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Blockchain Technology Will Not Disrupt Financial Services Anytime Soon

Twenty venture capitalists gathered in Silicon Valley last week to discuss the impact of blockchain technology, including digital currency, on financial services and venture capital. The 20 VCs represent an equal number of funds, which invest–or are looking for investment opportunities–all over the world, including the third world. They represented a diverse group of perspectives, with some having regulatory experience, some having experience with conventional payment mechanisms and some with innovative mechanisms such as PayPal. Even their disagreements were instructive of the uncertain future of blockchain technology and its various potential applications.

The consensus is that digital currency is entering a nuclear winter. A majority of Initial Coin Offerings made in 2017–perhaps as much as 75%–turned out to be fraudulent and have no value today. Not coincidentally, the vast majority of Initial Coin Offerings originated in Eastern European countries that are home to spam and bot farms…and where there is little, if any, regulatory oversight.

To the extent bitcoins may become a viable, commercial technology for B2B transactions, it is likely to occur in a technology hub in the U.S. or Europe. Those hubs have the talent, the infrastructure and the robust regulatory structures that can be adapted to ICOs and create the trust necessary to make digital currency a positive, viable alternative to government currencies. In fact, the centralization of technology talent in the U.S. is depriving the rest of the world of talent.

The attempts of island states, like Bermuda, Malta, Cyprus, the Isle of Mann, and even Singapore to draft regulations that facilitate the creation of bitcoin issuers on their soil is unlikely to have a significant impact. Nobody who is experienced and seriously intends to build a global digital technology company and change the financial services industry on a global scale will think one can create the necessary large organization on these islands. These islands do not have an ecosystem of sophisticated VCs and do not have a critical mass of talented engineers. The island states are going for broke because they have so little to lose. When and if the technology matures, U.S. companies will step in and crush competitors based in these islands.

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The Football Fan’s Guide to M&A Transactions

With both college and professional (not to mention fantasy) football in full swing, we find many conversations with clients drifting to topics from the
gridiron at this time of year.  Given that many of us are devoting a significant amount of our personal time to following our favorite teams, many times business points are best illustrated at this time of year by using football analogies.

Certain sports agents have posited that the highest achieving football coaches could easily run Fortune 500 companies but instead chose to coach football for a living.  While that point is debatable, we can certainly draw from the talking points of today’s best coaches in setting a framework for approaching a merger transaction.  While we can’t deliver Nick Saban, Bill Belichick, or Kirby Smart to your boardroom, use these sound bites to your advantage in setting the tone for how your board addresses an M&A transaction.

    1. Trust the process. “The Process” has become a hallmark of the University of Alabama’s championship dynasty.  Coach Saban focuses on the individual elements that yield the best results by the end of the season.  Similarly, a well-planned process can be trusted to yield the best long-term results.  This simple point is among the easiest for boards to miss.  We are often concerned when clients engage in “opportunistic” M&A activity.  Instead, we prefer to see a carefully planned process that includes the following fundamental elements:
      * Parameters around the profile that potential partners should have, including market presence, lines of business, and size;
      * Clearly defined financial goals and walkaway points; i.e., those metrics beyond which no deal can be justified;
      * For sellers, the forms of consideration that will be acceptable (i.e., publicly-traded stock, privately-held stock, or cash); and
      * Selection of qualified advisors.
    2. Self-scout. Great football teams have an honest self-awareness of their strengths and weaknesses and grasp them on a deeper level than their opponents.  Buyers and sellers should also have a frank assessment of their shortcomings.  In planning for the M&A process, those weaknesses should be addressed in advance to the extent possible.  To the extent they cannot be fixed in advance of embarking on an M&A process, parties should provide a transparent assessment of their weaknesses to potential partners.  Doing so enhances credibility and builds trust in the other facets of due diligence.
    3. Know the tendencies of your opponent. On the other side of self-scouting is a great team’s ability to understand and address the weaknesses of its opponents.  While we never advise clients to think of M&A partners as adversaries, advance due diligence of a potential partner to identify their needs can certainly help lead to a successful transaction.  At its core, a good M&A transaction is about giving a potential partner something it does not have and cannot build for itself.  To the extent that parties can identify the needs of potential partners in advance of their initial conversations, they can speak directly to those needs at the outset, thus positioning themselves as an optimal partner in a crowded M&A field.
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FinCEN Grants Permanent Relief for Autorenewals

