On May 14, 2012, the Federal Reserve, FDIC and the OCC released a joint statement confirming that that banking organizations with total consolidated assets of $10 billion and under will not be required to conduct formal stress tests. Management of many smaller banking organizations had been concerned that the stress testing required of larger banks would “trickle down” in an informal sense to smaller banks. With this regulatory statement, that concern is alleviated, at least in the official sense.
We continue to believe that the heightened (or perhaps renewed) emphasis on risk management by the regulators will affect banks of all sizes. It is likely that regulators, directors, and shareholders of all banks will want to confirm that management has identified the key risk factors affecting the institution and that the board has established the institution’s tolerance for accepting those risks and implemented any appropriate mitigants.
We recommend that banks of all sizes, even the smallest community banks, undertake an enterprise risk management analysis to identify the key risks facing the institution. The board of the institution, as a subpart of its strategic planning function, should review those risks and establish the institution’s risk tolerance with respect to each category of risk (many consultants will capture this analysis in a “risk appetite statement”). Establishing and understanding those risk tolerances will form a roadmap for setting and executing the institution’s strategic initiatives. In implementing this analysis, some institutions may undertake some level of stress testing with respect to certain risks.
This risk management analysis is a natural adjunct to the self examination process used we recommend using in preparing for a regulatory exam (see our prior “Self Exam” post). While the self exam process is typically more focused on the bank’s current position and past performance and this risk management analysis is more forward-looking, both processes require an introspective review. Senior regulators have repeatedly confirmed to us (and we have seen in practice) that where banks take the initiative in implementing credible risk management programs and other pre-examination preparation, the examiners are much more likely to defer to the judgment of management and the board of the bank – with the result being a much better interaction with regulators (who, in an ideal scenario, can be a partner in the risk identification process).
Many financial institutions, particularly community banks, have enhanced the experience level of their boards by adding a director who is a banker or serves on the board of another financial institution. In general, utilizing a director who has current experience with another financial institution is a great way to add valuable perspective to a variety of issues that the board may encounter. In addition, as private equity funds made substantial investments in financial institutions, they often bargained for guaranteed board seats. The individuals selected by private equity firms as board representatives often serve on a number of different bank boards. As market conditions have led to increased bank failures, however, a problem has resurfaced that may cause some financial institutions to take a closer look at nominating directors who also serve other financial institutions: cross-guarantee liability to the FDIC.
The concept of cross-guarantee liability was added to the Federal Deposit Insurance Act by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA). The pertinent provision states that any insured depository institution shall be liable for any loss incurred by the FDIC in connection with:
- the default (failure) of a “commonly controlled” insured depository institution; or
- open bank assistance provided to a “commonly controlled” institution that is in danger of failure.
This means that if two banks are “commonly controlled” and one of them fails, the other bank can be held liable to the FDIC for the amount of its losses or estimated losses in connection with the failure. As many of us see each Friday, the amounts of these estimated losses are often quite high. In fact, the FDIC’s estimated losses for 2011 bank failures were approximately 20 percent of total failed bank assets for the year. Accordingly, the prospect of cross-guarantee liability can be a tremendous financial issue for the surviving bank.
The United States Court of Appeals for the 11th Circuit rendered an important decision on March 5, 2012, addressing the enforceability of binding arbitration provisions in consumer deposit agreements. The case began when Lawrence and Pamela Hough brought suit against Regions Bank for allegedly violating federal and state law by collecting overdraft charges under its deposit agreement. The deposit agreement contained an arbitration provision and Regions moved to compel arbitration. The federal district court hearing the case denied the motion to compel on the ground that the arbitration clause was substantively unconscionable because it contained a class action waiver. Regions appealed the decision to the 11th Circuit Court of Appeals and the appellate court vacated the ruling and sent it back to the trial court in light of a recent United States Supreme Court which held that the Federal Arbitration Act preempted a California’s judicial rule regarding the unconscionability of class arbitration waivers in consumer contracts. This time around the district court found other reasons to deny Regions’ motion to compel arbitration, holding that the arbitration clause was substantively unconscionable under Georgia law because it believed that a provision granting Regions the unilateral right to recover its expenses for arbitration allocated disproportionately to the Houghs the risks of error and loss inherent in dispute resolution.
