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Subject:                                Banking and Finance Law Daily Wrap Up - Jan 17


Wolters Kluwer

Banking and Finance Law Daily

January 17, 2017

Wolters Kluwer

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In the News


·        Jones Day

·        Mashiri Law Firm


·        Amazon

·        Americans for Financial Reform

·        Apple


TOP STORY—9th Cir.: Collection of homeowner association fees was covered by collections act

By Richard A. Roth, J.D.

A law firm that was attempting to collect a homeowner association assessment on behalf of the HOA was attempting to collect a debt, not just enforce a security interest, and thus was required to comply with all of the requirements of the Fair Debt Collection Practices Act, the U.S. Court of Appeals for the Ninth Circuit has decided. Statements included in the firm’s demand letter also conflicted with the notice of the homeowner’s rights required by the FDCPA, the court said (Mashiri v. Epsten Grinnell & Howell, Jan. 13, 2017, Paez, R.).

The homeowner apparently failed to pay an annual HOA assessment of $385. This led to a collection letter from the firm Epsten Grinnel & Howell demanding payment of the assessment plus various collection-related fees, for a total of $598. The demand letter also included the notice of consumer rights required by the FDCPA and a state law-required warning that a lien would be recorded against the property if payment was not made.

The homeowner later paid the $385 assessment amount and disputed the remainder of the demand. Since the full amount had not been paid, the law firm recorded the lien. The homeowner then sued the firm under the FDCPA and several state laws, claiming the demand letter had overshadowed and conflicted with the notice of her rights.

Validation notice. The FDCPA requires a debt collector, either as part of or shortly after the first communication with a consumer, to notify the consumer of certain rights. Among these are the rights to demand within 30 days of the consumer’s receipt of the notice that the debt be validated and that collection efforts be halted while validation takes place.

The homeowner complained that the demand for payment within 35 days of the date of the letter overshadowed the notice of her right to demand validation within 30 days of when she received the letter.

Security interest. The law firm first claimed that it was not subject to the validation notice requirement because it was not attempting to collect a debt. The firm asserted instead that it was only attempting to enforce a security interest—the lien for the unpaid assessment. That argument failed.

The HOA assessment clearly met the FDCPA definition of "debt," the court said. Also, the letter warned the homeowner of the consequences of not paying that debt.

Moreover, there was no security interest for the firm to enforce when it sent the demand letter, the court pointed out. The unpaid assessment lien created a security interest, but the letter warned that the lien would be recorded in the future if the HOA assessment was not paid.

It is true that enforcing a security interest is not debt collection under the FDCPA, the court agreed. However, if a person who is enforcing a security interest also engages in debt collection activities, it is a debt collector.

Notice violation. The demand letter could have overshadowed the validation notice in a way that would confuse the least sophisticated consumer, the court continued.

It is not enough for the validation notice simply to include the rights listed in the FDCPA, the court pointed out; those rights must be effectively conveyed to the consumer. Other content of the collection letter cannot overshadow or contradict them.

The law firm’s letter told the homeowner that she had 30 days from the date she received the letter to assert her right to have the debt validated. However, it also warned of dire consequences if she did not pay the amount demanded within 35 days of the letter’s date. According to the court, by the time the homeowner received the letter, she might no longer have 30 days to demand validation of the debt without the 35-day deadline passing. Even if the 35-day deadline could be met, the homeowner might have had to mail her payment before the end of the 30-day validation period in order to satisfy the 35-day payment period.

There was another plausible violation, the court added. The FDCPA requires debt collectors to cease collection activities while they validate debts, but the law firm’s notice said that the lien would be recorded if she did not pay the overdue assessment and additional fees. The least sophisticated consumer could interpret that as meaning the lien would be recorded regardless of whether she asked for validation.

The state law that required the firm to warn the homeowner that a lien could be recorded was not inconsistent, the court also said.

The case is No. 14-56927.

Attorneys: Asil Marhiri (Mashiri Law Firm) for Zakia Mashiri. Anne Lorentzen Rauch, Epsten Grinnell & Howell APC.

Companies: Epsten Grinnel & Howell APC.; Westwood Club

MainStory: TopStory AlaskaNews ArizonaNews CaliforniaNews DebtCollection GuamNews HawaiiNews IdahoNews MontanaNews NevadaNews OregonNews WashingtonNews

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BANKING OPERATIONS—Fintech policy framework published by White House

By J. Preston Carter, J.D., LL.M.