Exercising “exceptive” relief authority, FinCEN has extended permanent relief from the beneficial ownership requirements of its new Customer Due Diligence (CDD) rule to existing autorenewing CDs and safe deposit boxes, as well as existing autorenewing commercial lines of credit and credit cards that do not require underwriting review and approval.  FinCEN reasoned that these products pose such a low risk for money laundering and terrorist financing activity that the benefits of requiring the collection of this information does not outweigh the impacts of compliance on financial institutions and their customers.  Specifically, institutions need not treat rollovers or renewals of such products as “new accounts” requiring the collection of the beneficial ownership elements of the CDD rule, whether or not the initial accounts were established prior to the rule’s May 11, 2018 effective date.

FinCEN previously issued temporary relief to autorenewing CDs and loan products established prior to May 11, 2018, and in a second release extended this relief through September 9, 2018.  The new release both extends this treatment indefinitely and expands it to include certain safe deposit box rentals, such that the exception applies now to any of the following occurring on or after May 11, 2018:

  • A rollover of a CD, defined as a deposit account that has a specified maturity date, prior to which funds cannot be withdrawn without the imposition of a penalty, and which does not permit the customer to add funds;
  • A renewal, modification, or extension of a loan (e.g., setting a later payoff date) that does not require underwriting review and approval;
  • A renewal, modification, or extension of a commercial line of credit or credit card account (e.g., setting a later payoff date) that does not require underwriting review and approval; and
  • A renewal of a safe deposit box rental (e.g., upon the automatic deduction of the rental fee as agreed-upon between a bank and its customer).

FinCEN is careful in this September 7, 2018, release to explain that it does not relieve institutions of the obligation to collect and verify the identity of beneficial owners of legal entity customers where the initial account opening of such accounts occurs on or after May 11, 2018.  It does mean, however, that institutions need not collect beneficial ownership information for certain older accounts of the types described above (those opened prior to May 11, 2018) solely because they are rolled over or renewed.

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A Litigator’s KISS Takeaways from CFPB’s Summer 2018 Supervisory Highlights

KISS. An acronym first utilized in military equipment design in the 1960’s, “Keep it Simple Stupid.” Litigators rely on KISS in formulating trial themes and presentations to juries. Simple messages resonate. In that vein, I offer three KISS takeaways from the Bureau of Consumer Financial Protection’s Supervisory Highlights, Issue 17, Summer 2018.

KISS #1: Details Matter. 

On two key levels: (a) your business compliance operations and consumer interactions, and (b) in the Bureau’s supervision and examination conclusions. Taking these in reverse order, the Bureau’s Introduction (p. 2) provides important guardrails:

[L]egal violations described in this and previous issues of Supervisory Highlights are based on the particular facts and circumstances reviewed by the Bureau as part of its examinations. A conclusion that a legal violation exists on the facts and circumstances described here may not lead to such a finding under different facts and circumstances.

This is critical to your supervision and examination preparedness and your interactions with the Bureau.  If the Bureau spots a concern, consider providing a fulsome explanation of the analysis that went into the policy formulation, how your organization believed it was operating in good faith under applicable laws and believed that the practice would not harm or mislead consumers, what steps your organization has done in monitoring and addressing any consumer concerns regarding the policy or practice. This may sound basic, but the Bureau’s statement matters and can be referenced. The Bureau should, in my view, consider such information in assessing whether any violation has occurred, whether any consumers actually were harmed and whether any remediation is necessary. Sometimes the conclusion may be that the practice presents a risk of potential confusion or harm and simply should be modified going forward. Present your best case; the Bureau appears to be open to considering all the facts and circumstances.

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Two Key EGRRCPA Provisions Now Effective

As of the end of August 2018, two key provisions of The Economic Growth, Regulatory Relief, and Consumer Protection Act (aka the Crapo bill, S.2155, or increasingly, EGRRCPA) have become effective: the increase in the small bank holding company policy statement threshold and the increase in the expanded examination cycle threshold.  Before looking at those provisions, I have to acknowledge the fabulous Wall Street Journal story by Ryan Tracy, “Can You Say EGRRCPA? Tongue-Twister Banking Law Confuses Washington.”  Personally, I’m now leaning towards “egg-rah-sip-uh.”

