Category: finance

CFPB Decision on “GSE Patch” Revives Debate About Prudent Underwriting

The Consumer Financial Protection Bureau (CFPB) recently announced that it will allow the so-called “GSE patch” to expire in January 2021.[1] This patch permits Government-Sponsored Entities Fannie Mae and Freddie Mac to buy loans even though the borrower’s debt-to-income (“DTI”) ratio exceeds the standard limit of 43%.[2]

The CFPB’s decision revives a long-standing debate about what constitutes a creditworthy loan. By eliminating the patch, the DTI ratio of 43% will become an absolute rule, making any loans with higher DTI’s ineligible for GSE funding.[3]

This type of bright-line rule—focused on a single component of a loan—has already drawn criticism as myopic.[4] Some have pointed out that, based on recent studies, DTI alone is a poor predictor for default of prime and near-prime loans.[5] For example, in each year since 2011, the 90-day delinquency rate for loans with DTI ratios over 45% has actually been lower than that for loans with DTI ratios between 30% and 45%.[6]

In fact, some studies indicate that adequate compensating factors can completely offset any minimal increase in risk associated with a higher DTI.[7] Yet, under this new rule, a borrower with a 44% DTI cannot qualify for a GSE loan, notwithstanding any number of other positive factors in the loan file.

It is entirely possible that this new decision could harm consumers, contrary to the CFPB’s mandate to protect them. Barring “high” DTI borrowers from accessing GSE loans could, at best, force such borrowers to obtain more expensive and riskier products, and at worst, preclude such borrowers from qualifying for any product at all.[8] Over the last six years, more than 10% of GSE-backed loans have relied on the patch.[9] Eliminating the patch is also likely to have a disproportionately adverse effect on minorities and others living in underserved communities.[10]

The creditworthiness of a loan, we firmly believe, must be evaluated by considering the loan as a whole. Simply isolating one aspect of the loan file such as DTI does not necessarily provide a thorough understanding of the risk profile. Instead, one typically must consider many characteristics beyond DTI–such as credit score and history, LTV and CLTV, asset and cash reserves, type and length of employment, and many more–to assess whether a loan should qualify for credit.[11]

Simply put, a loan typically cannot be considered a “bad” loan simply because of one feature. Instead, as some lawyers and courts have colorfully put it, each loan is a “snowflake” that must be considered independently and holistically on its own merits.

[1] See, for example.

[2] The other criteria for a Qualifying Mortgage (QM) include: (1) a lack of negative amortization, interest-only, or balloon features; (2) fully-documented income verification; (3) a total of points and fees less than 3 percent of the loan amount; and (4) a fully amortized payment schedule no longer than 30 years, with a fixed rate for at least five years, and all principal, interest, taxes, insurance, and other assessments included. See “Qualified Mortgage Definition for HUD-Insured and Guaranteed Single-Family Mortgages,” 78 Fed. Reg., 75215 (December 11, 2013); “Loan Guaranty: Ability-to-Repay Standards and Qualified Mortgage Definition under the Truth in Lending Act,” 79 Fed. Reg., 26620 (May 9, 2014); “Single-Family Housing Guaranteed Loan Program,” 81 Fed. Reg., 26461 (May 3, 2016).

[3] This rigid model stands in stark contrast to the FHA, VA, and USDA, which have no maximum DTI requirement. See, at page 2.

[4] See, for example.

[5] Id. at page 1; see also, e.g., Richard Green, “The Trouble with DTI as an Underwriting Variable—and as an Overlay,” Richard’s Real Estate and Urban Economics Blog, December 7, 2016.

[6] See(see Table 2).

[7] See page 10 and footnote 33.

[8] Id. at page 7.

[9] Mortgage Rule (see Table 1).

[10] Mortgage GSE Patch.

[11] (see Table 2) (noting that credit scores and LTV ratios might predict default more accurately than DTI ratios).

© 2019 Bilzin Sumberg Baena Price & Axelrod LLP
This article was written by Kenneth Duvall and Philip R. Stein of Bilzin Sumberg.
For more CFPB regulation updates, see the National Law Review Financial Institutions & Banking Law page.

House Financial Services Committee Passes Credit Reporting Bills

Four bills dealing with credit reporting were passed last Thursday by the House Financial Services Committee.  While there has been bipartisan support for credit reporting reform, none of the bills received any Republican votes.

The bills, which are listed below, would make various amendments to the FCRA (Fair Credit Reporting Act), including those described below:

  • The “Improving Credit Reporting for All Consumers Act” would impose new requirements for conducting reinvestigations of consumer disputes and related standards, require consumer reporting agencies to create a webpage providing information about consumer dispute rights, require furnishers to retain records necessary to substantiate the accuracy and completeness of furnished information, create a right for consumers to appeal the results of a reinvestigation, prohibit automatic renewals of consumer reporting and credit scoring products and services, and require a credit scoring model to treat multiple inquiries for a credit report or credit score made in connection with certain consumer credit products within a 120-period as a single inquiry.
  • The “Restoring Unfairly Impaired Credit and Protecting Consumers Act” would shorten the time period during which adverse information can stay on a consumer report, require the expedited removal of fully paid or settled debts from consumer reports, impose restrictions on the reporting of information about medical debts, require a consumer reporting agency to remove adverse information relating to a private student loan where the CFPB has certified that the borrower has a valid “defraudment claim” with respect to the educational institution or career education program, allow victims of financial abuse to obtain a court order requiring the removal of adverse information, and prohibit a credit scoring model from taking into account in an adverse manner the consumer’s participation in certain credit restoration or rehabilitation programs or the absence of payment history for an existing account resulting from such participation.
  • The “Free Credit Scores for Consumers Act of 2019” would expand the information that must be given to consumers about credit scores, require nationwide consumer reporting agencies to provide a free credit score when providing a free annual consumer report requested by the consumer, and require free consumer reports and credit scores to be provided under certain circumstances.
  • The “Restricting Use of Credit Checks for Employment Decisions Act” would prohibit the use of consumer reports for most employment decisions other than where the person using the report is required by federal, state, or local law to obtain the report or the report is used in connection with a national security investigation.

