The Legislature, Bitcoins and Other

December 7, 2013.  “Old soldiers never die, just the young ones.”  (Anon). 

Seventy two years ago today the Japanese Empire attacked the U.S. fleet at Pearl Harbor in a surprise attack.  The world changed thereafter.  How many of our children remember the event or the great and small persons who survived that attack, the battles and the war?  Patton, Wainwright, Bataan, Bradley, MacArthur,  Hurtgen Forest, Guadacanal, Code Talkers?

Manny is back, sort of.   Former New Mexico Senator Manny Aragon has been released from federal prison to a half-way house after about four years incarceration for his conviction on kick-backs from an Albuquerque court house construction project.  At one time Manny virtually controlled the New Mexico Senate and much of state government.  Although Manny will likely not be there, we are within about six weeks of the start of the “short” session of the N.M. Legislature.  Despite the N.M. Constitutional restrictions on the matters that can be considered—budget, vetoed bills and matters on the Governor’s call—most of the legislation which should be of concern to the financial services industry seems to come back year after year.  I think this year will not be unique.  As we approach the Session, I will review the proposed legislation as it appears.

Social Media and electronic communication continue to cause problems to business and government.  Winston Brooks, Superintendent of the Albuquerque Public Schools, is an opponent of the Martinez’ administrations’ education reforms that involve testing which may impact teacher evaluations.  Apparently, after having been told by e-mail or a “tweet” that the Martinez’ education chief, Ms. Skandera, was to appear at a rural location, Brooks made inappropriate and allegedly sexist comments about her on his Tweeter account.  Mr. Brook’s was suspended for three days and his future contract with the school system was not extended.  His future is uncertain.

Although one may question the judgment of Mr. Brook’s posting anything on an obviously public site, any business operating in 2013 should be aware that all managements’ company e-mails are subject to discovery in litigation, if not publicly available.  Depending on the case, an officer’s social media may be discovered in litigation.  The solution is neither easy nor fool proof—education and the threat of inappropriate behavior being made public may be the only preventive measure.

            Bitcoins are in the news and being studied by the regulators.  Bitcoins are a product of the Internet age. A programmer or group of programmers invented Bitcoins in 2009.  The Bitcoin “currency” is a rigid system of virtual supply and demand functions, monitored by a peer group called “miners”.  Please don’t expect me to explain this, except that the total Bitcoin supply is limited in its founding program.  No more than 21 million Bitcoins will ever be issued and by 2013 about half that number had been issued.  Exchanges that trade Bitcoins for hard currency are limited—they have a short life and two of the most prominent are Japanese and Chinese.  A small number of companies accept them as a matter of routine commerce.  Two of the Facebook veterans have announced a purchase of 1% of the Bitcoins in existence, and are preparing a filing of a Bitcoin ETF. 

            Why all the fuss about Bitcoin?  Until 2013 the Bitcoin market was fairly stable and unknown to most people.  However, in October 2013, the F.B.I. arrested the mastermind of the “Silk Road” drug empire, which operated in the so-called “Dark Web” (an invention of U.S. security and law enforcement agencies formed for clandestine activities—but downloadable by anyone).  Silk Road was an Internet market place in which transactions in drugs and I.D. theft occurred, masked by the “Dark Web” promise of anonymity.  All transactions were in Bitcoin.  “Silk Road” operated with impunity until its mastermind felt aggrieved by some employees or business associates and let out contracts to kill.  In the process he let his real Internet identity slip, and he was caught. 

            Almost immediately, the Bitcoin value dropped to less than $2.00 and then in the wake of the “Silk Road” story, the Bitcoin value climbed to $1000 per Bitcoin.  In testimony before Congress the regulators voiced concern about the lack of regulation of the Bitcoin market, but generally stated that such virtual currency had a place in the market.  Ben Bernanke voiced support for the concept of virtual currencies.  But, like a wet blanket, on December 4, former Federal Reserve Chairman Alan Greenspan termed Bitcoin “not a currency” and predicted a “bubble” in Bitcoins. 

            On November 8, 2013, the CFPB released its “tool” to assist lenders in complying with the Dodd-Frank Act that requires that consumers be furnished a means to find housing counselors before entering into housing and mortgage transactions.  The deadline is near, February 2014. The regulations appear at 12 CFR Part 1024.  Although the regulations do not appear all that burdensome (although detailed), one wonders if New Mexico consumers will ever use a housing counselor.   How many housing counselor meeting HUD requirements are there in rural areas of New Mexico.  The regulations require a list of ten and some proximity by zip code.  Sounds simple.  Is it?

I will be in touch, as we know more about the legislature.

Do good.

