Category: finance

Treasury Releases Report on Nonbank Institutions, Fintech, and Innovation

On July 31, 2018, the U.S. Department of the Treasury released a reportidentifying numerous recommendations intended to promote constructive activities by nonbank financial institutions, embrace financial technology (“fintech”), and encourage innovation.

This is the fourth and final report issued by Treasury pursuant to Executive Order 13772, which established certain Core Principles designed to inform the manner in which the Trump Administration regulates the U.S. financial system.  Among other things, the Core Principles include:  (i) empower Americans to make independent financial decisions and informed choices; (ii) prevent taxpayer-funded bailouts; (iii) foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis; (iv) make regulation efficient, effective, and appropriately tailored; and (v) restore public accountability within federal financial regulatory agencies and rationalize the federal financial regulatory framework.

Treasury’s lengthy report contains over 80 recommendations, which are summarized in an appendix to the report.  The recommendations generally fall into four categories:  (i) adapting regulatory approaches to promote the efficient and responsible aggregation, sharing, and use of consumer financial data and the development of key competitive technologies; (ii) aligning the regulatory environment to combat unnecessary regulatory fragmentation and account for new fintech business models; (iii) updating a range of activity-specific regulations to accommodate technological advances and products and services offered by nonbank firms; and (iv) facilitating experimentation in the financial sector.

Some notable recommendations include:

Embracing Digitization, Data, and Technology

  • TCPA Revisions: Recommending that Congress and the Federal Communications Commission amend or provide guidance on the Telephone Consumer Protection Act to address unwanted calls and revocation of consent.

  • Consumer Access to Financial Data: Recommending that the Bureau of Consumer Financial Protection (“BCFP”) develop best practices or principles-based rules to promote consumer access to financial data through data aggregators and other third parties.

  • Data Aggregation: Recommending that various agencies eliminate legal and regulatory uncertainties so that data aggregators can move away from screen scraping to more secure and efficient methods of access.

  • Data Security and Breach Notification:  Recommending that Congress enact a federal data security and breach notification law to protect consumer financial data and notify consumers of a breach in a timely manner, with uniform national standards that preempt state laws.

  • Digital Legal Identity:  Recommending efforts by financial regulators and the Office of Management and Budget to enhance public-private partnerships that facilitate the adoption of trustworthy digital legal identity products and services and support full implementation of a U.S. government federated digital identity system.

  • Cloud Technologies, Artificial Intelligence, and Financial Services:  Recommending that regulators modernize regulations and guidance to avoid imposing obstacles on the use of cloud computing, artificial intelligence, and machine learning technologies in financial services, and to provide greater regulatory clarity that would enable further testing and responsible deployment of these technologies by financial services firms as these technologies evolve.

Aligning the Regulatory Framework to Promote Innovation

  • Harmonization of State Licensing Laws:  Encouraging efforts by state regulators to develop a more unified licensing regime, particularly for money transmission and lending, and to coordinate supervisory processes across the states, and recommending Congressional action if meaningful harmonization is not achieved within three years.

  • OCC Fintech Charter:  Recommending that the Office of the Comptroller of the Currency move forward with a special purpose national bank charter for fintech companies.

  • Bank-Nonbank Partnerships:  Recommending banking regulators tailor and clarify regulatory guidance regarding bank partnerships with nonbank firms.

Updating Activity-Specific Regulations

  • Codification of “Valid When Made” and True Lender Doctrines:  Recommending that Congress codify the “valid when made” doctrine and the legal status of a bank as the “true lender” of loans it originates but then places with a nonbank partner, and that federal banking regulators use their authorities to affirm these doctrines.

  • Encouraging Small-Dollar Lending:  Recommending that the BCFP rescind its Small-Dollar Lending Rule and that federal and state financial regulators encourage sustainable and responsible short-term, small-dollar installment lending by banks.

  • Adoption of Debt Collection Rules:  Recommending that the BCFP promulgate regulations under the Fair Debt Collection Practices Act to establish federal standards governing third-party debt collection, including standards that address the reasonable use of digital communications in debt collection activities.

  • Promote Experimentation with New Credit Models and Data:  Recommending that regulators support and provide clarity to enable the testing and experimentation of newer credit models and data sources by banks and nonbank financial firms.

  • Regulation of Credit Bureaus:  Recommending that the Federal Trade Commission and other relevant regulators take necessary actions to protect consumer data held by credit reporting agencies and that Congress assess whether further authority is needed in this area.

  • Regulation of Payments:  Recommending that the Federal Reserve act to facilitate a faster payments system, as well as changes to the BCFP’s remittance transfer rule.

Enabling the Policy Environment

  • Regulatory Sandboxes:  Recommending that federal and state regulators design a unified system to provide expedited regulatory relief and permit meaningful experimentation for innovative financial products, services, and processes, essentially creating a “regulatory sandbox.”

  • Technology Research Projects:  Recommending that Congress authorize financial regulators to undertake research and development and proof-of-concept technology partnerships with the private sector.

  • Cybersecurity and Operational Risks:  Recommending that financial regulators consider cybersecurity and other operational risks as new technologies are implemented, firms become increasingly interconnected, and consumer data are shared among a growing number of third parties.