The House Financial Services Committee is scheduled to mark up more bills dealing with credit reporting today.

 

Copyright © by Ballard Spahr LLP
For more financial legislation, please see the Financial Institutions & Banking page of the National Law Review.

Bombas Settles with NYAG Over Credit Card Data Breach

Modern sock maker, Bombas, recently settled with New York over a credit card breach, agreeing to pay $65,000 in penalties.  According to the NYAG, malicious code was injected into Bombas’ Magento ecommerce platform in 2014.  The company addressed the issue over the course of 2014 and early 2015, and according to the NYAG, determined that bad actors had accessed customer information (names, addresses and credit card numbers) of almost 40,000 people. While the company notified the payment card companies at the time, it concluded that it did not need to notify impacted individuals because the payment card companies “did not require a formal PFI or otherwise pursue the matter beyond basic questions.”

In 2018, Bombas updated its cyber program, causing it to “revisit” the incident, deciding to notify impacted individuals and attorneys general. The NYAG concluded that the company had delayed in providing notice in violation of New York breach notification law, which requires notification “in the most expedient time necessary.” In addition to the $65,000 penalty, the company has agreed to modify how it might handle potential future breaches. This includes conducting prompt and thorough investigations, as well as training for employees on how to handle potential data breach matters.

Putting it into Practice: This settlement is a reminder to companies to ensure that they have appropriate measures in place to investigate potential breaches, and understand their notification obligations.

 

Copyright © 2019, Sheppard Mullin Richter & Hampton LLP.
For more on financial breaches, please see the Financial Institutions & Banking page on the National Law Review.

Cardholders Seek to Capital-ize on Madden

Last week, three Capital One cardholders filed a putative class action in the Eastern District of New York, Cohen v. Capital One Funding, LLC,1 alleging that the rates of interest they paid to a securitization trust unlawfully exceed the sixteen percent threshold in New York’s usury statutes.  The Plaintiffs seek to recoup the allegedly excessive interest payments and an injunction to cap the interest rates going forward.

The Plaintiffs seek to leverage the Second Circuit’s decision in Madden v. Midland Funding, LLC.2  There are factual differences between the current lawsuit and Madden.  In Madden, the loan in question was a nonperforming credit card account that Bank of America’s Delaware-based credit card bank had assigned to Midland Funding, which sought to enforce the past-due loan.  In Cohen, the loans involve credit card receivables from otherwise performing loans that have been deposited into securitization trusts.  Another distinction is that Cohen, unlike Madden, is a putative class action.  The legal theory in both cases, however, is the same:  the Plaintiffs argue that the holders—here, securitization vehicles—do not have the originating national bank’s right to collect interest at rates above the limits of New York’s usury laws.  And any usurious interest collected, the Plaintiffs argue, must be disgorged.

As we discussed in our prior C&F Memorandum, “It’s a Mad, Mad, Madden World” (June 29, 2016), the Second Circuit’s Madden ruling is unsound.  Under the Second Circuit’s Madden theory, the usury rate applicable to a given loan—and thus its enforceability—turns on the identity of the loan’s holder.  The notion that the enforceability of a loan originated by a national bank turns on who holds the loan from time-to-time conflicts with the well-settled valid-when-made doctrine—a doctrine that provides that whether a loan is usurious is determined at the loan’s inception.   This approach was abandoned in Madden.  As a result, under Madden, bank-originated consumer loans can be less valuable if sold, thus devaluing the loans on the books of the originating bank.  Banks, then, are discouraged from originating such loans or, once originated, from selling them.  The net result is—at least in theory—a tightened consumer credit market.

In many corners, Madden is viewed to be “bad law.”  Even so, the Office of the Comptroller of the Currency recommended against petitioning the Supreme Court for a writ of certiorari in Madden.  Nor did Congress produce a legislative fix, despite such a bill being introduced in 2018.  Both the OCC and Congress faced political headwinds over the practice by some marketplace and payday lenders that originate high-rate consumer loans through banks under the so-called bank origination model; the concern was that reversing Madden could enshrine such practices and could be potentially harmful to consumers.  (For a discussion of the bank origination model, see our prior C&F Memorandum, “Marketplace Lending Update:  Who’s My Lender?” (Mar. 14, 2018).)  But that concern is not present in Cohen, where the Plaintiffs rely on Madden to attack traditional, currently performing credit card receivables that were originated by a national bank—a structure unrelated to the bank-origination model used by some marketplace lenders.

Cohen is the second Madden-related lawsuit brought against securitization trusts; the first is proceeding in Colorado against marketplace-lending receivables originated by Avant and Marlette.  See “Marketplace Lending #5:  The Very Long Arm of Colorado Law” (Apr. 24, 2019).  Until Madden is reversed, we continue to recommend that clients exercise caution when acquiring, securitizing, or accepting as collateral consumer loans (or asset-backed securities backed by such loans), when the loans were originated to residents of a state in the Second Circuit (New York, Connecticut, and Vermont) and carry a rate above the applicable general usury rate (generally, sixteen percent in New York, twelve percent in Connecticut, and eighteen percent in Vermont).

1   No. 1:19-cv-03479-KAM-RLM (E.D.N.Y. filed June 12, 2019), https://www.cadwalader.com/uploads/media/CapitalOneCase.pdf.

2   786 F.3d 246 (2d Cir. 2015), cert. denied, __ U.S. __, 136 S. Ct. 2505, 195 L. Ed. 2d 839 (2016).

 

© Copyright 2019 Cadwalader, Wickersham & Taft LLP
More on financial issues on the National Law Review Financial Institutions & Banking page.