The Obama Administration has published its fintech statement of principles to be used as a policy framework by the financial services sector and U.S. government. Publication of "A Framework for FinTech" follows the White House FinTech Summit held in June 2016, in which Cabinet Secretaries and senior officials from across the Administration engaged with stakeholders about the potential for fintech to further myriad policy goals, including small business access to capital, financial inclusion and health, domestic growth, and international development.

The administration urges industry and other stakeholders to use the framework to understand how they can contribute to a well-functioning and inclusive financial system, and to examine their products and services against the framework. The framework’s 10 principles encourage stakeholders to:


think broadly about the financial ecosystem;


start with the consumer in mind;


promote safe financial inclusion and financial health;


recognize and overcome potential technological bias;


maximize transparency;


strive for interoperability and harmonize technical standards;


build in cybersecurity, data security, and privacy protections from the start;


increase efficiency and effectiveness in financial infrastructure;


protect financial stability; and


continue and strengthen cross-sector engagement.

RegulatoryActivity: BankingOperations CommunityDevelopment CyberPrivacyFeed FinTech IdentityTheft Privacy

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FINANCIAL STABILITY—Treasury: Housing reform requires regulatory oversight supporting secondary mortgage market

By Charles A. Menke, J.D.

An issue brief posted on the Treasury Department’s blog highlights the importance of independent regulatory oversight to support the secondary mortgage market in serving consumers and financial institutions of all sizes, as well as safeguarding the safety and soundness of the housing finance system. The brief, authored by Deputy Assistant Secretary for Financial Economics Jane Dokko and Counselor in the Office of Domestic Finance Sam Valverde, is the third and final in a series of issue briefs from the Treasury focusing on housing reform. The first two briefs discussed the need for housing finance reform to provide access to affordable housing for all Americans and promote sustainable mortgage lending across the U.S. economy’s ups and downs (see Banking and Finance Law Daily, Dec. 28, 2016, and Oct. 27, 2016).

The latest issue brief highlights the following needs for housing reform:


A regulatory framework for the secondary mortgage market that supports fair competition across all lenders, regardless of size or type.


Regulatory oversight to protect the safety and soundness of the secondary market.


Regulatory oversight of a stronger secondary market infrastructure.

Fostering competition. According to the authors, a reformed housing system must be carefully supervised by an independent regulator with sufficient resources and enforcement authority to oversee the institutions that benefit from an explicit government guarantee. The regulatory framework, moreover, should support fair competition across all lenders, regardless of size or type. Fostering competition among lenders benefits consumers and provides competitive access to funds that smaller institutions use in providing mortgages, the authors contend.

Regulatory authority. In order to safeguard broad access and prudential oversight, a secondary market regulator must have both supervisory and enforcement authority. Accordingly, supervised market participants should be subject to penalties for violating rules designed to protect families in their capacity as both consumers and as taxpayers.

Independence. Lastly, the authors argue that regulatory oversight must ensure that private capital is supporting fair and affordable housing opportunities for all American families and that taxpayers are adequately compensated for government support in times of stress. To achieve this goal, "the regulator should be strong and independent enough to withstand pressure from the public and private sectors that may steer it toward relaxing requirements and undermining safety and soundness standards."

RegulatoryActivity: CommunityDevelopment FinancialStability GovernmentSponsoredEnterprises Mortgages OversightInvestigations

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FINANCIAL TECHNOLOGY—OCC’s FinTech proposal needs strong consumer protection and supervisory requirements

By John M. Pachkowski, J.D.

A number of stakeholders have begun to weigh in on a December 2016 proposal by the Office of the Comptroller of the Currency that would allow financial technology or FinTech companies that offer bank products and services to apply for a special purpose charter.

The OCC issued its paper, entitled "Exploring Special Purpose National Bank Charters for Fintech Companies," that discusses several important issues associated with the approval of a national bank charter as part of its yearlong initiative regarding the use of innovative financial technology (see Banking and Finance Law Daily, Dec. 2, 2016).

Unlawful and invalid nature. The Conference of State Bank Supervisors submitted a comment letter reiterating its opposition to the OCC’s proposal to issue a special charter for FinTech companies. The CSBS previously expressed its concerns on an OCC proposal that would establish a framework to address the conduct of receiverships for national banks that are not insured by the Federal Deposit Insurance Corporation. The proposed rule would implement the provisions of the National Bank Act that provides the legal framework for receiverships of uninsured banks. The OCC ultimately issued a final rule in December 2016 based on the proposal (see Banking and Finance Law Daily, Sept. 12, 2016 and Dec. 19, 2016).

