Category: Financial Services Law

Q&A / Fee Disclosure Requirements Top the List of Issues Facing Retirement Plan Sponsors

 Recently posted in the National Law Review an article by  f Much Shelist Denenberg Ament & Rubenstein P.C.  Much Shelist spoke toNorman D. Schlismann (Senior Managing Director) and David H. Dermenjian (Senior Vice President) in the Retirement Plan Advisory Group about current issues facing 401(k) plan sponsors.

 

In today’s turbulent economy, 401(k) defined-contribution plans are under the microscope. Plan participants and government agencies are scrutinizing every element of retirement plans, paying special attention to the fiduciary responsibilities of plan sponsors and the fees being paid to their service providers. As a diversified financial services firm, Mesirow Financial provides a broad range of asset management, investment advisory, broker-dealer and consulting services to institutions and private clients worldwide. Much Shelist spoke toNorman D. Schlismann (Senior Managing Director) and David H. Dermenjian (Senior Vice President) in the Retirement Plan Advisory Group about current issues facing 401(k) plan sponsors.

Much Shelist: What have been some of the primary effects of the economic crisis on employer-sponsored retirement plans and 401(k) plans in particular?

David Dermenjian: Perhaps the greatest effect of the global economic situation is that everyone—from individual plan participants to plan sponsors, investment fund managers and regulatory officials—is looking more closely at fund performance, employee education and the administrative and other costs associated with these plans. This is quite understandable; over the past several years, virtually every retirement plan has experienced at least a temporary decline in value.

Individual plan participants, including employees and executives, tend to focus on the range of funds available in their plans, as well as fund performance and minimizing costs. Plan sponsors are typically interested in ensuring that they are fulfilling their fiduciary responsibilities and limiting potential liability. Government regulators want to protect individuals against unnecessary losses by stepping up their use of audits and investigations to uncover and correct potential irregularities in financial reporting, self-dealing or the occasional misuse of employee contributions. Ultimately, all of these steps are being taken in pursuit of the same goal: to help employees make wise decisions regarding their retirement assets and preserve value to the maximum extent possible.

Norm Schlismann: Education is the centerpiece of these efforts. By providing in-person counseling and seminars, online webinars and printed materials that clearly describe the various fund options, rules and fees, employers can help employees make more informed decisions, and plan sponsors can be sure they are meeting their fiduciary obligations.

One example of how education can help is in the area of target-date retirement funds. Typically, these funds are built around an estimated retirement year, say 2030. As the target date approaches and participants near their expected retirement, the fund will shift into a more conservative investment mode, often moving assets from stocks into bonds and money market instruments. What many people don’t realize, however, is that target-date funds may appear to be similar but are actually based on different assumptions. A “to-date” fund assumes that participants will withdraw all of their assets upon retirement, whereas a “through-date” fund assumes that smaller withdrawals will occur over time, perhaps on a monthly basis. Since through-date funds assume that assets will remain in the fund even after retirement, they may take a more risky approach to investment allocations.

MS: Fee disclosures have received significant attention of late. Briefly, what are they?

DD: The concept of fee disclosures has been floating around for a while, but the final rule—described under ERISA Section 408(b)2—will go into full effect April 2012. Under the rule, retirement plan fiduciaries must ensure that “reasonable fees” are being paid to providers for “reasonable services.” Fiduciaries must also obtain information sufficient to enable them to make informed decisions about the costs associated with these providers and must disclose this information to plan participants.

Typical information contained in a disclosure includes benchmarking data (comparing the fees associated with a particular fund or retirement plan to other, similar funds or plans) and fee structures. It’s important to note that higher fees are not necessarily unreasonable. Some providers offer a higher level of service—one-on-one employee counseling, real-time access to complete fund reports, etc.—which can justify the higher costs to participants.

NS: Clarity and transparency are the watchwords of disclosures. For this reason, disclosures should often include information beyond simple fee information. For example, disclosures should also include an assessment of the independence of—and potential conflicts between—service providers, as well as possible conflicts between service providers and fiduciaries. Revenue sharing and finders fees are typical areas of concern.

MS: To that point, what is the difference between a plan fiduciary and a service provider?

