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Nutter Bank Report, July 2012

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1. Massachusetts Legislature Sends Foreclosure Reform Bill to the Governor
2. Bank’s On-Line Security Procedures Ruled Commercially Unreasonable
3. Federal Reserve Issues Guidance for New Pre-Filing Review Process
4. Court Rejects Challenge to Springfield Foreclosure Ordinances
5. Other Developments: Corporate Debt Securities and Financial Market Utilities

1. Massachusetts Legislature Sends Foreclosure Reform Bill to the Governor

The Massachusetts legislature has approved a foreclosure reform bill that modifies the foreclosure process and requires creditors to make a good faith effort to avoid foreclosure before proceeding with a foreclosure sale on certain types of home mortgage loans. The bill (H. 4323) approved by the Massachusetts House and Senate on July 26 would add a new Section 35B to Chapter 244 establishing criteria that a creditor must satisfy in order to show that the creditor has taken “reasonable steps and made a good faith effort” to avoid foreclosure on certain types of home mortgage loans. Those criteria would include an assessment of the borrower’s current income, total debts and obligations, the net present value of receiving payments pursuant to a modified mortgage loan as compared to the anticipated net recovery following foreclosure, and the interests of the creditor. The good faith effort to avoid foreclosure requirements would apply to home mortgage loans with features such as a teaser rate, interest-only payments (other than an open-end home equity line of credit), negative amortization, limited or no documentation of the borrower’s income or assets, certain prepayment penalties or loans meeting certain loan-to-value criteria. The bill also includes penalties for documentation and processing errors in the foreclosure process. The Governor is expected to sign the legislation. 

    Nutter Notes: The bill includes an exemption from the good faith effort to avoid foreclosure requirements for loans originated under MassHousing and Massachusetts Housing Partnership programs. The bill would also amend Chapter 244, Section 14 of the General Laws of Massachusetts to require that documentation of assignment(s) of a mortgage be recorded before the foreclosing mortgagee may send a foreclosure notice. The final version of the foreclosure reform bill did not include a provision that had been included in an earlier version of the Senate bill that would have established a new foreclosure mediation program. The foreclosure mediation program under the Senate version would have required a creditor to deliver notice of the borrower’s right to participate in a foreclosure mediation program along with the notice of right to cure a default. Instead, the bill would create a new task force to study existing foreclosure mediation programs and to study ways in which unnecessary vacancies following foreclosures can be prevented. The task force would be made up of members representing the Massachusetts Bankers Association, the Massachusetts Attorney General, certain members of the legislature and members appointed by the governor. The task force must report its findings by December 31, 2013.

2. Bank’s On-Line Security Procedures Ruled Commercially Unreasonable

In a decision addressing security procedures for funds transfers under Article 4A of the Uniform Commercial Code (“UCC”), the U.S. Court of Appeals for the First Circuit has held that a bank’s online security procedures were not commercially reasonable, even though the bank used authentication technology that complied with the Federal Financial Institutions Examination Council Guidelines for Authentication in an Internet Banking Environment. The July 3 decision came in a case where fraudulent electronic funds transfers from a commercial customer’s account at the bank were initiated using the bank’s internet banking service. Malware had been installed on a computer used by the commercial customer to initiate electronic funds transfers for regular weekly payroll payments. The malware allowed hackers to capture the customer’s answers to security questions used to authenticate the identity of users of the bank’s internet banking system. The hackers used that information to initiate the fraudulent transfers. Though the bank’s security system flagged the fraudulent transfers as highly suspicious, the bank did not notify its customer of the potentially fraudulent transfers and allowed the payments to be processed. Although the federal trial court found that the bank’s security procedures were reasonable, the Court of Appeals reversed that decision, emphasizing that the collective failures of the bank’s security procedures, taken as a whole, rendered the security system commercially unreasonable as a matter of law. The case has been remanded to the federal trial court to determine how losses should be allocated in the absence of commercially reasonable security procedures under UCC Article 4A. 

    Nutter Notes: UCC Article 4A governs the respective rights, duties and liabilities between banks and their commercial customers in electronic funds transfers. Generally, under Article 4A, a bank bears the risk of loss resulting from any unauthorized funds transfer order it receives. However, a bank may shift the risk of loss to the customer by requiring that the customer use a commercially reasonable security procedure to verify that a payment order is authorized. The bank must prove that it accepted the payment order in good faith and in compliance with the security procedure and any written agreement or instruction of the customer restricting acceptance of payment orders issued in the name of the customer. One reason that the court found the bank’s security procedure to be unreasonable in this case was that the bank did not take any action once the transfers were flagged as highly suspicious. The bank failed to review the flagged transactions or contact the customer, relying entirely on automated authentication procedures. Monitoring and customer notification of the suspicious transactions would have increased the likelihood that the bank’s security procedures would have been found to be commercially reasonable. The court also questioned the bank’s procedure of using security questions in every transaction, thereby increasing the frequency with which users were required to input the answers and increasing the likelihood that those answers could be captured by unauthorized users. In the court’s view, under certain circumstances, the use of security questions as a stand-alone authentication protocol backing up user IDs and passwords is not a commercially reasonable security procedure. The bank’s petition for a rehearing was denied.

