Adapting Bank Supervision to the Covid-19 Reality

Can a bank socially distance itself from its primary federal regulator?

In the midst of the Covid-19 pandemic, the answer is apparently yes.

The Office of the Comptroller of the Currency, which oversees nationally chartered banks and thrifts, has been impacted by the virus’ shutdown in much the same way as the institutions it oversees.

In an interview with Bank Director, Acting Comptroller of the Currency Brian Brooks — who replaced former Comptroller Joseph Otting after his resignation on May 29 — says the pandemic has forced the agency to adapt its preferred method of operation to the restrictions of social distancing.

“One thing that I worry about from a supervision perspective is, historically, bank examiners go on-site,” Brooks says. “Not because it’s convenient, but because being able to be in a room with bankers and sit face to face with people … is a critical tool in identifying fraud and identifying trends that might not make it onto a management report, or might not be raised in a formal presentation. And the longer banks are in a work-from-home environment, the harder it is for us to do that human aspect of bank supervision.”

Brooks says while there are legitimate health reasons why much of the banking industry has operated with a distributed workforce for the last several months, he’s anxious to reintroduce the element of personal contact into bank supervision. “I know that may not happen next month or even this quarter, but we need to start charting that course back, because this method of supervision can’t go on forever,” he says.

The OCC is reopening its facilities on June 21 and is encouraging people who do not have underlying health conditions and would feel comfortable doing so to return to their offices. “That’s our way of showing leadership to the industry of how one can start charting this course back to normalcy,” Brooks explains. “But having said that, we’ve moved to significantly enhanced cleaning schedules. We’re obviously providing face masks and gloves to people who are in mail-handling or public facing positions. We’re changing seating arrangements to maximize the availability of social distancing. And of course, we’re continuing to allow anyone who wants to, to work remotely while making the office … more normalized for everybody else.”

Brooks believes that recent data on the virus suggests that the health risk for most people is manageable. “What the data seem to be showing is that hospitalization rates and fatality rates for people of working age, who don’t have particular risk conditions, seem to be within historic norms,” he says. “Which is not to say that this is not a dangerous disease, but it does appear to be that … people who are under a certain age and who don’t have certain conditions are not at special risk relative to other types of viruses that we’ve seen before.”

And when OCC examiners do return to on-site visits to their banks, they will follow whatever safety protocols the bank has in place.

The Covid-19 pandemic has dealt a crushing blow to the U.S. economy — which entered a recession in February — and the OCC wants national banks to take a hard look at their asset quality. It’s not an easy assessment to make. Banks have granted repayment deferrals of 90 days or greater to many of their borrowers at the same time as the federal government suspended troubled debt restructuring guidance and pumped money into the economy through the Paycheck Protection Program. A clear asset risk profile has yet to emerge for many institutions.

“Some of the traditional metrics that we’ve used to determine asset quality … could be masked by a lot of the relief efforts,” says Maryann Kennedy, senior deputy comptroller for large-bank supervision at the OCC. “Many of our institutions are going back and retooling many of their stress testing models in response to the breadth, depth and velocity of the number of programs that they’re instituting there.” 

Just because OCC examiners don’t have personal contact with their banks doesn’t mean they haven’t been talking to them through the pandemic. Some of those conversations are an effort to triage which banks may need the greatest attention from regulators.

“There is a real time risk-based assessment of what’s happening with our national banks and federal savings associations, so we can try to understand how we move forward and where we focus our attention. [It’s] is very challenging, similar to the challenge [banks have] trying to understand their asset quality and the situation with their loan portfolios,” says Kennedy.

The OCC is essentially trying to assess the pandemic’s economic impact on national banks and thrifts while those institutions make their own credit risk assessments.

“A real-time conversation that’s going on right now, particularly in that in our larger banks, is ‘What is your stress forecasting looking like for provision expense in the second quarter, as well as what could be those potential impacts to earnings, particularly as it relates to any earnings expectations that might be out there?’” Kennedy says. “Those are challenging conversations going on right now … as our bank managements sort of work through the struggle [with] some of those specifics. It’s not a real predictive economy right now.”

What Regulators Are Doing About Coronavirus

For the last few weeks, bank regulators have been gearing up their responses and preparations as the U.S. financial industry and broader economy confront the impact of the coronavirus pandemic.

On March 13, President Donald Trump declared a national state of emergency that freed billions in aid as cities and sectors grappled with the pandemic. The announcement capped off a tumultuous week of market freefalls and rallies, the cancelation of major sporting events, closed college campus and the start of millions of Americans voluntary and involuntary quarantining and national social distancing. It remains to be seen how long the outbreak will last and when it will peak, as well as the potential economic fallout on businesses and consumers.