NS: Plan fiduciaries are individuals or groups of individuals who use their own judgment in administering and managing the plan or who have the power to actually control the plan’s assets. Service providers, on the other hand, execute the instructions of plan fiduciaries; they may include plan recordkeepers, administrators, custodians, advisors and other financial or investment professionals engaged to operate retirement plans or provide guidance with respect to the plans.

In some cases, a service provider may also act in the role of a fiduciary. For example, a broker-dealer, whose responsibility to the client for suitability and appropriateness of a recommendation ends the moment a sale is made, could be considered a service provider but not a fiduciary. A registered investment advisor, who may be involved in the recommendation of a particular investment option to the plan and who may continue to provide guidance over the life of an investment, is considered both a service provider and a fiduciary.

MS: Where can plan sponsors find the information they need to make proper disclosures?

DD: That’s the $64,000 question! While it is getting easier to obtain this information, plans and their cost structures have grown more complex over the years. Understanding exactly what the data is telling you, vis-à-vis your own plans, can be difficult. This is where the assistance of experienced financial professionals is critical.

In terms of accessing information, the trend today is toward a more open plan architecture, which makes it easier to find the required data. Similarly, a number of third-party providers offer benchmarking data and analytics. Other companies, such as Fi360, offer a more comprehensive range of resources, tools and training to help fiduciaries fulfill their duties.

However, as we’ve already noted, it is often in the best interests of fiduciaries to obtain the services of an experienced investment advisor and fiduciary consultant. In doing so, independence is probably the most important consideration. Consultants should also have proven tools and procedures that enable them to conduct a fiduciary audit (including a detailed analysis) and provide evidentiary documentation in the process.

MS: How do I know if I need this type of fiduciary audit?

NS: The easy answer is that all plan sponsors need information, and they need to fully understand how that information applies to their unique combination of employer-sponsored retirement plans and services. That said, a number of companies—especially small and mid-sized businesses—have let their plans go “dormant” over the years, acting as if nothing has changed. If you can’t clearly articulate your fiduciary process, then you probably don’t have one! And, you are probably at greater risk of failing a Department of Labor audit of your plan.

Plan sponsors may also be concerned about the cost of a consultant. However, the money spent on the services of an experienced consultant is often considerably less than the savings recouped once the plan sponsor has actionable information. The likelihood increases over time that your retirement plan is spending too much on administrative and management fees. We advise plan sponsors to benchmark their plans against comparable averages annually and benchmark against other providers in the market every few years.

The bottom line? Plan sponsors are in a better position to fulfill their fiduciary responsibilities, and lower costs mean that more money is preserved in participants’ accounts—which can result in improved returns over time.

For more information on this topic, contact Norm Schlismann (nds@mesirowfinancial.com) or Dave Dermenjian (dhd@mesirowfinancial.com).

This article contains material of general interest and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. Under professional rules, this content may be regarded as attorney advertising.

© 2011 Much Shelist Denenberg Ament & Rubenstein, P.C.

How Lessors and Lenders Can Audit the Eurocontrol Accounts of Lessees

Recently posted in the National Law Review an article by attorney John I. Karesh of Vedder Price P.C. regarding  lessors will no longer receive an aircraft operator’s statement of account from Eurocontrol via e-mail.

Eurocontrol has implemented a change to the way lessors, lenders and security trustees can audit the Eurocontrol accounts of lessees. Effective September 1, 2011, lessors will no longer receive an aircraft operator’s statement of account from Eurocontrol via e-mail. In an attempt to provide better security, Eurocontrol will now provide such statements only upon the lessor’s request via a secured extranet system called CEFA (Central Route Charges Office Extranet for Airspace Users). We have been advised by Eurocontrol that lenders and security trustees also will be granted access to CEFA under the same protocol. In order to gain access, the requesting party needs to complete an Agreement (available on Eurocontrol’s website). Once the Agreement is completed and received by Eurocontrol, the requesting party can view an operator’s statement of account online 24/7. Access is free. However, requesting parties must obtain approval from each operator whose statement of account they wish to view by having the operator sign an Authorization Letter in the prescribed form.

