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Nutter Bank Report, July 2009

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1.  Treasury Releases Details of Sweeping Regulatory Reform Plan
2.  Compensation Practices Targeted at Public and Non-Public Banking Companies
3.  Federal Reserve Proposes Tightened Truth in Lending Requirements
4.  Federal Court Upholds OTS Rule Limiting Minority Stock Ownership of Mutuals
5.  Other Developments: Charter Conversions and Mandatory Arbitration Clauses

Full Reports

1.  Treasury Releases Details of Sweeping Regulatory Reform Plan

The U.S. Department of the Treasury has submitted proposed legislation to Congress that would revise, in a wide range of significant ways, how the federal government regulates banks, other financial services companies and the capital markets. The proposed legislation, released in stages by Treasury throughout July, provides further details of Treasury’s plan announced on June 17 to streamline financial services regulation, close loopholes and otherwise address perceived causes of recent crises in the financial markets. Among other things, the legislation would eliminate the OCC and replace it with a new agency to be called the National Bank Supervisor (NBS); eliminate the OTS as well as the federal savings bank charter; make the Federal Reserve a systemic risk regulator and broaden its powers to more effectively carry out that function; and create a new agency to be called the Consumer Financial Protection Agency (CFPA) to enforce consumer protection requirements on financial institutions. The legislation would require credit rating agencies and advisers to many private pools of capital to register with the SEC, and require all standardized derivative contracts to be cleared through regulated central counterparties.  National banks would be permitted to exist in mutual or stock form, thereby allowing federal mutual savings banks to convert either to mutual national bank charters or state mutual charters. The Bank Holding Company Act would be amended to eliminate exceptions from the definition of “bank” covering special-purpose institutions such as industrial loan companies and limited purpose trust companies, putting regulation of the companies that control those institutions into the Federal Reserve’s hands under the Bank Holding Company Act.

Nutter Notes:  Treasury’s proposed legislation to create the CFPA, summarized in the July 8, 2009 Special Edition of the Nutter Bank Report, would require banks and other financial services providers to make “balanced” communications to consumers of the potential benefits and risks of banking or financial transactions, while prominently disclosing significant risks and costs; require the CFPA to write rules to ensure that banks and other financial services providers deal fairly with consumers, which may include restrictions on compensation practices; require banks and other financial services providers to make available in electronic form to customers who are consumers information relating to banking and financial transactions with those customers including costs, charges and usage data; and permit, but not require, the CFPA to write rules requiring that banks and other financial services providers offer basic or “standard” consumer financial products before offering more complex ones. A similar bill has been introduced in Congress by Chairman Frank as H.R. 3126. A key difference between H.R. 3126 and the draft released by Treasury is that H.R. 3126 would not shift Community Reinvestment Act responsibilities to the CFPA.  Another element of Treasury’s proposed financial regulatory reform legislation would apply national bank lending limits to state-chartered banks, preempting state lending limits. Currently, the per-borrower lending limit in Massachusetts is 20% of capital and surplus, with certain exceptions. The national bank limit, with certain exceptions, is 15% of capital and surplus with an additional 10% if the loan is secured by readily marketable collateral.

2.  Compensation Practices Targeted at Public and Non-Public Banking Companies

Treasury’s regulatory reform proposal would set standards of independence for compensation committees of publicly traded companies including publicly traded banking companies. A draft of the bill requiring members of the compensation committee of a public company to be independent of management was introduced in the House of Representatives on July 21 as H.R. 3269. The legislation would require each public company to give its compensation committee the authority and funding to hire independent compensation consultants, outside counsel and other advisers to help the committee negotiate with management for compensation packages that are in the best interests of the company’s shareholders. If the committee decides not to use its own compensation consultant, it would be required to explain that decision in proxy materials delivered to shareholders. The legislation would require that any such compensation consultant and legal counsel also be independent from management. Each member of the compensation committee would be required to satisfy new independence standards. Among other requirements, compensation committee members would be prohibited from being affiliated persons of the company or any of its subsidiaries, and committee members would be prohibited from accepting any consulting, advisory or other fees from the company other than fees for services as a director or committee member.