HUD Says “No” to DACA Recipients

For some time the mortgage industry, without success, has asked the US Department of Housing and Urban Development to provide a clear answer to the question of whether Deferred Action for Childhood Arrival (DACA) recipients are eligible for FHA loans.  HUD finally provided a clear answer in responding to an inquiry from Representative Pete Aguilar (D-CA): “DACA recipients remain ineligible for FHA loans.”

HUD policy, currently reflected in HUD Handbook 4000.1, provides that “[n]on-U.S. citizens without lawful residency in the U.S. are not eligible for FHA-insured Mortgages.”  In its letter to Representative Aguilar, HUD addresses the legal status of DACA recipients by referencing statements made by the Department of Homeland Security Secretary when DACA was established:

“In establishing DACA on June 15, 2012, Janet Napolitano, then the Secretary of Homeland Security, made clear that DACA is merely an exercise of ‘prosecutorial discretion’ and ‘confers no substantive right, immigration status or pathway to citizenship.’ Secretary Napolitano further stated that ‘[o]nly Congress, acting through its legislative authority, can confer these rights.’”

We will have to see if HUD’s reliance on the status of DACA recipients to advise that they are not eligible to receive FHA loans prompts Congress to address their immigration status.

 

Copyright © by Ballard Spahr LLP
Learn more about DACA issues on the National Law Review Immigration page.

And Here Come the Lawyers: Securities Fraud Suits Commence Private Litigation Phase of Danske Bank Scandal

More Allegations of Nordic Malfeasance Surface as Private Party Lawsuits Beset Danske Bank and SwedBank Gets Sucked into Unfolding Scandal

“Something was indeed rotten in the state of Denmark.” – Olav Haazen

In what is perhaps the least surprising development in the sprawling, continuously unfolding Danske Bank (“Danske”) money laundering scandal, investor groups have filed private securities fraud actions against the Denmark-based bank and its top executives: first in the United States District Court for the Southern District of New York then, most recently, in Copenhagen City Court in Denmark. These suits coincide with an announcement from the Securities and Exchange Commission (“SEC”) that it, too, was opening its own probe of potential securities and Anti-Money Laundering (“AML”) violations at Danske that could result in significant financial penalties on top of what could be the enormous private judgments. More significantly, the Danske shareholder suits and SEC investigation illustrate a second front of enormous exposure from a securities fraud standpoint for banks involved in their own money laundering scandals and a rock-solid guaranteed template for future investors similarly damaged by such scandals.

As we have blogged here, here and here, the Danske scandal – the largest alleged money laundering scandal in history – has yielded criminal and administrative investigations in Estonia, Denmark, France and the United Kingdom and by the United States Department of Justice. Those investigations have focused primarily on Danske’s compliance with applicable AML regulations, as well as the implementation and effectiveness of those regulations. The SEC and civil plaintiffs now have opened a new line of inquiry focusing less on the institutional and regulatory failures that yielded the scandal and responsibility for them and more on the damage those failures have caused Danske investors.

Meanwhile, banking stalwart Swedbank is reacting, with mixed success at best, to allegations that suspicious transactions involving billions of Euros passed from Danske’s Estonian branch through Swedbank’s own Baltic branches — allegations which have produced a controversial internal investigation report, a law enforcement raid, the loss of the bank’s CEO, and plunging stock value.

Background

The Danske story has been told many times. Between 2007 and 2016, at least 200 billion Euros were laundered through Danske’s Estonia branch primarily by actors connected to the former Soviet Union. During that time, numerous red flags allegedly were ignored by Danske operatives permitting countless suspicious transactions to flow through the bank unabated. Ultimately, a whistleblower alerted Danske management of his concerns over the suspicious transactions, prompting an internal investigation that ultimately revealed the massive scope of the money laundering operation.

The Securities Fraud Angle

While initial investigations have examined how a substantial European bank and the regulators responsible for overseeing it could miss or ignore thousands of suspicious transactions channeling hundreds of billions of illicitly-gained Euros to the West, the bank’s investors and the SEC are attempting to hold the bank accountable for misleading investors concerning what it knew of the Estonian money laundering and what it meant to the bank’s overall bottom line. When the results of the Danske internal investigation were announced in October 2018, revealing for the first time the full scope of the scandal, Danske’s share value cratered. Ultimately, Danske’s share price halved and investors in Denmark holding direct shares in the bank and foreign investors holding depositary shares lost almost $9 billion.

Plumbers & Steamfitters Local 773 Pension Fund v. Danske Bank, et al.

On January 9, 2019, the Plumbers & Steamfitters Local 773 Pension Fund filed a class action complaint (the “SDNY Action”) on its own behalf and on behalf of purchasers of Danske Bank American Depositary Receipts (“ADRs”) between January 9, 2014 and October 23, 2018. An ADR is a security that allows American investors to own and trade shares of a foreign company, created when a foreign company wants to list its shares on an American exchange. The company first sells its shares to a domestic branch of an American brokerage. Then those shares are deposited with a depositary bank, a United States bank with foreign operations that acts as a foreign custodian that, in turn, issues depositary shares to the purchasing broker. The depositary shares are then sold on an American exchange. Depositary shares are derivatives – they represent a security issued by the foreign company and their value derives from the share value of the foreign company. Thus if, for instance, the foreign company became embroiled in a money laundering scandal of unprecedented magnitude, and if that scandal had a deleterious effect on the company’s stock, it would create a coextensive loss in value to the ADR. As it happens, the American class of Danske investors who brought the SDNY Action have alleged this precise scenario.

The SDNY Action presents a standard Section 10(b) and Rule 10b-5 fraud claim (as well as a claim for control person liability under Section 20(a) of the 1934 Act) against Danske and its chief executives centered on the bank’s alleged knowledge of and failure to disclose the Estonian money laundering since 2014. According to the complaint, the deception took two forms.