Already, the Federal Open Market Committee has lowered the federal funds rate twice; the most recent was a surprise 100-basis point decline on March 15, to the range of 0 to 25 basis points. The Fed last lowered interest rates to near zero back in late 2008. The move is intended to support economic activity and labor market conditions, and the benchmark rate will stay low until the Fed is confident the economy has weathered recent events.

Additionally, the Fed announced it would increase its holdings of both Treasury securities by at least $500 billion and agency mortgage-backed securities by at least $200 billion.

Bank executives and directors must now contend with near-zero rates as they work with borrowers to contain the economic implications of the coronavirus.

“The adverse economic effects of a pandemic could be significant, both nationally and internationally,” the Federal Financial Institutions Examination Council wrote in recently updated guidance on how banks can minimize the adverse effects of a pandemic. “Due to their crucial financial and economic role, financial institutions should have plans in place that describe how they will manage through a pandemic event.”

The ongoing events serve as a belated reminder that pandemic preparedness should be considered as part of board’s periodic review of business continuity planning, according to a March 6 interagency release. These plans should address how a bank anticipates delivering products and services “in a wide range of scenarios and with minimal disruption.”

The FFIEC’s guidance says pandemic preparation in a bank’s business continuity plan should include a preventive program, a documented strategy that is scaled to the stages of an outbreak, a comprehensive framework outlining how it will continue critical operations and a testing and oversight program. The plan should be appropriate for the bank’s size, complexity and business activities.

A group of agencies including prudential bank regulators are encouraging financial institutions to work constructively with customers in communities impacted by the new coronavirus, according a statement released on March 9. They also pledge to provide “appropriate regulatory assistance to affected institutions,” adding that prudent accommodations that follow “safe and sound lending practices should not be subject to examiner criticism.”

The regulators also acknowledged that banks may face staffing and other challenges associated with operations. The statement says regulators will expedite requests to provide “more convenient availability of services in affected communities” where appropriate, and work with impacted financial institutions for scheduling exams or inspections.

The Federal Deposit Insurance Corp and the Office of Comptroller of the Currency highlighted more specific ways banks can work with customers in a set of releases dated March 13. Some of the suggested potential accommodations, made in a safe and sound manner and consistent with bank laws, include:

  • waiving ATM, overdraft, early time deposit withdrawal and late credit card or loan fees
  • increasing ATM daily cash withdrawal limits
  • reducing restrictions on cashing out-of-state and non-customer checks
  • increasing card limits for creditworthy borrowers
  • payment accommodations that could include deferring or skipping payments or extending the payment due date to avoid delinquencies and negative reporting if a disruption is related to COVID-19.

The OCC points out that lending accommodations for existing or new customers can help borrowers facing pressured cash flows, improve their ability to service debt and ultimate help the bank collect on the loans. It adds that banks should individually evaluate whether a loan modification would constitute a troubled debt restructuring.

The regulator also acknowledged that some banks with customers impacted by issues related to the coronavirus may experience an increase in delinquent or nonperforming loans, and says it will consider “the unusual circumstances” these banks face when reviewing their financial condition and weighing the supervisory response.

The FDIC specifically encouraged banks to work with borrowers in industries that are “particularly vulnerable to the volatility” stemming from COVID-19 disruption, as well as the small business and independent contractors reliant on those industries.

“A financial institution’s prudent efforts to modify the terms on existing loans for affected customers will not be subject to examiner criticism,” the FDIC wrote in its release.

Some of the largest and most dramatic regulatory accommodation related to the new coronavirus has come from the Federal Reserve, given its role in the funding market and its role overseeing large bank holding companies.

The Fed announced on March 12 that it would inject $1.5 trillion into the U.S. market for repurchase agreements over the course of two days. The increased purchases, which serve as short-term loans for banks, were not meant to directly stimulate the economy. Instead, they were done to “address the unusual disruption” in Treasury financing markets from the coronavirus and help ensure it would continue functioning properly.

The Fed also announced several more changes to accommodate banks on March 15. It is now allowing depository institutions to borrow from the discount window for as long as 90 days and is encouraging banks to use its intraday credit. It is explicitly encouraging banks to use their capital and liquidity buffers to lend to customers impacted by the coronavirus and lowered the reserve requirement ratio to 0%, effective at the start of the next reserve maintenance period on March 26.