Nutter Notes:  Separately, the proposed legislation would require “covered financial institutions,” a term defined to include public and non-public depository institutions, including mutual institutions, to disclose to their primary federal regulators the structures of incentive-based compensation arrangements for officers and directors. The regulators would use the information to determine whether these incentives were aligned with sound risk management, accounted for the time horizon of risks and meet other criteria to reduce incentives to take undue risks that could threaten the safety and soundness of covered financial institutions or have serious adverse effects on economic conditions or financial stability. Not later than 270 days after enactment, the federal agencies would be required to issue regulations prohibiting compensation structures and incentive-based payment arrangements, or any feature of them, that the agencies determine encourage inappropriate risks by covered financial institutions or officers and directors that could threaten the safety and soundness of covered financial institutions or could have serious adverse effects on economic conditions or financial stability. The term “covered financial institution” means any depository institution and any depository institution holding company, any credit union, any securities broker-dealer, any investment adviser, and any other financial institution that the federal agencies determine should be treated as a “covered financial institution” and covered by the rules.

3.  Federal Reserve Proposes Tightened Truth in Lending Requirements

The Federal Reserve Board has proposed sweeping changes to Regulation Z, its Truth in Lending rules, that would limit the way mortgage brokers and loan originators may be compensated and affect the timing and content of consumer disclosures for both closed-end mortgages and home-equity lines of credit (HELOCs). The proposed amendments to Regulation Z released on July 23 prohibit payments including yield spread premiums to a mortgage broker or a loan officer that are based on the loan’s interest rate or other terms. Mortgage brokers and loan officers would also be prohibited from “steering” a consumer to a transaction that is not in the consumer’s interest in order to increase the mortgage broker’s or loan officer’s compensation. The proposal does not specify how to determine whether a loan is in the consumer’s interest, but suggests that the determination would consider other possible loan offers available through the originator, and for which the consumer was likely to qualify, at the time the loan was offered to the consumer. Closed-end home loan disclosures would be modified so that the calculation of the annual percentage rate (APR) captures most fees and settlement costs paid by consumers. Lenders would also be required to show how the consumer’s APR compares to the average rate offered to borrowers with excellent credit. Among other changes proposed for HELOCS, a creditor would be prohibited from terminating an account for a consumer’s late payment unless the payment is more than 30 days overdue. The comment period will end 120 days after publication of the proposals in the Federal Register, which is expected shortly.

Nutter Notes:  The Federal Reserve also approved an interim final rule on July 15 that revises Regulation Z to implement some of the changes required by the Credit Card Accountability Responsibility and Disclosure Act of 2009 (the Credit Card Act) that President Obama signed into law in May. The revised rules increase to 45 days the amount of notice a creditor must give to a consumer before the rate on a credit card account is increased or a significant change is made to the account’s terms. The same notice must also inform the consumer of his or her right to cancel the account before the increase or change takes effect.  If the consumer does so, the creditor is generally prohibited from applying the increase or change to the account. The revised rules become effective on August 20, 2009, but the Federal Reserve will accept comments until September 21, 2009 and could make changes to the rules at a later date. The Credit Card Act’s amendments to the federal Truth in Lending Act go into effect in three stages. The interim final rule approved on July 15 implements the provisions of the Credit Card Act that go into effect on August 20, 2009. The remaining provisions of the act, which address, among other things, interest rate increases, over-the-limit transactions, the reasonableness and proportionality of penalty fees and charges, and reevaluation by creditors of rate increases become effective in 2010. The Federal Reserve plans to issue rules implementing those provisions at a later date, at which time it may amend or withdraw portions of two final Truth in Lending rules published in January 2009 that become effective on July 1, 2010, to the extent that those rules are inconsistent with the requirements of the Credit Card Act.