MARSHALL G MARTIN

Mobile:  505-228-8506

Office:  505-982-4611

Crowdfunding, SEC Rules

ATTORNEY: The youngest son, the 20-year-old, how old is he?
       WITNESS: He's 20, much like your IQ.  (Courtesy Lowell Hare)

“I have no idea what Gluten is, either, but I’m avoiding it just to be safe.” (Anon)

“Crowdfunding” as a way of raising capital for small businesses has been in the news since Congress passed the Jobs Act in 2012. Although the role of bankers in the Crowdfunding process may evolve, there is a role—how big may depend on the success of the concept. 

As presented in the media and in Congress, Crowdfunding was presented as a way to raise capital through the internet in a less rigid format than the usual U.S. Securities Act exemptions.  Ideally, small business issuers would present their start-up companies to a “crowd” of investors who would buy shares in the start-up for relatively small amounts. In the absence of explicit amendments to the Securities Act of 1933, Crowdfunding would not be a legal way to raise capital.  Small businesses would have to follow the very rigid exempt transaction rules of the Act with sales only to “accredited investors” or , limited Regulation A offerings or  “go public”.   Congress added the  Crowdfunding sections to the securities laws as a way to promote capital raises for small or start-up companies.

The SEC’s release of the proposed Crowdfunding rules on October 23, 2013 is more than 585 pages long and poses more than 250 questions for comment. The full release can be retrieved from the SEC EDGAR site.   The Crowdfunding  rules are not likely to become final for some time.  The rules are open for a 90 day comment period and then the Commission has to adopt the final rules, and then there is statutory 60 day wait for the rules be effective.  Most experts expect that no   Crowdfunding issues will occur before Summer 2014.  Some important highlights of the SEC’s proposed rules follow:

            1.  The maximum annual limit for a Crowdfund issue is $1 million, with rather stringent requirements concerning financial and other information about the issuer.  Lower Crowdfund limits of $500,000 and $100,000 have much less rigid or burdensome requirements for the issuer.  Given the expected legal and other costs of a Crowdfund issue it is not likely that many $100,000 issues will be done.

            2.  Significantly, the SEC’s proposed rules do not aggregate Crowdfund issues with other exempt issues (as is often the case in the SEC rules).  For example, the issuer could do a Crowdfund issue and, when successful, follow it with a much larger Regulation D exempt offering or vice-versa. 

            3. If the annual income or net worth of an investor is less than $100,000 (net worth does not include a principal residence), the investor may not contribute more than $2,000 or 5% of annual income or net worth, whichever is larger. If the investor’s income or net worth exceeds $100,000 the limit is 10% of net income or net worth.  Under the current proposal no laborious due diligence is required of the internet portal or broker-dealer (called collectively “intermediaries”)  to confirm the investor’s financial status.  One expert said that the investor would merely “check a box” and the intermediaries could rely on that, given good faith belief.  We will see if that survives the comment period. 

            4.  Although the Crowdfunding security issue can be done through a broker-dealer, it is difficult to imagine Raymond James or even small broker-dealers’ undertaking a $1 million Crowdfunding offering.  Most issues will probably take place through “funding portals” which, while not broker-dealers, will have to register with the SEC and follow a fairly rigid set of rules.  One of which, of interest to bankers, is the explicit requirement that all funds collected during the offering by the funding portal be deposited in an escrow type account with a bank.   The funding portals also have to be a member of a national exchange.  The SEC has designated FINRA to serve as the funding portal exchange.  FINRA is drafting rules for the funding portals. 

            5.  What about fraud?  Many pundits have predicted widespread fraud by the unscrupulous scam artists.  Obviously, there is no guarantee  that fraud can be prevented, rules or no rules.  However, the funding portals have a duty under the proposed rules to do background checks and pursue other means to determine if the issuers are real.  The issuers must give the “crowd” a fairly detailed disclosure statement, which when the lawyers get involved will look like a full blown prospectus.  In the $1 million offerings, detailed financials and business plans are required. I think the most likely ground for fraud may lie in funding portals.    Despite the requirement that funds be deposited in banks one knows that such requirements are easily dodged.  The Act and rules contain provisions for legal recoveries for fraudulent conduct similar to the Securities Act’s anti-fraud provisions.

            6.  The investors in a Crowdfunding venture are subject to restrictions on resale of their stock.  They must hold the stock for one year, except  for sales to an accredited investor, to the issuer or to family. 

Crowdfunding, as presented by the SEC proposed rules, is not simple or cheap.  One expert has predicted that the legal and  business cost of raising capital under the Crowdfunding concept may amount to 20-25% of the amount raised.  I think this is possible, but not after funding portals become more common and expert in their work. The accounting requirements for issuers for the $1 million issue will be expensive and the issuer will also have to do what amounts to  SEC style MD&A (management discussion and analysis) for  issuer. 

Sorry to take up so much space but Crowdfunding may be a significant way to raise capital for small business.  Bankers may get involved in escrowing funding portal’s issuer funds or  evaluating the chances of success for an existing customer.  Among other things, it will be a faster way to raise capital from the public than existing stock raises.  Until it gets going it is difficult to determine if it will be a success. 