The lower court decision was again appealed to the 11th Circuit. On appeal the Houghs argued that while the arbitration provision in the deposit agreement capped the Houghs’ costs for the arbitration proceeding at $125, another paragraph required the Houghs to reimburse Regions as a prevailing party for its costs of arbitration. The arbitration agreement permitted Regions, if it was “the prevailing party,” to obtain “reimburse[ment] for [its] costs and expenses (including reasonable attorney’s fees) … [in] arbitration” and to collect that amount by “charg[ing] [the Houghs'] account.” The district court concluded that the reimbursement provision was unconscionable because Regions had an exclusive right of setoff. The 11th Circuit disagreed, and noted that under Georgia law an arbitration provision is not unconscionable because it lacks mutuality of remedy. The district court also ruled that the arbitration clause had a degree of procedural unconscionability, but the 11th Circuit found that to be unconscionable under Georgia law, a contract must be so one-sided that “no sane man not acting under a delusion would make and that no honest man would participate in the transaction.” The court found that the arbitration clause in the Houghs’ agreement fell well short of that standard. Although the district court found it troubling that the clause was presented to the Houghs “on a take-it-or-leave-it basis with no opt-out provision,” the 11th Circuit noted that under Georgia law, an adhesion contract (i.e., one that is not truly negotiated between the parties such as a deposit agreement or a credit card agreement) is not per se unconscionable.
Legislation has been introduced in the United States House of Representatives that, if passed, would relieve banks of the responsibility of installing and monitoring the presence of physical notices on their ATMs notifying customers about the imposition of ATM transaction fees.
On April 17, 2012, Representatives Blaine Luetkemeyer (R-MO) and David Scott (D-GA) introduced H.R. 4367 which seeks to amend the Electronic Fund Transfer Act to limit the fee disclosure requirement for operators of ATMs to the electronic notice alone. The electronic notice allows a consumer to choose whether the consumer wishes to continue with the ATM transaction and pay the fee or exit the transaction. This proposed bill comes in the wake of class action litigation filed against banks and other ATM operators nationwide (and most recently against several Georgia community banks) alleging that the banks failed to post or maintain the physical notice on their ATMs.
As currently written, the Electronic Fund Transfer Act requires both a physical notice at or on the ATM in addition to the electronic notice the customer receives on the computer screen when making the withdrawal. Currently, there are statutory penalties for failure to comply with the Act. While there is no minimum penalty proscribed for a class action, the statute provides that in a successful class action, plaintiffs may recover up to “the lesser of $500,000 or 1 percent of the net worth of the (ATM operator),” plus attorneys’ fees and costs. There may be a defense to such claims when the bank maintains procedures reasonably adapted to avoid a failure to comply with the Act and the failure to comply was a “bona fide error.”
Even where banks have been in full compliance with the physical notice requirements, many banks have found that their fee notice placards have mysteriously disappeared or have been removed by persons as yet unknown in the time periods preceding the institution of litigation against them.
Georgia foreclosure law has been given a lot of attention over the last several years, both by the courts as well as the legislature. The Georgia Supreme Court has had to resolve the issue of whether a lender must sue on a note prior to foreclosing under a security deed and held that the choice is up to the lender. (See REL Development, Inc. v. BB&T, 699 SE2d 779 (2010).) Likewise, the legislature addressed a perceived problem in large loan servicing companies foreclosing on real property even though a division of the servicer was still negotiating with the borrower to cure the default. Thus, a lender can rescind a foreclosure, for among other reasons, the fact that it had entered into an agreement when the default was cured prior to the sale or the borrower had entered into an agreement to cure the default. (See OCGA 9-13-172.1.) What happens though if a lender actually conducts a foreclosure sale and then simply decides that it would rather sue on the note. Can it unwind the foreclosure even if its reasons for doing so do not fall with the statutory guidelines?
