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Nutter Bank Report, June 2009

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1.  States May Enforce State Laws Against National Banks, Supreme Court Rules
2.  Administration’s Regulatory Reform Plan Targets “Regulatory Arbitrage”
3.  TARP: Warrant Valuation Process Outlined and New Compensation Rules Issued
4.  Final FACT Act Rules Allow Consumers to Dispute Credit Information
5.  Other Developments: Audit Requirements, Loan Originators and Identity Theft

Full Reports

1.  States May Enforce State Laws Against National Banks, Supreme Court Rules

The U.S. Supreme Court has struck down a regulation of the Office of the Comptroller of the Currency that bars states from going to court to enforce state laws against national banks. In the June 29 decision in Cuomo vs. Clearing House Association, the Court held that the OCC exceeded its statutory authority when it crafted a regulation that bars states from “prosecuting enforcement actions” in court against national banks. At the same time, the Court held that the issuance of a subpoena by the New York State Attorney General to a national bank was properly enjoined by a lower court under the OCC’s preemption regulations because such a subpoena, not in connection with a judicial enforcement action, would have amounted to an impermissible visitation by a state official. The New York State Attorney General had sent letters to several national banks, in lieu of subpoenas, requesting documents related to their lending practices to evaluate whether the banks violated New York’s fair lending laws. The OCC and a banking trade group filed a lawsuit to enjoin the information request. The suit claimed that the Attorney General had no authority to require the banks to produce the requested information, or to enforce the state law against a national bank even if there were a violation, based on an OCC preemption regulation. A lower court granted an injunction prohibiting the Attorney General from enforcing state fair lending laws through demands for documents or judicial proceedings. The Supreme Court overruled the injunction to the extent that it prohibited the Attorney General from bringing a judicial enforcement action to enforce state fair lending laws against a national bank, but affirmed it as it applied to the Attorney General’s threat to force disclosure by issuing subpoenas.

Nutter Notes: “Preemption” is the term used to describe the dominance of federal law over state law when the two are in conflict. Federal law preempts state law when they are in conflict as a result of the Supremacy Clause of the U.S. Constitution, which generally provides that the laws of the federal government are “supreme.” Courts have interpreted that language to mean that, in cases where federal and state law are in conflict, federal law must prevail. In cases where federal laws and state laws are clearly or explicitly in conflict, it is relatively easy for a court to resolve the conflict by applying federal law instead of the conflicting state law. However, in many cases, the conflict is more subtle.  For example, a national bank derives its power to conduct a banking business from federal law but, at the same time, states in which the national bank operates are responsible for governing certain types of activities and for protecting their citizens from various types of harm. The Uniform Commercial Code, trust laws and real estate conveyancing laws are examples of state laws that national banks must generally comply with.  Certain federal consumer protection laws specifically allow stronger or more protective state laws to apply to federally chartered institutions. The Cuomo v. Clearing House Association case is an example of a conflict that arose when a state sought information from a national bank that the state determined was necessary to protect its citizens from certain types of harm, while the national bank argued that only federal banking agencies have the authority to demand that kind of information.

2.  Administration’s Regulatory Reform Plan Targets “Regulatory Arbitrage”

The Treasury Department on June 17 released a comprehensive plan to reform the financial services regulatory system in the United States. The plan, Financial Regulatory Reform: A New Foundation, identifies causes of the current crises in the financial markets and proposes changes to the current system of financial services regulation in the United States in an effort to prevent similar events in the future. The plan was not accompanied by proposed legislation but many if not all of the key elements of the proposal will likely be contained in legislation to be proposed in the future. Among other things, the plan would “promote uniformity” of the regulatory framework for state-chartered banks and national banks; 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 and require federal savings banks to become national banks regulated, supervised and examined by the NBS; subject systemically significant institutions to heightened regulation and supervision; make the Federal Reserve a systemic risk regulator and broaden its powers to enable it to more effectively carry out that function; and create a new agency to be called the Consumer Financial Protection Agency to enforce consumer protection requirements on financial institutions.

