thorough due diligence to verify that the service provider understands and is capable of complying with the law, and requesting and reviewing the service provider’s policies, procedures, internal controls, and training materials.

  • Federal Reserve Amends Regulation D to Simplify Reserves Administration

The Federal Reserve approved final amendments to Regulation D on April 5 that it said will simplify the administration of reserve requirements and reduce administrative and operational costs for depository institutions. The amendments will become effective in two phases, the first of which will take effect on July 12, 2012.

    Nutter Notes: The amendments that become effective on July 12 will eliminate contractual clearing balances, discontinue as-of adjustments related to deposit report revisions and replace all other as-of adjustments with direct compensation. The next phase will implement amendments on the creation of a common two-week maintenance period and replacement of carryover and routine waivers effective as of January 24, 2013.

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 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
Tel: (617) 439-2989

Michael K. Krebs 
Tel: (617) 439-2288

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.

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