Do Good,

Marshall Martin

(505)228 8506

(505)982 4611

More On Credit Unions, the Low Income Designation and Other Matters.

ATTORNEY: Now doctor, isn't it true that when a person dies in his sleep, he doesn't know about it until the next morning?  WITNESS: Did you actually pass the bar exam? (Courtesy of Lowell Hare)

 Although we all hope for solutions to the government shutdown and the debt ceiling even the federal courts may not be immune. The U.S. Administrative Office of the Courts has announced that the federal courts will be stay open through October 18. After that there may be some question. In the meantime, the U.S. Attorney Offices have put on a hold on processing civil cases, devoting their resources to criminal matters. Banks have their own problems with the shutdown, ranging from the SBA to FHA inability to fully process loans to partial shutdowns of the Consumer Financial Protection Bureau and S.E.C. (the inability of the CFPB to issue new regulations may be one of the hidden benefits of the shutdown).

 On the Credit Union cap and low income designation, I owe an apology to Senator Tom Udall and my readers. In my last Blog, I stated that Senator Udall was a co-sponsor of legislation to abolish the 12.5 % asset cap on Credit Union member business loans. I had the wrong  Udall. Another Udall, Senator Mark Udall of Colorado, is the sponsor of the legislation. New Mexico’s Senator Udall is not the sponsor of the any cap abolishment  legislation. Thanks to the many savvy readers who caught my error and pointed it out.

 The more one looks at the low income designation for credit unions, which allows those designated as such to be free of the cap on member business loan, the more intriguing the designation becomes. Although the low income designation is apparently not based on actual member earnings, the regulations state that designation is based on “data” “obtained through examinations” . However, the actual designation, as explained in a prior Blog, is based on median family income for the metropolitan area where the members live. The regulations provide “[m]ember earnings will be estimated based on data reported by the [Census Bureau] for the geographic area where the member lives.” 12 C.F.R. §701.34(a)(2) In August 2012 the NCUA notified more than 1000 Credit Unions that they were entitled to the low income designation—doubling the total number of Credit Unions having the low income designation. Besides the member business lending cap being waived, other benefits of the designation are eligibility for Community Development Revolving Loan Fund grants and low-interest loans, ability to accept deposits from non-members, and authorization to obtain supplemental capital. The NCUA action was part of a 2012 drought relief and recovery package which made gaining the designation less burdensome, according to the NCUA.

 Although the information is not current, it appears that only one New Mexico federal Credit Union has been chosen for the low income designation—New Mexico Educators Federal Credit Union. Since gaining the low income designation, New Mexico Educators Federal Credit Union has been busy in Albuquerque and Santa Fe. Although I mentioned the loan in a prior Blog, New Mexico Educators recently financed the purchase of the Hyatt Hotel in downtown Albuquerque for a well known New Mexico hotel operator. There is apparently no limitation on the type of member business loans which the Credit Union can make, and there is no requirement of lending to the impoverished or to business located in high poverty areas.

 New Mexico lost a valued banker, Paul Boushelle, on September 23. Paul was past President of the New Mexico Bankers Association in the 1990’s and later lobbied for the Association in Santa Fe. His memorial service on October 5 was full of the states’ bankers and his close friends—of which there were many.

 Do good,
 Marshall Martin
 505 982 4611 Office 505 228 8506 Cell

Government Shut Down? Credit Union Low Income Designation. Some Musings.

"My Karma ran over your Dogma."  Unknown

As we move closer to a government shutdown by a dysfunctional government one wonders if Vladmir Putin might step in with a solution like he did in the recent Syrian crisis.  Whatever your politics the present political situation demonstrates a total lack of leadership on both sides of the political aisle.

Several bankers have asked me how the NCAU determines if a credit union qualifies for the low income designation and, as a consequence, is freed from the business lending cap of 12.5% of assets?
Under the NCAU regulations low income members must constitute 51% of the credit union's membership.  How is that determined?  The NCAU regulations (12 CFR 701.34) state that any federal credit union whose members' family income is less than 80% of median for the metropolitan area where they live or national metropolitan area whichever is greater.  Similar guidelines apply to individual members.  Member earnings are reported based upon data reported by the U.S. Census Bureau.  

NCAU makes the low income designations based upon the above types of data and then notifies the credit union that it has made the low income sweepstakes for business loans.  Note that no actual earning data is used in this process.  However, if a credit union thinks it qualifies it may submit actual income data from loan files.  It may also use surveys to establish its low income membership qualification.  Actual income data must be compared to data from the metropolitan area or the national metropolitan area.  NCAU imposes some rather strict statistical deadlines on survey results.