First, in 2014, Danske executives became aware that billions of dollars in illegal transactions were flowing through the Estonian branch and generating significant profits for the branch and the bank generally. Yet, armed with the knowledge that its “outsized profits” were the result of illegal money laundering, Danske issued annual reports in 2014 to 2016 to its investors in which it “attributed the results to Danske Bank’s purported ongoing operation and strategic prowess, rather than to the money laundering that the whistleblower had already disclosed to Dansk Bank’s senior executives.” Danske’s concealment of the true basis for its financial performance permitted its shares to trade at artificially inflated prices. Share prices were further inflated when Danske, relying on its financial performance (driven by its processing of stolen Russian money) sought and obtained several corporate debt rating increases that facilitated its raising hundreds of millions of dollars by issuing and selling bonds in the European bond markets.

Second, in February 2017, rumors began to spread concerning Danske’s Estonian bank operations. Danske initially downplayed these rumors, releasing a statement that “[s]everal media today report on a case of possible international money laundering, and Danske Bank is mentioned as one of the banks that may have been used. For Danske Bank, the transactions involved are almost exclusively transactions carried out at out Estonian branch in the 2011-2014 period.”   The statement continued to tout the significant steps Danske had taken since 2014 to combat money laundering and the success of those efforts. Later, in September 2017, as reporting increased on Danske’s involvement in money laundering, it issued another release, stating that it had “expanded its ongoing investigation into the situation at its Estonian branch” and following “a root cause analysis concluding that several major deficiencies led to the branch not being sufficiently effective in preventing it from potentially being used for money laundering in the period from 2007 to 2015.”

From there the scandal broke in waves of investigations, fines, management departures, scaled-down and closing operations, and an ever-increasing total figure culminating in a Wall Street Journal report in October 2017 on Danske’s investigations pegging the total amount of illicit transactions at 200 billion Euros involving upwards of 15,000 non-resident customers.

According to the SDNY Action plaintiffs, between February 2018, “when Danske Bank ADRs traded at their Class Period high of $20.90 per share” and October 2018, when the magnitude of the scandal was revealed, “Danske Bank lost $11.40 per share in value, or 54%, erasing more than $2.793 billion in market value.” As luck would have it, the plaintiffs further note that “[a]s the U.S. SEC, DOJ and Treasury and Estonian Authorities continue to investigate, Danske Bank has built a reserve of $2.7 billion – equivalent to 85% of its 2017 net profit – to cover potential fines and reportedly continues to add to that reserve.”

The Danish Front

And Danske might be right to “continue to add to that reserve.” On March 14, 2019, a group of institutional investors filed a lawsuit against Danske in Copenhagen City Court on behalf of “[a]n international coalition of public pension funds, governmental entities, and asset managers” from Asia, Australia, Europe and North America (the “Copenhagen Action”). The Copenhagen Action was brought by the Delaware law firm Grant & Eisenhower and Florida securities fraud firm DRRT and was filed on behalf of all investors who purchased Danske securities since December 31, 2012.

Grant & Eisenhower explains in its press release, “[t]o date, more than 169 institutional investors, including many of the world’s largest pension funds, suffered substantial losses at the hands of Danske Bank unchecked laundering of funds passing through its branch in Estonia. The claimant group seeks $475 million USD in damages.” The Copenhagen Action follows the arc of the SDNY Action. As the lead attorney on the matter, Olav Haazan, describes: “Although the criminal laundering scheme flowed through the little Estonian branch, our lawsuit asserts that something was indeed rotten in the state of Denmark. . . . Danske Bank’s management engaged in a concerted cover-up of its enormous money laundering exposure, while continuing to paint a rosy picture to investors. For years, leadership made no disclosures about the problem and then misrepresented the extent of its participation in the scheme, while touting the bank’s anti-money laundering policies and procedures.”

Mr. Haazan has promised a second filing by June 1 by another group of aggrieved investors.

What – Me Worry?

Danske held its annual shareholders meeting over the course of five days after the Copenhagen suit was filed. Predictably, investors were displeased. Yet, Danske’s new Chairman, Karsten Dybvad struck a defiant tone in the face of potential civil exposure in the billions of dollars. Responding to the lawsuits, Dybvad told investors, “[i]t is our fundamental position that the bank has lived up to its information obligation. As such we don’t find any basis for lawsuits or for a settlement.” Nevertheless, according to Dybvad, “[t]he executive board has decided to waive the bonuses that could have been paid for 2018.”

Enter Swedbank

Howard Wilkinson, the Danske insider whose report launched a thousand investigations, testified that, while Danske’s role in facilitating money laundering was clear, where that money ultimately went is unknown. He went on to speculate that with the uncertainty surrounding any subsequent transactions from Danske involving laundered funds, Danske’s involvement is likely “the tip of the iceberg.” Recent events involving Swedbank have begun to take us further from the summit.

In late February, reports from Swedish broadcaster SVT revealed that between 2007 and 2015, suspicious transactions involving billions of Euros passed from Danske’s Estonian branch through Swedbank’s own Baltic branches. Swedbank’s shares fell nearly 20% on this news. Swedbank then hastily commissioned an internal investigation that yielded a widely lambasted and heavily redacted report from Forensic Risk Alliance concluding that an undisclosed number of suspicious Danske customers were also Swedbank customers and those customers moved some amount of money through Swedbank. From there, the Swedbank story has predictably exploded in size and scope.

First, on March 26, 2019, Swedish broadcaster SVT, which initially reported on the Swedbank scandal, reported that as much as 23 billion Euros in suspicious transactions flowed through the Swedbank Estonian operations. The following day, SVT reported that Swedbank was under investigation for withholding information from U.S. investigators about suspicious transaction and customers, including Paul Manafort and deposed Ukranian President Viktor Yanukovych. Later that day, Sweden’s Economic Crime Authority raided Swedbank’s headquarters related to an insider trading probe investigating whether the bank informed its largest shareholders of the February SVT report in advance.