© 2018 Covington & Burling LLP

Bank Deregulation Bill Becomes Law: Economic Growth, Regulatory Relief, and Consumer Protection Act

On May 24, President Trump signed into law the most significant banking legislation since the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) in 2010.  The bill – named the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Act”) – passed its final legislative hurdle earlier this week when it was approved by the U.S. House of Representatives.  Identical legislation passed the U.S. Senate last March on a bipartisan basis.

The Act makes targeted, but not sweeping, changes to several key areas of Dodd-Frank, with the principal beneficiaries of most provisions being smaller, non-complex banking organizations.

Below is a summary of several key changes:

  • Higher SIFI Threshold – The controversial $50 billion asset threshold under Dodd-Frank is now $250 billion, affecting about two dozen bank holding companies. Under Section 165 of Dodd-Frank, bank holding companies with at least $50 billion in total consolidated assets were subjected to enhanced prudential standards.  Under the Act, the enhanced prudential standards under Section 165 no longer apply to bank holding companies below $100 billion, effective immediately.  Bank holding companies with total consolidated assets of between $100 billion and $250 billion will be exempted from such standards starting in November 2019, although the Federal Reserve retains the authority to apply the standards to any such company if it deems appropriate for purposes of U.S. financial stability or to promote the safety and soundness of the particular firm.

The increase in the Section 165 threshold does not eliminate the $50 billion threshold used in other areas of regulation and supervision, such as the Office of the Comptroller of the Currency’s (“OCC”) “heightened standards,” the “living will” regulations adopted by the Federal Deposit Insurance Corporation (“FDIC”) for insured depository institutions or the Federal Reserve’s capital plan rule pursuant to which it administers the CCAR process.  However, it is expected that the federal banking agencies may reconsider the appropriateness of using the $50 billion asset threshold elsewhere.

The increase in this threshold is especially important because it may spark renewed interest in M&A opportunities among regional banks that have carefully managed growth to avoid crossing $50 billion or that have otherwise been reluctant to pursue transactions in light of the significant regulatory scrutiny that has accompanied applications by large acquirors.

  • Volcker Rule – The Volcker Rule is amended so that it no longer applies to an insured depository institution that has, and is not controlled by a company that has, (i) less than $10 billion in total consolidated assets and (ii) total trading assets and trading liabilities that are not more than 5% of total consolidated assets. All other banking entities, however, remain subject to the Volcker Rule.  The other change to the Volcker Rule relates to the name-sharing restriction under the asset management exemption, which the Act modifies slightly by easing the prohibition on banking entities sharing the same name with a covered fund for marketing or other purposes.  Going forward, a covered fund may share the same name as a banking entity that is the investment adviser to the covered fund as long as the word “bank” is not used in the name and the investment adviser is not itself (and does not share the same name as) an insured depository institution, a company that controls an insured depository institution or a company that is treated as a bank holding company.  This change allows separately branded investment managers within a bank holding company structure to restore using the manager’s name on its advised funds.

The Act represents only the first set of changes to the Volcker Rule.  The federal banking agencies are expected to release a proposal the week of May 28 to revise aspects of the regulations first adopted in late 2013.

  • “Off-Ramp” Relief for Qualifying Community Banks – A depository institution or depository institution holding company with less than $10 billion in total consolidated assets will constitute a “qualifying community bank” under the Act. The benefit of such a designation is that the institution will be exempt from generally applicable capital and leverage requirements, provided the institution complies with a leverage ratio of between 8% and 10%.  The federal banking agencies must develop this ratio and establish procedures for the treatment of a qualifying community bank that fails to comply.  The regulators have the authority to determine that a depository institution or depository institution holding company is not a qualifying community bank based on the institution’s risk profile.

  • Stress Testing – The Act provides relief from stress testing for certain banking organizations. Notably, bank holding companies with total consolidated assets of between $10 billion and $250 billion will no longer need to conduct company-run stress tests.  Bank holding companies with more than $250 billion in assets and nonbank companies deemed systemically important still need to conduct company-run stress tests, but are permitted to do so on a “periodic” basis rather than the previously required semi-annual cycle.  As for supervisory stress tests, which are conducted by the Federal Reserve, bank holding companies with less than $100 billion are no longer subject to such stress tests.  Bank holding companies with total consolidated assets between $100 billion and $250 billion are subject to supervisory stress tests on a periodic basis, while such firms with $250 billion or more in total consolidated assets and nonbank companies designated as systemically important remain subject to annual supervisory stress tests.

  • Risk Committees and Credit Exposure Reports – The Act raises the asset threshold that triggers the need for publicly-traded bank holding companies to establish a board-level risk committee, from $10 billion to $50 billion. In addition, the Act amends Dodd-Frank’s requirement that bank holding companies with at least $50 billion in assets and nonbank companies designated as systemically important submit credit exposure reports.  Instead, the Act authorizes, but does not mandate, the Federal Reserve to receive reports from these firms, but with respect to bank holding companies, only those with more than $250 billion in assets are within scope.

  • Exam Cycle and Call Report Relief for Smaller Institutions – The Act increases the asset threshold for insured depository institutions to qualify for an 18-month on-site examination cycle from $1 billion to $3 billion. The Act also directs the federal banking agencies to adopt short-form call reports for the first and third calendar quarters for insured depository institutions with less than $5 billion in total consolidated assets and that meet such other criteria as the agencies determine appropriate.