Any person interest in credit unions and their impact on the financial services industry may wish to look at a study of the competitive advantage of the tax exemption for credit unions.  In a 2004 study, Competitive Advantage: A Study of the Federal Tax Exemption for Credit Unions (Tatom),  traces the history of the exemption and its effect on the financial services business.  The study predates the recession and Dodd-Frank and in true academic fashion avoids a clear verdict.  However, the study clearly shows that large federal credit unions derive a competitive advantage from the tax exemption. Both political parties have avoided tackling the credit unions, and Tom Udall of New Mexico is a sponsor of legislation to remove the lending cap for business loans.  Face it, despite budget deficits the exemption is here to stay.

Dennis Domrzalski, of Albuquerque Business First weekly business newspaper, continues to do excellent work on banking in New Mexico.  In the newspapers' publication of September 6-12, he surveys all sectors of the financial services community--including credit unions--to explore whether the nation learned anything from the last economic meltdown.  On balance, the answer seems to be "no".  A highlight of the issue was an interview with Bill Enloe, retired CEO of LANB, who concluded with strong evidence that things might be worse now than in 2008.  The nub of Enloe's reasoning is that the "big banks" are at risk in the international game and need more capital.  Enloe's argument that small banks do not need the same regulatory framework as big banks is not unique, but grows increasingly obvious.  After all it is hard to imagine a Hobbs bank engaging in the type of trading practices in which  the "London Whale"engaged. Albuquerque Business First's website is www.albuquerquebusinessfirst.com.   The Albuquerque Journal's Winthrop Quigley is the unquestioned intellect of New Mexico financial reporting, but Domrzalski may be Quigley's equal in banking.

I think I hear Harry Truman's ghost uttering muffled obscenities about what is happening in Washington, D.C.

Do good,

Marshall G. Martin
505-982-4611
505-228-8506

A Federal Judge Drops a Bomb on the Federal Reserve, and Others

"Surveys show that politicians rank lower than lawyers and journalists in the public view".  Thomas Cole, Albuquerque Journal Article on New Mexico corruption. (August 12, 2013)

Before we get to the lead story,  a reader of my last Blog describing the "low income" designation for some credit unions that exempts them from the 12.25% of asset cap on member business loans asked what is the standard for  a "low income" member.  The NCAU regulations provide the following:

Low-income members are those members whose family income is 80% or less than the median family income for the metropolitan area where they live or national metropolitan area, whichever is greater, or those members who earn 80% or less than the total median earnings for individuals for the metropolitan area where they live or national metropolitan area, whichever is greater. NCUA will use the statewide or national, non-metropolitan area median family income instead of the metropolitan area or national metropolitan area median family income for members living outside a metropolitan area. Member earnings will be estimated based on data reported by the U.S. Census Bureau for the geographic area where the member lives. The term “low-income members” also includes those members enrolled as students in a college, university, high school, or vocational school.

I hope that helps you understand the standard.  It barely makes sense to me-- but I am lawyer, as my dear friend Pat Dee would say.

On July 31, 2013 Judge Richard Leon ruled that the Board of Governors of the Federal Reserve ("FED") "has clearly disregarded Congress's statutory intent by inappropriately inflating all debit card transactions by billions of dollars and failing to provide merchants with multiple unaffiliated networks for each debit card transaction". NACS v. Federal Reserve System, Civil Case No. 11-02075-RJL  (District of Columbia July 31, 2013).  The judge ruled that Fed used data it should not have used under Dodd-Frank in setting a cap on debit card transaction fees.  These fees are known as "swipe" fees.  Judge Leon  traced the history of debit card use in the U.S., but also tracked the ways in which Visa and MasterCard gained a market share exceeding 80%.  The FED's rule or cap permitted each issuer  to receive a fee as high as $0.21 per transaction plus an additional ad valorem amount of five basis points (0.05%). This standard was struck down.  In addition, the ruling dictates a merchant's choice between more than two unaffiliated networks (other than Visa, MasterCard) to increase competition.

 Judge Leon was highly critical of the FED rule making.  The FED was directed to revisit its rule making quickly.  The American Banking Association stated that the ruling would harm all banks "of all sizes".  On August  15, 2013 Judge Leon held a hearing on the remedies which might flow from his ruling.  He stated that not only would retailers bear lower "swipe fees" but retailers might be entitled to substantial refunds of unlawful fees paid.  He also demanded that the FED move quickly on re-writing the rule, stating that FED decision makers "can come back from Nantucket, ...or wherever they are on vacation..." and make decisions on the re-write of the rule.  The FED's General Counsel was directed to reply to the Court in a week concerning the time it would take to revise the rule.  The FED has not disclosed its intentions to appeal.  Judge Leon is an appointee of the first President Bush.  If an appeal is taken the District Judge would have to stay his decision, or on appeal the Circuit Court for the District of Columbia would have to do so.  Although the chances of an appeal to the U.S. Supreme Court is unknown, the FED might note that Judge Leon is a college classmate of Justice Howard Thomas.