For more information from the regulators, check out their websites

FDIC: Coronavirus (COVID-19) Information for Bankers and Consumers
OCC: COVID-19 (Coronavirus)
Federal Reserve Board: Coronavirus Disease 2019 (COVID-19)
Conference of State Bank Supervisors: Information on COVID-19 Coronavirus and State Agency Nonbank Communication/Guidance on Coronavirus/COVID-19

The Year Ahead in Banking Regulation

Although it is difficult to predict whether Congress or the federal banking agencies would be willing to address in a meaningful way any banking issues in an election year, the following are some of the areas to watch for in 2020.

Community Reinvestment Act. The Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. issued a proposed rule in December 2019 to revise and modernize the Community Reinvestment Act. The rule would change what qualifies for CRA credit, what areas count for CRA purposes, how to measure CRA activity and how to report CRA data. While the analysis of the practical impact on stakeholders is ongoing and could require consideration of facts and circumstances of individual institutions, the proposed rule may warrant particular attention from two groups of stakeholders as it becomes finalized: small banks and de novo applicants.

First, for national and state nonmember banks under $500 million, the proposed rule offers the option of staying with the current CRA regime or opting into the new one. The Federal Reserve Board did not join the OCC and the FDIC in the proposed rule, so CRA changes would not affect state member banks as proposed. As small banks weigh the costs and benefits of opting in, the calculus may be further complicated by political factors beyond the four corners of the rule itself.

Second, a number of changes in the proposed rule could impact deposit insurance applicants seeking de novo bank or ILC charters, including those related to assessment areas and strategic plans.

Brokered Deposits. The FDIC issued a proposed rule in December 2019 to revise brokered deposits regulations. While the proposed rule does not represent a wholesale revamp of the regulatory framework for brokered deposits — which would likely require statutory changes — some of the changes could expand the primary purpose exception in the definition of deposit broker and establish an administrative process for obtaining FDIC determination that the primary purpose exception applies in a particular case. Also, the new administrative process could offer clarity to banks that are unsure about whether to classify certain deposits as brokered.

LIBOR Transition. The London Interbank Offered Rate, a reference rate used throughout the financial system that proved vulnerable to manipulation, may no longer be available after 2021. The U.K.’s Financial Conduct Authority announced in 2017 its intention to no longer compel panel banks to contribute to the determination of LIBOR beyond 2021. In the U.S., the Financial Stability Oversight Council has flagged LIBOR as an issue in its annual Congressional report every year since 2012. Its members stepped up their rhetoric in 2019 to pressure the financial services industry to prepare for transition away from LIBOR to a new reference rate, one of which is the Secured Overnight Financing Rate, or SOFR, that was selected by the Alternative Reference Rates Committee.

For banks in 2020, it is likely that federal bank examiners, whose agency heads are all members of the FSOC, will increasingly incorporate LIBOR preparedness into exams if they have not done so already. In addition, regulators in New York are requiring submission of LIBOR transition plans by March 23, 2020.

The scope of work to effectuate a smooth transition could be significant, depending on the size and complexity of an institution. It ranges from an accurate inventory of all contracts that reference LIBOR to devising a plan and adopting fallback language for different types of obligations (such as bilateral loans, syndicated loans, floating rate notes, derivatives and retail products), not to mention developing strategies to mitigate litigation risk. Despite some concerns about the suitability of SOFR as a LIBOR replacement, including a possible need for a credit spread adjustment as well as developing a term SOFR, which is in progress, LIBOR transition will be an area of regulatory focus in 2020.

12 Questions Directors Should Ask About New Bank Activities


governance-3-18-19.pngA bank’s board of directors must answer to a variety of constituencies, including shareholders, regulatory agencies, customers and employees. At times those constituencies may have competing interests or priorities. Other times, what may appear to be competing interests are actually variations of aligned interests.

One area where this is particularly true is the board’s responsibility to strike the right balance between driving revenues and ensuring the bank adheres to its risk appetite established as part of its enterprise risk management framework.

The failure to strike this proper balance can be devastating to the institution, and if widespread, could result in consequences across the entire industry, such as the 2008 financial crisis. As technology and innovation accelerate the pace of change in the banking industry, that balance will become more critical and difficult to manage. And as banks explore ways to increase profits and remain competitive, especially with respect to noninterest income, bank directors will need to remain diligent in their oversight of new bank activities.

Regulators have offered guidance to bank boards on the subject. For example, the Office of the Comptroller of the Currency (OCC) issued a bulletin in 2017 that defines “new activities” to include new, modified, and/or expanded products and services and provide guidance related to risk management systems for new activities. While it is management’s role to execute strategy and operate within the established risk appetite on a day-to-day basis, the board’s role is to oversee and evaluate management’s actions, and the board should understand the impact and risks associated with any new activities of the bank.