The Georgia Supreme Court has decided that a lender may in fact rescind a properly conducted foreclosure sale for its own internal business reasons.(See Tampa Investment Group, Inc. v. BB&T, 2012 WL 933110 (Ga.).) From 2005 to 2008, BB&T made 16 loans for residential housing development to two companies secured by various deeds to secure debt. After the borrowers defaulted on the notes, BB&T conducted non-judicial foreclosures on June 2, 2009 on nine of the notes. BB&T credit bid the properties in but later informed the borrowers that it was rescinding the sale. Most importantly, BB&T did not record a deed under power. On June 22, 2009, BB&T brought suit against borrowers and guarantors for more than $19 million then due under the notes.
At the trial on the enforcement of the notes the court found that BB&T could not pursue the notes since it had failed to confirm the initial foreclosure sale. The Georgia Court of Appeals reversed that decision on the basis that acceptance of a bid at a foreclosure sale under power creates an oral contract which is subject to the Statute of Frauds. The Statute of Frauds provides that certain contracts, such as for the sale of real property or an extension of credit, are not enforceable unless they are in writing. In this case, BB&T, either as borrowers’ attorney-in-fact or as the creditor on the notes, never executed a deed under power conveying the borrowers’ interest to itself or any writing showing that it had applied any foreclosure proceeds. The court further found that rescinding the foreclosures did not harm borrowers but left them in the same position as before the auctions.
On March 27, 2012, the House of Representatives approved the version of the JOBS Act, as amended by the Senate, by a vote of 380 to 41. Accordingly the legislation has been sent to President Obama for signature, who has previously indicated his support of the legislation. The White House has indicated that the President anticipates signing the JOBS Act early in the week of April 2, 2012.
The text of the final JOBS Act is available here. We have previously summarized the provisions of the JOBS Act generally applicable to the community banks, as well as the impact of the Senate amendment to the JOBS Act. In this post we focus on the timing implications for effectiveness of the amendments to Regulation D and shareholder thresholds for SEC registration and deregistration.
With regard to Regulation D, Section 201 of the JOBS Act requires the SEC to eliminate the prohibitions on general solicitation and general advertising in connection with Rule 506 and Rule 144A offerings, so long as the securities are only sold to accredited investors and qualified institutional buyers, respectively. The JOBS Act requires the SEC to implement these changes no later than 90 days after the JOBS Act is signed by the President. Until the SEC amends the existing regulations, general solicitation and general advertising will remain prohibited.
With regard to the shareholder threshold changes, Sections 501 and 601 of the JOBS Act immediately amend the statutory provisions related to the number of shareholders of record at which a company must register and when the company is permitted to register. The statutory changes are effective immediately upon enactment of the JOBS Act. However, the SEC has also adopted regulatory requirements based on the original statutory language that will likely need to be amended in order to fully take advantage of the revised thresholds.
On March 22, 2012, the U.S. Senate adopted H.R. 3606, the Jumpstart Our Business Startups Act (a.k.a., the JOBS Act) by a vote of 73 to 26. Prior to its passage, the U.S. Senate adopted Amendment 1884 proposed by Senators Merkley and Brown that replaced the “Crowdfunding” exemption contained in the house-passed legislation with a narrower provision. As the Senate and the House have adopted different versions, the House will have to consider and pass the Senate amendment before a bill could become law, or convene a conference committee to reconcile the House and Senate versions of the bill. (The Senate rejected by a voice vote Amendment 1931 proposed by Senator Reed that would have changed the SEC’s shareholder counting rules from record holders to beneficial owners.)
As the bulk of the JOBS Act was approved without change, our summary of the impact of the JOBS Act on community banks remains accurate.
The amended “Crowdfunding” provision includes significant restrictions on the potential utility of the new exemption, particularly for how it may have utilized by community banks. The ultimate utility of the Crowdfunding exemption will largely be tied to the implementing regulations to be adopted by the SEC. Under the Senate’s version of the JOBS Act, the Crowdfunding exemption would be available for up to $1 million in issuances in any 12-month period, require investors to purchase no more than 5-10% of their net worth in the issuance, and require the use of either a broker or “funding portal” as that term is defined in the bill.