Robert P. Tinnin, long time New Mexico labor and employment attorney, noted to me that the recent employment case of Yedidag, M.D. v. Roswell Clinic Corp., decided on July 3, 2013 by the N.M. Court of Appeals should be of concern to employers.  The case if of obvious concern to the medical community, since it holds that Dr. Yedidag could bring a lawsuit if the employer violated the N.M. Review Organization Immunity Act--an important part of the peer review process in hospitals and the medical profession.  But, Bob Tinnin says that the case does not stop there.  Indeed,  he maintains:

The main significance of the case is, of course, to the medical community because of the recognition of a private right of action against peer review organizations. However, the case also conveys a strong message to all employers about implied employment contracts. In this case, there was a strong at will disclaimer in the doctor's employment contract, which the employer argued would trump any implied contract argument under our "at will" doctrine. Without any substantive discussion, the Court summarily dismissed the argument, reinforcing the almost inescapable conclusion to be drawn from all NM appellate decisions in the recent past, that at will is effectively dead in NM because almost any claim of implied employment contract will be submitted to a jury for decision.   

That jury decision in conservative Chavez County resulted in Dr.  Yedidag's receiving $970,000 in actual damages and $3,000,000 in punitive damages.  Such a result should warn any employer that employment contracts need to be reviewed for options when the  at will doctrine is gone.  There are options, but they sometimes are not attractive to business.

Do Good,

Marshall G. Martin
505-982-4611 (office)
505-228-8506 (cell)

Cyber Crime and Cyber Insurance

"I bear no grudges. I have a mind that retains nothing." Bette Midler

Although it is old news, the confirmation of Richard Cordray as Director of the Consumer Financial Protection Bureau saves CFPB from some uncertain times. However, it guarantees that the financial service business will continue to face the certainty of more regulation.

As most business people know, there has been an increase in credit union "member business" lending. At least one, and possibly more, New Mexico credit unions are not subject to the limit on business loans of 12.25% of total assets. They have taken advantage of the NCUA's "low income designation" which permits a credit union with more than 51% low income membership to be exempt from the statuory asset cap on business lending. Indeed, in one case, a New Mexico credit union, New Mexico Educators Federal Credit Union, just made a sizeable loan for the purchase of the Albuquerque Downtown Hyatt and reportedly has made sizeable loans for other business purposes. The credit union is reportedly one of the 2000 credit unions nationwide who have recieved the NCAU low income designation. To the author's knowledge, no state chartered credit union has recieved the low income designation, which must be approved by the state Financial Services Division Director.

Often the most sophisticated security system can be hacked if not frequently updated and checked by good IT security personnel. The criminal computer minds who operate in the cyber shadows can by-pass or invade passwords and other fancy FINCEN requirements.

What do you do? Well, first you should have a competent IT staff well versed in all areas of internet security. But, suppose that all that effort fails on one day and one of your customer's payroll accounts is drained of funds. She does not notice the loss until five days later. Despite your best efforts, the customer sustains a significant loss. Or, for example, a rogue employee takes confidential customer information covered by Gramm-Leach-Bliley's privacy provisions from your system and puts it on his hard drive. He may sell it or just keep it, but you may not be able to discovery what he did with it. (In my experience an overworked and sequestered F.B.I. may not help you at all).

In the first example, your general liability policy may not cover the claim. Your professional liability E&O policy may not cover the claim. Advertising and personal injury coverage may be triggered, but that is not certain. You can be certain of coverage only if you have legal counsel review your policies, in conjunction with your insurance agent. Is this worth it?  If you suffer a hacker attack and your customer loses $500,000, the litigation cost and reputational risk will make that advance review cheap by any measure.  Plus you may find you have other insurance.

In the second example, there is very little chance that the reputational damage, the remediation cost (cost to notify customer) etc., the damage to the data on the system, etc. will be covered by any policy except a Cyber Risk Insurance policy. Any bank should explore Cyber Risk Insurance in this era of cyber crime.

When the coverage surfaced in the last decade it was spotty and claims adjusting was imperfect. In one case, in which the author was consulted, the bank was subject to a rogue employee invading the system and engaging in identity theft. The bank engaged in remediation to customers concerning any loss and gave customers notice that they could have free identity theft protection for a year. However, the claims process was so tedious and expensive to collect that the bank gave up--the cost of meeting picky insurance demands for data exceeded the remediation cost. Since then the claims process has improved.

In many reports of identity theft,  plaintiff have filed class action suits with signficant recoveries. However, bankers should be aware there is no private right of action to sue for breach of the Gramm-Leach-Bliley privacy provisions--a data breach alone may not expose a bank to litigation. However, if the identity theft results in monetary damage to the customer, a customer may have a cause of action for the loss.  Most bank litigation involved to date, involves identity theft in cases where the hackers were able to invade accounts or ATMs and cause monetary loss.