Because lenders and lessors must execute the Agreement, they should take note that the Agreement contains various noteworthy provisions including the following: Article 4 provides that to the extent permitted by national law, in the event of a dispute, Eurocontrol’s data, including metadata, shall be admissible in court and shall constitute evidence of the facts contained therein unless contrary evidence is adduced. Section 9.2 provides that once a statement of account becomes available on CEFA, it shall be deemed received by the “Leasing Company,” which agrees to proactively and regularly check the CEFA site. Article 13 contains various provisions concerning confidentiality and protection of data. Section 14.2 requires the Leasing Company to indemnify Eurocontrol against any claims for damages made by third parties where the claims or damages are due to a fault of the Leasing Company. Article 15 provides that without prejudice to any mandatory national law, the transmission of electronic data under the Agreement shall be governed by Belgian law. Article 16 provides that any dispute arising out of or in connection with the Agreement shall be referred to the Brussels Court of First Instance (Belgium), which shall have sole jurisdiction.

Also, Section 17.3 provides that the Agreement is for an indefinite period, but either party may terminate it on not less than three months’ written notice, and that Eurocontrol is entitled to terminate or suspend the Agreement in a case foreseen under the confidentiality and protection of data provisions (Section 13.1) or if all authorizations to release Statements of Account to the lessor have been withdrawn. Section 17.4 provides that access to the Statements of Account of an Aircraft Operator will be terminated without notice in case of the withdrawal of the authorization to release such Statements of Account. However, the prescribed form of Authorization Letter provides that it may only be revoked or amended by written instructions from the operator and lessor.

The foregoing is merely a summary of a few of the provisions of the Agreement. All provisions should carefully be reviewed before signing. However, it appears the only way lessors, lenders and security trustees can obtain the statement of an operator’s account is by means of the Authorization Letter and signed Agreement.

© 2011 Vedder Price P.C.

Second Circuit's Citigroup Decision Endorses Presumption of Prudence, Upholds Dismissal of Disclosure Claims

Posted this week at the National Law Review by Morgan, Lewis & Bockius LLP regarding the decision that employer stock in a 401(k) plan is subject to a “presumption of prudence” that a plaintiff alleging fiduciary breach:

 

 

 

In a much-anticipated decision, the U.S. Court of Appeals for the Second Circuit joined five other circuits in ruling that employer stock in a 401(k) plan is subject to a “presumption of prudence” that a plaintiff alleging fiduciary breach can overcome only upon a showing that the employer was facing a “dire situation” that was objectively unforeseeable by the plan sponsor. In re Citigroup ERISA Litigation, No. 09-3804, 2011 WL 4950368 (2d Cir. Oct. 19, 2011). The appellate court found the plaintiffs had not rebutted the presumption of prudence and so upheld the dismissal of their “stock drop” claims.

BACKGROUND

The Citigroup plaintiffs were participants in two 401(k) plans that specifically required the offering of Citigroup stock as an investment option. The plaintiffs alleged that Citigroup’s large subprime mortgage exposure caused the share price of Citigroup stock to decline sharply between January 2007 and January 2008, and that plan fiduciaries breached their duties of prudence and loyalty by not divesting the plans of the stock in the face of the declines. The plaintiffs further alleged that the defendants breached their duty of disclosure by not providing complete and accurate information to plan participants regarding the risks associated with investing in Citigroup stock in light of the company’s exposure to the subprime market. On a motion to dismiss, the district court found no fiduciary breach because the defendants had “no discretion whatsoever” to eliminate Citigroup stock as an investment option (sometimes referred to as “hardwiring”). Alternatively, the lower court ruled that Citigroup stock was a presumptively prudent investment and the plaintiffs had not alleged sufficient facts to overcome the presumption.

SECOND CIRCUIT DECISION

Oral argument in the Citigroup case occurred nearly a year ago, and legal observers have been anxiously awaiting the court’s ruling. In a 2-1 decision, with Judge Chester J. Straub issuing a lengthy dissent, the Second Circuit rejected the “hardwiring” rationale but confirmed the application of the presumption of prudence, which was first articulated by the Third Circuit in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995). The court also rejected claims that the defendants violated ERISA’s disclosure obligations by failing to provide plan participants with information about the expected future performance of Citigroup stock.