To exercise this responsibility, directors should challenge plans for new activities by posing the following questions to help them determine if the proper risk approach has been taken. Questions may include:

  • Does the activity align with the bank’s strategic objectives?
  • Was a thorough review of the activity conducted? If so what were the results of that review and, specifically, what new or increased risks are associated with the activity, the controls, and the residual risk the bank will be assuming?
  • Is the associated residual risk acceptable given the bank’s established risk appetite?
  • Is the bank’s infrastructure sufficient to support the new activity?
  • Are the right people in place for the activity to be successful (both the number of people required and any specific expertise)?
  • Are there any new or special incentives being offered for employees? If so, are they encouraging the correct behavior and, just as importantly, discouraging the wrong behavior?
  • What are the specific controls in place to address any risks created?
  • How will success be measured? What reporting mechanism is in place to track success?
  • Will there be any impact on current customers? Or in the case of consumers, will there be any disparate impact or unfair or deceptive acts or practices (UDAAP) implications?
  • What third parties are required for successful implementation?
  • What limits on the amount of new business (concentration limits) should be established?
  • Are the applicable regulators aware of the bank’s plans, and what is their position/guidance?

These threshold questions will assist directors in becoming fully informed about the proposed new activities, and the answers should encourage follow up questions and discussions. For example, if third parties are necessary, then the focus would shift to the bank’s vendor management policies and procedures. Discussions around these questions should be properly documented in the meeting minutes to evidence the debate and decision-making that should be necessary steps in approving any new bank activity.

If these questions had been posed by every bank board contemplating the subprime lending business as a new activity, it may have averted the challenges faced by individual banks during the financial crisis and lessened the impact on the entire industry.

In the future, if boards seek the answers to these questions, the following discussions will help ensure directors will give thoughtful consideration to new activities while properly balancing the interests of all of their constituencies.

What You Need to Know About the OCC’s Fintech Charter


OCC-10-17-18.pngOn July 31, 2018, the Office of the Comptroller of the Currency said it will begin accepting applications for a special purpose national bank charter designed specifically for fintech companies. The news came hours after the Treasury Department issued a parallel report preemptively supporting the move.

In connection with its announcement, the OCC issued a supplement to its Comptroller’s Licensing Manual as well as a Policy Statement addressing charter applications from fintech companies. Both are worth reviewing by anyone thinking about submitting an application.

The Application Process
To apply for a fintech charter, a company must engage in either or both of the core banking activities of paying checks or lending money. Generally, this would include businesses involved in payment processing or marketplace lending.

The fintech charter is not available for companies that want to take deposits, nor is it an option for companies seeking federal deposit insurance. Such companies would have to apply instead for a full-service national bank charter and federal deposit insurance.

The application process for a fintech charter is similar to that for a de novo bank charter, with each application reviewed on its own unique facts and circumstances.

The four stages of the application process are:

  1. The pre-filing phase, involving preliminary meetings with the OCC to discuss the business plan, proposed board and management, underlying marketing analysis to support the plan, capital and liquidity needs and the applicant’s commitment to providing fair access to its financial services
  2. The filing phase, involving the submission of a completed application
  3. The review phase, during which the OCC conducts a detailed review and analysis of the application
  4. The decision phase, during which the OCC determines whether to approve the application

The process from beginning to end can take up to a year or longer.

Living with a fintech charter
Fintech banks will be supervised in a similar manner to national banks. They will be subject to minimum capital and liquidity requirements that could vary depending on the applicant’s business model, financial inclusion commitments, and safety and soundness examinations, among other things.

Additionally, to receive final approval to open a fintech bank, an applicant must adopt and receive OCC approval of a contingency plan addressing steps the bank will take in the event of severe financial stress. Such options would include a sale, merger or liquidation. The applicant must also develop policies and procedures to implement its financial inclusion commitment to treat customers fairly and provide fair access to its financial services.
Similar to a traditional de novo bank, a fintech bank will be subject to enhanced supervision during at least its first three years of operation.

Pre-application considerations
A company thinking about applying should consider:

  1. The advantages of operating under a single, national set of standards, particularly for companies operating in multiple states
  2. The ability to meet minimum capital and liquidity requirements
  3. The time and expense of obtaining a charter
  4. Whether a partnership with an existing bank is a superior alternative
  5. The potential for delays in the regulatory process for obtaining a charter, including delays resulting from the OCC application process or legal challenges to that process

There is one complicating factor in all of this. Following the OCC’s initial proposal to issue fintech charters in 2017, two lawsuits were filed challenging the OCC’s authority to do so—one by the Conference of State Bank Supervisors and one by the New York State Department of Financial Services. Both were dismissed, because the OCC had yet to reach a final decision. But now that the OCC has issued formal guidance and stated its intent to accept applications, one or both lawsuits may be refiled.

