Nevada Courts Provide Additional Guidance on HOA Super Priority Lien Law for Lenders

Nevada Supreme CourtAs we’ve discussed on this blog before, Nevada’s courts remain a battleground for lenders seeking to establish that their security interests were not eliminated by homeowners’ association foreclosure sales under NRS 116. In recent weeks, the Ninth Circuit and Supreme Court of Nevada have issued new opinions providing more guidance to ultimately resolve those issues. Lenders now have more support for two of their strongest arguments. First, for loans owned by Fannie Mae and Freddie Mac, the Nevada Supreme Court held that the security interests could not have been extinguished by a homeowners’ association’s foreclosure sale due to the preemptive effect of the Housing and Economic Recovery Act (HERA), even if the loan had been placed into a securitized trust. Second, the court reaffirmed its recognition of the doctrine of tender, holding that under longstanding blackletter law, a lender’s unconditional offer to pay the full superpriority amount of the association’s lien caused that lien to be discharged, and protected the lender’s security interest in the ensuing association foreclosure sale. On the other hand, the Nevada Supreme Court also issued a decision in favor of association-sale purchasers, holding that an association’s sale of the right to receive payment from a delinquent homeowner’s account to a third party did not deprive the association of standing to foreclose upon its lien.

First, HERA seems to be the lenders’ strongest arguments, and both the Ninth Circuit and the Nevada Supreme Court have consistently ruled in favor of lenders on that point. In 2017, the Ninth Circuit endorsed the argument in Berezovsky v. Moniz, holding that HERA’s so-called “Federal Foreclosure Bar” barred NRS 116 sales from extinguishing deeds of trust securing loans owned by Fannie Mae and Freddie Mac. In March 2018, the Supreme Court of Nevada reached the same conclusion in Saticoy Bay LLC Series 9641 Christine View v. Fannie Mae.

On June 25, 2018, the Ninth Circuit issued its second major opinion on HERA in FHMLC v. SFR Investments Pool 1, rejecting an argument made by SFR (the purchaser at the association’s sale and a frequent player in the litigation) that the Federal Foreclosure Bar did not apply to loans that had been securitized. The court held that the securitization of a loan did not prevent the Federal Housing Finance Agency (FHFA) from succeeding to ownership of that loan when it became conservator of Fannie Mae and Freddie Mac. To the contrary, the court wrote that HERA “confers additional protections upon [Fannie and Freddie’s] securitized mortgage loans” (emphasis original). The court also rejected SFR’s argument that FHFA deprived it of a property right without due process. The court wrote that NRS 116 “does not mandate … vestment of rights in purchasers at HOA foreclosures sales” and so held that purchasers “lac[k] a legitimate claim of entitlement.”

Purchasers will probably continue to seek to challenge the application of HERA, even after the FHLMC decision, possibly by challenging specific evidence offered in support of the lender’s position that Fannie Mae or Freddie Mac owned the loan at the time of the association’s foreclosure sale. But both the Ninth Circuit and the Nevada Supreme Court have consistently rejected every argument the purchasers have raised to date; after FHMLC, it looks like that streak will continue.

Second, the Nevada Supreme Court recently addressed another one of the lenders’ strongest arguments: that a lender or servicer’s pre-foreclosure offer to pay the association’s superpriority lien extinguished that lien, and thereby protected the lender’s security interest in the association’s foreclosure sale. On April 27, the Nevada Supreme Court issued its opinion in Bank of America, N.A. v. Ferrell Street Trust, which reaffirmed the underlying validity of the lenders’ tender arguments, even if it did not address every issue. In Ferrell Street Trust, the court made several pro-lender statements about the law of tender: (1) Tender is sufficient to discharge the lien and preserve the lender’s interest; (2) an unjustified rejection of valid tender does not prevent the lien from being discharged; (3) the tendering party does not have to deposit a rejected payment into escrow to “keep the tender good;” and (4) an “unconditional offer to pay” is valid tender. The court reversed the district court’s grant of summary judgment for the purchaser and remanded the case for further development with proper application of the tender doctrine.

Ferrell Street Trust was an unpublished, non-binding decision and did not purport to resolve every issue concerning the application of the tender doctrine in HOA sale cases. While it is helpful in noting that the underlying premise of the tender argument appears to be valid and well-grounded in the law, we will have to wait for a more comprehensive published decision (which could come at any time) for the final word on tender.