4.  Federal Court Upholds OTS Rule Limiting Minority Stock Ownership of Mutuals

The U.S. Court of Appeals for the D.C. Circuit has upheld an OTS regulation that allows stock holding company subsidiaries of mutual holding companies to provide in their charters that no person may acquire more than 10% of the outstanding minority stock. In its July 7, 2009 decision, the court rejected a challenge to the OTS regulation brought by a private investor on the grounds that the rule was arbitrary and capricious, and instead found that the OTS had “struck a permissible balance between the goals of deterring management’s self-dealing and preventing abusive short-term investment strategies.” OTS regulations generally govern the process by which a federal mutual savings bank may convert into the mutual holding company form of organization and sell a minority portion of the resulting mid-tier holding company to the public. The regulations also require that stock benefit plans for directors, officers and employees be approved by a majority of the minority stock of the mid-tier to limit self-dealing by directors and management. The regulation in question allows a mid-tier holding company to include in its charter a provision barring any investor from acquiring more than 10% of the outstanding minority stock within a certain period (up to five years) after the minority stock issuance.  In addition, the optional charter provision provides that, if a person acquires more than 10% of the minority stock during the restricted period, the investor may not vote the excess stock. The court noted that the OTS regulation was, in part, a reaction to concern by the OTS that minority shareholders may use leverage in voting on stock benefit plans to improperly influence the governance of the corporation.

Nutter Notes:  The case highlights competing regulatory concerns relating to federal thrift institutions in the mutual holding company form that have issued a minority equity interest to the public. On the one hand, the OTS had previously sought to limit the ability of directors and management to reward themselves through generous stock benefit plans by requiring that a majority of the public shareholders approve any such plan. Once that regulation was in place, however, the OTS became concerned about minority investors requiring concessions from management in order to gain their approval of the benefit plans. The court gave examples, cited in the OTS’s notice of the proposed regulation prior to adoption of the final rule, of investors demanding that management cause the institution to repurchase their stock or commit to sell the institution in exchange for their vote on a benefit plan. The ownership restriction may have implications beyond the approval of stock benefit plans. While the approval of a stock benefit plan may be one of the most economically significant transactions presented to shareholders in the first five years after a minority stock offering, both the ownership limitation and the voting limitation apply to all minority holders and voting rights on all matters presented to shareholders during that time.  As a result, the optional charter provision could be unattractive to investors in a minority stock offering. Only July 22, Representative Caroln Maloney introduced a bill, H.R. 3291, that would effectively overturn the OTS regulation.

5.  Other Developments: Charter Conversions and Mandatory Arbitration Clauses

  • Federal Banking Agencies Warn Banks Against Charter Shopping

The Federal Financial Institutions Examination Council (FFIEC) issued a Statement on Regulatory Conversions to reaffirm that the federal banking regulators are unified in their approach to charter conversions. According to the July 1 statement, a federal banking agency will only consider conversion applications undertaken for legitimate reasons and will not entertain applications that “undermine the supervisory process.”

Nutter Notes:  The statement advised that a depository institution should not file a conversion application while serious or material enforcement actions are pending with the current chartering authority or primary federal regulator because such requests could delay or undermine supervisory actions. The FFIEC said that ratings assigned under uniform rating systems and outstanding corrective programs will remain in place following a charter conversion or supervisory agency change.

  • Massachusetts High Court Strikes Down Mandatory Arbitration Clause

The Massachusetts Supreme Judicial Court recently ruled that a clause compelling mandatory arbitration in a consumer contract was unenforceable. The Supreme Judicial Court’s July 2 decision held that the mandatory arbitration clause was “contrary to the fundamental public policy of [Massachusetts] favoring consumer class actions” under the Massachusetts Consumer Protection Law.

Nutter Notes:  Chapter 93A, the Massachusetts Consumer Protection Law, prohibits unfair and deceptive acts or practices in the conduct of any trade or business in Massachusetts. The ruling affects any provision in a consumer contract in Massachusetts that has the effect of barring a class action lawsuit by requiring the consumer to resolve any dispute in private arbitration.

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 Rena Marie Strand 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

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