Whether this happens remains to be seen. But either way, the OCC’s decision to accept applications for fintech charters speaks to its commitment to clear the way for further innovation in the financial services industry.

Weighing the Benefits of a State Charter


charter-11-17-17.pngWithin the past year, several national banks and federal savings banks have come to realize the benefits of converting to a state bank charter. This is not a new concept. Since 2000, hundreds of national banks and federal savings banks across the country have converted to state charters. These banks typically cite three reasons for converting: cost savings and increased earnings, regulatory access and relationships, and the dilution (or disuse) of national bank powers.

1. Lower Expenses & Increased Earnings
Most national banks pay significantly higher regulatory and examination fees than their state bank peers. Depending on the state, a $250 million asset national bank may save $25,000 to $50,000 or more in annual supervisory assessment fees by converting. In addition, banks in many states may see their legal lending limit increase, allowing them to better compete for loans and reduce participations.

However, the conversion process is not free. Each state has a filing fee, and the applicant must pay for legal costs, a state regulatory examination and the costs of rebranding the institution to remove any references to being a national bank. Even with these costs, several banks have found that the costs of converting are justified when compared to the aggregate costs saved and the potential for increased earnings.

2. Improved Regulatory Access and Relationships
In the current regulatory environment, banks are increasingly attuned to the benefits of having local access to their primary regulators. In certain parts of the country, the Office of the Comptroller of the Currency has been experiencing significant turnover, thus making it hard for some banks to establish and maintain continuity with their regulatory contacts. In some areas, seemingly routine matters are being handled through a regional or national office. Further, the OCC has been rotating examination staff around different areas of the country. This constant change in examination staff may impact the examiners’ ability to gain a thorough understanding of the bank, its markets and culture.

With a state charter, all decision makers are local and should be better aware of the issues affecting banks in their state. That being said, with a state charter, the bank will now have two regulators: the state, and the Federal Deposit Insurance Corp. or the Federal Reserve. Even so, for many it is appealing to be able to visit the state’s banking commissioner face-to-face on relatively short notice to discuss the bank, appeal a finding, or seek guidance and assistance.

3. Dilution of National Bank Powers
Historically, a primary benefit of a national bank charter was the broad federal preemption of state laws that the charter offers. This was especially important for banks operating in multiple states, as they did not need to comply with many aspects of the differing laws in the states where they operated. However, the enactment of the Dodd-Frank Act resulted in significant cutbacks and a reduction in the availability of federal preemption. In addition to narrowing the differences between state and national bank charters, the majority of national banks are community banks that do not actually operate nationally. Therefore, national banks should consider whether the availability of federal preemption is truly benefiting the bank, and what other real or perceived benefits the national charter carries.

Each state will have its own statute providing the authority for converting from a national bank to a state bank. It is important that the board and management team of a bank considering a conversion determine whether its current charter is best suited for its business model, goals and objectives. If the state agency believes that the bank is just forum shopping for regulators in order to avoid difficulties with the OCC, the agency will be more likely to decline the conversion application.

Note that Dodd-Frank generally restricts the charter conversion of troubled banks, including a bank with any formal enforcement order or memorandum of understanding. Dodd-Frank also requires a bank seeking a conversion to file its application with both its current and its prospective regulator. Therefore, be aware that the OCC will know in advance of the plan to convert.

Overall, the combination of reduced costs, potential for increased earnings, easier access to regulators and favorable state laws make the conversion to a state charter an enticing choice for many financial institutions. If your bank has a national charter, it is something to consider.

A Cautionary Tale for Compensation Committee Members


committee-8-25-17.pngThe Office of the Comptroller of the Currency (OCC) recently took an enforcement action in the form of a consent order against a bank director that serves as a cautionary tale for the banking industry. The consent order, agreed to by and between the OCC and a director and former senior vice president of a small national bank in Wisconsin, reminds bank boards of directors of their fiduciary duties with respect to executive compensation and the consequences of breaching those duties. In particular, this action puts board compensation committee members on notice that they may be found liable for unsafe or unsound executive compensation practices that occur on their watch.