On July 6, 2018, the federal banking agencies released an Interagency statement regarding the impact of the Economic Growth, Regulatory Relief, and Consumer Protection Act that provided guidance as to which provisions were immediately effective versus which provisions would require further regulatory action.  Included in this guidance was confirmation that the banking regulators would immediately implement EGRRCPA’s changes to the Volcker Rule, freeing most institutions with total assets of less than $10 billion from the constraints of the Volcker Rule.  The regulators noted that they “will not enforce the final rule implementing section 13 of the BHC Act in a manner inconsistent with the amendments made by EGRRCPA to section 13 of the BHC Act.”

Unfortunately, two of the more significant areas of regulatory relief for community banks, the respective increases in thresholds for the small bank holding company policy statement and the expanded examination cycle were not granted such immediate effectiveness.  While EGRRCPA required the Federal Reserve to act on the expansion of the policy statement within 180 days, anyone familiar with the deadlines set forth in the Dodd-Frank Act for regulatory action would not be holding their breath.

Small Bank Holding Company Policy Statement Expansion.  On August 30, 2018, the Federal Reserve published an interim final rule implementing the revisions to the small bank holding company policy statement.  The Federal Reserve’s small bank holding company policy statement generally exempts such institutions from the requirement to maintain consolidated regulatory capital ratios; instead, regulatory capital ratios only apply at the subsidiary bank level.  The small bank holding company policy statement was first implemented in 1980, with a $150 million asset threshold.  In 2006, it was increased to $500 million, and in 2015, it was increased to $1 billion.  Section 207 of EGRRCPA called for the Federal Reserve to increase the threshold to $3 billion, and the interim final rule implements this change.

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Modifications on My Mind: When “Will” Means “Must” and a Conventional Hand Signature is Not Required

The Sixth Circuit has issued another opinion regarding loan modifications, following its opinion two weeks ago in Segrist v. Bank of New York Mellon (2018 WL 3773785, August 9, 2018), on which I earlier wrote.

Now, in Pittman v. Experian Information Solutions, Inc. — F.3d —- 2018 WL 4016604, August 23, 2018), the Sixth joins the First, Seventh, Ninth, and Tenth Circuits, in holding that loan servicers are contractually obligated under the terms of their Trial Modification Plan (“TPP”), pursuant to the Home Affordable Mortgage Program (“HAMP”), to offer a permanent modification to borrowers who comply with the TPP by submitting accurate documentation and making trial payments.

The Court relied on language in the TPP that said, “[a]fter all trial period payments are timely made and you have submitted all the required documents, your mortage will be permanently modified.” The court noted hornbook contract law that “the mere fact that an offer or agreement is subject to events not within the promisor’ control … will not render the agreement illusory.”

Additionally, the TPP was sufficiently definite to constitute an enforceable contract, even though it did not set the precise terms for the permanent modification, because HAMP guidelines provide the existing standard by which the ultimate terms of the permanent modification were to be set in order to bring down the monthly payments to 31% of gross income.

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OCC Provides a Path for FinTech Charters

On July 31, 2018, the OCC announced that it had finalized parameters for its new limited-purpose financial technology national bank charter and is ready to begin taking applications.  This release follows several years of formal deliberation on the topic and coincided with the release of a 222-page U.S. Treasury report on innovation.  Industry reactions have been wide-ranging – will this level the playing field or usher in a FinTech “apocalypse“?

Highlights of the OCC notice include:

  • Designation of the charter type as a national bank.  Like its other special-purpose charters, including the non-depository trust company or the credit card bank, the FinTech charter will be a “national association” in the National Bank Act sense of the term.  As the saying goes, membership will have its privileges (and burdens):  capital requirements, examinations, and federal preemption of certain state laws.
  • Eligibility for qualified applicants that plan to conduct activities “within the business of banking.”  Pursuant to existing OCC regulations, a limited-purpose national bank not engaging in fiduciary activities “must conduct at least one of the following three core banking functions:  receiving deposits; paying checks; or lending money.”  In its FinTech charter announcement, the OCC notes that it “views the National Bank Act as sufficiently adaptable to permit national banks to engage in traditional activities like paying checks and lending money in new ways.  For example, facilitating payments electronically may be considered the modern equivalent of paying checks.”
  • A requirement for a commitment to “financial inclusion.”  We will see how this element is administered.  In theory it provides a non-depository parallel to the Community Reinvestment Act (“CRA”).
  • Publication and comment period.  Just as for other types of national banks, applications will feature newspaper publication requirements and will be generally subject to public review and comment.