In its latest comment letter, the CSBS called the OCC’s proposal an "unprecedented expansion" of the agency’s chartering authority and that it amounted to an end run around Congress. The letter also noted that the proposal would stifle innovation while activities-based state licensing encourages and enables financial innovation. Furthermore, the CSBS stated that the OCC’s proposal poses dangerous consequences stemming from the preemption of state laws. Finally, as part of its letter, the CSBS provided a Legal and Policy Assessment that provided "a more in-depth discussion of the unlawful and invalid nature of a special purpose national nonbank charter."

Recently, Sens. Sherrod Brown (D-Ohio) and Jeff Merkley (D-Ore) wrote to the OCC expressing concerns that a new federal charter for FinTech firms could weaken consumer protections, limit competition, and threaten financial stability. They added that the granting of federal charter, or as they termed it an "alternative charter" for FinTech companies, could encourage charter shopping in order to avoid unfavorable state and federal laws (see Banking and Finance Law Daily, Jan. 10, 2017).

Uniform supervision and regulation. In its comment letter, the National Association of Federally-Insured Credit Unions initially expressed support for the OCC’s initiative to offer FinTech companies the opportunity to obtain a special purpose bank charter. However, the NAFCU added that FinTech companies require a minimum level of regulation and supervision to ensure fair competition and consumer protection. As for consumer protection, the comment letter noted that chartered FinTech companies should be held to the same consumer protection laws as chartered banks and credit unions, and that the OCC should only deviate from such uniformity in extraordinary circumstances. The letter added that the OCC must ensure that consumers are not getting a "bad bargain" due to FinTech companies being allowed to grow without being restrained by regulation or consumer protection laws.

Primary line of defense. A group of 250 consumer advocacy organizations, led by Americans for Financial Reform and the Center for Responsible Lending, expressed strong opposition to the OCC’s proposal. The groups were concerned that the proposal would enable lenders to avoid state interest rate caps, other state protections, and state oversight. The groups’ letter noted, "State laws often operate as the primary line of defense for consumers and small businesses; thus, the proposal puts them at great risk."

Optional federal charter. Finally, a comment letter from Financial Innovation Now, a public policy coalition comprised of Amazon, Apple, Google, Intuit, and PayPal, supported the OCC’s proposal and called on the agency to provide that the federal charter be optional.

FIN noted, "A federal option can provide uniform regulation regardless of the location of the customer. Such an option may be well suited for Fintechs involved in internet-enabled lending and payment services." The coalition also stated that the OCC’s supervision of any company operating under the special interest charter should be "based on risk and the business model of a Fintech company."

Companies: Amazon; Americans for Financial Reform; Apple; Center for Responsible Lending; Conference of State Bank Supervisors; Financial Innovation Now; Google; Intuit; National Association of Federally-Insured Credit Unions; PayPal

RegulatoryActivity: BankingOperations CommunityDevelopment ConsumerCredit DepositInsurance DoddFrankAct FinancialIntermediaries FinancialStability FinTech Loans OversightInvestigations Preemption PrudentialRegulation StateBankingLaws

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FLOOD INSURANCE AND DISASTER RELIEF—Mortgage bankers, Financial Services Roundtable comment on flood insurance regulation

By Thomas G. Wolfe, J.D.

The Financial Services Roundtable and the Mortgage Bankers Association have submitted comments on the joint proposal by federal regulators to amend their regulations concerning private insurance for loans in areas having special flood hazards. While both trade organizations commend the regulatory undertaking, the FSR urges federal regulators to further refine their proposal, particularly because the rule "might impose inappropriate regulatory burdens that may reduce the incentives for insurance groups to provide products and services to borrowers related to flood protection." Similarly, the MBA maintains that the proposed rules "present a significant burden for lenders, since the requirements necessitate comprehensive review and comparison of private flood insurance policies."

Proposal. As previously reported (see Banking and Finance Law Daily, Oct. 19, 2016), to facilitate implementing the private flood insurance provisions of the Biggert-Waters Flood Insurance Reform Act (BWA), the proposed rule by the Office of the Comptroller of the Currency, Federal Reserve Board, Federal Deposit Insurance Corporation, National Credit Union Administration, and Farm Credit Administration would amend flood insurance regulations to allow loan borrowers to rely more heavily on private flood insurance.