With the right Cyber Risk policy a bank can be covered for data loss, hacker vandalism (not a small risk),remediation, failures of technology or security systems, slander or libel (may be covered elsewhere as well), cyber extortion, and customer loss of funds. A good insurance agent can insure that your Cyber Risk Insurance fits in with the other coverage you have and  to avoid needless costs or over-coverage (although most knowledgeable lawyers would doubt you can be "over-covered").

You may find that you do not need Cyber Risk Insurance.  However, if you do, find out now and not when you have a claim.

My thanks to Charlie Wheeler of Hub International for information on current Cyber Risk Insurance.

Do good.

MARSHALL G MARTIN
Comeau, Maldegen, Templeman & Indall, LLP
505-228-8506 (cell)505-982-4611

Overdraft Fees—CFPB and Class Action Lawyers On the Prowl

“Talk is cheap until you hire a lawyer.” Unknown

Our old friends at the federal Consumer Financial Protection Bureau (“CFPB”) have just published a comprehensive study of bank overdraft programs.  It is scholarly, well researched and boring as Hell.  The Report is 72 pages long and is study of a “small set of large banks” within CFPB’s jurisdictional size (over $10 billion in assets).  The study includes NSF fees.  The size of the average overdraft and NSF at the study banks is surprisingly high: $225 for accounts with at least one overdraft. The study also included the effect of the Regulation E amendment of 2009 that required a customer to opt-in for ATM and POS debit card transactions.

Surprisingly, the study came to no conclusions about the methods or procedures used in charging overdraft fees.  But the report ominously warned that the heavy overdraft fees incurred by some customers and “wide variations” among studied institutions merit further analysis.

            The CFPB study confirms that overdraft and NSF fees contribute a significant portion of fee revenue generated by banks.  The CFPB report states that a trade association found that 61% of fee revenue is generated by overdraft and NSF fees on checking accounts at the banks studied.  The fees also account for 37% of the total deposit service charges.  It is little wonder that overdraft and NSF fees are important to banks. 

            The CFPB report is long and detailed and it discusses every facet of bank processing of checks and charges.  However, amid the tedious detail of overdraft operations, the key factor in any overdraft procedure is in what order a customer’s checks and charges are recorded and charged against the customer’s account.  The study reports in detail the ways in which the study banks charge the overdraft and NSF fees.  But in essence the study reports three ways banks can charge checks and ATM/debit card against a customer’s account: (1) charge the largest item first, which has the effect of depleting the customer’s bank account of funds before smaller items are charged; (2) charge the items chronologically, as they occur; and (3) charge the smallest item first—usually done when a bank processes ATM and debit card transactions first.

            However, any bank that charges the largest item first is risking legal and perhaps, long term, regulatory intervention.  Recently class action attorneys have filed lawsuits against most of the nation’s major banks seeking to have the banks repay customers for overdraft fees charged on the largest item first instead of charging items as the occur. The legal theory is that the practice violates unfair trade practice or other similar laws. New Mexico has an Unfair Trade Practices Act, which is almost identical to the uniform act existing in most states. 

Most of the lawsuits have been settled for sizable amounts but many are still subject to approval of the courts hearing the cases.  A list of some of the banks and settlements follows: Bank of America $410 million; Citizens Bank (part of RBS) $137.5 million; J.P. Morgan Chase $110 million; and TD Bank $62 million.  Wells Fargo was ordered to pay $203 million to California customers, but is appealing.  There is also a major class action case pending in Florida against 20 of the nation’s largest banks—including Wells Fargo.  Amusingly, in the Bank of America case some of the class members are complaining that the class action lawyers are profiting to their detriment—and many of them complain that they are getting much less than the overdraft fees charged to them.  In the settlements the banks have agreed to cease the practice of charging the larger items first and move to a chronological basis.

Class action lawyers are looking for clients to sue other big national or regional banks. Other than big banks already sued in other states, it is unlikely that many (if any) New Mexico bank is large enough to merit a class action lawyer’s target bottom line—although I usually have been proven wrong in predicting the behavior of my fellow attorneys. 

            Word comes from the ABA that the Uniform Law Commission, drafter of the Uniform Commercial Code, is working on a model “Home Foreclosure Protection Act”.  It is still in debate stages, but it reportedly has broad mediation provisions and other sections that will materially change the rights of the parties in foreclosure actions.  Should it materialize in its present radical form, it still has to pass the legislatures of the various states.  However, it would make the task of changing the foreclosure process easier for those who oppose the present system. 

            In the wake of the leak of the NSA secrets, I was tempted to cover the increasing risks that all business has of damaging hacking and intrusion and the insurance solutions, if any.  But that will wait.

Do good.