Later still that day, news broke that Swedbank is under investigation by the New York Department of Financial Services for providing investors with misleading information concerning the money laundering scandal. Finally, March 27, 2019 was capped with an announcement that the Economic Crime Authority was also investigating whether Swedbank misled investors and the market through communications made in the months preceding the emergence of the scandal. The bank’s shares plunged an additional 12%.

Responding to the onslaught, Swedbank CEO Birgette Bonnensen – former head of Swedbank’s Baltic operations – issued a press release intended to reassure shaken investors. Noting that “[t]his has been a very tough day for Swedbank, our employees and our shareholders” Bonnensen stated that “Swedbank believes that it has been truthful and accurate in its communications,” adding “I will do everything in my power to handle the current situation.” Ms. Bonnensen was fired by the Swedbank board the following day.

Swedbank halted trading on the Stockholm exchange that day, but not before its shares fell another 7.8%, bringing its total decline since February to over 30% – wiping away approximately 7 billion Euro of its market value.

Adding to the intrigue swirling around the Swedbank story, a legal fight has broken out between Swedbank and Swedish prosecutors concerning the contents of a sealed envelope – a report prepared by Norwegian lawyer Erling Grimstad, who was commissioned by the bank to examine its activities after the scandal came to light in February. Swedbank contends the report is protected from disclosure by the attorney-client privilege and the bank will not waive the privilege until “all foreseeable consequences are known and assessed,” stating further “[i]t is incomprehensible that the prosecutor doesn’t respect the law and instead uses media to cast suspicion over the management of the bank by implying that the management is hampering the investigation.”

In just over a month, Swedbank went from Danske spectator to the subject of its own now 135 billion Euro Estonian money laundering scandal. More details will follow when the inevitable shareholder complaints are filed.

 

Copyright © by Ballard Spahr LLP.
This post was written by Terence M. Grugan of Ballard Spahr LLP.

Wyoming Cements Position as Leading U.S. Jurisdiction for Blockchain with Sweeping New Legislation

In its most recent legislative sessions, Wyoming has undertaken substantial efforts to build on the momentum created by its 2018 enactment of legislation friendly to the blockchain and digital assets industries. In the months that followed that enactment, industry participants and legislators alike ascertained that further reforms and legislation were needed to cement Wyoming’s position as the leading jurisdiction in the sector. Through the public comment and legislative meeting protocols unique to Wyoming, eight blockchain-related bills made it to the floor of the legislature for a vote, all of which were passed and are now poised to become law.

Wyoming’s latest wave of blockchain legislation is, in sum, intended to facilitate the creation of blockchain ventures within the state and to further cement Wyoming’s status as the leading corporate jurisdiction in the United States for blockchain-related ventures.

HB 74- Special purpose depository institutions

In what is perhaps the most groundbreaking legislation among the bills passed, the Wyoming legislature recognized that blockchain businesses in general have difficulty opening and maintaining traditional banking relationships due to FDIC and OCC inclusion of blockchain ventures in the same buckets as firearms and cannabis. Wyoming now will permit corporate entities to charter “special purpose depository institutions,” which will perform all traditional bank functions except for lending. With the lending exclusion, these institutions will be under the primary supervision of the Wyoming Banking Commission and not the federal government. These banks will be required to maintain at least 100 percent of reserves against deposits as well as (a) $5 million of capital, (b) three years of operating expenses and (c) private insurance against theft, cybercrime and other wrongful acts.

SF 125- Digital assets (UCC & Custody)

Custody of digital assets has been a global challenge for investors and industry participants. Wyoming has addressed this concern by specifically authorizing banks (including special purpose ones under HB 74) to hold digital assets in custody under their charter trust powers and in accordance with Rule 206-4(2) of the Investment Advisers Act of 1940. In addition, Wyoming amended its provisions of the Uniform Commercial Code to facilitate the custody of these assets along with the means by which security interests may be perfected. Wyoming is now the only U.S. state with comprehensive UCC provisions to address digital assets, which makes it a favorable jurisdiction for those lending or securing funds through digital assets.

HB 57- Financial technology sandbox (includes reciprocity for overseas regulators)

Those entrepreneurs in the blockchain industry who may require special treatment or waivers of unclear regulation in Wyoming may now seek to avail themselves of a “regulatory sandbox” much akin to the one enacted in Arizona last year. Use of the “sandbox” will require applications to state agencies that may have interests in the requested waiver, including the Wyoming Banking Commission and the Wyoming Securities Commission. The “sandbox” will provide a two-year period of relief from legislation for those ventures, all of which must be domiciled and operating within Wyoming.

HB 62- Utility token amendments

Wyoming broke ground in 2018 with its widely reported utility token “exemption” for digital assets having a pure utility function and were not created for investment purposes or for trading on exchanges. Amendments to this legislation were made to further clarify the definition of “utility token” and define when parties may properly seek a token utility designation from Wyoming authorities.

HB 70- Commercial filing system

Wyoming has legislatively determined that records maintained by the Wyoming Secretary of State, including corporate formation records, are to be implemented on blockchain media. In combination with the Series LLC legislation enacted in Wyoming last year, this provision will provide the basis for the swift formation of corporate entities and other related corporate records through blockchain.

HB 185- Tokenized corporate stock

In recognition of the migration of the blockchain industry from “initial coin offerings” to “security tokens,” Wyoming enacted legislation authorizing and permitting the creation of digital assets that represent certificated shares of stock. A “certificate token” under this legislation has been defined as “a representation of shares” that is (a) entered into a blockchain or other secure, auditable database, (b) linked to or associated with the certificate token and (c) electronically transmittable to the issuing corporation, the person to whom the certificate token was issued and any transferee.