Under the proposal, by following a "Compliance Aid," lenders would be required to accept private insurance policies meeting the BWA’s explicit statutory definition of "private flood insurance." In addition, the proposed rule would create standards for lenders to follow in exercising their discretion to accept private flood insurance policies that do not satisfy the BWA’s statutory definition. Further, a lender would be able to accept private insurance coverage from a "mutual aid society"—including certain religious or cultural institutions—that has a track record of fulfilling its commitment to cover damages resulting from a flood or other hazard.

FSR’s comments. In its recent comment letter, the FSR acknowledges the federal agencies’ "laudable objectives" but contends that the proposed rule creates administrative and compliance obstacles that will make it difficult for regulated lending institutions (RLIs) to underwrite loans to private flood insurance (PFI) protected properties. Underscoring this point, the FSR maintains that the rule’s requirement "for RLIs to accept policies that offer coverage ‘at least as broad as’ the coverage provided under a Standard Flood Insurance Policy (SFIP) will present practical difficulties that will impede or, in some circumstances, prevent RLIs from underwriting loans to PFI protected properties."

Consequently, the FSR recommends that the federal agencies:

·        refine the "at least as broad as" standard, where possible, to provide "greater certainty for lenders and policyholders;"

·        consider alternatives to requiring an RLI, which lacks the technical expertise, to make compliance determinations based on a comparison of a given insurance policy to the SFIP, or to provide written summaries demonstrating how policies meet the statutory definition of PFI;

·        reconsider and reformulate the criteria for "discretionary acceptance of PFI" to make such criteria more permissive; and

·        allow RLIs more discretion in accepting flood insurance policies related to commercial property that "will increase the ability of insurers to develop a wider array of private market options that will be acceptable to lenders and nonresidential policyholders alike."

MBA’s comments. Likewise, in its Jan. 6, 2017, comment letter, the MBA recommends that the federal agencies’ proposal should:

·        place the burden of demonstrating compliance on "the parties most logically able to bear it: the insurers themselves;"

·        include a "safe harbor" for RLIs in the event a lender accepts a flood insurance policy—properly documented and certified—from a private insurer that, later, is found not to meet the PFI statutory definition;

·        allow lenders to rely on a "financial strength rating of the insurer" that is recognized by the industry;

·        refrain from restricting policies issued by surplus lines insurers to nonresidential commercial properties;

·        alleviate lenders’ concerns about potential liability associated with the acceptance of PFI policies;

·        set a broader timeframe to facilitate an insurer’s evaluation of the pertinent SFIP policy "in advance of the effective date of the insurance coverage;" and

·        clarify the "methodology by which a lender will be able to determine NFIP policy changes."

Companies: Financial Services Roundtable; Mortgage Bankers Association

RegulatoryActivity: BankingOperations FloodInsurance Loans Mortgages

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LOANS—CFPB promotes updated student loan Payback Playbook

By Katalina M. Bianco, J.D.

The Consumer Financial Protection Bureau has updated its student loan Payback Playbook after receiving feedback from nearly 3,500 borrowers, consumer advocates, and members of industry. The bureau worked with the Departments of Education and Treasury to develop prototype disclosures intended to ensure that student loan servicers provide the information borrowers need to obtain affordable monthly payments, according to the CFPB. The bureau has provided the DOE with the updated playbook prototype.

The updated playbook comes in the wake of an August 2016 report by the CFPB detailing the continuing complaints by consumers about student loan servicing problems (see Banking and Finance Law Daily, Aug. 19, 2016). In the report, the bureau’s Student Loan Ombudsman indicated that student loan borrowers wishing to make use of income-driven repayment plans with their federal student loans have experienced servicing "breakdowns" when trying to navigate the system, prompting the CFPB to call on servicers to fix the costly breakdowns.

General observations. In light of borrowers’ difficulties navigating the student loan servicing system, the bureau created the student loan Payback Playbook to provide federal student loan borrowers with personalized and actionable information on federal student loan repayment plans (see Banking and Finance Law Daily, April 28, 2016). To further its goal, along with the updated playbook, the CFPB presented to the DOE five general observations based on its review of public comments and feedback gained through user testing. The observations are the basis of the revised playbook disclosures. The general observations made by the bureau are:


the need for actionable information on student loan repayment options, particularly for borrowers at risk of financial hardship;


support for the presentation of personalized information in targeted disclosures, especially in relation to monthly payments under various income-driven repayment;


consumers support for the prototype Payback Playbook’svisual presentation;


adaptation to specific borrower segments, including at-risk borrowers; and


targeted distribution of disclosures.