Enforcement Action Details
The consent order described that the director had a longstanding affiliation with the bank, serving in multiple operational positions throughout her tenure, culminating in her election to the bank’s board of directors in 2005. Despite these 32 years of service, the OCC’s findings in the consent order focused on the director’s relatively short period of service on the board’s executive compensation committee, where she served from 2010 to 2013.

During this period, it appears, based on a notice of charges issued in 2016 and a $1.6 million civil money penalty issued in 2017—both against the bank’s former chief executive officer (who also held the titles of president and chairman of the board)—that this individual abused his power and used it to reap excessive compensation from the bank. In particular, the notice of charges cited a report finding that the former CEO “was a dominant influence in all aspects of bank operations,” which ultimately led to insider abuse with respect to compensation and breaches of his fiduciary duties.

Based on such abuse and the resulting action against the former CEO, the OCC apparently then turned its attention to the director. Indeed, the consent order identified the director’s conduct during the period of 2012 to 2013 as the relevant period leading to the issuance or the consent order. During this time, the OCC said that the director failed to do the following:

  • Oversee or control the use of bank funds by its former CEO for his personal expenses despite knowing that he had previously used bank funds for personal expenses.
  • Ensure that disinterested and independent directors determined and approved the compensation of the bank’s former CEO, thereby allowing him to receive excessive compensation.
  • Recuse herself from voting on the bank’s former CEO compensation even though she had a conflict of interest because he was personally indebted to the director and her husband in an amount exceeding $2 million.

Based on these failures as a member of the board’s executive compensation committee, the OCC concluded that the director engaged in conduct satisfying 12 U.S.C. 1818(i) and ordered her to pay a civil money penalty in the amount of $5,000.

Takeaways for Bank Directors
As banks continue to report an uptick in regulatory inquiries and examination findings focusing on executive and incentive compensation, agency enforcement actions relating to compensation issues may become more common in the coming years. This is a trend that is developing even in the face of recent reports that some of the federal banking agencies are likely to postpone consideration of currently proposed regulations regarding incentive compensation required under the Dodd-Frank Act.

Boards should utilize this trend and the lessons learned from the consent order as a reminder to periodically review compensation arrangements and compensation standards at their bank to ensure they are adequately fulfilling their fiduciary duties. Such reviews should critically analyze executive and incentive compensation arrangements and seek to ensure that bank and board policies governing such arrangements meet regulatory expectations. In addition, boards should periodically inquire about and analyze any relationships board compensation committee members may have with senior management to be able to confirm the independence of the committee members.

Banks Need to Watch Out for Compliance with the Servicemembers Civil Relief Act


compliance-3-1-17.pngDuring the past year, federal regulators have increased enforcement activities under the Servicemembers Civil Relief Act (SCRA). In the last four months, banks have been ordered to pay more than $25 million in penalties and restitution, and a recent federal district court decision clarified the scope of the U.S. Department of Justice’s authority to enforce pattern or practice violations of the SCRA.

Recent Consent Orders
The Office of the Comptroller of the Currency (OCC) recently issued a consent order imposing a $20 million civil penalty against Wells Fargo, ordering restitution to consumers harmed by SCRA violations and mandating implementation of an enterprise-wide SCRA compliance program to prevent future violations. The consent order sets forth minimum SCRA compliance program requirements, including:

  1. Written policies and procedures to ensure: identification of consumers eligible for SCRA benefits and protections; the accuracy of assertions made in affidavits of military service; adequate use of searches of the Department of Defense Manpower Data Center database to determine SCRA eligibility; consistent application of state laws that provide more protection to service members than the SCRA; and documentation and record retention.
  2. An SCRA Training Program to provide instruction to all senior management and covered employees.
  3. A system for ongoing monitoring, testing and reporting on SCRA compliance.

The requirements outlined in the OCC’s consent order will provide a useful guide for other financial institutions to review their SCRA compliance procedures.

Recently, Wells Fargo also settled a Department of Justice lawsuit alleging that the bank repossessed more than 400 motor vehicles without first obtaining the necessary court orders. The Justice Department consent order required Wells Fargo to pay more than $4 million to the victims of improper repossessions, remove the repossessions from their credit reports, pay a $60,000 civil penalty and institute new procedures to prevent future unlawful repossessions. The Justice Department filed a similar complaint against HSBC Financial Corp., and the consent order resolving that matter requires HSBC to pay $434,500 to the victims of the illegal repossessions.

Pattern or Practice Violations of SCRA
In July of 2016, the Justice Department filed suit against Michigan-based COPOCO Community Credit Union, alleging it had violated the SCRA by repossessing protected service members’ motor vehicles without obtaining the necessary court orders. The SCRA provision that grants enforcement authority to the Justice Department requires that a defendant either engage in a pattern or practice of violation or violate the statute in a way that raises an issue of significant public importance.