Finally, in West Sunset 2050 Trust v. Nationstar Mortgage, LLC, the Nevada Supreme Court ruled against lenders’ interest in a case that involved an unusual, though not unique, fact pattern. In West Sunset, a third party had entered into a factoring agreement with the homeowners’ association, under which the third party received the right to any recovery by the association against a homeowner’s delinquent account. After the association foreclosed, the servicer challenged the validity of the foreclosure sale, arguing that the factoring agreement had severed the lien from the underlying debt and thereby made the lien unenforceable. The Nevada Supreme Court rejected this argument, holding that the agreement did not affect the relationship between the association and the homeowner—and thus, by extension—could not be challenged by the party with a security interest on the homeowner’s property. The court concluded with a note that it is “disinclined to so interfere with HOA’s financing practices” absent a policy rationale.

The latest trio of decisions provides some more clarity to the Nevada landscape, although—as we’ve reported for years now—there are still issues to be decided. The application of HERA seems nearly unassailable at this point, however, representing a significant victory for lenders’ interests. We will continue to monitor the courts in hopes of a similar comprehensive victory on the tender issue.

Borrower Can’t Blindly Rely on Lender’s Appraisal, Court Rules

Borrower Can’t Blindly Rely on Lender’s Appraisal, Court RulesA June 19, 2018, decision by the North Carolina Court of Appeals will likely make it more difficult for borrowers in the Tar Heel State to sue on the claim that their mortgage originator misled them as to their home’s value. In Cordaro v. Harrington Bank, FSB, the Court of Appeals underscored the need for borrowers to show they reasonably relied on the lender’s appraisal as a predicate for claims based on an allegedly inflated valuation. To demonstrate such reliance, the court held, the borrower must either show that he made an independent inquiry as to the value of the home or that he was prevented from doing so.

The plaintiff in Cordaro alleged various tort and contract claims against the lender based on a 2012 appraisal that substantially overvalued the plaintiff’s property: the appraiser selected by the lender valued the home at $1.15 million, but a valuation four years later found the home’s value was only $765,000. The court found that each of the borrower’s tort claims required evidence of the plaintiff’s justifiable reliance on the appraisal.  Although past decisions by the Court of Appeals and North Carolina Supreme Court rejected suits with insufficientallegations of reliance on an inflated appraisal, the Cordaro court acknowledged that the plaintiff’s suit was factually distinguishable. Here, the plaintiff alleged he had a verbal agreement with his builder to cancel a contract to build the home if it did not appraise for the value of the lot plus the cost of construction, and the plaintiff told the bank’s loan officer that he would not go forward with the loan if the house did not appraise for a sufficient value. Nevertheless, the court affirmed the trial court’s dismissal of the plaintiff’s complaint, holding that such reliance could not be justifiable unless the plaintiff were to allege “either that he undertook his own independent inquiry regarding the validity of the Construction Appraisal or that he was somehow prevented from doing so.” The plaintiff could not blindly rely on an appraisal conducted by the bank for its own underwriting purposes.

Cordaro suggests that the circumstances in which a lender can be sued for an allegedly faulty appraisal are quite narrow. The decision would bar virtually all claims for borrowers who do not obtain an independent appraisal of their property. At the same time, it is unlikely that a borrower who obtains her own independent valuation would thereafter rely on the lender’s appraisal. Assuming the decision withstands any further challenge, it should provide an effective argument for lenders seeking dismissal of similar suits at the pleading stage.

California Sets the Bar for Privacy with the Passage of The California Consumer Privacy Act of 2018 – Part I

California Sets the Bar for Privacy with the Passage of The California Consumer Privacy Act of 2018 - Part IAs most people started to wind down for the July 4th holiday week, California was just ramping up its “as California goes” focus on data privacy. On June 28, 2018, California passed a comprehensive data privacy bill that has been touted as the strictest in the nation.

The good news first—businesses have until January 1, 2020, to revamp privacy compliance programs, update policies, procedures and processes, and operationalize the sweeping new changes passed by the California legislature. The not-so-good news for businesses, however, is that this new law proposes a significant number of restrictions to the way businesses collect, use, store, and share personal data. In addition, consumers now have a private right of action for certain disclosures or loss of personal data. While the new California Consumer Privacy Act of 2018  amends Sections 1798.100 through 1798.198 of the California Civil Code, there is still a lot of uncertainty as to what specific requirements may be revised in the next 18 months.

This initial overview provides a few high-level practical questions to help your company get a head start on determining how best to implement this new legislation. Bradley will continue its review and coverage of this law in an ongoing series devoted to state privacy law updates, so please check back here for more information.

Who Is Affected?