  • Small BHC and SLHC Policy Statement – The asset threshold for the application of the Federal Reserve’s Small Bank Holding Company and Savings and Loan Holding Company Policy Statement is raised from $1 billion to $3 billion. As a result, those institutions with less than $3 billion in consolidated assets are not subject to consolidated capital requirements and have the benefit of less restrictive debt-to-equity limitations.

  • Flexibility for Federal Thrifts to Operate as National Banks – Federal savings associations with total consolidated assets of $20 billion or less (as of December 31, 2017) may elect to be subject to the same rights, privileges, duties, restrictions, penalties, liabilities, conditions and limitations that apply to a national bank, without having to convert their charters. As a result, institutions that make the election would be exempt from certain restrictions unique to savings associations, including asset-based limitations applicable to commercial and consumer loans, unsecured constructions loans, and non-residential real property loans.  To make an election, a federal savings association must provide 60 days’ prior written notice to the OCC.

  • “Ability to Repay” Safe Harbor for Smaller Institutions – The Act provides a safe harbor from the “ability to repay” requirement under the Truth in Lending Act (“TILA”) for mortgage loans originated and retained in portfolio by an insured depository institution or insured credit union that has, together with its affiliates, less than $10 billion in total consolidated assets. However, mortgage loans that have interest-only, negative amortization or certain other features do not qualify for this ability-to-repay relief.

  • Capital Treatment for HVCRE Exposures – The Act eases the treatment for certain “high-volatility commercial real estate” (“HVCRE”) loans under U.S. Basel III capital rules. HVCRE exposures had been assigned a 150% risk-weight under the U.S. standardized approach, but the Act now restricts this higher risk-weight to those exposures that constitute acquisition, development and construction (“ADC”) loans meeting a new “HVCRE ADC loan” definition.  Various loans are excluded from HVCRE ADC loan definition, including loans to finance the acquisition, development or construction of one- to four-family residential properties, community development project loans, and loans secured by agricultural land.  In addition, loans to acquire, refinance or improve income-producing properties and commercial real estate projects that meet certain loan-to-value ratios are also excluded from the new HVCRE ADC loan definition.

  • Reciprocal Deposits – The Act excludes deposits received under a reciprocal deposit placement network from the scope of the FDIC’s brokered deposit rules if the agent institution’s total amount of reciprocal deposits does not exceed either $5 billion or 20% of the institution’s total liabilities. The exclusion applies generally to a bank that has a composite condition of outstanding or good and is well capitalized, but it may be relied upon by a bank that has been downgraded or ceases to be well capitalized if the amount of reciprocal deposits it holds does not exceed the average of its total reciprocal deposits over the four quarters preceding its rating or capital downgrade.

  • PACE Financing – The Act requires the Consumer Financial Protection Bureau (“CFPB”) to issue ability-to-repay rules under TILA to cover Property Assessed Clean Energy (“PACE”) financing. The Act defines such financing to include a loan that covers the costs of home improvements and which results in a tax assessment on the consumer’s real property.  In developing these regulations, the CFPB must consult with state and local governments and PACE bond-issuing authorities.

  • Protections for Student Borrowers – The Act provides protections for student loan borrowers in situations involving the death of the borrower or cosigner and those seeking to “rehabilitate” their student loans. In particular, the Act amends TILA to prohibit a private education loan creditor from declaring a default or accelerating the debt of the student obligator solely on the basis of the death or bankruptcy of a cosigner.  In addition, in the case of the death of the borrower, the holder of a private education loan must release any cosigner within a “reasonable timeframe” after receiving notice of the borrower’s death.  The Act also amends the Fair Credit Reporting Act by allowing a borrower to request that a financial institution remove a reported default on a private education loan from a consumer credit report if the institution offers and the borrower successfully completes a loan rehabilitation program.  The program, which must be approved by the institution’s federal banking regulator, must require that the borrower make consecutive on-time monthly payments in a number that, in the institution’s assessment, demonstrates a “renewed ability and willingness to repay the loan.”

  • Immunity from Suit for Disclosure of Financial Exploitation of Senior Citizens – The Act shields financial institutions and certain of their personnel from civil or administrative liability in connection with reports of suspected exploitation of senior citizens. The reports must be made in good faith and with reasonable care to a law enforcement agency or certain other designated agencies, including the federal banking agencies.  Personnel covered by the immunity (which include compliance personnel and their supervisors, as well as registered representatives, insurance producers and investment advisors) must have received training in elder care abuse by the financial institution or a third party selected by the institution.

  • Mortgage Relief – The Act contains a number of provisions easing certain residential mortgage requirements, especially with respect to such loans made by smaller institutions. The Act amends the Home Mortgage Disclosure Act to exempt from specified public disclosure requirements depository institutions and credit unions that originate, on an annual basis, fewer than a specified number of closed-end mortgages or open-end lines of credit.  The Act revises the Federal Credit Union Act to allow a credit union to extend a member business loan with respect to a one- to four-family dwelling, regardless of whether the dwelling is the member’s primary residence.  The Act also amends the S.A.F.E. Mortgage Licensing Act of 2008 to allow loan originators that meet specified requirements to continue, for a limited time, to originate loans after moving: (i) from one state to another, or (ii) from a depository institution to a non-depository institution.  Further, the Act exempts from certain escrow requirements a residential mortgage loan held by a depository institution or credit union that: (i) has assets of $10 billion or less, (ii) originated 1,000 or fewer mortgages in the preceding year, and (iii) meets other specified requirements.

