The Banking Law Connection

The Banking Law Connection

Trends and topics related to banking law and litigation

How Can the Republican Congress Help Fix Dodd-Frank?

After a strong performance in the midterm election, the Republicans now control both the Senate and the House of Representatives. What should the Republicans do with this control over Congress? Bank holding companies and financial institutions might have an idea or three.

In an op-ed piece published in The Wall Street Journal yesterday, Paul H. Kupiec called for Congress to quickly enact three reforms in order to reduce stifling regulation and to help spur economic growth. Those proposed reforms are, as follows:

1. “Raise the trigger for mandatory, enhanced prudential standards and Federal Reserve oversight for bank holding companies to $250 billion.” The current trigger is simply too low. Bank holding companies with only $50 billion in consolidated assets should not be burdened with the costs of compliance with regulations, disruptive testing by regulators, and living will requirements. Raising the trigger threshold would allow regulators to focus on the bank holding companies which might actually disrupt the economy in the event of failure, rather than smaller bank holding companies that would likely not cause any significant disruption in the event of failure.

2. “Remove the Financial Stability Oversight Council’s power to designate a nonbank financial firm as a ‘systemically important financial institution (SIFI)’—which subjects them to heightened supervision by the Federal Reserve Board of Governors—and rescind any existing SIFI designations.” Such a designation is far too significant for the subject institution to allow the government to escape absolute transparency about the process and criteria leading to a SIFI designation. According to the WSJ, “[t]he process is intentionally opaque to conceal the fact that designations are based on weakly defensible assumptions and hypothetical arguments about the alleged dangers these nonbank institutions would pose to the financial system were they to fail—arguments and assumptions that would not survive scrutiny if they were made public.” The Financial Stability Oversight Council’s largely unfettered and unreviewable discretion in making SIFI designations gives it license to intervene in and interfere with a business without any showing that the business’s failure might cause a significant disruption to the financial system.

3. Instead of requiring large bank holding companies to submit “living wills” that outline the institution’s plan for rapid and orderly bankruptcy in the event of failure, living wills should focus on eliminating the weakness in the FDIC bank resolution process. The WSJ piece argues that a living will should outline a plan to break up a large failing bank into multiple pieces and facilitate the process for doing so. While it might be prudent to require large institutions to create such a breakup plan, I wonder whether all institutions currently subjected to Dodd-Frank need to create such a plan. Perhaps my concerns could be addressed by simply raising the trigger level, as mentioned in number 1 above.

This would be a good start to correcting some of the shortcomings of Dodd-Frank. In my opinion, the American people elected Republicans in 2014 partly because they are tired of overreach by the federal government and the federal government’s interference with business. It is time for Republicans to listen to the voice of the American people and free up the economy to grow and prosper.

Apple Announces “Apple Pay”

I follow a lot of people on twitter (437, since you asked), and most of them are payments or financial technology professionals (or, er, college football writers, but that’s not important right now).  Today was the busiest day I’ve ever seen on my twitter feed, because today was the day that APPLE (squee) finally made its long-rumored announcement of its plans to alter the world of payments through its creatively-named “Apple Pay” platform (sorry, iPay was already taken).  Apple CEO Tim Cook humbly told the world that “We’ve created an entirely new payments process.”

There are surely some very cool things about Apple Pay, and I can promise you’ll I’ll be buying an iPhone 6 and adding my airlines reward card as soon as I can.  And there were at least a few minor surprises in the announcement, such as the e-commerce functionality and API to encourage third party development.  But it is not an “entirely new payments process.”

In fact, the remarkable thing about Apple Pay is the extent to which it rides the existing Visa/MasterCard rails, instead of trying to bypass them like MCX (coalition of very large retailers), bitcoin, PayPal, or a variety of other similar new platforms.  This is because, despite retailers’ dislike (to put it kindly) of the status quo, the existing Visa/MasterCard systems work very well.  This is not just because they are ubiquitous for consumers and merchants alike, but also a product of their detailed rules for handling the multitude of problems that can crop up in a payments system (the most obvious being disputes between consumers and merchants).