According to some accounts, the act will apply to more than 500,000 U.S. companies and has the potential to affect hundreds of thousands more companies worldwide. Additionally, even though the law does not apply to information already regulated under various federal laws, it does apply to entities traditionally covered by regulations such as the Gramm-Leach Bliley Act, the Fair Credit Reporting Act, and the Health Insurance Portability and Accountability Act.

Any company that meets certain criteria and receives personal data from California residents must comply with the new statute. Note that although the act is touted as a “consumer privacy” law, California has broadly defined consumer to include “any natural person who is a California resident.”

Under the act, any company that (1) has an annual gross revenue of $25 million, (2) obtains personal information of 50,000 or more California residents, households or devices annually, or (3) derives 50 percent or more annual revenue from selling California residents’ personal information would be a covered entity under the statute. Note that parent companies and subsidiaries using the same branding are covered, even if those companies and subsidiaries do not exceed the applicable thresholds.

Why Is This Different?

In passing the act, legislators declared that it was their intent to provide Californians with specific rights to privacy, including: (1) the right to know what personal information is being collected about them; (2) the right to know whether their personal information is being sold or disclosed and to whom; (3) the right to say no to the sale of personal information; and (4) the right to access and delete their personal information.

Additionally, as currently drafted, “personal information” is defined as “information that identifies, relates to, describes, is capable of being associated with, or could reasonably be linked, directly or indirectly, with a particular consumer or household.” The broad nature of this definition encompasses data that relates not just to a single individual, but an entire household—effectively encompassing information regarding web browsing histories, IP addresses, energy consumption, or other general information—even if no individual name is associated with it.

What Can I Do Now?

First and foremost, understand what data you collect. The concept of data mapping has been recommended by privacy professionals for some time, however, this new act makes it even more pertinent that companies map and inventory data. What information does your company collect on California residents? What are those sources of data? Is the information shared with third parties and in what context? These and many other questions will need to be answered before an entity can evaluate whether the new act will apply and in what ways the company may need to alter its practices or update its policies and procedures.

In addition, companies should start to consider whether or not current systems and processes will allow compliance with the new rights afforded to consumers, such as the ability to verify the identity of persons who make requests for data deletion, access or transfer. Also, how will companies store and maintain records on consumers who have opted out of data sharing or made a request for information?

Although the implementation of the new act is still another 18 months away, companies should begin the process of assessing the act’s impact on business processes, operations and data handling practices. Additionally, anyone affected by the act should pay close attention to potential revisions and changes to the law as we move toward January 1, 2020.

Bureau of Consumer Financial Protection Once Again Deemed Unconstitutional

Bureau of Consumer Financial Protection Once Again Deemed UnconstitutionalThe Bureau of Consumer Financial Protection has once again been deemed unconstitutional, this time in an opinion issued on June 21, 2018, by Loretta A. Preska, Senior U.S. District Judge for the Southern District of New York, in Consumer Financial Protection Bureau et al. v. RD Legal Funding LLC et al. Although there are a number of interesting components to this case, the aspect of the decision that is most likely to garner headlines is the constitutionality holding. Specifically, Judge Preska determined that the Bureau’s structure as set forth in Title X of the Dodd-Frank Wall Street Reform and Consumer Protection Act violates the Constitution’s separation of powers because it attempts to create “an independent agency that exercises substantial executive power and is headed by a single Director.”

Judge Preska notes at the outset of the constitutionality discussion that, while she certainly is aware of the contrary holding from the Court of Appeals for the D.C. Circuit on January 31, 2018, in PHH v. CFPB, the Southern District of New York is not bound by decisions of the D.C. Circuit Court of Appeals. Instead of adopting the majority’s decision from the PHH case, Judge Preska instead chose to adopt Sections I-IV of the dissent that was written by Judge Brett Kavanaugh and Section II of the dissent written by Judge Karen LeCraft Henderson.

Collectively, this means that Judge Preska held that, “based on considerations of history, liberty, and presidential authority,” the Bureau’s single director structure, whereby the director can only be removed by the president for cause, is unconstitutional. According to Judge Preska, rather than simply strike the for-cause removal provision from Title X of Dodd-Frank, the appropriate remedy for this situation is to strike the entirety of Title X.