  • Liquidity Coverage Ratio – The Act directs the federal banking agencies to amend their liquidity coverage ratio requirements to permit certain municipal obligations to be treated as higher quality “level 2B” liquid assets if they are investment grade, liquid and readily marketable.

  • Custodial Bank Capital Relief – The Act requires the agencies to exclude, for purposes of calculating a custodial bank’s supplementary leverage ratio, funds of a custodial bank that are deposited with a central bank. The amount of such funds may not exceed the total value of deposits of the custodial bank linked to fiduciary or custodial and safekeeping accounts.

  • Fair Credit Reporting Act – The Fair Credit Reporting Act is amended to increase the length of time a consumer reporting agency must include a fraud alert in a consumer’s file. The Act also: (i) requires a consumer reporting agency to provide a consumer with free “credit freezes” and to notify a consumer of their availability, (ii) establishes provisions related to the placement and removal of these credit freezes and (iii) creates requirements related to the protection of the credit records of minors.

  • Cyber Threat Report – Within one year of enactment, the Secretary of the Treasury must submit a report to Congress on the risks of cyber threats to U.S. financial institutions and capital markets. The report must include: (i) an assessment of the material risks of cyber threats, (ii) the impact and potential effects of material cyber attacks, (iii) an analysis of how the federal banking agencies and the Securities and Exchange Commission are addressing these material risks and (iv) a recommendation of whether additional legal authorities or resources are needed to adequately assess and address the identified risks.

Apart from the changes in the thresholds for banks with assets above $100 billion, most of the Act’s provisions are effective immediately.

 

© Copyright 2018 Cadwalader, Wickersham & Taft LLP
Read more news on banks at the National Law Review’s Finance Practice Group Page.

Can I Secure a Loan with Bitcoin? Part I

Each day seems to bring another story about Bitcoin, Ethereum, Litecoin, or another virtual currency. If virtual currencies continue to grow in popularity, it’s only a matter of time before borrowers offer to pledge virtual currency as collateral for loans.  This article does not advise lenders on whether they should secure loans with virtual currency, but instead it focuses on whether a lender can use the familiar tools of Article 9 of the Uniform Commercial Code (“UCC”) to create and perfect a security interest in bitcoin.  (In this article, “bitcoin” is used as a generic term for all virtual currencies.)

Article 9 Basics

Article 9 allows a creditor to create a security interest in personal property. The owner of the property grants the creditor a security interest through a written security agreement. The security agreement creates the security interest between the secured party and the debtor. The secured party must then “perfect” the security interest to obtain lien priority over third parties and to protect its secured status should the debtor file bankruptcy.

Security interests are perfected in different ways depending on the type of collateral. Article 9 divides personal property into different categories, such as goods, equipment, inventory, accounts, money, and intangibles. The primary ways to perfect a security interest are (1) filing, with the appropriate filing agency, a UCC-1 financing statement containing a sufficient description of the collateral, (2) possession, or (3) control.

Bitcoin and Blockchain

Virtual currencies are electronic representations of value that may not have an equivalent value in a real government-backed currency. They can be used as a payment system, or digital currency, without an intermediary like a bank or credit card company. While virtual currencies can function like real currencies in certain transactions, and certain virtual currencies can be exchanged into real currencies, a virtual currency itself does not have legal tender status. Virtual currency is virtual—there is no bitcoin equivalent to a quarter or dollar bill.

Bitcoin operates on a protocol that uses distributed-ledger technology. This technology is called the blockchain. The blockchain eliminates the need for intermediaries such as banks. Unlike a dollar, which is interchangeable, each bitcoin is unique. The blockchain records all bitcoin transactions to prevent someone from re-spending the same bitcoin over and over.

Suppose you wanted to transfer cash to a friend. You could transfer funds from your bank account to her bank account. The banks act as intermediaries. Suppose you wanted to transfer cash to that same friend without a middle man. The only way to do that is meet her and hand over the cash. This exchange many not be practical for many reasons. You might live far from each other. Even if you’re near each other, you might not want to travel around town with a briefcase full of cash. Bitcoin and blockchain technology allow the transfer of cash directly and digitally without a middle man.

The blockchain is both transparent and opaque. It is transparent as to the ownership chain of every bitcoin.  In this way, it is easier to “trace” a bitcoin than to trace cash.  But the blockchain presently does not show liens on bitcoin.  So a secured party can confirm if a borrower owns bitcoin, but not if the borrower or a previous owner encumbered the bitcoin.

Is Bitcoin Money?

At first glance, bitcoin would seem to fall in the category of “money.” Article 9 defines money as a medium of exchange authorized or adopted by a domestic or foreign government. No government has adopted bitcoin as a medium of exchange. Dollars, euros, and pounds meet the definition of money—bitcoin does not. Therefore, bitcoin does not meet the definition of money. And a secured party perfects its security interest in money by physical possession, but because bitcoin is virtual, physical possession is impossible.

Is Bitcoin a Deposit Account?

