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Nutter Bank Report, April 2014

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The Nutter Bank Report is a monthly electronic publication of the firm’s Banking and Financial Services Group and contains regulatory and legal updates with expert commentary from our banking attorneys.

1. Banking Agencies Warn of Cyber-Attacks on ATMs and Bank Websites
2. Massachusetts Court Rules that NDIP Disclosures Were Adequate
3. Federal Reserve Issues Examination Guidance for Larger Banks on Loan Sampling
4. CFPB Proposes Amendments to International Money Transfer Rule
5. Other Developments: Oil and Gas Lending and the Heartbleed Bug 

1. Banking Agencies Warn of Cyber-Attacks on ATMs and Bank Websites

The federal banking agencies, through the FFIEC, have issued guidance to banks on the risks associated with cyber-attacks on ATM and card authorization systems and distributed denial of service (“DDoS”) attacks on banks’ public-facing websites. The guidance published on April 2 describes measures that the banking agencies expect banks to take from a risk management standpoint to address these attacks. The attacks on ATM and card authorization systems are a type of large dollar value cash-out fraud that the U.S. Secret Service calls “Unlimited Operations.” In an Unlimited Operations attack, criminals are able to withdraw funds beyond the cash balance in customer accounts or beyond other control limits typically applied to ATM withdrawals. According to the guidance, criminals perpetrate the fraud by initiating cyber-attacks to gain access to web-based ATM control panels, which enables them to withdraw customer funds from ATMs using stolen customer debit, prepaid or ATM card account information. For example, the guidance describes an instance where a recent Unlimited Operations attack netted over $40 million in fraud using only 12 debit card accounts. According to the guidance, an Unlimited Operations attack may begin with phishing e-mails sent to bank employees as a means to install malicious software onto the bank’s network. Criminals use the malicious software to monitor the bank’s network to determine how the bank accesses ATM control panels and obtain employee login credentials. Aside from fraud losses, the risks associated with Unlimited Operations include operational risk, liquidity and capital risks, depending on the size of the institution and the losses incurred, and reputation risk. According to the guidance, the federal banking agencies expect banks to manage these risks by following the processes contained in the FFIEC Information Technology Examination Handbook, and specifically the Information Security, Outsourcing Technology Services and Retail Payment Systems booklets of the handbook.

    Nutter Notes: The agencies’ guidance describes recent DDoS attacks launched against banks by politically motivated groups. According to the guidance, these DDoS attacks have increased in sophistication and intensity, cause slow website response times, intermittently prevent customers from accessing banks’ websites and interfere with back-office operations. The guidance warns that, in some cases, DDoS attacks serve as a diversionary tactic by criminals attempting to commit fraud using stolen customer or bank employee credentials to initiate fraudulent wire or automated clearinghouse transfers. According to the guidance, the federal banking agencies also expect banks to prepare for DDoS attacks as part of their ongoing information security and incident plans. The guidance recommends that each bank monitor incoming traffic to its website, activate incident response plans if it suspects that a DDoS attack is occurring and ensure sufficient staffing for the duration of the attack, including the use of third-party service providers when appropriate. The guidance for both DDoS attacks and Unlimited Operations attacks advises banks to conduct ongoing information security risk assessments, perform security monitoring to detect attacks, and develop and test incident response plans for these types of attacks. The guidance also recommends that banks consider sharing information with organizations like the Financial Services Information Sharing and Analysis Center and law enforcement to help identify and mitigate new criminal threats and tactics. The FDIC on April 10 issued guidance that lists a number of other resources that may help banks identify and mitigate potential cyber-related risks, including the Department of Homeland Security’s United States Computer Emergency Readiness Team, the U.S. Secret Service’s Electronic Crimes Task Force and the FBI’s InfraGard.

