The Third Circuit issued a long-awaited decision in the New Jersey Abandoned Property litigation, NJ Retail Merchants Association v. Andrew Sidamon-Eristoff. The court affirmed the District Court’s decision in this important escheat case with broad implications for members of the prepaid industry.
BACKGROUND
In 2010 New Jersey passed a new abandoned property law that, if upheld, would have been devastating for gift card and prepaid card issuers doing business in New Jersey.
- First, the new law shortened the dormancy period for prepaid cards and gift cards from being not even subject to escheat, to requiring escheat after 2 years of inactivity (a shorter period than other states, and far shorter than the required 5 years validity under the CARD Act).
- Second, the new law also required prepaid card issuers to retroactively escheat all funds from inactive prepaid cards sold in the last 5 years.
- Third, the new law required sellers of prepaid cards (both open and closed loop cards) to collect the name and address of the purchaser, or at the very least, the purchaser’s zip code. Later this requirement was modified so that only collection of the purchaser’s zip code was “mandatory.”
- Fourth, if the purchasers name and address (or zip code) was not known or collected, the purchaser’s address would be deemed to be the address of the store where the card was purchased.
NOTE – The reason New Jersey wants sellers to collect purchasers’ name and address, or otherwise wants to “deem” the purchasers’ address to be in New Jersey, is because under the uniform abandoned property laws, unused funds from gift cards and other prepaid cards would be paid to the state of the last known address of the purchaser. But if the last known address of the purchaser is not known (which is the case for virtually ALL gift cards), then the unused funds are paid to the state where the card issuer is domiciled. New Jersey’s new law, deeming purchasers’ addresses to be in NJ, or otherwise requiring collection of zip code data from purchasers, was intended to make sure that more of the unused funds escheat to NJ rather than to other states where the card issuers are domiciled. Since many prepaid card issuers are domiciled in states that don’t require escheat, the imposition of NJ’s new law as initially passed, with retroactivity, could have had serious consequences for many prepaid card programs.
BOTTOM LINE
The Third Circuit’s Opinion represents both good news and bad news for the gift card and prepaid card industry. See details below.
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Doctors recommend various self exams to catch disease early, so it can be treated before it’s too late. As it turns out, a self examination can be good for the health of a bank as well. My colleagues and I recommend that our banking clients and friends undertake a regular self examination in order to identify potential internal and external challenges that the bank may face. As discussed more thoroughly below, these self examinations can also be very helpful when the bank’s doctor (your friendly regulator) comes in for a check-up.
Enlist internal audit
To initiate the self examination, the audit committee of the bank’s board of directors should charge management with preparing a report that outlines the current and projected status of the bank’s key areas of risk. Ideally, the bank’s internal audit function will take the lead in performing the examination and preparing the related report. In order to maximize the value of this report, the audit committee should direct management to deliver the report at least 60 days prior to the bank’s next scheduled regulatory exam. The self examination report, in its most basic form, should cover the areas that are the focus of the bank’s regulators: CAMELS (capital, asset quality, management, earnings, liquidity and sensitivity to market risk). The report should also address any key areas of risk identified by the directors.
Analyze your market
In addition to analyzing the typical CAMELS components and other areas of risk, a very important part of the self examination process is a market study. The report should present facts, trends and projections related to the market area in order to define the opportunities and challenges being faced by the bank’s customers. While many bank directors have a good feel for market trends, we have found that this data, when presented with specific facts and trends, can inform the board’s discussions of a variety of topics a great deal. It can also provide the bank with support for dealing with its examiners, who conduct their own market analysis prior to each examination.
The CFPB is requesting suggestions for streamlining the regulations it has inherited from other agencies pursuant to the Dodd-Frank Act.
In particular, the bureau is asking the public to identify provisions of such regulations that it should make the highest priority for updating, modifying or eliminating because they are outdated, unduly burdensome or unnecessary, including:
- Certain definitions in Reg E, Reg P, Reg Z
- Annual privacy notices under Reg P
- ATM fee disclosures under Reg E
- Coverage and scope of Reg Z
- Electronic disclosures required under Reg E and Reg Z
Publication of the CFPB’s notice in the Federal Register is available at http://www.gpo.gov/fdsys/pkg/FR-2011-12-05/pdf/2011-31030.pdf. Comments are due by March 5, 2012; commenters will have until April 3, 2012, to respond to other comments.
The CFPB is republishing regulations for which it is assuming authority from other agencies pursuant to the Dodd-Frank Act and making technical and conforming changes to reflect the transfer of authority and other changes required by the act. Among others, the CFPB issued interim final rules with request for public comment for the Federal Reserve’s Regulation E (Electronic Fund Transfers, Regulation P (Privacy of Consumer Financial Information) and Regulation Z (Truth in Lending).