A deposit account is a demand, time, savings, passbook, or similar account maintained with a bank. With a traditional deposit account, the secured party perfects its security interest by having “control” over that account. This is usually accomplished when the debtor, the debtor’s bank, and the secured party execute a deposit account control agreement. If the debtor defaults, the secured party can direct the debtor’s bank to transfer the funds from the account.

Bitcoin often is stored in a digital wallet with an exchange like Coinbase. The wallet is access-restricted by private keys or passwords, but that wallet is not a deposit account. The bitcoin itself is held by its owner on the blockchain, which is decentralized. Unlike a deposit account, there is no intermediary like a bank. With no intermediary, there is no way to establish “control” over the bitcoin. Consequently, bitcoin does not meet the definition of a deposit account.

Bitcoin is (Probably) a General Intangible

By process of elimination, bitcoin should be treated as a general intangible. A general intangible is personal property that does not fall into any other Article 9 category. A lender perfects a security interest in general intangibles by filing a UCC-1 financing statement. In North Carolina, you file it with the Secretary of State.

Although we can categorize bitcoin as a general intangible for Article 9 purposes, and create and perfect a security interest accordingly, several issues arise that question the overall effectiveness of that security interest. For starters, a security interest in general intangibles follows the sale, license, or other disposition of the collateral, unless the secured party consents to the transfer free of its security interest, the obligations secured by the security interest have been satisfied, or the security interest has otherwise terminated.

This is a problem for the lender wanting a first-priority lien on the bitcoin. Before approaching the lender, the borrower may have granted a secured party a security interest in bitcoin, or granted a security interest in “all assets whether now owned or acquired later” and then acquired bitcoin. In both instances, the bitcoin is encumbered by the security interest. The lender could not confirm prior liens without searching UCC-1 filings in all 50 states (and even that might not catch international liens).

Even if a secured party acquires a senior lien in bitcoin, that party still has the problem of lack of control over the bitcoin. Without control, bitcoin collateral is susceptible to unauthorized transfers. Even if a borrower has an account at an online currency exchange like Coinbase—which allows you to exchange bitcoin into traditional money—the exchange may be unwilling to sign a tri-party control agreement to restrict the debtor’s ability to exchange the bitcoin. Upon default, without the debtor’s cooperation, it will be difficult or impossible to enforce, take possession, and liquidate the bitcoin.

Conclusion

Putting aside its value and volatility, the intrinsically unique nature of bitcoin makes it an imperfect and problematic form of collateral under Article 9. Part II of this article will discuss the pros and cons of using Article 8 of the UCC to create and perfect a security interest in bitcoin. Article 8 has the potential to be a safer and more reliable solution for these transactions.

© 2018 Ward and Smith, P.A.. All Rights Reserved.

This post was written by Lance P. Martin of Ward and Smith, P.A.

               

State of Washington Enacts Student Loan Servicing Law

Washington has become the latest state to impose a licensing requirement on student loan servicers. Yesterday, Governor Jay Inslee signed  SB 6029, which establishes a “student loan bill of rights,” similar to the bills that have been enacted in California, Connecticut, the District of Columbia, and Illinois.

The law’s requirements include the following:

  • Creation of Advocate Role: The law creates the position of “Advocate” within the Washington Student Achievement Council to assist student education loan borrowers with student loans. This role is analogous to that of “ombudsman” under proposed and enacted servicing bills in other states.  One of the Advocate’s roles is to receive and review borrower complaints, and refer servicing-related complaints to either the state’s Department of Financial Institutions (“DFI”) or the Attorney General’s Office, depending on which office has jurisdiction. The Advocate is also tasked with:
    • Compiling information on borrower complaints;
    • Providing information to stakeholders;
    • Analyzing laws, rules, and policies;
    • Assessing annually the number of residents with federal student education loans who have applied for, received, or are waiting for loan forgiveness;
    • Providing information on the Advocate’s availability to borrowers, institutions of higher education, and others;
    • Assisting borrowers in applying for forgiveness or discharge of student education loans, including communicating with student education loan servicers to resolve complaints, or any other necessary actions; and
    • Establishing a borrower education course by 10/1/20.
  • Licensing of Servicers: SB 6029 requires servicers to obtain a license from the DFI. There are various exemptions from licensing for certain types of entities and programs (trade, technical, vocational, or apprentice programs; postsecondary schools that service their own student loans; persons servicing five or fewer student loans; and federal, state, and local government entities servicing loans that they originated), although such servicers would still need to comply with the statute’s substantive requirements even if they are not licensed.
  • Servicer Responsibilities: All servicers, except those entirely exempt from the statute, are subject to various obligations. Among other things, servicers must:
    • Provide, free of charge, information about repayment options and contact information for the Advocate ;
    • Provide borrowers with information about fees assessed and amounts received and credited;
    • Maintain written and electronic loan records;
    • Respond to borrower requests for certain information within 15 days;
    • Notify a borrower when acquiring or transferring servicing rights; and
    • Provide borrowers with disclosures relating to the possible effects of refinancing student loans.
  • Modification Servicer Responsibilities: The bill imposes a number of requirements on third-parties providing student education loan modification services, including mandates that such persons: not charge or receive money until their services have been performed; not charge fees that are in excess of what is customary; and immediately inform a borrower in writing if a modification, refinancing, consolidation, or other such change is not possible.
  • Requirements for Educational Institutions: Institutions of higher education are required to send borrower notices regarding financial aid.
  • Fees: The bill also calls for the establishment, by rule, of fees sufficient to cover the costs of administering the program created by the bill.
  • Bank Exemption: The statute provides for a complete exemption for “any person doing business under, and as permitted by, any law of this state or of the United States relating to banks, savings banks, trust companies, savings and loan or building and loan associations, or credit unions.” Notably, this exemption does not expressly cover state banks chartered in other states.