2. Massachusetts Court Rules that NDIP Disclosures Were Adequate

A Massachusetts appeals court recently ruled in favor of a depository institution in a consumer protection case in which a customer who wished to purchase a certificate of deposit was steered instead to purchase a non-deposit investment product. In the March 31 decision under the Massachusetts consumer protection law, Chapter 93A of the General Laws of Massachusetts, the court held that the consumer could not demonstrate that any false or deceptive act or practice of the depository institution misled the consumer into investing in nonguaranteed mutual funds instead of the certificate of deposit he originally intended to purchase. The court’s decision hinged on the fact that the risks of the investments were disclosed to the consumer. The consumer claimed that he spoke with an employee of the depository institution about purchasing a $200,000 one-year certificate of deposit with an interest rate of 5% per annum. The employee allegedly stated that she thought the consumer could “do much better than that,” and referred the consumer to a financial planner affiliated with the depository institution. The financial planner discussed uninsured non-deposit investment products with the consumer and the consumer decided to invest in nonguaranteed mutual funds instead of a certificate of deposit. After approximately four years, the consumer decided to sell his interests in the mutual funds at a loss of over $26,000. The court found that the risks of the investment were fully explained to the consumer and there were no other facts that describe the kind of unfair or deceptive acts or practices prohibited by Chapter 93A.

    Nutter Notes: The consumer in this case argued that the statement by the depository institution’s employee was more than an expression of opinion, and that it could have misled the consumer into believing that the non-deposit investment products offered by the financial advisor were “much better” than a CD because they provided a higher rate of return with no greater risk. The consumer also argued that the financial advisor made “very optimistic projections” and “presented a very optimistic view of how much money could be made.” The court noted that the depository institution profits from the sale of non-deposit investment products to its customers, and that the institution’s employees were urged to refer customers to the affiliated financial advisor. The court also noted that the institution’s employee evaluations included an assessment of whether employees were making such referrals. However, the court pointed out that the consumer himself acknowledged that the risks of the non-deposit investment options proposed by the financial advisor were “thoroughly explained to him.” The court found that the referring employee did not inform the financial advisor that the consumer initially wished to purchase a certificate of deposit, and the financial advisor did not include a certificate of deposit among the investment options presented to the consumer. The court held, however, that where the consumer made the decision to invest in mutual funds only after having the risks explained to him, and where he was aware that a certificate of deposit presented no risk, the consumer cannot demonstrate that any false or deceptive act or practice within the meaning of Chapter 93A misled him into buying the mutual funds instead of the certificate of deposit.

3. Federal Reserve Issues Examination Guidance for Larger Banks on Loan Sampling

The Federal Reserve has published examination guidance that describes loan sampling expectations for the examination of state member banks with $10 to $50 billion in total consolidated assets. According to Supervision and Regulation Letter 14-4, issued on April 18, the Federal Reserve Banks will conduct at least two loan quality reviews during the annual supervisory cycle of each state member bank with $10 to $50 billion in total consolidated assets. Each review will focus on one or more material commercial loan segment exposures by Call Report loan type and, in total over the annual cycle, will cover the four highest concentrations for commercial credits in terms of total risk-based capital for any Call Report loan type from Schedule RC-C. The guidance says that examiners will also sample any loan category that contributes 25% or more to annual revenues, because loan segments that generate substantial revenues are generally likely to entail higher risk, and other loan segments that examiners or the bank’s internal loan review have identified as exhibiting high risk characteristics. Such risk characteristics include liberal underwriting standards, high levels of policy exceptions, high delinquency trends, rapid growth, new lending products, concentrations and concentrations to industry, significant levels of classified credits, or significant levels of special mention credits, according to the guidance.

    Nutter Notes: According to the Supervision and Regulation Letter, examiners will generally consider a bank’s internal risk rating system to be less reliable when examiner downgrades or internal loan review downgrades equal 10% of the total number of loans reviewed, or 5% of the total dollar amount of loans and commitments reviewed. When a bank’s risk rating system is determined to be unreliable, the guidance suggests that examiners may need to expand the loan sample to better evaluate the effect of rating differences on the bank’s allowance for loan and lease losses and capital. In such situations, examiners will likely direct the bank to take corrective action to validate its internal ratings and to evaluate whether the allowance for loan and lease losses or capital should be increased, according to the guidance. The guidance also recommends that an institution’s internal loan review program should cover substantially more loans than examiners’ annual samples of material loan portfolios. Examiners will review the findings and recommendations of each institution’s internal loan review program to help identify areas of risk, according to the guidance. In selecting loans from each segment of the loan portfolio to review, the Federal Reserve said that examiners will review a selection of the largest loans, problem loans and newly originated loans.