Prudence

Joining the Third, Fifth, Sixth, Seventh, and Ninth Circuits,[1] the court adopted the presumption of prudence as the “best accommodation between the competing ERISA values of protecting retirement assets and encouraging investment in employer stock.” Under the presumption of prudence, a fiduciary’s decision to continue to offer participants the opportunity to invest in employer stock is reviewed under an abuse of discretion standard of review, which provides that a fiduciary’s conduct will not be second-guessed so long as it is reasonable. The court also ruled that the presumption of prudence applies at the earliest stages of the litigation and is relevant to all defined contribution plans that offer employer stock (not just ESOPs, which are designed to invest primarily in employer securities).

Having announced the relevant legal standard, the court of appeals dispatched the plaintiffs’ prudence claim in relatively short order. The plaintiffs alleged that Citigroup made ill-advised investments in the subprime market and hid the extent of its exposure from plan participants and the public; consequently, Citigroup’s stock price was artificially inflated. These facts alone, the court held, were not enough to plead a breach of fiduciary duty: “[T]hat Citigroup made a bad business decision is insufficient to show that the company was in a ‘dire situation,’ much less that the Investment Committee or the Administrative Committee knew or should have known that the situation was dire.” Nor could the plaintiffs carry their burden by alleging in conclusory fashion that individual fiduciaries “knew or should have known” about Citigroup’s subprime exposure but failed to act. Relying on the Supreme Court’s decision in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), the court of appeals held these bald assertions were insufficient at the pleadings stage to suggest knowledge of imprudence or to support the inference that the fiduciaries could have foreseen Citigroup’s subprime losses.

Disclosure

The court’s treatment of the disclosure claims was equally instructive. Plaintiffs’ allegations rested on two theories of liability under ERISA: (1) failing to provide complete and accurate information to participants (the “nondisclosure” theory), and (2) conveying materially inaccurate information about Citigroup stock to participants (the “misrepresentation” theory).

As to the nondisclosure theory, the court found that Citigroup adequately disclosed in plan documents made available to participants the risks of investing in Citigroup stock, including the undiversified nature of the investment, its volatility, and the importance of diversification. The court also emphasized that ERISA does not impose an obligation on employers to disclose nonpublic information to participants regarding a specific plan investment option.

Turning to the misrepresentation theory, the court found plaintiffs’ allegations that the fiduciaries “knew or should have known” about Citigroup’s subprime losses, or that they failed to investigate the prudence of the stock, were too threadbare to support a claim for relief. Though plaintiffs claimed that false statements in SEC filings were incorporated by reference into summary plan descriptions (SPDs), the court found no basis to infer that the individual defendants knew the statements were false. It also concluded there were no facts which, if proved, would show (without the benefit of hindsight) that an investigation of Citigroup’s financial condition would have revealed the stock was no longer a prudent investment.

IMPLICATIONS

Coming from the influential Second Circuit, the Citigroup decision represents something of a tipping point in stock-drop jurisprudence, especially with respect to the dozens of companies (including many financial services companies) that have been sued in stock-drop cases based on events surrounding the 2007-08 global financial crisis. The Second Circuit opinion gives the presumption of prudence critical mass among appellate courts and signals a potential shift in how stock-drop claims will be evaluated, including at the motion to dismiss stage.[2]

Under the Citigroup analysis, fiduciaries should not override the plan terms regarding employer stock unless maintaining the stock investment would frustrate the purpose of the plan, such as when the company is facing imminent collapse or some other “dire situation” that threatens its viability. Like other circuits that have adopted the prudence presumption, the Citigroup court emphasized the long-term nature of retirement investing and the need to refrain from acting in response to “mere stock fluctuations, even those that trend downhill significantly.” It also sided with other courts in holding that the presumption of prudence should be applied at the motion to dismiss stage (i.e., not allowing plaintiffs to gather evidence through discovery to show the imprudence of the stock). Taken together, these rulings may make it harder for plaintiffs to survive a motion to dismiss, especially where their allegations of imprudence are based on relatively short-lived declines in stock price.

Some had predicted the Second Circuit would endorse the “hardwiring” argument and allow employers to remove fiduciary discretion by designating stock as a mandatory investment in the plan document. The Citigroup court was unwilling to go that far, but it did adopt a “sliding scale” under which judicial scrutiny will increase with the degree of discretion a plan gives its fiduciaries to offer company stock as an investment. This is similar to the approach taken by the Ninth Circuit inQuan and consistent with the heightened deference that courts generally give to fiduciaries when employer stock is hardwired into the plan. Thus, through careful plan drafting, employers should be able to secure the desired standard of review. Language in the plan document and trust agreement (as well as other documents) confirming that employer stock is a required investment option should result in the most deferential standard and provide fiduciaries the greatest protection.