Nutter Notes: The plan concludes, among other things, that the rationale for federal thrifts as a specialized class of depository institution focused on residential mortgage lending no longer makes sense. Over the past few decades, the “powers of thrifts and banks have substantially converged.” The availability of the federal thrift charter has created “opportunities for private sector arbitrage of our financial regulatory system” and that one “clear lesson learned from the recent crisis was that competition among different government agencies responsible for regulating similar financial firms led to reduced regulation in important parts of the financial system.” In addition, the plan concludes that further homogenization of the regulation and supervision of national banks and state-chartered banks would be desirable.  Under the plan, the Federal Reserve and the FDIC would retain their respective roles in the supervision and regulation of state-chartered banks.  However, efforts to simplify and strengthen “weak spots” in the system of federal bank supervision and regulation “will not end with the elimination of the federal thrift charter.” Although federal legislation over the past few decades has “substantially improved the uniformity of the regulatory framework” for national banks and state banks, “more work can and should be done in this area,” the Treasury plan states. To further minimize “arbitrage opportunities associated with the multiple remaining bank charters and supervisors,” the Treasury plan proposes to further reduce the differences in the substantive regulation and supervisory policies applicable to national banks, state member banks, and state nonmember banks.

3.  TARP: Warrant Valuation Process Outlined and New Compensation Rules Issued

The Treasury Department on June 26 announced its policy with respect to the disposition of warrants it received in connection with investments made under the Capital Purchase Program (CPP). The agreement between Treasury and the institutions that received CPP investments generally provides the institution with a right to repurchase the warrants at fair market value through an independent valuation process. The new policy states that, when a publicly-traded institution wishes to repurchase its warrants, it should submit a determination of fair market value to Treasury within 15 days before the proposed date for the repurchase. Treasury will conduct a process to determine whether or not to accept the institution’s determination of fair value. Under the agreement, Treasury has 10 days to respond to the initial determination. If Treasury objects to the institution’s determination and cannot reach agreement with the institution on fair market value, the transaction documents outline an appraisal procedure by which the two parties will reach a final price. In this procedure, the institution and Treasury will each select an independent appraiser. These independent appraisers will conduct their own valuations and attempt to agree on the fair market value. If these appraisers fail to agree, a third appraiser will be hired and, subject to some limitations, a composite valuation of the three appraisals will be used to establish the fair market value.

Nutter Notes: In the case of CPP investments in publicly-traded institutions, Treasury received warrants to purchase common shares which have not been exercised. In the case of institutions that are not publicly-traded, Treasury exercised the warrants it received immediately upon closing the initial investment and, as a result, they are no longer outstanding. Treasury’s evaluation of warrant repurchase offers will consider market prices, financial modeling, and advice from third party consultants. When available, market prices will be used. However, if the warrants are not listed on an exchange or otherwise traded, Treasury will consider market prices for securities that have similar characteristics to assess the fair market value of the warrants. Treasury will also obtain quotations for the warrants from 5 - 10 relevant market participants and will also use a set of well-known financial models to assess the fair value of the warrants. Separately, Treasury issued an interim final rule on June 10 that establishes standards for compensation and corporate governance for institutions that participate in the Troubled Asset Relief Program including the CPP. The rule, which became effective on June 15, extends the required risk analysis of compensation plans that institutions must perform for senior executive officers to all employees. All TARP participants will have to adopt luxury expenditure policies and conduct a non-binding “Say on Pay” vote at annual shareholders meetings. The rule also prohibits tax gross-ups, requires additional perk disclosures and mandates disclosure of whether an institution’s compensation committee or board of directors has engaged a compensation consultant. Comments on the interim final compensation and corporate governance rule are due by August 14.