Assistance to borrowers. To help ease the path for borrowers, the Payback Playbook describes each payment option using clear, straightforward language intended to make it easier for borrowers to understand the different plans and choose one that fits their financial situation. The CFPB also provided a link to a tool for consumers who have questions about repaying their student loans.

RegulatoryActivity: CFPB CommunityDevelopment Loans

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OVERSIGHT AND INVESTIGATION—OIG evaluation ensures that shared-loss agreement recoveries are remitted to FDIC

By Stephanie K. Mann, J.D.

The Federal Deposit Insurance Corporation’s Office of Inspector General has issued a report evaluating the risks and controls associated with assuming institutions identifying and remitting Shared-Loss Agreements (SLAs) to the FDIC. In its December 2016 report (Report No. EVAL-17-001), the Inspector General assessed the Division of Resolutions and Receiverships’ (DRR) efforts to ensure that assuming institutions identify and remit SLA recoveries to the FDIC. To address the objective, the OIG assessed FDIC policies, procedures, and training pertaining to SLA recoveries and DRR’s timeliness in identifying assets that assuming institutions are required to report on during the recovery-only period.

Background. As observed by the Inspector General in its report, when a financial institution fails, the FDIC may enter into SLAs "to reduce the FDIC’s immediate cash needs, provide continuity to failed bank customers, and move assets into the private sector." Generally, under the SLA arrangement, the FDIC enters into an agreement with an assuming institution to absorb a portion of the loss on a specified asset pool in order to "maximize asset recoveries and minimize the FDIC’s losses."

A recovery typically comprises: (1) funds paid by the borrower on assets that the AI previously charged off or experienced a loss on and received reimbursement from the FDIC pursuant to an SLA; or (2) gains from the sale of foreclosed property or SLA assets. The FDIC is entitled to share in recoveries on SLA assets charged off for all 10 years on single family SLAs. The FDIC is generally entitled to share SLA recoveries with an assuming institution on SLA assets charged off during the first five years of the CSLA and may also receive a share of recoveries on those assets through year eight of the commercial SLA.

Evaluation. The OIG found that DRR has established controls to mitigate risks and help assuming institutions appropriately identify and remit recoveries to the FDIC. These controls include a process for identifying recovery and non-recovery assets and conducting on-site reviews that focus on recoveries. DRR also issued guidance and provided training to DRR employees, assuming institutions, and third-party contractors on recovery period procedures and expectations.

At the inception of the recovery-only period for commercial SLAs, DRR generates a Recovery Asset Workbook, which identifies assets the assuming institution is required to report on during the recovery-only period. The OIG found that DRR timely finalized the majority of the Workbooks that were reviewed.

At one assuming institution, the report found that the assuming institution overpaid the FDIC by $249,937 in recoveries. The net over payment was due to internal control weaknesses and accounting software limitations at the AI. The AI stated that improved internal controls, processes, and software changes that have either been implemented or are underway should prevent similar findings from occurring in the future.

Recommendation. The report has recommended that DRR assess the progress made by the assuming association that overpaid the FDIC in implementing changes to ensure accurate identification and reporting of SLA recoveries to the FDIC. It also recommended that DRR review a sample of the "SLA certificates to determine whether errors similar to the ones identified by the review are prevalent with other SLA certificates," and take appropriate action.

The OIG noted that DRR concurred with the report’s recommendations and described corrective actions that were responsive.

RegulatoryActivity: DepositInsurance OversightInvestigations

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REGULATION TRACKER—Upcoming comment deadlines and effective dates

The Banking and Finance Law Daily Regulation Tracker includes a Proposed Rules Comment Calendar and a table of Final Rule Effective Dates. Recent activity includes the following:

The Consumer Financial Protection Bureau has issued a final rule to adjust the civil monetary penalties within the bureau’s jurisdiction for inflation, as required by the Federal Civil Penalties Inflation Adjustment Act of 1990. The Federal Civil Penalties Inflation Adjustment Act Improvements Act of 2015 requires federal agencies to adjust the civil penalty amounts within their jurisdiction for inflation by July 1, 2016, and then by January 15 every year thereafter. To determine the new penalty amount, the agency must apply a multiplier reflecting the "cost-of-living adjustment" to the penalty amount as it was most recently established. The agency must then round that amount to the nearest dollar. For the 2017 annual adjustment, the multiplier reflecting the "cost-of-living adjustment" is 1.01636.