Interestingly, the opinion also sheds light on the Bureau’s attempt to rebut the constitutional question. The Bureau filed its action in this case on February 7, 2017, while Richard Cordray was still serving as the director of the Bureau. After Mick Mulvaney was appointed by the president to serve as acting director, the Bureau filed a Notice of Ratification with the court, attempting to ratify its decision to file the enforcement action. The Bureau then apparently argued that, because Acting Director Mulvaney is removable by the president at will, the defendants’ constitutional argument was mute. Judge Preska disagreed with this argument, and noted that “the constitutional issues presented by the structure of the [Bureau] are not cured by the appointment of Mr. Mulvaney. As Defendants point out, the relevant provisions of the Dodd-Frank Act that render the [Bureau’s] structure unconstitutional remain intact.”

As a result of the unconstitutionality holding, Judge Preska dismissed the Bureau’s claims because it “lacks authority to bring [the] enforcement action,” and terminated the Bureau as a party to the action. The attorney general for the state of New York, who joined the Bureau in its suit against RD Legal Funding and the other defendants, can proceed with the case. We will continue to track this case and any other developments that occur.

The Supreme Court Levels the SEC Playing Field

The Supreme Court Levels the SEC Playing FieldIn a highly anticipated decision, the United States Supreme Court ruled the practice employed for years by the Securities and Exchange Commission of choosing administrative law judges to hear SEC enforcement actions, violates the Appointments Clause of the Constitution. The Supreme Court, in Lucia v. Securities and Exchange Commission, held that administrative law judges (ALJs) are “officers of the United States” subject to the Appointments Clause.

The SEC has long been criticized for the process of choosing ALJs to hear enforcement matters. Going forward, ALJs will need to be appointed by the president or the head of the SEC. Holding for the requirement of an appointment, the court did not agree that ALJs are regular federal employees hired through the civil service process.

The case was brought by former investment advisor Raymond J. Lucia who appealed sanctions handed down by an ALJ that included a bar from the industry, as well as a $300,000 fine. Lucia argued that his constitutional rights were violated because the ALJ was not constitutionally authorized to have such broad power. Lucia asserted that ALJs should be subject to the Appointments Clause because they carry out judicial proceedings, including evidentiary rulings and rendering decisions. Lucia (as well as others), noted that the SEC rarely overturns or gives more than a passing review to ALJ decisions.

This decision should help level the playing field, at least within the SEC, for internally handled enforcement matters.

CFPB Issues Second Consent Order under Acting Director Mulvaney

CFPB Issues Second Consent Order under Acting Director MulvaneySecurity Group, Inc. and several of its wholly owned subsidiaries entered into a consent order with the Consumer Financial Protection Bureau (CFPB) in which it agreed to injunctive relief and to pay a $5 million penalty. Security Group is a financial services company that originates, purchases, services, and collects on short-term secured and unsecured loans. Security Group operates approximately 900 locations in 21 states.

The Highlights

The CFPB alleged that Security Group engaged in unfair activity in the following ways:

  1. In-person collection visits that included:Discussing debts with consumers in places where third parties could see or overhear the interaction;
    • Handing field cards to third parties, including family members and neighbors;
    • Identifying themselves as Security Finance when speaking with neighbors;
    • Informing third parties of consumers’ delinquency;
    • Visiting consumers’ places of employment when Security Group knew or had reason to know that consumers were not allowed to have personal visitors there; and
    • Visiting consumers’ homes or places of employment with excessive frequency.
  1. Collection calls to consumers’ places of employment that included:
    • Calling consumers on shared phone lines and disclosing or risking disclosing the existence of consumers’ delinquent debts;
    • Calling consumers after being told that consumers were not allowed to receive calls at work; and
    • Failing to properly track and review cease and desist requests, which resulted in calls to parties who had previously requested that calls cease.
  1. Collection calls to third parties that included:
    • Calling third parties, including credit references, supervisors, landlords, family members, and suspected family members in a manner that disclosed or risked disclosing the existence of a delinquent debt; and
    • Failing to properly track and review cease and desist requests, which resulted in calls to parties who had previously requested that calls cease.

The CFPB also alleged that Security Group violated the Fair Credit Reporting Act by:

    • Failing to maintain written policies and procedures related to credit reporting, including policies and procedures regarding the accuracy and integrity of consumer information;
    • Failing to provide accurate information to credit reporting agencies; and
    • Failing to promptly update reported accounts to reflect account activity such as payments and settlements.

Impacted Industries

The Security Group consent order has implications for any financial services company that (1) furnishes credit reports to the credit reporting agencies or (2) collects delinquent debts from borrowers. Likely the most important aspect of this consent order to financial services companies is the fact that the CFPB used UDAAP rather than the FDCPA to pursue its debt collection claims. So, the CFPB could pursue similar claims against first-party creditors as well as third-party debt collectors.