4. CFPB Proposes Amendments to International Money Transfer Rule

The CFPB has proposed amendments to Subpart B of Regulation E, governing international money transfers, that would extend a temporary provision that permits banks to estimate certain pricing disclosures under Section 1073 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). The proposed amendments released on April 15 would provide banks with additional time to provide exact pricing disclosures in certain cases. Absent the proposed amendments, the temporary provision would expire on July 21, 2015. The CFPB has determined that the expiration of that provision would negatively impact the ability of banks to send remittance transfers, and has proposed to extend the temporary provision for five years to July 21, 2020. The CFPB said that some banks have indicated that current market conditions would make it impossible for them to determine the exact fees and exchange rates associated with certain remittance transfers in order to satisfy the disclosure requirements that become applicable when the exception expires in July 2015. Banks that are unable to comply with the disclosure requirements would be unable to send some transfers to certain parts of the world that they currently serve, according to the CFPB. Comments on the proposed amendments are due by May 27.

    Nutter Notes: Section 1073 of the Dodd-Frank Act amended the Electronic Fund Transfers Act (“EFTA”) by establishing a new consumer protection regime, including required disclosures of third-party fees and exchange rates, for remittance transfers sent by consumers in the United States to individuals and businesses in foreign countries. The EFTA defines “remittance transfer” to include most electronic transfers of funds sent by consumers in the United States to recipients in other countries. The CFPB’s final rule implementing Section 1073 of the Dodd-Frank Act took effect on October 28, 2013. The EFTA and the final rule create a temporary exception that allows covered remittance transfer providers to estimate fees and exchange rates in certain circumstances. Specifically, the exception allows a remittance transfer provider to estimate certain third-party fees and exchange rates associated with a remittance transfer if the provider is an insured depository institution or credit union, the remittance transfer is sent from the sender’s account with the provider, and the provider cannot determine the exact amounts for reasons outside of its control. In addition to the CFPB’s proposal to extend that temporary exception, the CFPB is proposing some clarifications and technical corrections to the final remittance transfer rule, such as clarifying how U.S. military installations abroad are treated under the rule.

5. Other Developments: Oil and Gas Lending and the Heartbleed Bug 

  • OCC Issues New Guidance on Oil and Gas Production Lending

The OCC issued a new Oil and Gas Production Lending booklet to the Comptroller’s Handbook on April 9. The new booklet provides guidance on oil and gas production lending, including an overview of oil and gas markets, lending structures, types of reserves, associated risks and the OCC’s supervisory expectations for risk management.

    Nutter Notes: The principles contained in the new Oil and Gas Production Lending booklet apply to all national banks and federal savings associations engaged in oil and gas production lending, regardless of the size of the institution. There is no specific limit on a national bank’s oil and gas lending exposure, but certain exposure limitations do apply to federal savings associations. 

  • Federal Banking Agencies Issue Guidance on the Heartbleed Bug

The federal banking agencies, through the FFIEC, announced on April 10 that they expect banks to incorporate patches on information systems and services, applications and appliances using the OpenSSL cryptographic software library, and to upgrade systems as soon as possible to address the OpenSSL vulnerability commonly referred to as the Heartbleed Bug.

    Nutter Notes: The Heartbleed Bug could allow an attacker using the Internet to read the memory of systems protected by the vulnerable versions of the OpenSSL software. Attackers could potentially impersonate bank customers, steal bank employee login credentials, access sensitive e-mail or gain access to internal networks.

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, after interviewing our clients and our peers in the profession, has ranked Nutter’s Banking and Financial Services practice among the top banking practices in the nation. The 2012 Chambers and Partners review says that a “broad platform” of legal expertise in the practice “helps clients manage challenges and balance risks while delivering strategic solutions,” while the 2013 Chamber and Partners review reports that Nutter’s bank clients describe Nutter banking lawyers as “proactive” in their thinking, “creative” in structuring agreements, and “forward-thinking in terms of making us aware of regulation and how it may impact us,” which the clients went on to describe as “indicative of a true partner.” 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 Wendy M. Fiscus, Beth H. Mitchell and 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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