New civil penalties. Under the final rule, the CFPB has recalculated the following penalties for 2017:

·        Consumer Financial Protection Act, Tier 1 penalty—$5,526;

·        CFPA, Tier 2 penalty—$27,631;

·        CFPA, Tier 3 penalty—$1,105,241;

·        Interstate Land Sales Full Disclosure Act, per violation—$1,925;

·        ILSFDA, annual cap—$1,924,589;

·        Real Estate Settlement Procedures Act, per failure—$90;

·        RESPA, annual cap—$181,071;

·        RESPA, per failure when intentional—$181;

·        SAFE Act, per violation—$27,904;

·        Truth in Lending Act, first violation—$11,053; and

·        TILA, subsequent violations—$22,105.

Extended comment period. The Federal Reserve Board, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation have extended the comment period for the advance notice of proposed rulemaking on enhanced cyber risk management standards for large and interconnected entities under their supervision and those entities’ service providers. The agencies extended the comment period to allow interested persons more time to analyze the issues and prepare their comments.

The agencies’ proposed the standards in October 2016 as a means to reduce the impact on the financial system in case of a cyber event experienced by one of these entities. The proposed standards would be integrated into the existing supervisory framework by establishing enhanced supervisory expectations for the entities and services that potentially pose heightened cyber risk to the safety and soundness of the financial sector. The proposed enhanced standards would also be tiered, with an additional set of higher standards for systems that provide key functionality to the financial sector. For sector-critical systems, the agencies are considering requiring firms to substantially mitigate the risk of a disruption or failure due to a cyber event (see Banking and Finance Law Daily, Oct. 19, 2016).

See the Regulation Tracker for details.

RegulatoryActivity: BankingOperations CFPB CyberPrivacyFeed EnforcementActions FinancialStability IdentityTheft Privacy PrudentialRegulation RESPA TruthInLending

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ENFORCEMENT ACTIONS—Moody’s settles claims against its pre-financial crisis conduct for $864 million

By Joseph Arshawsky, J.D.

The Department of Justice, 21 states, and the District of Columbia, reached a nearly $864 million settlement agreement with Moody’s Investors Service Inc., Moody’s Analytics Inc., and their parent, Moody’s Corporation (collectively, Moody’s). The settlement resolved allegations arising from Moody’s role in providing credit ratings for residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDO), contributing to the worst financial crisis since the Great Depression.

During the years leading up to the financial crisis, Moody’s was a nationally recognized statistical ratings organization. For a fee, Moody’s issued alphanumeric credit ratings of structured finance instruments, including RMBS and CDOs. Moody’s also issued credit ratings of corporate bonds and other types of structured finance instruments, financial and non-financial entities, and governments, among other things.

The settlement agreement resolved pending state court lawsuits in Connecticut, Mississippi, and South Carolina, as well as potential claims by the Justice Department, 18 states and the District of Columbia. The multi-faceted settlement included a statement of facts in which Moody’s acknowledged key aspects of its conduct, and a compliance agreement to prevent future violations of law.

Statement of Facts. The statement of facts addressed Moody’s representations to investors and the public generally about: 1) its objectivity and independence; 2) its management of conflicts of interest; 3) its compliance with its own stated RMBS and CDO rating methodologies and standards; and 4) the analytic integrity of certain rating methodologies.

The statement of facts addressed whether Moody’s credit ratings were compromised by what Moody’s itself acknowledged were the conflicts of interest inherent in the so-called "issuer pay" model, under which Moody’s and other credit rating agencies were selected by the same entity that put together and marketed the rated securities and therefore stood to benefit from higher credit ratings.

Among other things, Moody’s acknowledged:

·        Moody’s published and maintained online its "Code of Professional Conduct" for the stated purpose of promoting the "integrity, objectivity, and transparency of the credit ratings process," including managing conflicts of interest that it publicly acknowledged arose from the fact that RMBS and CDO issuers determined whether to retain Moody’s to rate these securities.

·        Moody’s passed these conflicts on to the managing directors of the business units, who were then asked to resolve the "dilemma" between maintaining ratings quality and the need to win business from the issuers that selected them.

·        Moody’s publicly stated that its ratings "primarily address the expected credit loss an investor might incur," which included its assessment of both the "probability of default" and the "loss given default" of rated securities.

·        Starting in 2001, Moody’s RMBS group began using an internal tool in rating RMBS that did not calculate the loss given default or expected loss for RMBS below Aaa and did not incorporate Moody’s own rating standards. Instead, the tool was designed to "replicate" ratings that had been assigned based on a previous model that calculated expected loss for each tranche and incorporated Moody’s rating level standards. In October 2007, a senior manager in Moody’s Asset Finance Group (AFG) noted the following about Moody’s RMBS ratings derived from the tool: "I think this is the biggest issue TODAY. [A Moody’s AFG Senior Vice President and research manager]’s initial pass shows that our ratings are 4 notches off."