HB 113- Special electric utility agreements

Given that Wyoming utilities produce some of the cheapest and most abundant electricity in the United States, Wyoming has through HB 113 enabled those utilities to negotiate power rates with blockchain companies (including miners) and others without approval from Wyoming’s Public Utility Commission.

SF 28- Electronic bank records

This legislation enables banking institutions to issue securities and maintain corporate records on blockchain to an extent not permitted by other provisions of Wyoming law. In particular, this provision allows for the creation of non-voting shares of Wyoming banking institutions in tokenized form.

Summary

In short, Wyoming has further honed its regulatory ecosystem to become the most blockchain-friendly jurisdiction in the United States. While all legislation will be effective as of July 1, 2019, it should be noted that many blockchain industry participants are already undertaking significant efforts to take advantage of the opportunities this legislation presents. Blockchain companies in United States and abroad should carefully examine Wyoming’s new blockchain legislation with counsel to ascertain suitable business opportunities.

 

© 2019 Wilson Elser
This post was written by Robert V. Cornish Jr. of Wilson Elser.
Read more news about Blockchain on the National Law Review’s Finance Type of Law Page.

Trouble In Paradise: Florida Court Rules That Selling Bitcoin Is Money Transmission

The growing popularity of virtual currency over the last several years has raised a host of legislative and regulatory issues. A key question is whether and how a state’s money transmitter law applies to activities involving virtual currency. Many states have answered this – albeit in a non-uniform way – through legislation or regulation, including regulatory guidance documents. For instance, Georgia and Wyoming have amended their money transmitter statutes to include or exclude virtual currencies explicitly. In other states, such as Texas and Tennessee, the state’s primary financial regulator has issued formal guidance. In New York, the Department of Financial Services issued an entirely separate regulation for virtual currencies. Still, in others, neither the legislature nor the relevant regulator has provided any insight into how the state’s money transmitter law may apply.

In most states, the judicial branch has not yet weighed in on the question. But Florida is an exception. On January 30, 2019, in State v. Espinoza, Florida’s Third District Court of Appeal interpreted the state’s money transmission law broadly and held that selling bitcoin directly to another person is covered under the law. [1] The decision will have broad implications for the virtual currency industry in Florida.

BACKGROUND: MIAMI BEACH POLICE DEPARTMENT AND MICHELL ESPINOZA

In December 2013, the Miami Beach Police Department (“MBPD”) perused an Internet website that provided a directory of buyers and sellers of bitcoin. In an undercover capacity, an MBPD agent contacted one of the users, Michell Espinoza. Shortly thereafter, the agent arranged to meet and purchase bitcoin from Espinoza in exchange for cash. The MBPD agent who purchased the bitcoin implied that he would use the bitcoin to fund illicit activities. One month later, the MBPD made a second purchase from Espinoza, telling him that the bitcoin would be used to purchase stolen credit card numbers. After a third and fourth transaction, the MBPD arrested Espinoza. The State of Florida charged him with two counts of money laundering and one count of engaging in the business of a money transmitter without a license. Espinoza moved to dismiss the charges, arguing, among other things, that Florida’s money transmitter law does not apply to bitcoin. The trial court agreed and dismissed all counts against Espinoza.

THE THIRD DISTRICT COURT’S OPINION: SELLING BITCOIN CONSTITUTES MONEY TRANSMISSION

Florida appealed, and the appellate court reversed the trial court’s ruling. The court started its analysis noting that the state’s money transmitter law requires anyone engaging in a “money services business” to be licensed. [2] A “money services business” is defined as “any person . . . who acts as a payment instrument seller, . . . or money transmitter.” [3] The court held that bitcoin is regulated by Florida’s money transmitter law, and, as a result, Espinoza was both “acting as a payment instrument seller” and “engaging in the business of a money transmitter.”

Under the Florida statute, a “payment instrument seller” is an entity that sells a “payment instrument.” [4] The phrase “payment instrument” is defined to include a variety of instruments, including “payment of money, or monetary value whether or not negotiable.” [5] The phrase “monetary value,” in turn, is defined as “a medium of exchange, whether or not redeemable in currency.” [6] The court interpreted these definitions – which it described as “plain and unambiguous” – to conclude bitcoin falls under the definition of “payment instrument.” To reach that conclusion, it reasoned that bitcoin, which is redeemable for currency, is a medium of exchange, which falls under the definition of “monetary value.” Therefore, it falls under the definition of “payment instrument.” [7] To purportedly bolster its point, the court noted that several businesses in the Miami area accepted bitcoin as a form of payment. It also pointed to a final order from the Florida Office of Financial Regulation (“OFR”) in which OFR granted Coinbase a money transmitter license. The court noted that Coinbase provides a service “where a Coinbase user sends fiat currency to another Coinbase user to buy bitcoins.” “Like the Coinbase user,” the court reasoned, the MBPD detective “paid cash to Espinoza to buy bitcoins.”

The court also concluded Espinoza was acting as a money transmitter. Under the Florida statute, a money transmitter is an entity that “receives currency, monetary value, or payment instruments for the purpose of transmitting the same by any means….” [8] Espinoza argued he fell outside this definition because he did not receive payment for the bitcoin for the purpose of transmitting the same to a third party. The court disagreed. It held that the law does not require the presence of a third party because the definition of money transmitter does not mention a third party, either expressly or implicitly. [9] It also disagreed with the trial court and Espinoza’s “bilateral limitation,” which would require Espinoza to have both received and transmitted the same form of currency, monetary value, or payment instrument. According to the court, Espinoza fell within the ambit of the law because he received fiat for the purpose of transmitting bitcoin. It explained that the phrase “the same” in the definition of “money transmission” modifies the list of payment methods, and the use of “or” in that list of payment methods – “currency, monetary value, or payment instrument” – means that “any of the three qualifies interchangeably on either side of the transaction.”