4.  Final FACT Act Rules Allow Consumers to Dispute Credit Information

The OCC has approved final rules and guidelines regarding the accuracy and integrity of information furnished to consumer credit reporting agencies. The rules and guidelines released on June 10 implement section 312 of the Fair and Accurate Credit Transactions Act of 2003 (FACT Act). The other federal banking agencies, along with the FTC and the NCUA, are considering approval of the same rules and guidelines, which were jointly developed by the agencies under the FACT Act. The FACT Act requires that the federal agencies issue guidelines for use by institutions that provide information to credit reporting agencies to improve the accuracy and integrity of the information about consumers that they provide. The FACT Act also requires that the federal agencies prescribe regulations requiring such institutions to establish reasonable policies and procedures for implementing the guidelines. With certain exceptions, the final rules generally enable a consumer to submit a written dispute directly to the furnisher when the consumer believes that credit information that has been provided by the furnisher to a credit reporting agency is inaccurate. The rules will become effective on the first day of the first calendar quarter one year after the date the rules are published in the Federal Register.

Nutter Notes:  The FACT Act amended the Fair Credit Reporting Act (FCRA) to improve the accuracy of consumer credit reports. The rules require that, after receiving a valid dispute notice from a consumer, the furnisher conduct a reasonable investigation, review all relevant information provided by the consumer with the dispute notice, complete its investigation of the dispute and report the results to the consumer and, if the investigation finds that the information reported was inaccurate, correct such inaccuracies with the credit reporting agencies. Under the final rules, a “furnisher” generally refers to any entity including a bank or thrift institution that provides information relating to consumers to one or more credit reporting agencies for inclusion in a consumer report. The term “accuracy” is defined in connection with information about a consumer provided by a furnisher and refers to information that correctly reflects the terms of and liability for the consumer’s account, reflects the consumer’s performance and other conduct with respect to the account and identifies the appropriate consumer. The definition of “accuracy” in the final rule does not contain the “without error” standard that was included in the definition as originally proposed because it could create an expectation that information must be reported according to unreasonably high standards.

5.  Other Developments: Audit Requirements, Loan Originators and Identity Theft

  • FDIC Amends Independent Audit and Reporting Requirements

The FDIC released amendments on June 23 to Part 363 of its regulations, the annual independent audit and reporting requirements for insured institutions with total assets of $500 million or more. As amended, Part 363 requires disclosure of the internal control framework and material weaknesses, provides some reporting relief for certain merged institutions and acquired businesses, requires that management’s assessment of compliance with laws and regulations disclose any noncompliance, and provides illustrative management reports.

Nutter Notes: The amendments specify an audit committee’s duties regarding the independent public accountant, require the audit committee to ensure that engagement letters do not contain any unsafe or unsound limitation of liability provisions, and require boards of directors to develop and apply written criteria for evaluating audit committee members’ independence. Independence standards for accountants are also clarified. The amended rule will become effective 30 days from the date it is published in the Federal Register.

  • Rule Proposed for Registration of Loan Originators

The federal banking agencies on June 1 issued for public comment a proposed rule requiring residential mortgage loan originators to meet the registration requirements of the Secure and Fair Enforcement for Mortgage Licensing Act of 2008, including employees of federally chartered and state chartered banks and thrifts, and certain of their subsidiaries. These mortgage loan originators would be registered with the Nationwide Mortgage Licensing System and Registry, and would have to submit background information and fingerprints for a background check.

Nutter Notes: The proposal would require each individual mortgage loan originator to obtain a unique identifier through the registry that will remain assigned to that originator regardless of where he or she is employed. When the system is fully operational, the public will be able to use the unique identifiers to access employment and other background information of registered mortgage loan originators. Comments on the proposal are due by July 9.

  • Frequently Asked Questions on Identity Theft Rules

The so-called Red Flags Rule adopted by the federal banking agencies, the NCUA and the FTC under the FACT Act to resist attempts at identity theft will become effective on August 1. The federal agencies published answers to frequently asked questions about the new rule on June 11 to help financial institutions, creditors, users of consumer reports, and issuers of credit cards and debit cards to comply.

Nutter Notes: All banks and thrifts and their functionally regulated subsidiaries are covered by the Red Flags Rule and must develop identity theft prevention programs to protect covered accounts. The guidance also addresses questions about a separate FACT Act rule issued by the agencies concerning discrepancies in changes of address that requires issuers of credit cards and debit cards to assess the validity of notifications of changes of address.

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

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