While still in proposed form, and subject to significant political uncertainty, we offer this summary of the impact of the Jumpstart Our Business Startups Act (a.k.a., the JOBS Act). This summary is based on the version that passed the House on March 8, 2012, and was brought to the Senate floor on March 19, 2012. On March 20, 2012, the Senate failed to achieve sufficient votes to substitute the JOBS Act for the INVEST in America Act of 2012 (technically, it would have been the “Invigorate New Ventures and Entrepreneurs to Succeed Today in America Act of 2012,” but I think the acronym is a LOT better in this case), which contained some similar, but not identical, provisions. Accordingly, it appears that the JOBS Act, as adopted in the House, may be voted upon by the Senate this week.
Emerging Growth Companies
The bulk of the JOBS Act, and focus of most of the congressional debate, is on the creation of a new class of registered companies deemed “Emerging Growth Companies.” These registrants are not limited by business operations, and banks and bank holding companies could quality. An Emerging Growth Company would generally consist of newly public companies (IPO registration statement effective after December 8, 2011), with market caps of less than $750 million and total gross annual revenues (presumably interest income plus non-interest income for banks) of less than $1 billion. New registrants could quality for Emerging Growth Company status for up to five years following their IPO, at which time they would lose the advantages of being an Emerging Growth Company even if they otherwise continued to qualify.
An Emerging Growth Company would be exempt for the say on pay vote, as well as pay vs. performance and pay equality disclosures, and would not be required to have independent auditors attestations regarding internal controls under SOX 404. In addition, they would be eligible to generally rely on the scaled disclosures otherwise permitted for smaller reporting companies. In addition, an Emerging Growth Company would be provided the opportunity to initially file their draft IPO materials confidentially with the SEC and otherwise have greater flexibility in communications with regard to their IPO.
Modification of Securities Offering Exemptions
Within 90 days of passage, the SEC would be required to amend Regulation D and Rule 144A to permit general solicitation and advertising in Rule 506/Rule 144A offerings so long as the securities are only sold to accredited investors or qualified institutional buyers, respectively.
Four class action complaints have been filed in the last two weeks against four different Georgia community banks alleging that the banks have violated the Electronic Fund Transfer Act. The complaints were filed in the federal courts and all allege that the banks imposed fees on consumers who withdrew cash from the bank’s ATMs and that the banks allegedly failed to post a physical notice on the ATMs that a fee would be imposed for such services.
The Electronic Fund Transfer Act requires both a physical notice at or on the ATM in addition to the electronic notice the customer receives on the computer screen when making the withdrawal. There are statutory penalties for a failure to comply with the Act. While there is no minimum penalty proscribed for a class action, the statute provides that in a successful class action, plaintiffs may recover up to “the lesser of $500,000 or 1 percent of the net worth of the (ATM operator),” plus attorneys’ fees and costs. There may be a defense to such claims when the bank maintains procedures reasonably adapted to avoid a failure to comply with the Act and the failure to comply was a “bona fide error.”
The attorneys associated with these cases have filed similar class actions, alleging the same violations of the Electronic Fund Transfer Act, against other banks, hotels and retailers around the country.
Just as many bankers believed that the worst of the enforcement environment was behind them, a threat of “new” Consent Orders for some state non-member banks has arisen. These “new” orders are not reflective of banks for which the regulators have identified new problems but are instead based upon the FDIC’s apparent decision that orders that were “led” by state regulators are not adequate for the FDIC’s enforcement purposes. To illustrate this point, the new orders we have seen thus far have been substantively consistent with the existing state orders.
This movement by the FDIC comes at an unfortunate time given overall downward trend in the number of FDIC consent orders being issued as banks continue to identify and manage their problems. From a practical standpoint, the publication of a new FDIC order may result in perception that a bank’s condition is worsening when in fact the bank is well on its way to compliance with the existing state order.