The preambles to the interim final rules state that the regulations do not impose any new substantive obligations on persons subject to the existing regulations as published by the Federal Reserve.
The interim final rules became effective Dec. 30, 2011. The Reg E interim final rule is available at http://www.gpo.gov/fdsys/pkg/FR-2011-12-27/pdf/2011-31725.pdf; comments are due by Feb. 27, 2012. Reg P is available at http://www.gpo.gov/fdsys/pkg/FR-2011-12-21/pdf/2011-31729.pdf; comments are due by Feb. 21, 2012. Reg Z is available at http://www.gpo.gov/fdsys/pkg/FR-2011-12-22/pdf/2011-31715.pdf; comments are due by Feb. 21, 2012.
The lead-participant relationship arising from a loan participation has become a fairly contentious one over the last two years as the interests of the two have diverged. For example, loan participants that may be in a troubled condition are never terribly anxious to hear that the lead bank has obtained a current appraisal of the primary collateral. Likewise, a strong loan participant my push a weak lead bank to take more decisive action regarding collecting the loan and possibly foreclosing on the collateral. Throw in the implications inherent in a loss-share transaction where a lead bank’s losses may be reimbursed by the FDIC and things really get interesting. At the end of the day, however, the lead bank and the participants generally have the same economic interest in taking steps to maximize the economic recovery on the loan. Likewise, if bad things happen on the loan then lead and participants are all in it together.
What if participants could tell the lead that it had to keep the losses while they kept the loan payments? A recent bankruptcy case from Kansas provides an interesting illustration of that situation. In the case of In re Brooke Corp., the debtor filed bankruptcy after having made three payments to Stockton National Bank, the lead bank, totaling $487,973 in the 90 days prior to filing. Stockton kept its portion of those payments and forwarded the remainder to the participants. The Bankruptcy Trustee later sued Stockton for recovery of the three payments on the grounds that they were preferential transfers. Stockton, which had sold 94.44% of the loan to the participants, prepared to take the pretty standard defense of the matter arguing that it had merely served as a “conduit” for the payments and should thus have very limited liability. Interestingly, the participants filed pleadings arguing that the lead bank was in fact liable for the entire amount, arguing that the lead bank had dominion and control over the loan proceeds.
In effect, the participants sought to bifurcate the lead-participant relationship by arguing that the lead bank had a certain amount of discretion over what to do with the loan proceeds it received and the fact that it passed them along to the participants was a nice gesture but was no different than using the proceeds to pay salaries or the rent. In a lengthy opinion the bankruptcy court rejected multiple arguments by the participants and found that whatever discretion the lead had was solely as to the administration of the loan, not to whether it could decide to keep the loan proceeds for itself rather than passing them along to the participants. Ultimately, the Trustee would be allowed to pursue the participants if in fact all of the elements of preferential transfer were met.
If you are a lead bank how do you protect yourself in this type of situation?
In recent exam cycles, bankers have generally been no strangers to heightened scrutiny by FDIC examiners on a variety of topics. In the past several months, the insurance policies carried by banks have been added to the list of potential hot-button items.
Specifically, FDIC examiners have begun to scrutinize bank insurance policies to determine whether the policies provide coverage for civil money penalties (“CMPs”) that may be assessed against bank officers or directors. If any bank insurance policies are found on examination to contain an endorsement extending coverage for CMPs to officers or directors, the FDIC is citing such policies as being in violation of Part 359 of the FDIC’s Rules and Regulations.
Part 359, among other things, prohibits banks and affiliated holding companies from making certain “prohibited indemnification payments.” These prohibited payments include any payment or agreement to pay or reimburse bank officers or directors for any CMP or judgment resulting from any administrative or civil action which results in a final order or settlement in which that officer or director is assessed a CMP, removed from office or ordered to cease and desist from certain activities. As a matter of public policy, this provision is designed to prevent banks from bearing the costs of penalties assessed against individuals for actions that could result in harm or potential harm to a bank or to the safety and soundness or integrity of the banking system more generally.
Part 359 explicitly permits reasonable payments by banks to purchase commercial insurance policies, provided that the policy not be used to pay or reimburse an officer or director the cost of any judgment or CMP assessed against him or her. However, Part 359 does permit the insurance paid for by the bank to cover (1) legal or professional expenses incurred in connection with such a proceeding and (2) the amount of any restitution to the bank, its holding company, or its receiver.
While any relief still has a long (and uncertain) path before it would be effective, on October 26, 2011, the House Financial Services Committee approved four bills (with bipartisan support) that would remove regulatory federal securities law obstacles to capital formation.
H.R. 1965 would, for banks and bank holding companies, raise the SEC registration threshold to 2,000 shareholders and the deregistration threshold to 1,200 shareholders.