·        Starting in 2004, Moody’s did not follow its published idealized expected loss standards in rating certain Aaa CDO securities. Instead, Moody’s began using a more lenient standard for rating these Aaa securities but did not issue a publication about this practice to the general market.

·        In 2005, Moody’s authorized the expanded use of this practice to all Aaa CDO securities and, in 2006, formally authorized the use of this practice, or of an even more lenient standard, to all Aaa structured finance securities. Throughout this period, although "[m]any arrangers and issuers were aware" that Moody’s was using a more lenient Aaa standard, Moody’s did not issue publications about these decisions to the general market.

The statement of facts further addressed other important aspects of Moody’s rating methodologies, including its "inconsistent use of present value discounts" in assigning CDO ratings and its selection of assumptions about the correlations between assets in CDOs.

Compliance commitments. Under the terms of the compliance commitments, Moody’s agreed to maintain a host of measures designed to ensure the integrity of its credit ratings. These include:

·        Separation of Moody’s commercial and credit rating functions by excluding analytical personnel from any commercial related discussions and excluding personnel responsible for commercial functions from determining credit ratings or developing rating methodologies;

·        Independent review and approval of changes to rating methodologies by maintaining separate groups to develop and review rating methodologies;

·        Changes to ensure that specified personnel are not compensated on the basis of the company’s financial performance;

·        Enhancing Moody’s oversight functions to monitor the content of press releases and the timeliness of methodology development;

·        Deploying new technological platforms and centralized systems for documentation of rating procedures; and

·        Certifications of compliance by the President/CEO of Moody’s with these commitments for at least five years.

Penalties. In addition to the non-monetary measures, such as the compliance commitments, the settlement includes a $437.5 million federal civil penalty, which is the second largest payment of this type ever made to the federal government by a ratings agency. The remainder, over $426 million, will be distributed among the settlement member states in alignment with terms of the agreement, as compensation for the harm they suffered as a result of Moody’s conduct.

Companies: Moody’s Investors Service Inc.; Moody’s Analytics Inc.; Moody’s Corp.

LitigationEnforcement: EnforcementActions FinancialStability Mortgages SecuritiesDerivatives

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SUPREME COURT DOCKET—U.S.: Does Bankruptcy Code trump Fair Debt Collection Practices Act?

By Richard A. Roth, J.D.

A debt collector that filed a bankruptcy court proof of claim on a stale debt attempted to convince the Supreme Court justices that remedies available under the Bankruptcy Code made the application of the Fair Debt Collection Practices Act unnecessary in arguments on Midland Funding, LLC, v. Johnson. On the other hand, the consumer, backed by the U.S. government, asserted that FDCPA liability is needed because the bankruptcy system does not function well enough to protect consumers from claims that debt collectors know are uncollectible.

Debt collector Midland Funding is appealing a decision by the U.S. Court of Appeals for the Eleventh Circuit that the Bankruptcy Code provision permitting debt collectors to file claims and the FDCPA ban on misrepresentations and unfair practices do not conflict (see Johnson v. Midland Funding, LLC, discussed at Banking and Finance Law Daily, May 25, 2016).

Bankruptcy Code is enough. Arguing for Midland Funding, Kannon Shanmugam relied on the way bankruptcy courts are supposed to work: the creditor files a proof of claim and provides enough information about the claim to allow the bankruptcy court trustee and consumer to decide whether a statute of limitations defense might be raised. The creditor is not required to certify that there is no valid time limit defense, he said.

Questions posed by Justice Sotomayor led Shanmugam to concede that Midland Funding would not have engaged in any "exhaustive inquiry" into whether a defense existed. However, he argued that doing so was not required by the Code. The Bankruptcy Code advisory committee considered requiring a certification that an investigation had been performed and decided against it. The Code is intended to permit creditors to file claims that are presumed to be valid and then shift the burden of defense to the trustee, he said.

The Code says that unenforceability is a reason for a claim to be disallowed, not a reason why it cannot be filed, Shanmugam asserted.

Justice Kagan voiced a practical concern—allowing claims on stale debts either would result in time-consuming objections by the trustees or would "swamp" the trustees so that claims would be paid even though they were invalid. According to Shanmugam, creditors nevertheless should be able to file claims on debts known to be stale because the objection process should be expected to weed them out.