As we recently noted, bills like  SB 6029 are being introduced in legislatures across the country at an increasing rate, and we are continuing to track the progress of these proposals as they move through various statehouses.

Hopefully the torrent of such proposals will soon be reduced to a trickle, now that the U.S. Department of Education has formally weighed in on this trend, issuing an interpretation emphasizing that the Higher Education Act, federal regulations, and applicable federal contracts preempt laws like SB 6209 that purport to regulate federal student loan servicers.

 

Copyright © by Ballard Spahr LLP 2018
This post was written by Jeremy C. Sairsingh of Ballard Spahr LLP.

               

The Unique Quandaries Faced in Recovering International Cryptocurrency Frauds

Cryptocurrency itself is a string of computer-generated code.  This line of code is accessed by an owner’s unique passcode secret private key.  Each owner’s cryptocurrency is kept in their “Virtual Wallet”. Virtual wallets are similarly anonymous as are the virtual currency balances. The transfer of cryptocurrency is based upon the block chain protocol, a public decentralized ledger that identifies transactions by a digital code with no link to a person or place.

Practically, there is no public record of virtual currency transfers.  Other than the debtor’s own testimony, a creditor would not know where to begin searching for evidence of virtual currency purchases or transactions. There is no way for a creditor to identify either the owner or location of a transferee’s cryptocurrency address. In some cases, the debtor could honestly state that he does not know the identity of the individual who received his cryptocurrency transfers.

For asset protection purposes, a cryptocurrency account currently functions similarly to offshore banking prior to the IRS’s crackdown of anonymous personal foreign accounts.  Today, it is almost impossible for U.S. citizens to establish an anonymous bank account, or any type of bank account, outside of the U.S. With the advent of Bitcoin, a U.S. citizen can open and maintain a financial account that has creditor protection features similar to an offshore bank account in that the Bitcoin account is anonymous and can be maintained outside the geographical jurisdiction of domestic courts. Since block chains are decentralized, they are not subject to any central authority (such as a bank or other financial institution) that might be legally compelled to provide a court with access or control over assets in its possession. Without the complete private key, no court or legal authority can manipulate ownership of a block chain asset.

At the moment, creditors face obstacles of identifying potential defendants and the international nature of the transaction.  Properly selected offshore fiduciaries holding accounts are unlikely to become subject to the jurisdiction of a court where a defendant may be sued.  Absent jurisdictional authority, a court is powerless to compel the fiduciary to turn over assets. Similarly, a US court could try to compel the party to turn over the account or information about the transaction. The court’s contempt powers could be used to coerce compliance. Arrest and incarceration can be utilized. See In Re Lawrence, 279 F.3d 1294,1300 (11th Cir. 2002); FTC v. Affordable Media Inc., 129 F.3d 1228, 1229 (9thCir. 1999). But, on cruel and unusual punishment grounds, incarceration cannot be imposed forever. If the asset is more important than personal freedom, a court’s power of compliance is limited.

There are two equitable remedies that exist under English common law which could be flexibly applied to these evolving transactions. One existing remedy is the equitable pre-trial discovery device known as a Norwich Pharmacal order requiring third parties to disclose information to potentially identify the wrongdoer, to trace funds and to assist prospective plaintiffs in determining whether a cause of action exists.  (There are five states in the U.S. that also allow for pretrial discovery to identify the wrongdoing.)  Norwich orders, being a flexible tool of equity, could assist in claims involving cryptocurrency transactions.  It may be possible that identification information might come from “know your customer” information given a bitcoin exchange.  Proceedings could be constituted as “the bitcoin holder with the public key number…”  However, the hurdle still exists to identify the wrongdoer.

The second equitable remedy is injunctive relief.  Courts have granted world-wide injunctions, particularly when the impugned conduct is occurring online and globally, such as the internet.  InGoogle Inc. v. Equustete, 2017 SC 34, the Supreme Court of Canada recently held that injunctive relief can be ordered against somebody who is not a party to the underling lawsuit, even if that third party is not guilty of wrongdoing.  Google was ordered to stop displaying search results globally for any Data Link websites.  “The problem in this case, is occurring online and globally.  The internet has no borders; its natural habitat is global.  The only way to ensure interlocutory injunction (order) attain its objection was to have it apply where Google operates – globally.”  Thus, if the third party to the block chain transaction can be identified, there may be a remedy to discover information and wrongdoing.

Therefore, courts will need to apply not only new remedies, but expand existing ones.  While the identities of the buyer and seller are encrypted, a transaction record is maintained on the public ledger. In the future, anti-money laundering laws and cryptocurrency exchanges may require the collection of personal data of customers. Until then, the challenge of recovery will require creativity and experience.