MARSHALL G MARTIN

Comeau, Maldegen, Templeman & Indall, LLP

505-228-8506 (cell)

505-982-4611

The Most Powerful Agency in Government?

“All things are subject to interpretation whichever interpretation prevails at a given time is a function of power and not truth.”  Friedrich Nietzsche

In 1933 President Roosevelt established the NRA (National Recovery Administration) as part of his “100 days” to get the U.S. out of the depression. Its symbol was a blue eagle.   It had vast powers over business, markets and labor.  Among other things it instituted a system of industrial codes for key industries and labor, farmers and businesses.  It attempted to abolish child labor, instituted minimum wages in coded industries. It promoted a system of price stabilization which effectively leads to cartels and price fixing.  It had approximately 5000 business practices that were prohibited and administrative orders numbering over 3000.   In 1935 the U.S. Supreme Court declared the NRA unconstitutional, in a case involving a chicken farmer, Schechter Poultry Corp. v. U.S.    Some referred to the holding as “the sick chicken killed the blue eagle.”

Has the Consumer Financial Protection Bureau (“CFPB”) inherited the NRA mantle of the “most powerful agency in government”?  With the I.R.S. hobbled by scandal, arguably the CFPB is the most powerful agency in the U.S. government.  Some key factors support this view:  (1) it is not subject to budget control or oversight by the Congress, and is financed by having access up to 12% of the Federal Reserve Board’s total operating budget; (2) its rulings and regulations are not subject to any monitoring and can only be overturned by a vote of 2/3 of the members of the Financial Stability Oversight Council and only if the CFPB’s actions would put the “safety and soundness  of the United States banking system or the stability of the financial system of the United States at risk.”; and (3) its director has a five year term and can only be removed by the President  “for cause”.  The Financial Stability Oversight Council is made up of the Secretary of Treasury and most regulatory agencies of the federal government, 10 in number, including the Director of the CFPB.

With extremely limited exceptions, most of the consumer financial functions of the Federal Reserve, OCC, OTS [gone now], FDIC and NCUA were transferred to the CFPB.  Neither the Federal Reserve nor any listed agency can overrule the CFPB. Because of CFPB’s jurisdiction over the alphabet soup of consumer law (RESPA, SAFE Act, Truth in Lending, etc.) CFPB has issued more than 25 guidance and regulation documents and more are coming almost every day.  Mortgages and mortgage servicing are under CFPB’s jurisdiction and news comes out almost every day on some new development or exemption.  CFPB does not have direct or supervisory jurisdiction over banks or credit unions that are smaller than $10 billion in assets.  However, the responsible regulator (usually FDIC) must coordinate with the Bureau and may recommend action if there are material violations of consumer laws.  CFPB can also use its regulatory and supervisory authority over “covered persons”, which do not have to be financial services.  For example, in the last few days the CFPB asserted jurisdiction over AIG, the large insurance giant, on the basis that it was a key player in the economy and engaged in consumer services.  CFPB has also drawn a bead on credit reporting agencies and issued a report on private student loans. 

Most New Mexico banks and credit unions will have immediate and direct contact with CFPB in the mortgage industry.  A bank or credit union mortgage compliance officer who does not subscribe to the CFPB periodic internet releases is risking his or her institution’s regulatory well-being.  The Bureau’s Supervision and Examination Manual is also available on line at the Bureau’s website.   

Is there a “sick chicken” on the horizon?  A Texas bank, the Competitive Enterprise Institute (“CEI”) and others filed suit against CFPB, the Treasury Department, and the Director of CFPB and others claiming that the CFPB and its enabling legislation in Dodd-Frank was unconstitutional.  The suit is pending in in federal court in the District of Columbia.  The Director, Richard Cordray, was alleged to have been fraudulently appointed and various constitutional grounds were alleged as the basis for declaring the Bureau and its founding legislation invalid.  The case is in the judicial process and there is no guidance as to its likely outcome. 

If Richard Cordray is not confirmed by the Senate the CFPB may face other problems.  Recently the D.C. Circuit Court of Appeals held that President Obama’s recess appointments of three N.L.R.B. commissioners were invalid.  The Third Circuit Court of Appeals has just joined in a similar ruling.  Since N.L.R.B. rules and decisions are by a vote of the commissioners, the recess appointment threatens to invalidate most the Board’s actions over the last years.  President Obama used the same recess appointment procedure when Richard Cordray was appointed as Director of CFPB.  It appears that Cordray’s appointment is similarly in jeopardy if he is not confirmed by the Senate—and Republicans have threatened filibuster.  CFPB’s regulations to date are probably not at risk, since CFPB does not act as a board like N.L.R.B.  However, there is serious doubt if the Bureau can continue it regulatory avalanche without a director.

And so the beat goes on.