Congress was aware when it adopted the burden-shifting claims process that some invalid claims would be paid, he claimed. Whether the creditor knew a debt was stale was irrelevant. What mattered was that the information described by the Code was disclosed properly.

FDCPA effects. Justice Kagan then moved on to the issue raised more clearly by the Eleventh Circuit decision—even if filing the proof of claim was allowed by the Bankruptcy Code, why couldn’t it be banned by the FDCPA? Filing was a choice, she pointed out.

Taking the opportunity to address the FDCPA directly, Shanmugam argued there would be no violation. As long as the claim was accurate and included required information such as when the debt was incurred, there would be no misrepresentation, he argued. The claim only represented the creditor had a good faith belief that the claim existed and said nothing about whether that claim was enforceable.

Filing the claim could not be unfair because the bankruptcy trustee was in place to object to invalid claims, he added.

The consumer’s "principal beef" was that the bankruptcy court system does not work as it is supposed to, Shanmugam asserted. That is no reason to insert the FDCPA into the process rather than fixing the bankruptcy system.

FDCPA is violated. "Midland is, in fact, using a business model that intentionally floods bankruptcy courts with time-barred debts," charged Daniel Geyser, the consumer’s attorney. These claims always will be denied if the trustee objects and Midland never will collect if the bankruptcy court operates as it is supposed to operate, he claimed. A creditor should not be allowed to bring a claim without a good faith belief there is no statute of limitations defense.

Who decides if there is a good faith defense, Justice Breyer wondered. If an FDCPA suit results, that question will be decided not in bankruptcy court but rather in an ordinary trial court where damages and attorney fees can be awarded. That is contrary to the goal of an efficient, dedicated bankruptcy court that decides claims, he observed. "We want bankruptcy matters decided in bankruptcy court."

Geyser tried to explain that there should be FDCPA liability only when a statute of limitations defense is "obvious on the face of the claim" and there is no articulable reason why that defense would not apply. Chief Justice Roberts, however, pointed out that if the defense was obvious, it would be obvious to the consumer and trustee, not just the creditor.

Why don’t trustees automatically object to all claims that are, on their face, stale, Justice Alito asked. Geyser first relied that objections cost time and money. Second, he said, there is an "information asymmetry"—trustees assume that creditors act in good faith and may assume that there is some reason why an apparently time-barred claim remains collectible.

"Beautiful" business model. Commenting on the uselessness of sanctions to address claims on stale debts, Justice Sotomayor said "This model—this model is beautiful. You file a claim you know is old. If you get paid, wonderful. If somebody objects, you withdraw it. There’s no sanction that’s possible . . . And it just keeps on going."

That, Geyser emphasized, is why the FDCPA must be available to supply a remedy.

Banning time-barred debt claims. The government’s view is that "no creditor is entitled to file a proof of claim in bankruptcy on a claim that the creditor knows is time barred," said Assistant to the Solicitor General Sarah Harrington. In fact, that view extends to civil litigation generally, she added.

When asked, Harrington conceded that if the Bankruptcy Code permits claims to be filed on stale debts, then the filing would not violate the FDCPA.

The case is No. 16-348.

Supreme Court docket. For details about this and other petitions and cases pending before the Supreme Court, please consult this list of selected banking and finance law cases awaiting action in the 2016 term. Issued opinions, granted petitions, pending petitions, and denied petitions are listed separately, along with a summary of the questions presented and the current status of each case.

Attorneys: Kannon K. Shanmugam (Williams & Connolly LLP) for Midland Funding, LLC. Daniel L. Geyser (Stris & Maher LLP) for Aleida Johnson. Sarah R. Harrington, Assistant to the Solicitor General, for amicus curiae United States.

Companies: Midland Funding, LLC

LitigationEnforcement: DebtCollection SupremeCtNews

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LAW FIRM NEWS—Jones Day welcomes data privacy and cybersecurity lawyer

Richard M. (Rick) Martinez has joined Jones Day in the firm's Minneapolis Office as a partner in its Cybersecurity, Privacy & Data Protection Practice. He has established an extensive record of representing Fortune 100 companies, educational institutions, startup and early-stage tech companies, and individuals in a wide range of data privacy, cybersecurity, and intellectual property matters, according to the announcement.

Martinez has experience in various technological fields and computer-implemented technologies, including hardware and software programs, and network and web-based communications. His significant client matters have included internet and cloud technologies, flash memory, automated systems, and consumer electronic devices.

Attorneys: Richard M. Martinez (Jones Day).

IndustryNews: LawFirmNews MinnesotaNews

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