As additional support for its position, the court distinguished a final order entered into by OFR: In re Petition for Declaratory Statement Moon, Inc. According to the court’s description, Moon sought to establish a bitcoin kiosk program under which a Moon customer would pay fiat to a licensed money services business in exchange for a PIN, and the customer would then enter the PIN into a Moon kiosk, which would initiate a transfer of bitcoins to the user from a Moon bitcoin address. Once the PIN was redeemed, the licensed entity would pay Moon. OFR determined Moon did not a license. The court distinguished the Moon order because “Moon merely facilitated the transfer of bitcoins through the use of a licensed money services business,” whereas “[h]ere, no licensed money services business was utilized in the exchange of U.S. dollars for bitcoins that occurred between Espinoza and” the MBPD agent.

COUNTERPOINTS TO THE COURT’S OPINION

Several state legislatures or regulators have amended or interpreted their money transmitter laws to apply to virtual currency, but those actions do not take the form of a judicial opinion. Here, the Third District Court provided its specific reasoning for reaching its conclusions. It remains to be seen whether Espinoza will seek review from the Florida Supreme Court, but there are at least a few points in the court’s opinion that warrant further review and analysis.

First, Espinoza did not receive money for the purpose of transmitting it. He received it in exchange for selling bitcoin; he received it for the purpose of possessing it. The court rejected Espinoza’s attempt to impose a third-party requirement, but the most natural reading of the phrase “transmitting” would require Espinoza to send onward whatever value he received. Merriam-Webster defines “transmit” as “to send or convey from one person or place to another.” By using the words “receive” and “transmit,” the Florida law focuses on the act of sending money to another person and excludes the act of selling money or monetary value. If simply selling property were sufficient to trigger the money transmitter law, the statute would likely sweep far more broadly than intended. Here, Espinoza was acting as a merchant selling goods. This would not constitute money transmission under any reasonable reading of the law. Indeed, some states (and FinCEN) have recognized that a party selling its own inventory of virtual currency in a two-party transaction is not a money transmitter.

Second, the court’s conclusion is further undercut by considering the Moon proceeding the court discusses. The opinion notes “the PIN provided by the licensed money services business to Moon’s customers provided a mechanism by which the exchange of U.S. dollars for bitcoins could be identifiable.” The PIN could arguably be classified as a payment instrument because it is an “other instrument” or “monetary value.” If transmission to a third party is not required, as the court holds, then Moon should have needed a license when it received the PIN and then transmitted bitcoins back to the user that was redeeming the PIN. But that wasn’t the conclusion OFR reached.

Third, the court’s interpretation of how OFR would treat Espinoza’s actions is questionable. In 2014, OFR issued a consumer alert stating that “[v]irtual currency and the organizations using them are not regulated by the OFR.” [10] In addition, in January 2018, OFR released another consumer alert regarding cryptocurrency, stating that “[cryptocurrencies] are subject to little or no regulation,” which further indicates OFR does not interpret the money transmission law to cover cryptocurrencies. [11] The court does not acknowledge these statements. Although the court focuses on an OFR order regarding Coinbase, that order granted Coinbase a license and listed a variety of activities in which Coinbase was engaged or planned to engage. The order does not specify what specific activity was licensable, but it is likely that a license was granted because of the receipt and transmission of fiat currency.

CONCLUSION

If Espinoza appeals, the case could go to the Florida Supreme Court, where the virtual currency industry will receive a more definitive answer. In the meantime, virtual currency businesses should be aware that the Florida Attorney General’s Office interprets the state’s money transmitter act to regulate bilateral sales of virtual currency for fiat currency and is willing to prosecute at least certain cases of unauthorized sales. As of now, Florida’s Third District Court agrees. How the Espinoza case concludes and whether and how the Florida legislature responds will be important to the virtual currency industry.

NOTES

[1] — So. 3d –, 2019 WL 361893 (Fla. 3d DCA 2019).

[2] FLA. STAT. § 560.125.

[3] Id. § 560.103(22).

[4] Id. § 560.103(30).

[5] Id. § 560.103(29) (emphasis added).

[6] Id. § 560.103(21).

[7] The court principally discusses whether bitcoin falls under Florida’s money transmitter law. In a few instances, it also references “virtual currency” generally, but it is not clear how broadly it was intending to apply its holding.

[8] Id. § 560.103(23).

[9] As a counterpoint, the court noted that the Financial Crime Enforcement Network’s (“FinCEN”) definition of money transmitter explicitly includes a third party requirement because it defines a money transmitter as someone that accepts value from one person and transmits value to “another location or person by any means….” 31 C.F.R. § 1010.100(ff)(5)(i)(A).

[10] Consumer Alert: Update on Virtual Currency, Office of Financial Regulation, Sept. 17, 2014.

[11] Consumer Alert: Cryptocurrency, Office of Financial Regulation, Jan. 17, 2018.

 

Copyright 2019 K&L Gates

A Year-End Estate and Financial Planning Checklist: Make Your List and Check it Twice

During the holidays, it can be hard to find the time (or desire) to review your finances and estate plan. To help with that effort, here is a short list of things that you can easily accomplish before the ball drops on New Years’ Eve.

1. Review required minimum distributions (“RMDs”). If you’re 70½ or older, you must take RMDs from certain retirement accounts by December 31 or face a penalty equal to 50% of the sum you failed to withdraw. If you turned 70½ this year, you have until April 1, 2019, to take your first RMD without penalty. (However, note that deferring your first RMD to 2019 will mean taking two RMDs in the same tax year, which could bump you into a higher income tax bracket). These rules also apply in the case of an inherited or “stretch” IRA. Generally, you must begin taking RMDs for inherited IRA assets by December 31 of the year after the year of the original owner’s death, but certain exceptions may apply. The IRS provides some helpful worksheets here.

2. Reduce taxable income and rebalance investments. Work with your financial advisors to sell losing positions in taxable investment accounts as necessary to offset gains. Then review your asset allocation and, if necessary, rebalance your investment portfolio.