The OCC stated that its decision to open the door for this new form of national bank “is consistent with bi-partisan government efforts at federal and state levels to promote economic opportunity and support innovation that can improve financial services to consumers, businesses, and communities.”  Comptroller Otting added:

Providing a path for fintech companies to become national banks can make the federal banking system stronger by promoting economic growth and opportunity, modernization and innovation, and competition.  It also provides consumers greater choice, can promote financial inclusion, and creates a more level playing field for financial services competition.

Treasury’s report is consistent with these themes, noting, “A forward-looking approach to federal charters could be effective in reducing regulatory fragmentation and growing markets by supporting beneficial business models” and that the OCC should proceed with “thoughtful consideration” of FinTech charter applications.  Treasury also calls out specifically the need for updating regulations that relate to data aggregation, for addressing those which have become “outdated” in light of technological advances (e.g., in the mortgage lending and servicing space, according to Treasury), and for a regulatory approach that enables “responsible experimentation” in the financial sector.

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Lender’s “Boilerplate” Disavowal Dooms Rescission of a Common Loan Modification Agreement

In a case with potentially broad implications, the Sixth Circuit becomes the first federal circuit court to hold that the Truth in Lending Act provides no right to rescind a loan modification agreement entered into with a successor creditor. TILA exempts from rescission “refinancing” transactions with “the same creditor secured by an interest in the same property” but not “refinancing” with a different creditor.

The case impacts those borrowers whose loans were assigned after origination (an everyday occurrence), and who seek rescission after receiving a common form of modification that lowered their interest rate, recalculated the principal due to include only the unpaid balance plus earned finance charges and premiums for continuation of insurance, and perhaps even extended their payment schedule.

Regulation Z provides that a “refinancing occurs when an existing obligation … is satisfied and replaced by a new obligation undertaken by the same consumer” and that a refinancing does not include a “reduction in the annual percentage rate with a corresponding change in the payment schedule.”

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We’re Back! And Having a Conversation with Terry Ammons

Our unannounced and unplanned summer hiatus is over, and Jonathan and I are back in the studio to provide the latest episode of The Bank Account.  Between travel for various banking conferences, a full work plate, and a few summer vacations, we stepped away from the podcasting studios for a few months (or three months exactly), but now we’re bank and re-energized!

Joining us in the studio is Terry Ammons.  Terry is a partner with Porter Keadle Moore LLC and the host of GroundBanking, PKM’s podcast on innovation in the financial industry.  If you’ve enjoyed The Bank Account, I suggest you also give GroundBanking a listen; I know I’ve enjoyed the first several episodes.

Before turning to the intersection of banking and fintech, we spend a little time on another industry focus for PKM that personally interests Jonathan and me, craft beverages.   We also each select our “rest of life” beer:  Terry selected Automatic by Creature Comforts Brewing Company, Jonathan selected a Sierra Nevada Pale Ale, and I went with a 420 Extra Pale Ale by Sweetwater Brewery.

Terry, Jonathan and I then turned to looking at some of the interesting interactions we’ve each seen between depository institutions and fintech companies.  We looked at the strengths of each and how partnerships can help each thrive in the 21st century.  We also examined some of the diligence items that are necessary in any such partnership.

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Dutta: The Ninth Circuit Strikes Another Blow to FCRA Plaintiffs

On July 13, 2018, in Dutta v. State Farm Mutual Automobile Insurance Company, 895 F.3d 1166 (9th Cir. 2018), the United States Court of Appeals for the Ninth Circuit affirmed summary judgment against a plaintiff that lacked Article III standing to assert a claim under the Fair Credit Reporting Act, 15 U.S.C. § 1681, et seq. (“FCRA”).

The Ninth Circuit relied on Spokeo, Inc. v. Robins, 136 S. Ct. 1540 (2016), and held that the plaintiff lacked standing because he “failed to establish facts showing that he suffered actual harm or material risk of harm.”

This ruling is significant in the Ninth Circuit and elsewhere because it provides construct under which defendants may successfully challenge a plaintiff’s Article III standing to assert claims under the FCRA or other federal statutes.

Bryan Cave Leighton Paisner’s full client alert on the Dutta decision is available here.

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