 

© Horwood Marcus & Berk Chartered 2018.
This post was written by Eric (Rick) S. Rein from Horwood Marcus & Berk Chartered.

Climate Change and Trends in Global Finance

On December 12, French President Emmanuel Macron, joined by President of the World Bank Group, Jim Yong Kim and the Secretary-General of the United Nations, António Guterres, hosted the One Planet Summit highlighting public and private finance in support of climate action. The summit’s focus centered on addressing the fight against climate change and ensuring that climate issues are central to the finance sector.

The summit’s most notable event was perhaps the announcement that insurance giant Axa would be dumping investments in and ending insurance for controversial U.S. oil pipelines, quadrupling its divestment from coal businesses, and increasing its green investments fivefold by 2020. Axa’s plans echo those of BNP Paribas, who, in mid-October, announced that it would terminate business with companies whose principal activities involve exploration, distribution, marketing, or trading of oil and gas from shale or oil sands. The bank also ceased financing projects that are primarily involved in the transportation or export of oil and gas. These moves themselves follow controversy over the Dakota Access pipeline in the U.S. from mid-March that resulted in ING’s $2.5 billion divestment in the loan that financed the pipeline.

These measures prefigure what might be a more conspicuous trend of large institutional investors moving more rapidly away from fossil fuel investments and into green investments. In mid-December, the World Bank said it would end all financial support for oil and gas exploration by 2019. Around the same time, New York Governor Andrew Cuomo revealed a plan for the state’s common retirement fund, with over $200 billion in assets, to cease all new investments in entities with significant fossil-fuel related activities and to completely decarbonize its portfolio. Recently, HSBC pledged $100 billion to be spent on sustainable finance and investment over the next eight years in an effort to address climate change. Additionally, JP Morgan Chase committed $200 billion to similar clean-minded investments, Macquarie acquired the UK’s Green Investment Bank, and Deutsche Bank and Credit Agricole both made exits from coal lending. As the landscape of global finance shifts, it will be important to monitor how funds, banks, and insurers address the issues related to climate change.

 

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MAS Releases “A Guide to Digital Token Offerings”

On 14 November 2017, the Monetary Authority of Singapore (the “MAS”) released  “A Guide to Digital Token Offerings” providing general guidance on the application of the securities laws administered by the MAS in relation to offers or issues of digital tokens in Singapore.

The main consideration is whether the digital token is designed in a way that would make it a product regulated under Singapore’s securities laws i.e. if it behaves like a share, debenture or some other form of security. If a token does not function like a security, then technically, neither will the security laws apply.

In the first case study in the guide, Company A plans to set up a platform to enable sharing and rental of computing power amongst the users of the platform. In order to raise funds to develop this platform, Company A intends to offer and sell digital tokens wherein the token will have utility upon completion. The MAS states that the digital token in this case study would not constitute a security under the Securities and Futures Act (Cap. 289). It appears that this is because other than the right to access the issuer’s platform to rent computing power, the digital token in question did not appear to have any other “rights” or “features” that made it look like a security.

Therefore, if a digital token is structured in a similar way as set out in this case study, then it would presumably not trigger the relevant Singapore securities laws, notwithstanding the fact that the sale of the token may have been used to fund the building of the platform.

The practical issue to consider then is this:- How will a company convince its investors to purchase such digital tokens in the first place, given that they do not appear to offer any type of rights or features that would give potential purchasers of those digital tokens a return on their investment?

Singapore is devoting huge resources to building the FinTech industry and offering many incentives to new entrants in the jurisdiction. Initial Coin Offerings (“ICOs”) structured like the example herein would seem to be acceptable.

This post was written by Nicholas M. Hanna & Samantha See of  K& L Gates., Copyright 2017

Equity Plan Share Reserves: How to Increase Its Life Expectancy: Executive Compensation Practical Pointers

Efforts to conserve an equity plan’s share reserve should begin the day the issuer’s stockholders approve the plan (or share increase), and should continue going forward. Issuers that do not make such efforts tend to face problems relating to dwindling share reserves, including moving to cash-based programs, hiring proxy solicitation firms to garner stockholder support for share increases, and overcoming possible negative reactions from ISS.

The following are some ideas an issuer could use to extend the life of its plan share reserve:1

  • Grant awards that are settled in cash – Depending on the terms of the plan, a cash-settled award may not draw from the share reserve.2 An alternative would be settling a portion of the award in shares (e.g., up to target), with any achievement above that settled in cash.
  • Grant full value awards like restricted stock or RSUs – Such grants provide greater value to the holder than options or SARs, the latter providing incentive only to the extent the share price exceeds the exercise/strike price, but draw from the share reserve the same as full value awards.3
  • Permit net-exercise of stock options – Depending on the terms of the plan, the shares subject to the option that are netted in a net-exercise may not draw from the share reserve. Also, a net-exercise could be helpful to a Section 16 insider to avoid a blackout (i.e., no open market transaction occurs with a net-exercise).4
  • Amend the plan to permit maximum withholding – A recent change in accounting rules provides that maximum withholding will not result in liability accounting treatment. Depending on the terms of the plan, withholding of shares to cover taxes may not draw from the share reserve.
  • Grant stock-settled SARs rather than options – A stock-settled SAR will provide the same economic result as a net-exercised option, but since a SAR is settled in shares with respect to only the excess over the strike price, fewer shares are burned than with a net-exercised option.
  • Use inducement awards for new executive-level hires and certain M&A events – The award must be a material inducement to getting the executive/employee to accept the position. If properly structured, these awards can be made outside of the plan and do not require stockholder approval under NYSE or NASDAQ rules.5
  • Implement an ESOP or ESPP – ESOPs, which are subject to ERISA, do not require stockholder approval under NYSE or NASDAQ rules. Depending upon the structure of an ESPP, stockholder approval may be required.6

1. Some of these methods involve liberal share counting, which is disfavored by ISS.

2. Liability classification would apply for accounting purposes and settlement in cash will not count towards satisfying any share ownership requirements.