What It Means

First, the CFPB continues to live up to Acting Director Mulvaney’s promise to narrow its focus. Since Acting Director Mulvaney took over in November of 2017, the CFPB has issued only two consent orders, dismissed two high profile cases, taken steps to delay the effective date of payday lending rules, and generally slowed rulemaking while seeking community input in a series of requests for information. A second consent order, on its own, does not indicate a return to the volume of enforcement actions under former Director Richard Cordray.

Second, the CFPB appears to be focused on the debt collection industry.  Acting Director Mulvaney has, on several occasions, noted the significant number of consumer complaints related to debt collection and the importance of those consumer complaints in shaping the CFPB’s agenda.  While one debt collection consent order certainly does not indicate a trend, the limited evidence suggests the CFPB is paying additional attention to the debt collection industry.

Third, the CFPB’s allegations provide interesting insights into the CFPB’s views on debt collection and credit reporting practices.

  • The CFPB continues to disfavor in-person collection practices, and the Security Group consent order suggests that in-person collection efforts inherently run the risk of unfairly alerting third parties to the existence of a debt.
  • The Security Group consent order seems to suggest that calling a consumer on a shared line at the consumer’s place of employment, regardless of the precautions the debt collector may take to avoid disclosing its identity, may constitute an unfair practice because of the potential that this type of call could alert third parties to the existence of a debt.
  • The CFPB based part of its FCRA claims on a failure to report positive credit activity during a period in which Security Group implemented a credit reporting freeze while it evaluated and updated its credit reporting policies.

A Bid to Delay Implementation of the Payday Rule Ends in a Judicial Cul-de-sac

A Bid to Delay Implementation of the Payday Rule Ends in a Judicial Cul-de-sacLate last month, the CFPB took the extraordinary step of joining two trade groups in requesting a stay of a case challenging the bureau’s final payday/auto title/high-rate installment loan rule (“Payday Rule”) pending the CFPB’s reconsideration of the rule promulgated under the prior administration. Significantly, the joint motion also seeks a stay of the Payday Rule’s compliance date. The CFPB’s decision to join the plaintiff in requesting the stay of the rule is a firm indication of the bureau’s altered priorities under Director Mick Mulvaney. Indeed, the joint motion goes so far as to state that the CFPB’s rulemaking “may result in repeal or revision of the Payday Rule and thereby moot or otherwise resolve this litigation or require amendments to Plaintiffs’ complaint.” On this basis, the CFPB and the trade groups asked the federal court in Texas to stay the compliance date until 445 days from the date of final judgment in the litigation.

In response, several consumer advocacy groups filed amicus memorandum opposing the joint request for a stay. These groups argue that the CFPB’s decision to join the plaintiffs in seeking to stay the case and the Payday Rule compliance date deprive the court of the “benefit of adversarial briefing.” The consumer groups also argue that the CFPB lacks authority under 5 U.S.C. § 705 to delay implementation of the Payday Rule because Section 705 can only “stay agency action for the purpose of maintaining the status quo during judicial review.” The consumer groups argue that the CFPB is not seeking to maintain the status quo to protect against litigation uncertainties but rather to address uncertainties created by its reconsideration of its own rule. The consumer groups argue that, in fact, “the parties are not litigating and have no intention to do so,” and that application of Section 705 is therefore improper. The plaintiffs in the case filed a reply to the oppositions on June 11.

On June 12, 2018, the court entered an order staying the litigation and relieving the CFPB of the obligation to file an answer. Importantly, however, the order denied the request to stay the Payday Rule compliance date. This leaves the industry in essentially the same position that it was before the suit was filed. It is still possible that Director Mulvaney could propose a change to the rule extending the compliance date. Until then, impacted entities must continue to prepare for the August 2019 compliance date.

Financial Reform Legislation (S. 2155) Becomes Law with Industry Support

Financial Reform Legislation (S. 2155) Becomes Law with Industry SupportDescribed as “the first bipartisan banking law to be enacted in a decade” by the American Bankers Association, the Economic Growth, Regulatory Relief, and Consumer Protection Act was signed into law on May 24, 2018 following a vote of 258 to 159 in the House of Representatives. The act addresses a number of subjects ranging from mortgage lending and consumer protection to regulatory reform for community and large banks.