The credit union moved to dismiss, arguing that because the Justice Department’s complaint had alleged only a single SCRA violation, therefore it had failed to demonstrate a “pattern or practice” or “issue of significant public importance.” The Justice Department responded that a “pattern or practice” can be established by the lack of a written compliance program and the inference that other consumers are likely harmed if one is harmed.

The Justice Department argument is troubling because it suggests a nebulous enforcement standard of whether something will “inevitably lead to a pattern of illegal conduct.” Perhaps even more concerning is the contention that what it deems to be of “significant public importance” cannot be subject to judicial review, which suggests a lack of any meaningful check on the Justice Department’s prosecution authority under the SCRA. On January 5th, the U.S. District in Eastern Michigan denied the credit union’s motion to dismiss, holding that the absence of policies or procedures to check the Manpower Data Center database to determine military status was enough to allege a “pattern or practice” in violation of the SCRA.

Takeaway
The scope of these penalties highlights that the SCRA remains a focus of federal regulators, and the compliance requirements outlined in the OCC’s consent order with Wells Fargo can serve as a template for other financial institutions to follow in creating their own compliance programs. Furthermore, the COPOCO decision makes clear that the lack of a compliance policy can itself be a “pattern or practice” in violation of the SCRA. Compliance is key to avoiding costly litigation and resulting adverse publicity.

For more information, Dinsmore publishes a resource to provide general guidance on the SCRA: Servicemembers Civil Relief Act (SCRA) Handy Desk Reference.

Regulators Focus on Sales Practices: Responding to Heightened Scrutiny


Regulators-2-13-17.pngFederal and state regulatory enforcement actions and unprecedented fines for alleged fraud—fraud that apparently originated with sales incentive compensation plans—have left bank executive management teams and boards wondering if the same thing could be happening at their institutions. These concerns are shared by banking regulators, as evidenced by the flurry of activity, including testimonies, speeches and information requests, in the fourth quarter of 2016.

Given the huge media attention to one bank’s alleged misdeeds, bank executive management teams and boards are wondering if the same thing could be happening at their institutions.

Excessive risk-taking, without proper risk management and controls, often has been cited as one of the root causes of the recession that begin in late 2007. Progress certainly has been made since the financial crisis, particularly in fostering a healthy compliance culture, committing to effective risk management and governance, and improving how customers are treated. However, the issues associated with sales and incentive plans have thrust these concerns back into the open to be scrutinized by the public, policymakers, law enforcement and regulatory agencies.

The 2010 Guidance on Sound Incentive Compensation Policies
In June 2010, the Office of the Comptroller of the Currency (OCC), the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Office of Thrift Supervision published their final Guidance on Sound Incentive Compensation Policies in the Federal Register. The guidance applies to all banking organizations supervised by the OCC, the FDIC and the Federal Reserve, regardless of the size of banking organization.

The guidance is based upon three key principles about incentive compensation arrangements, namely that they should:

  1. Provide employees with incentives that appropriately balance risk and financial results in a manner that does not encourage employees to expose their organizations to imprudent risks.
  2. Be compatible with effective controls and risk management.
  3. Be supported by strong corporate governance, including active and effective oversight by the banking organization’s board of directors.

The guidance, as well as other similarly focused rulemaking activities, clearly indicates that incentive-based compensation arrangements now are under the microscope. Every bank should review its incentive-based compensation arrangements to make sure they are in compliance with the applicable regulations.

What’s My Exposure?
Bank executives and directors who are trying to determine their entity’s exposure related to sales incentive programs need their bank to undergo a risk assessment focused on common activities that are aligned to their bank’s sales incentive practices. If the assessment reveals problems with improper behavior, the bank then must determine its level of exposure.

A comprehensive approach to assessing exposure should encompass the following high-level areas and analyze associated data at a level sufficient to identify whether improper behaviors are occurring:

  • Review accounts, products and services offered to consumers or small businesses through all channels (including branches, phone, internet and private banking).
  • Analyze incentive program payments by product or service provided.
  • Consider noncash incentive programs.
  • Ensure reports are issued by internal audit, front-line self-assessments or an external party that cover sales practices or account opening or closing procedures.
  • Establish policies, procedures and reports of concerns with sales practices or account opening or closing procedures resulting from employee terminations or exit interviews, whistleblower or ethics hotlines or consumer complaints.
  • Develop training program materials for employees who sell products and services.
  • Institute policies, procedures and detection controls specific to account opening and closing metrics.