3. Max out company retirement plan contributions. In 2018, you can contribute up to $18,500 in your employer-sponsored retirement plan (i.e., 401(k), 403(b), most 457 plans, and the Federal government’s Thrift Savings Plan). Employees aged 50 or older who participate in such plans can contribute an additional $6,000 in “catch-up” contributions. If you are not able to contribute the maximum, try to contribute enough to qualify for any matching contributions by your employer.

4. Review insurance coverage. Make sure you have adequate policies in place insuring your life, health, disability, business, and assets (home and auto), which can help protect you and your family from unforeseen liabilities and expenses.

5. Review estate plans and beneficiary designations. Estate planning should be reviewed holistically and periodically to be sure that the plan you have in place accomplishes your goals. See “So You Think You’re Done With Your Estate Plan” for a more in-depth discussion.

6. Make gifts. The 2018 annual gift tax exclusion is $15,000. This exclusion is the amount of money you can give away per person per year, tax-free. In addition, married couples can elect to “split gifts”. By utilizing this strategy, married taxpayers can gift up to $30,000 to an individual in 2018 before a gift tax return is required. On top of annual exclusion gifts, an unlimited gift tax exclusion is available for amounts paid on behalf of a person directly to an educational organization, but only for amounts constituting tuition payments. Amounts paid to health care providers for medical services on behalf of a person also qualify for an unlimited gift tax exclusion. Annual gifting is an excellent way to reduce the value of your gross estate over time, thereby lowering the amount subject to estate tax upon your date of death. Charitable and philanthropic gifts (whether outright, in trust, or through a donor advised fund or similar vehicle) should also be considered.

7. Fund your Health Savings Account (“HSA”). In 2018, those in high-deductible health-insurance plans can save as much as $3,450 in pre-tax dollars in a health savings account. For families, the figure is $6,900, and those aged 55 and older can contribute an additional $1,000. Unlike a Flexible Spending Account, your HSA balance rolls over from year to year, so you never have to worry about losing your savings. If you are over age 65 and enrolled in Medicare, you can no longer contribute to an HSA, but you can still use the money for eligible out-of-pocket medical expenses.

8. Use your flexible spending dollars. Unused funds in a Flexible Spending Account (“FSA”) are typically forfeited at year’s end, so make sure to spend them for eligible health and medical expenses by December 31. Some plans offer a “grace period” of up to 2 ½ months to use FSA money. Other plans may allow you to carry over up to $500 per year to use in the following year. Bottom line, check with your employer to confirm your plan’s deadlines.

9. Check your credit and identity. Under the Fair Credit Reporting Act, each of the national credit-reporting agencies is required to provide you with a completely free copy of your credit report, upon request, once every 12 months. Get yours at www.annualcreditreport.com.

10. Organize your records for 2019. Now is the time to gather and organize the documents and 2018 records that will be needed to prepare your tax returns in 2019. As part of that process, shred documents that no longer need to be retained.

© Copyright 2018 Murtha Cullina

ARTICLE BY

Lisa P. Staron
Murtha Cullina

Republican Senators seek action from FDIC to ensure end of Operation Choke Point

Thirteen Republican Senators have sent a letter to FDIC Chairman Jelena McWilliams urging the FDIC to take action to ensure that lawful businesses are no longer at risk of adverse financial consequences as a result of “Operation Choke Point, and its associated culture and Choke Point-like regulatory actions.”

“Operation Choke Point” was a federal enforcement initiative involving various agencies, including the DOJ, OCC, FDIC, and Fed.  Initiated in 2012, Operation Choke Point targeted banks serving online payday lenders and other companies that have raised regulatory or “reputational” concerns.  In June 2014, the national trade association for the payday lending industry and several payday lenders initiated a lawsuit in D.C. federal district court against the FDIC, Fed, and OCC in which they alleged that certain actions taken by the regulators as part of Operation Choke Point violated the Administrative Procedure Act and their due process rights.  In September 2018, pursuant to a joint stipulation of dismissal, the Fed was dismissed from the lawsuit.  Cross-motions for summary judgment are currently pending before the court.

In their letter, the Senators ask the FDIC if it is the agency’s official position “that lawful businesses should not be targeted by the FDIC simply for operating in an industry that a particular administration might disfavor” and “[i]f so, what [the FDIC is] doing to make sure that bank examiners and other FDIC officials are aware of this policy and have communicated it to regulated institutions?”  They also ask whether there were any communications explaining supervisory expectations of “elevated risk” or “high risk” merchants with regulated institutions that would likely qualify as a rule under the Congressional Review Act that were not properly submitted to Congress and what the FDIC is doing to ensure that its staff does not communicate policy in a matter that is inconsistent with the position of the FDIC’s Board of Directors.

The letter does not reference the FDIC’s January 2015 Financial Institution Letter(FIL) entitled “Statement on Providing Banking Services” that attempted to rectify the damage created by Operation Choke Point.  In the Statement, the FDIC “encourages institutions to take a risk-based approach in assessing individual customer relationships rather than declining to provide banking services to entire categories of customers, without regard to the risks presented by an individual customer or the financial institution’s ability to manage the risk.”  The Statement followed the FDIC’s July 2014 FIL in which the FDIC withdrew the list of “risky” merchant categories (such as payday lenders and money transfer networks) that was included in prior guidance on account relationships with third-party payment processors (TPPPs).  Consistent with the July 2014 FIL and an October 2013 FIL on TPPP relationships, the 2015 FIL advised banks that they were neither prohibited nor discouraged from providing services to customers operating lawfully, provided they could properly manage customer relationships and effectively mitigate risks.  However, unlike the prior FILs, the new FIL expressly acknowledged that “customers within broader customer categories present varying degrees of risk” and should be assessed for risk on a customer-by-customer basis.

 

Copyright © by Ballard Spahr LLP
This post was written by Barbara S. Mishkin of Ballard Spahr LLP.