In general, I think Apple Pay is a strong endorsement of the existing Visa/MasterCard “payments stack”.  Some are arguing that Apple Pay is a Trojan Horse, designed to have consumers associate Apple with paying for anything and everything, and once consumers are hooked, Apple will “disintermediate” the payment networks in favor of a cheaper solution.  That may be true.  But for now, the existing card-based structure may no longer always use physical cards, but it’s as entrenched as ever.

PS – Just for giggles, I’ve copied this link to a blog post from Summer 2007 on this topic (so “out of print” I had to find it on  My basic view on this is (comfortingly or distressingly) unchanged, but the security question (which I’m still not that concerned about) has already come up in two conversations with payments laymen today.  This is unsurprising in light of the recent iCloud hack.

CFPB Targets Payment Processors and Debt Collection Fees

The Consumer Financial Protection Act of 2010 and the Telemarketing and Consumer Fraud and Abuse Prevention Act regulate certain actions of debt relief service providers. Specifically, those Acts prohibit debt relief service providers from requesting or receiving fees from consumers until after the service provider has successfully renegotiated at least one of the consumer’s debts and the consumer has made at least one payment under the renegotiated plan.

On August 25, 2014, the Consumer Financial Protection Bureau (the “CFPB”) filed a Complaint and submitted to the United States District Court for the Central District of California a proposed consent order against Global Client Solutions, LLC (“GCS”) for violating those laws.

The Complaint alleges that GCS violated the law by providing “substantial assistance” to its debt relief service clients by processing the illegal fee payments. Specifically, the Complaint alleges that GCS “knew or consciously avoided knowing” that its clients were charging illegal fees and thereby violated the prohibition on “assisting and facilitating others’” violations.

Pending court approval, the Order specifically finds that GCS does not admit or deny any of the CFPB’s allegations but does require that GCS:

(1) stop processing fees for entities that GCS “know[s] or consciously avoid[s] knowing” are “requesting or receiving unlawful” fees;

(2) perform a “reasonable screening” of all of its clients that provide debt relief services to determine if the clients are complying with applicable law;

(3) “continue to monitor each . . . client pursuant to the reasonable screening requirements” including semi-annual audits of those clients;

(4) pay the CFPB $6,099,000 to be distributed as restitution; and

(5) pay the CFPB an additional $1,000,000 as a civil penalty.

This action follows the CFPB’s earlier action against Meracord, LLC for nearly identical allegations of wrongdoing. In a CFPB press release on the GCS settlement, CFPB Director Richard Cordray is quoted as stating that “Global Client Solutions made it possible for debt-settlement companies across the country to charge consumers illegal fees. Consumers struggling to pay off a debt are among the most at risk and deserve better. We will continue to crack down on illegal debt-settlement firms and the companies that help these operations collect illegal fees from consumers.”

Understanding that the Order pending against GCS is a negotiated settlement, the proposed provisions of the Order are extreme. To require that a payment processor audit and screen its customers to avoid allegations of wrong-doing is indisputably onerous. Such provisions, even in the context of a settlement, raise serious questions about the steps payment processors need to take to protect themselves from the potential liability associated with serving debt relief service providers. Are you ready?

Lender Liability for a Borrower’s Unpaid Employment Taxes

Most taxpayers readily accept that they may be liable for various taxes based on, among other things, their income, the goods they buy and the wages they pay to their employees. On the other hand, the average person would cringe at the thought of being held responsible for tax obligations generated by the activities of an unaffiliated third-party. Commercial lenders, however, are routinely faced with this possibility when lending to distressed borrowers, yet many may not know such potential liability exists under the Internal Revenue Code (and has since the mid-1960s).

Pursuant to Section 3505(b) of the Internal Revenue Code, if a lender advances funds to a borrower for the specific purpose of paying such borrower’s employees, the lender may be held liable to the United States for such borrower’s employment taxes if the advance is made with the actual notice or knowledge that the borrower does not intend to or will not be able to make timely payment or deposit of such taxes. The lender’s overall liability will be capped at 25% of all funds disbursed to the borrower for payroll purposes, but the thought of incurring any penalty while funding a distressed borrower is likely to be unsettling at best.