It is important that assessment and data analysis activities include third-party risk management programs to identify and effectively manage risks related to third parties that are involved in opening and maintaining customer accounts.

In addition, banks should consider performing culture assessments to determine if there are conflicting elements or subcultures that are misaligned. Many banks change their cultures by sequentially aligning strategies, structures, processes, rewards and people practices.

Actionable Information
With assessment information in hand, executives and boards are better able to make informed decisions and take appropriate actions necessary to help protect the bank and its customers. Depending on the assessment results, the bank then might need to take the following steps to mitigate the risk:

  • Further investigate the areas for which the exposure assessment identifies improper behavior or potential fraud.
  • Test the design and operating effectiveness of existing controls to prevent and detect account origination, servicing and termination fraud as well as unfair, deceptive, or abusive acts and practices (UDAAP) within the sales process.
  • Develop and implement new controls within the sales, account origination, servicing and termination processes.
  • Review incentive compensation plans and their governance processes.
  • If necessary, reshape overall compensation plans to eliminate incentives that could lead to a higher likelihood of fraud and undue risk-taking.
  • Design and implement systems or functions to identify, measure, monitor and control risk-taking and standards of behavior.

Expecting the Unexpected


fintech-1-26-17.png“If past history was all that is needed to play the game of money, the richest people would be librarians.”
– Warren Buffett

This may be a phenomenal—or scary year—for banks. Banks have benefited from rising stock prices and rising interest rates, which are expected to boost low net interest margins. Indeed, the change in the U.S. presidency has resulted in a steepened yield curve, as investors predict improved economic growth. Currently, many anticipate regulatory relief for banks and the prospect of major corporate tax cuts. Such change could have a significant impact on banks; however, those running financial institutions also need to keep an eye on potential challenges ahead.

As we head to our 23rd Acquire or Be Acquired Conference in Phoenix, Arizona, with a record breaking 1,058 attendees Jan. 29-Jan. 31, I am expecting the mood to be good. Why wouldn’t it be? But what is on the horizon are also fundamental changes in technology that will change the landscape for banking. What will your competitors be doing that you won’t be? Our conference has always been a meeting ground for the banking industry’s key leaders to meet, engage with each other and learn what they need to do deals. It is still that. Indeed, most of the sessions and speakers will be talking about M&A and growth.

But this year, more than 100 executives from fintech companies that provide products and services to banks join us in the desert, on our invitation. We want to help banks start thinking about the challenges ahead and how they might solve them.

Here are some things to consider:

How will the Office of the Comptroller of the Currency’s limited-purpose fintech charter enable more established fintech companies to compete with some of the incumbents in the room?

If smaller banks are indeed relieved of many of the burdens of big bank regulation, will they use the savings to invest in technology and improvements in customer service? How will customer expectations change, and from whom will customers get their financial services?

To this last point, I intend to spotlight three companies that are changing the way their industries operate to inspire conversations about both the risks and rewards of pursuing a path of change. Yes, it’s OK to think a little bit beyond the banking industry.

Spotify
Rather than buying a CD to get their favorite songs, music-lovers today favor curated playlists where people pick, click and choose whom they listen to and in what order. There is a natural parallel to how people might bank in the future. Just as analytics enable media companies to deliver individually tailored and curated content, so too is technology available to banks that might create a more personalized experience. Much like Spotify gives consumers their choice of music when and where they want it, so too are forward-looking banks developing plans to provide consumer-tailored information “on-demand.”

Airbnb
The popular home-rental site Airbnb is reportedly developing a new service for booking airline flights. Adding an entirely new tool and potential revenue stream could boost the company’s outlook. For banks, I believe Airbnb is the “uber-type” company they need to pay attention to, as their expansion into competitive and mature adjacent markets parallels what some fear Facebook and Amazon might offer in terms of financial services.

WeChat
One of China’s most popular apps, the company counts 768 million daily active users (for context, that’s 55 percent of China’s total population). Of those users, roughly 300 million have added payment information to the wallet. So, WeChat Pay’s dominance in the person-to-person payments space is a model others can emulate. PayPal already is attempting such dominance, which Bank Director magazine describes in our most recent issue.

Many of those attending our conference also have done amazing things in banking. I can’t name all of them, but I’d be remiss to not mention CEO Richard Davis of U.S. Bank, our keynote speaker. After a decade leading one of the most phenomenal and profitable banks in the country, he is stepping down in April. We all have something to learn from him, I’m sure.

Let us think about the lessons the past has taught us, but keep an eye on the future. Let’s expect the unexpected.