3. This method will not work if the plan contains fungible share counting provisions.

4. However, a net-exercise of an incentive stock option could jeopardize the ISO’s favorable tax treatment.

5. Without stockholder approval, such awards could not qualify for deduction under Section 162(m), if applicable.

6. Broad participation requirements may apply.

This post was written by Matthew B. Grunert  & Carolyn A. Exnicios of Andrews Kurth Kenyon LLP.,© 2017
For more legal analysis go to The National Law Forum 

CFTC Clarifies That Variation Margin Constitutes Settlement

The Division of Clearing and Risk (DCR) of the Commodity Futures Trading Commission has issued an interpretive letter clarifying that payments of variation margin, price alignment amounts and other payments in satisfaction of outstanding exposures on a counterparty’s cleared swap positions constitute “settlement” under the  (CEA) and CFTC Regulation 39.14. The CEA and CFTC Regulation 39.14 provide that a derivatives clearing organization (DCO) must effect a settlement at least once each business day and ensure that settlements are final when effected.

Although not mentioned by DCR, the letter is clearly intended to complement earlier guidance issued jointly by the Federal Reserve Board, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation (Guidance) regarding the Regulatory Capital Treatment of Certain Centrally Cleared Derivatives Contracts Under Regulatory Capital Rules. As the Guidance explains in greater detail, for purposes of the risk-based capital calculation and the supplementary leverage ratio calculation, the regulatory capital rules require financial institutions to calculate their trade exposure amount with respect to derivatives contracts. The trade exposure amount, in turn, is determined, in part, by taking into account the remaining maturity of such contracts. The Guidance goes on to explain that for a derivatives contract that is structured such that on specific dates any outstanding exposure is settled and the terms are reset so that the fair value of the contract is zero, the remaining maturity equals the time until the next reset.

“Accordingly, for the purpose of the regulatory capital rules, if, after accounting and legal analysis, the institution determines that (i) the variation margin payment on a centrally cleared Settled-to-Market Contract settles any outstanding exposure on the contract, and (ii) the terms are reset so that fair value of the contract is zero, the remaining maturity on such contract would equal the time until the next exchange of variation margin on the contract.”

CFTC Letter No. 17-51 provides the legal analysis to confirm that, as a condition of registration with the CFTC as a DCO, each DCO must provide for daily settlement of all obligations, including the payment and receipt of all variation margin obligations, which payments are irrevocable and unconditional when effected. As a result, a clearing member’s obligations to each DCO are satisfied daily and the fair value of the open cleared derivatives held at the DCO is effectively reset to zero daily.

This post was written by James M. Brady & Kevin M. Foley of Katten Muchin Rosenman LLP., ©2017
For more Financial & Banking legal analysis, go to The National Law Review

New Rules Offer Clarity On China’s Outbound M&A Crackdown

On August 18, 2017, China’s State Council issued guidelines clarifying rules passed a year ago by the State Administration of Foreign Exchange (SAFE) limiting outbound investments as cover-up to move money out of China.

The new guidelines provide different policies for Chinese companies’ investment overseas, broadly dividing overseas investment into three categories:

  • investments in “real estate, hotels, entertainment, sport clubs, [and] outdated industries” are restricted;

  • investments in sectors that could “jeopardize China’s national interest and security, including output of unauthorized core military technology and products” and investments in gambling and pornography are prohibited; and

  • investments in establishing R&D centers abroad and in sectors like high-tech and advanced manufacturing enterprises that could boost China’s Belt and Road Initiative, and investments that would benefit Chinese products and technology will be encouraged by Chinese outbound regulators.

These guidelines are new and we have to wait and see how they will be interpreted and implemented by regulators. Still, there may be reasons to believe they will have a net positive effect on the China-U.S. M&A market. The new guidelines bring about greater certainty to buyers, lenders and targets on whether a deal will get approved by Chinese regulators.

The volume and size of Chinese outbound M&A is already on an upward trajectory in the second quarter of 2017, as buyers are already getting more acclimated to SAFE rules announced at the end of 2016 restricting the outflow of Chinese capital. Chinese buyers completed 94 deals totaling $36 billion in Q2, compared to the 74 deals totaling $12 billion in Q1. The current Chinese outbound M&A trend, coupled with greater certainty under the new guidelines, is likely to result in more Chinese outbound M&A deals during the last quarter of 2017, as well as in 2018.

This post was written by Shang Kong & Zhu Julie Lee of Foley & Lardner LLP © 2017

For more legal analysis go to The National Law Review