As is often the case with tax analysis, the devil is in the details and whether the two primary requirements for liability – that the loan be specifically for payroll and that the lender have actual notice or knowledge of the borrower’s inability or intent not to pay – are met will depend on the specific facts at hand. For example, where the parties have an express agreement that the lender will fund a borrower’s payroll, a specific purpose can easily be found. The water becomes murky, however, when a general working capital line (which is normally exempted) allows funds to be earmarked for payroll purposes or when a lender knows that substantially all of a borrower’s general working capital expenses consist of salaries and wages. With respect to the second requirement, the statute does not require a lender to actively patrol the use of all loan funds, but notice or knowledge will include the situation where an individual loan officer is actually aware that a borrower will be unable to pay its employment taxes even if there are no broader warning signs.

In order to minimize exposure to potential lender liability under Section 3505(b), a lender should consider (i) educating its loan officers regarding Section 3505, (ii) including provisions in their loan documentation that allow the lender to make direct payments of payroll taxes and add such payments to the loan balance, (iii) requiring a borrower to use a third-party payroll services company that will ensure the proper payment of all withholding taxes, (iv) requiring a borrower to execute an appropriate Form 8821 to permit the lender to directly monitor or inspect the borrower’s confidential tax information, and (v) documenting the assurances received from a distressed borrower regarding its timely payment of all payroll taxes.

United States Supreme Court Adds Teeth to Bank Fraud Statute

Resolving a split between Federal Circuits regarding the applicability of the federal bank fraud statute, 18 U.S.C. § 1344(2), the United States Supreme Court in Loughrin v. United States has added significant teeth to the statute by ruling that the Government need not prove that a defendant had actual intent to defraud a financial institution in order to secure a conviction thereunder.

Section 1344 of the United States Code provides as follows:

Whoever knowingly executes, or attempts to execute, a scheme or artifice –

(1) to defraud a financial institution; or

(2) to obtain any of the moneys, funds, credits, assets, securities, or other property owned by, or under the custody or control of, a financial institution, by means of false or fraudulent pretenses, representations, or promises;

Shall be fined not more than $1,000,000 or imprisoned not more than 30 years, or both.

The Defendant in Loughrin was convicted of bank fraud under § 1344(2) after forging stolen checks to purchase goods at Target retail stores, only to return such purchases for cash refunds.  The Defendant did not dispute that § 1344(2) required the Government to prove (1) intent to obtain bank property, (2) “by means of false or fraudulent pretenses, representations, or promises.”  However, the Defendant asserted that he only intended to defraud Target and further argued that the Government was required to prove that he had a specific intent to defraud a bank in order to secure a conviction under § 1344(2).  Rejecting the Defendant’s position, the Court held that:

(1) While an intent to defraud a financial institution constitutes a requirement under the first clause of § 1344, such a requirement is not contained in the second clause of the statute, which is separated from the first clause by a disjunctive “or” and, thus, sets forth an independent basis for conviction.  The Court further noted that interpreting the second clause to include the element of specific intent to defraud a bank would subsume it into the first clause, thus rendering the second clause superfluous in violation of the well-established rule of statutory construction that “courts ‘must give effect, if possible, to every clause and word of a statute.’ ”

(2) The Court’s interpretation of § 1344(2) did not violate principles of federalism by subsuming traditional state jurisdiction over all “garden-variety cons” involving payment by check rather than cash. Rather, the Court noted that the “by means of” language of §1344(2) requires that false or fraudulent conduct “have some real connection to a federal bank” and constitute the actual mechanism inducing a bank to part with its funds or assets.  Thus, the Court held that “garden-variety cons” involving merely a fraud upon a consumer, who in turn pays the con artist with a valid check, would fall outside § 1344(2) because the fraud would not directly cause the bank to part with funds or property.  However, false representations made via a forged or altered check submitted by a con artist to a merchant do fall within § 1344(2) because the fraudulent instrument itself would naturally induce a bank to part with funds.

Despite the Court’s attempt to distinguish between the types of fraudulent acts falling within the scope of § 1344(2), the Court nevertheless acknowledged in a footnote that the determination of whether a fraudulent act has a real connection to a bank so as to induce the bank to part with property constitutes a facts and circumstances test which “will depend almost entirely on context.”