3. Federal Reserve Issues Guidance for New Pre-Filing Review Process

The Federal Reserve has issued supervisory guidance describing a new optional process for an applicant to request a response on a potential bank acquisition or other transaction requiring Federal Reserve approval before the submission of a formal application or notice. The guidance contained in Supervision and Regulation Letter No. 12-12 (July 11, 2012) outlines the pre-filing process by which applicants may work with Federal Reserve staff to receive feedback on potential issues related to proposed transactions, which could shorten the review period for formal applications. According to the guidance, pre-filings should be submitted to the appropriate Reserve Bank, and may be submitted electronically through the Federal Reserve’s Electronic Applications System, E-Apps. The Federal Reserve said that most pre-filings can be addressed swiftly and that reviewing a pre-filing will typically take no more than 60 days, though some may require additional time. If additional time for review is required, the guidance recommends that the final application or notice should be filed and the applicant should not wait for staff to complete its review and assessment of the pre-filing. The guidance notes that staff review will be targeted to the specific request for feedback and is not intended to identify or resolve all issues or concerns related to the application or notice. 

    Nutter Notes: Pre-filings may include information about a specific aspect of a proposed transaction, a business plan, pro forma financial information related to an application or notice, or a presentation outlining a specific proposal. Pre-filings also may include draft transactional and structural documents such as shareholder agreements, purchase agreements, and other transaction documents. In addition, pre-filings may include questions about the type of filing required, the individuals or entities that would need to join a filing, and whether an entity would be considered to be a “company” or have “control” under the Bank Holding Company Act (in the case of acquisition of control of a bank) or the Home Owners’ Loan Act (in the case of acquisition of control of a savings association). Under the Freedom of Information Act, written inquiries and documents submitted in connection with a pre-filing become public records of the Federal Reserve and may become publicly available unless they are determined to fall, in whole or in part, within the scope of one or more of the FOIA exemptions from disclosure. Communications through brief phone conversations or limited e-mail correspondence are not generally considered pre-filings.

4. Court Rejects Challenge to Springfield Foreclosure Ordinances

The U.S. District Court for the District of Massachusetts has dismissed a challenge brought by several banks to the City of Springfield’s foreclosure ordinances. The July 3 decision was handed down in response to the banks’ effort to enjoin Springfield from enforcing a city ordinance that regulates the maintenance of vacant properties and properties in the foreclosure process, as well as a city ordinance that requires mediation prior to foreclosures. The banks argued that both ordinances were preempted by Massachusetts law, that the vacant property ordinance is unconstitutional, and that a provision of the vacant property ordinance requiring a cash bond was a tax that is prohibited by state law. The court in ruling for the city held that the ordinances are not preempted by Massachusetts law. The court held that there is no conflict between the two ordinances on the one hand and Massachusetts law on the other hand that would support a conclusion that the ordinances are preempted. The court also held that the vacant property ordinance does not violate the U.S. Constitution, and that the cash bond requirement constitutes a regulatory fee, not a tax. 

    Nutter Notes: Springfield’s vacant property ordinance requires a foreclosing mortgagee to notify the Building Commissioner and Fire Commissioner of the status of the building, remove all hazardous materials from the building, secure all windows and doors at the discretion of the Fire Commissioner, post “No Trespassing” signs on the property and remove rubbish, standing pools of water, and overgrowth of vegetation. The requirements apply to any vacant property or property in the foreclosure process, including commercial and residential properties. The ordinance also requires a foreclosing mortgagee to maintain liability insurance on the property and post a cash bond in the amount of $10,000 with the Building Commissioner to ensure continued compliance with the ordinance and to reimburse the city for any expenses it incurs in maintaining the property. The mediation ordinance requires any mortgagee who attempts to foreclose on an owner-occupied residential property to participate in a city-approved mediation program. Both parties must make a good faith effort during mediation to “negotiate and agree upon a commercially reasonable alternative to foreclosure . . . .” The ordinances went into effect on December 13, 2011 and apply to all mortgages in effect as of that date.

5. Other Developments: Corporate Debt Securities and Financial Market Utilities

  • FDIC Rule Prohibits Investments by Thrifts in Certain Corporate Debt Securities

The FDIC has issued a final rule that prohibits state and federal savings associations from acquiring or holding a corporate debt security if the issuer does not have an adequate capacity to meet all financial commitments under the security for the projected life of the security. Compliance with the final rule is required by January 1, 2013. 

    Nutter Notes: The final rule was issued under section 939(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The FDIC has also issued guidance that describes due diligence standards for determining the credit quality of a corporate debt security.

  • Eight Financial Market Utilities Deemed Systemically Significant

The Financial Stability Oversight Council on July 18 designated eight financial market utilities as systemically significant, which will mean that the organizations will be subject to heightened risk management standards required by the Dodd-Frank Act. The organizations include payments systems, derivatives clearinghouses and settlement systems, among other firms. 

    Nutter Notes: The eight financial market utilities that have been designated as systemically significant are: The Clearing House Payments Company LLC, CLS Bank International, Chicago Mercantile Exchange, The Depository Trust Company, Fixed Income Clearing Corporation, ICE Clear Credit LLC, National Securities Clearing Corporation, and The Options Clearing Corporation.

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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