Sen. Mike Crapo (R-ID), chairman of the Senate Banking Committee, described the act as “a bipartisan compromise” with commonsense changes, while Acting Director of the Consumer Financial Protection Bureau Mick Mulvaney applauded the bill as “the most significant financial reform legislation in recent history.” Sen. Sherrod Brown (D-OH), ranking member of the Senate Banking Committee, however, has criticized the bill as a win for special interests and “a giveaway that loosens rules” for large banks. The act’s significance has already been recognized among industry groups including the Mortgage Bankers Association.

Three sections of the act are briefly highlighted: (1) Section 106’s response to employment barriers for loan originators; (2) Section 304’s restoration of the Protecting Tenants at Foreclosure Act of 2009; and (3) Section 401’s revisions to the asset thresholds set forth in Section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).

Section 106: Job Mobility and Barriers for Mortgage Loan Originators

Section 106 of the act amends the S.A.F.E. Mortgage Licensing Act of 2008 by addressing barriers for mortgage loan originators.    The act provides certain qualifying loan originators that are moving interstate or from a depository institution to a non-depository institution with “temporary authority” to originate loans in the state in which the originator seeks to be licensed.  The temporary authority serves as a “grace period” to allow originators who are shifting positions and who satisfy specific performance and eligibility criteria to become licensed.  David W. Perkins, et al., Congressional Research Service, Economic Growth, Regulatory Relief, and Consumer Protection Act (S. 2155) and Selected Policy Issues at 9 (Apr. 12, 2018).  In doing so, Section 106 addresses a concern raised by the real estate finance industry since S.A.F.E.’s enactment – job mobility for loan officers. Section 106’s amendments take effect 18 months after the act’s enactment.

Section 304: Restoration of the PTFA

Section 304 restores the Protecting Tenants at Foreclosure Act of 2009 (PTFA) by repealing its sunset provision. The PTFA had imposed “requirements on successors in interest to foreclosed properties in order to protect tenants,” Mik v. Fed. Home Loan Mortg. Corp., before expiring on December 31, 2014. The PTFA’s expiration left behind a patchwork of state and local laws protecting tenants in foreclosed property. However, effective 30 days after its enactment, the act restores Sections 701 through 703 of the PTFA and “any regulations promulgated pursuant to such sections, as were in effect on December 30, 2014.”

Section 401(a): Enhanced Supervision and Prudential Standards Thresholds

Section 401(a) of the act amends the asset thresholds established in Section 165 of Dodd-Frank, codified at 12 U.S.C. § 5365.

First, Section 401(a) raises Section 5365(a)’s asset threshold for enhanced prudential standards. Section 5365(a) originally provided that the Board of Governors of the Federal Reserve System “shall establish prudential standards for nonbank financial companies supervised by the Board of Governors and bank holding companies with total consolidated assets equal to or greater than $50,000,000,000.”  Prudential standards encompass, inter alia, risk-based capital, risk management, and liquidity requirements.  These standards were designed to be stringent and to reflect the risks posed by the failure of a large financial institution.  Section 401 of the act replaces Section 5365(a)’s $50 billion threshold with a $250 billion threshold. However, according to Section 401(f) of the act, “[a]ny bank holding company, regardless of asset size, that has been identified as a global systemically important BHC” under 12 C.F.R. § 217.402 is “considered a bank holding company with total consolidated assets equal to or greater than” $250 billion for purposes of Section 5365.

Second, for bank holding companies with total consolidated assets between $100 billion and $250 billion, Section 401(a) enables the Board of Governors to apply, upon a determination of appropriateness and consideration of certain risk-related factors, any prudential standard established under Section 5365.  Third, for publicly traded bank holding companies, Section 401(a) substitutes the asset threshold that triggers the risk committee requirement in Section 5365(h)(2) from $10 billion to $50 billion. In effect, Section 401(a) “exempt[s] banks with assets between $50 billion and $100 billion from enhanced regulation, except for the risk committee requirements.”  David W. Perkins, et al., Congressional Research Service, Economic Growth, Regulatory Relief, and Consumer Protection Act (S. 2155) and Selected Policy Issues at 31 (Apr. 12, 2018). As an additional resource, the Congressional Research Service has compiled a table of bank holding companies and intermediate holding companies with over $50 billion in assets, as of September 30, 2017, in CRS Report R45073.

Section 401’s amendments take effect 18 months after the act’s enactment. However, for a bank holding company with total consolidated assets of less than $100 billion, Section 401’s amendments were effective on the date of its enactment, May 24, 2018. The import of Section 401(a) goes well beyond the subjects addressed in this blog and includes, inter alia, a requirement that the Board of Governors “differentiate among companies on an individual basis or by category” when prescribing prudential standards and amendments related to Section 5365(i)’s stress test subsection, as well as Section 5365(j)’s leverage limitation subsection.