H.R. 2167, the “Private Company Flexibility and Growth Act,” would raise the SEC registration threshold for all companies to 1,000 shareholders and would exclude accredited investors and certain employees from the definition of “held of record” for registration purposes.
H.R. 2940, the “Access to Capital for Job Creators Act,” would permit general solicitation and general advertising for private offerings conducted under Rule 506, so long as all purchasers were accredited investors.
The CFPB published its Supervision and Examination Manual (the “Manual”) on October 13, 2011, designed to provide CFPB examiners with direction on how to determine if providers of consumer financial products are complying with consumer protection laws. The CFPB’s press release states that the Manual incorporates procedures already used by other federal regulators. The Manual does simply recite certain interagency procedures, such as for fair lending examinations. At the same time, the Manual addresses new Dodd-Frank concepts, such as unfair, deceptive and abusive acts or practices.
The CFPB will use the Manual initially to supervise the more than 100 large banks, thrifts, and credit unions that are subject to the CFPB’s examination authority pursuant to the Dodd-Frank Act (those with total assets over $10 billion, as well as their affiliates). The Bureau’s examiners will also ultimately use the Manual to supervise non-depository consumer financial service companies (e.g., mortgage lenders), with the stated goal of promoting “fair, transparent, and competitive consumer financial markets where consumers can have access to credit and other products and services, and where providers can compete for their business on a level playing field where everyone has to play by the rules.”
The CFPB Examination Framework and Philosophy
While only certain entities will be subject to CFPB examination, the Manual outlines an examination approach that is illustrative of the Bureau’s bend on matters over which it has rulemaking authority. This is particular true of its view of its authority over matters it considers unfair, deceptive or abusive acts or practices (UDAAP).
Like other bank regulators, the CFPB will prepare for examinations by gathering and reviewing a wide array of regulatory and public data about an institution: state and/or prudential regulator reports of examination and correspondence, enforcement actions, state licensing and registration information, complaint data, call reports, HMDA LARs, HAMP data, fair lending analyses, SEC or other securities-related filings, the institution’s website and advertising, and, among other things, “newspaper articles, web postings, or blogs that raise examination related issues.” The CFPB will then contact the institution about the examination and prepare its customized Information Request.
No, nothing to worry about yet, though it may be confusing for some time. One bureaucratic consequence of the Dodd-Frank Act moving the various consumer protection laws and regulations under the jurisdiction of the Consumer Financial Protection Bureau (CFPB) is that they now must reissue the relevant regulations.
Referred to by CFPB insiders as the “restatement project,” the CFPB is preparing to reissue over 3,000 pages of regulations through approximately fourteen Federal Register notices. The reissued regulations will be changed to reflect jurisdictional changes and some scope changes, but they are not expected to change substantively at this time (although we will be watching). We expect publication of these reissued regulations to begin within days.
The possible source of confusion will be a new numbering system. The regulations will still be in Title 12 of the Code of Federal Regulations, but moved to Chapter X. We understand that most of the numbers will be unchanged after the decimal point, but the other numbers could be very different. So, for example, 12 CFR § 226.1 of Regulation Z could become 12 CFR § 1000.1. In some cases, however, due to rules of the Office of the Federal Register, new numbers will be required. For example, Regulation Z sections 226.5a and 226.5b could become 12 CFR § 10XX.40 and 12 CFR § 10XX.60.
None of this is all that earth shaking except to lawyers with nothing else to worry about. All those years memorizing regulation numbers for naught.
The Georgia Court of Appeals recently issued a very favorable ruling for banks that have purchased loans from the FDIC. In the case of KENSINGTON PARTNERS, LLC et al. v. BEAL BANK NEVADA, the guarantors argued that the purchaser of a $7 million loan from the FDIC did not possess a valid assignment from the FDIC. The original loan had been extended by BankFirst in 2006. BankFirst subsequently failed and the FDIC sold the loan to Beal Bank Nevada.
The record established that the FDIC sold the loan and all related documents, including the guaranties and the court rejected the argument put forth by the guarantors. In a helpful comment, the court noted that even if the assignment from the FDIC had not referenced the guaranties, under Georgia law, the assignment of the note carried with it the assignment of the guaranties. The guarantors also argued that there were genuine issues of fact concerning the amounts owed under the note.
The court rejected these arguments as well based on evidence from the FDIC loan portfolio manager accounting for the loan balance from its inception. The case is typical of some of the lender liability litigation that lenders are having to grapple with right now as well heeled borrowers and guarantors attempt to put off the day of reckoning. The litigation can be lengthy and expensive and the loan obligors are seeking to use that to extract a settlement form the lender that is favorable to the obligors.
Lenders seeking to collect against loan obligors that have sufficient assets to cover the loan should enter into collection activities with realistic expectations about the time and cost involved. Bank counsel’s awareness of typical or new lender liability theories is also vital to a successful collection effort.