Do Good

Marshall G. Martin

 Office   505 982 4611

 Cell       505 228 8506

The Consumer Financial Protection Bureau and a New Wire Transfer Case

"President Obama’s pick to head the Consumer Financial Protection Bureau [“CFPB”] got a firsthand taste of the effects of the government sequester while trying to get to his confirmation hearing Tuesday. Richard Cordray... had to wait outside in the rain in a long line that wrapped around the corner of the Dirksen Senate office building to get into his 10 a.m. hearing before the Senate Banking Committee. Citing the budget cuts from the automatic sequester cuts, the Capitol Police have shut down several entrances to the congressional office building, resulting in longer waits at the doors and security checkpoints that are open."  Washington Times March 12, 2013.

The Business Lawyer, published by the American Bar Association’s Business Law Section, in its annual survey of Consumer Financial Services devotes 71 pages of single-spaced, heavily footnoted text to the first year of the CFPB.  The CFPB’s activities resemble nothing more than a whirling regulatory dervish.  It has jurisdiction over banks and credit unions with assets over $10 billion, over all mortgage companies, payday lenders and private education lenders (student loans).  It also has jurisdiction over larger participants in consumer financial products or services.  It has issued a number of final rules, a study on private student lending (just followed up in May with another report on private student loans), and a report on the three largest credit reporting agencies.  It is currently studying arbitration in consumer services (an area of law protected by the U.S. Supreme Court in recent years).    

CFPB has engaged in significant regulatory action in residential mortgage lending, through its RESPA, TILA and HOEPA jurisdiction.  It will shortly issue new regulations on “ability to repay” and “qualified mortgage” standards.  It is also preparing to regulate all residential mortgage servicers, with some indication that smaller servicers may be exempt.  It has also taken enforcement action against some of the same banks and credit card companies that Attorney General King recently sued in New Mexico state court over sale of payment protection plans.  It has issued rules on credit reporting services. It maintains an active complaint response program, and a cursory look at CFPB’s website shows that it encourages complaints.

For most New Mexico banks the main compliance issues will arise in the area of residential mortgage operations.  New and enhanced disclosures will cause compliance headaches without any easy cure-all. If Mr. Cordray is not confirmed, he risks ouster from his directorship under recent federal court cases which held that similar “recess” appointments of NLRB commissioner were void.  Unlike the NLRB rule making, Cordray’s ouster will not invalidate CFPB regulations or actions. 

A significant and long running case involving wire transfers and internet banking has finally come to a close after more than four years of intense litigation.  As you know, wire transfers and internet banking is under Article 4A of the Uniform Commercial Code.  In Patco Construction Co., Inc. v. People’s United Bank, Patco suffered a loss or more than $500,000 through a fraudulent hacking scheme.  Patco, a Maine company, used the bank’s internet banking system primarily for payroll.  In 2009 hackers drained funds from Patco’s payroll account on a daily basis over a substantial period of days.  The system vendor warned by its usual signals that these transactions might be fraudulent.  No monitoring occured.  The bank had instituted a system that essentially complied with federal guidelines with challenge questions and similar protections.  However, the “trigger” for the challenge questions was set at $1.00.  This low trigger enabled the hackers to have almost unlimited shots at deciphering the challenge questions.  At trial in the U.S. District Court, the judge found all the bank’s protections “commercially reasonable”—the Article 4A standard for bank freedom from liability.  On appeal, the U.S. Court of Appeals reversed  and found in favor of Patco.  The Court  found that the low trigger, failure to change challenge questions frequently and lack of monitoring not “commercially reasonable” and sent the case back for re-trial.  Patco, which had sought attorney fees and damages above the $500,000 actual loss then settled with the bank, based on the Court of Appeals statements that Patco may have been partially at fault for not monitoring its own accounts. 

One clear lesson stands out from Patco:  the Court of Appeals criticized the bank for having a “one size fits all” security system.  In other words, banks should have much more sophisticated and complex security for large depositors with significant flows of funds.  Otherwise, in the age of genius hackers, a bank risks an adverse outcome and as anyone who has experienced large scale hacking, a lot of money can leave very quickly. 

As an aside, I had to go to the Southeast part of the State last week.  For those suffering the malaise of the Albuquerque and Santa Fe recovery, a trip to Roswell, Artesia and that area is a real eye opener.  Roswell now has at least four new large chain hotel-motels on the border of N.M.M.I.  Committed to progress Roswell has  a prominent natural gas refueling station which resembles a small filling station.  Artesia is booming and housing is in short supply.  One prominent banker in Artesia said there were many jobs (not just oil field) vacant and unfilled in the market area.  A new apartment is being built, the first in many years. Albuquerque and Santa Fe ignore this part of the state, and do so at their peril. 

Have a good day and do good.

Marshall G. Martin
Comeau Maldegen Templeman & Indall
Cell:  505-228-8506
Office: 505-982-4611