Altogether, the Economic Growth, Regulatory Relief, and Consumer Protection Act, as well as the remainder of Section 401’s provisions, will warrant further analysis and attention both within the industry and among its observers.

Providing Banking Services to the Legal Marijuana Industry: Mitigating Risks to Maximize Potential Rewards

Providing Banking Services to the Legal Marijuana Industry: Mitigating Risks to Maximize Potential RewardsSince 1996, when California became the first state to legalize marijuana (at the time, for medicinal purposes only), 28 additional states and the District of Columbia have legalized marijuana to some extent. Public support for legalization continues to rise as more and more jurisdictions loosen their marijuana laws, with 64 percent of Americans in favor of legalization, nearly double the percentage that supported legalization in 2000.

While the use and possession of marijuana is still illegal under federal law, the long-term outlook for the legal-marijuana industry appears strong. This emerging industry took in approximately $9 billion in sales in 2017, with that number expected to grow to $11 billion in 2018 and $21 billion in 2021.

Despite these eye-popping numbers, the legal-marijuana industry is severely underserved by many of the industries it requires for support, perhaps none more so than the banking and financial services industry. Broadly speaking, the reason for this is obvious – the federal prohibition on marijuana found in the Controlled Substances Act. In light of that prohibition and the regulatory challenges that come with it, many financial institutions have decided that doing business with this industry is simply too risky.

But not all financial institutions share that view, and the number of institutions willing to reap the reward of engaging an underserved $11 billion industry continues to grow. Now, almost 400 banks and credit unions provide banking services to the legal-marijuana industry, more than three times the amount that served the industry in 2014.

Like most decisions in the financial world, whether to do business with the legal-marijuana industry is a question of risk tolerance. While the risks in this arena are certainly higher than most, so too are the potential rewards given the relative scarcity of competition compared to other industries.

To assist in evaluating those risks, this article provides a brief overview of two key laws governing a financial institution’s relationship with marijuana-related businesses: (1) the Bank Secrecy Act (BSA), and (2) the Federal Deposit Insurance Act’s prohibition of “unsafe or unsound practices” for banks insured by the Federal Deposit Insurance Corporation (FDIC). Future articles will provide a more in-depth look into each.

The Bank Secrecy Act

The BSA – along with its implementing regulations promulgated by the Office of the Comptroller of the Currency (OCC) – establish various recordkeeping and reporting requirements for national banks, federal savings associations, and agencies of foreign banks. The OCC, as well as the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) and Office of Foreign Assets Control (OFAC), all play a role in enforcing the BSA.

On February 14, 2014, FinCEN issued guidance that, by its terms, “clarifies how financial institutions can provide services to marijuana-related businesses consistent with their BSA obligations” (the FinCEN Guidance). The FinCEN Guidance is expressly based on the Cole Memorandum – Obama-era guidance from the Justice Department that directed federal prosecutors to take a hands-off approach to legal-marijuana businesses in states where marijuana had been legalized to some degree. Although Attorney General Sessions rescinded the Cole Memorandum on January 4, 2018, FinCEN has since indicated that the FinCEN Guidance remains in effect.

While some nonetheless viewed Sessions’ rescission of the Cole Memo as weakening the FinCEN Guidance, the pendulum may have swung back on April 13, when Colorado Senator Cory Gardner – who began blocking the confirmation of Justice Department nominees after Sessions rescinded the Cole Memo – announced that he received a commitment from President Trump “that the Department of Justice’s rescission of the Cole Memo will not impact Colorado’s legal marijuana industry.” The White House confirmed that Senator Gardner’s statement was “accurate,” but did not offer details as to how the Administration would implement President Trump’s directive. Given Trump’s directive and FinCEN’s indication that its Guidance remains in effect, financial institutions transacting with marijuana-related businesses should still look to the FinCEN Guidance to clarify their BSA obligations in this space.

The FinCEN Guidance requires that a financial institution engaging a marijuana-related business conduct substantial, and, importantly, continuing due diligence to determine whether that business is (1) complying with state law, (2) interfering with any of the eight priorities listed in the Cole Memorandum, or (3) otherwise engaging in “suspicious activity,” including a list of “red flags” enumerated in the Guidance. The institution must then file one of three marijuana-specific Suspicious Activity Reports (SAR), and continue filing SARs throughout its relationship with the marijuana-related business. Which of the three depends on what the institution uncovers in its due diligence:

  • The institution should file a “Marijuana Limited” SAR if “it reasonably believes, based on its customer due diligence,” that the business “does not implicate one of the Cole Memo priorities or violate state law[.]”
  • The institution should file a “Marijuana Priority” SAR if “it reasonably believes, based on its customer due diligence,” that the business “implicates one of the Cole Memo priorities or violates state law[.]”
  • The institution should file a “Marijuana Termination” SAR if “it reasonably believes, based on its customer due diligence,” that it must terminate its relationship with the business “to maintain an effective anti-money laundering compliance program[.]”

While the FinCEN Guidance mandates an onerous compliance program for financial institutions doing business with the legal-marijuana industry, the costs of such programs can be passed through to the legal-marijuana client. Given the dearth of supply and substantial demand for financial institutions willing to do business with them, such clients understand the need for and are willing to pay such fees.

“Unsafe and Unsound Practices”

The FDIC provides deposit insurance to its member banks, and all federally- and nationally-chartered banks, and nearly all state-chartered banks, are required to have FDIC Insurance. FDIC-insured banks that engage in “unsafe or unsound practices” are subject to FDIC enforcement actions. While the FDIC has broadly declared that “committing violations of law” is an unsafe and unsound practice, courts have interpreted the phrase “unsafe or unsound practice” as a “flexible concept which gives the administering agency the ability to adapt to changing business problems and practices in the regulation of the banking industry.”

Given the federal prohibition on marijuana, providing banking services to legal-marijuana businesses can put an institution’s FDIC Insurance at risk. But a financial institution serving the legal-marijuana industry may be able to decrease the risk that the FDIC would deem such service an “unsafe and unsound practice” through certain actions, like limiting marijuana-related deposits to a small percentage of its total deposits to decrease liquidity risk and ensuring its employees are well-trained on its policies and procedures for serving the industry.

Notably, unlike their bank counterparts, credit unions are not supervised by the FDIC, and the FDIC does not insure their deposits. Those deposits are instead insured by the National Credit Union Administration (NCUA), which also supervises federally-chartered credit unions. The NCUA has indicated that it will follow the FinCEN Guidance when examining the federally-chartered credit unions it supervises, and state-chartered credit unions are not supervised by federal banking regulators. For these reasons, many view the regulatory environment for providing banking services to the legal-marijuana industry as more favorable for credit unions than their bank counterparts.

Takeaways

Until marijuana is legalized at the federal level or Congress passes legislation protecting financial institutions that serve the legal-marijuana industry, providing banking services to that industry will be a risky endeavor. But financial institutions can minimize that risk to an extent by building out a robust compliance program. While that program may be costly, financial institutions can recoup those costs through the fees they charge to the legal-marijuana client, which can provide a potentially lucrative opportunity for financial institutions willing to engage with the industry.

Meltdown of the Iran Nuclear Deal—Sanctions Update

Meltdown of the Iran Nuclear Deal—Sanctions UpdateOn May 8, 2018, President Donald Trump announced that the United States would no longer participate in the Joint Comprehensive Plan of Action (JCPOA), the international agreement regarding Iran’s nuclear activities and sanctions imposed on Iran that was entered into in July 2015. The Treasury Department’s Office of Foreign Asset Control quickly issued a frequently asked questions bulletin explaining how the U.S. will re-impose sanctions that had been lifted pursuant to the JCPOA. The U.S. withdrawal from the deal will occur over either a 90-day (ending August 6, 2018) or 180-day (ending November 4, 2018) wind-down period, depending on the type of activity at issue. Here are some key takeaways:

  1. Until the expiration of the applicable wind-down period, all prior guidance, waivers, and licenses effectively remain in place (though under temporary wind-down waivers).
  2. Non-U.S. persons owed payment for goods or services supplied to non-Iranian persons that were legal under the JCPOA can still receive payment even after expiration of the wind-down period provided such payments do not involve U.S. persons or the U.S. financial system.
  3. All persons removed from the SDN (Specially Designated Nationals) List under the deal will be re-designated as such by November 5, 2018. These persons and entities will be subject to secondary sanctions after that date. Secondary sanctions are those targeting non-U.S. citizens and companies abroad that interface with the U.S. financial sector. This category of sanctions has been used particularly aggressively as it relates to Iran.
  4. Any specific or general licenses extended under the JCPOA will be revoked, including the licenses related to commercial aircraft sales and the importation of Iranian carpets and foodstuffs. Any applications still pending will be denied.

Because of the complexity of U.S. sanctions, individuals should confer with an attorney about the application of the new authority to their specific circumstances.

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