Also noteworthy was the court’s treatment of the disclosure claims. Many stock-drop complaints piggyback on allegations of securities fraud, creating an inevitable tension between disclosure obligations under the federal securities laws and disclosure obligations under ERISA. The Second Circuit did not resolve this tension, but it construed ERISA fiduciary disclosure requirements narrowly and rejected the notion that fiduciaries have a general duty to tell participants about adverse corporate developments. The court made this ruling in the context of SPD disclosures under the 401(k) plan that identified specific risks of investing in Citigroup stock. Plan sponsors should review their SPDs and other participant communications to make sure company stock descriptions are sufficiently explicit about issues such as the volatility of a single-stock investment and the importance of diversification. These disclosures may go beyond what is already required under Department of Labor regulations.

[1]. See Howell v. Motorola, Inc., 633 F.3d 552, 568 (7th Cir.), cert.denied, ­­­2011 WL 4530151 (2011); Quan v. Computer Sciences Corp., 623 F.3d 870, 881 (9th Cir. 2010); Kirschbaum v. Reliant Energy, Inc., 526 F.3d 243, 254 (5th Cir. 2008); Kuper v. Iovenko, 66 F.3d 1447, 1459-60 (6th Cir. 1995).

[2]. That said, plan sponsors and fiduciaries should continue to monitor future developments in Citigroup in light of Judge Straub’s dissenting opinion and the likelihood of a petition for rehearing (or rehearing en banc), which the Citigroup plaintiffs have indicated they intend to seek. In his dissent, Judge Straub rejected the Moench presumption in favor of plenary review of fiduciary decisions regarding employer stock. He also disagreed with the majority’s interpretation of ERISA disclosure duties.

Copyright © 2011 by Morgan, Lewis & Bockius LLP. All Rights Reserved.

Dodd-Frank Update — Several Regulatory and Legislative Proposals of Note

Recently posted in the National Law Review an article by attorneys  Sylvie A. Durham, Genna Garver and Dmitry G. Ivanov of Greenberg Traurig, LLP regarding  the OCC, FDIC and SEC’s proposed a joint rule implementing theVolcker Rule:

GT Law

REGULATORS PROPOSE VOLCKER RULE:

On October 11, 2011, the Office of the Comptroller of the Currency, Treasury (OCC), Board of Governors of the Federal Reserve System (Board), Federal Deposit Insurance Corporation (FDIC), and Securities and Exchange Commission (SEC) issued a joint proposed rule implementing the long awaited Volcker Rule. This proposal establishes exemptions from the prohibition on proprietary trading and restrictions on covered fund activities and investments as well as limitations on those exemptions. In addition, the proposal requires certain banking entities to report quantitative measurements with respect to their trading activities and to establish enhanced compliance programs regarding the Volcker Rule, including adopting written policies and procedures. Appendices to the proposal provide the quantitative measurements to be used to report trading activities, commentary regarding the factors the agencies propose to use to distinguish permitted market making-related activities from prohibited proprietary trading and the minimum requirements and standards for compliance programs. Comments should be received on or before January 13, 2012. A copy of the proposed rule is available here.

FSOC PROPOSES RULE TO SUPERVISE AND REGULATE CERTAIN NON-BANK FINANCIAL COMPANIES:

On October 11, 2011, the Financial Stability Oversight Council (FSOC) issued its second proposed rule and interpretive guidance to provide additional details regarding the framework that FSOC intends to use in the process of assessing whether a nonbank financial company could pose a threat to U.S. financial stability, and further opportunity for public comment on FSOC’s approach to making determinations to require supervision and regulation of certain nonbank financial companies in accordance with Title I of Dodd-Frank, previously proposed on January 26, 2011. The proposed rule, previously proposed on January 26, 2011, has been modified to provide additional details about the processes and procedures through which FSOC may make this determination under Dodd-Frank, and the manner in which a nonbank financial company may respond to and contest a proposed determination. Importantly, the interpretive guidance sets out a three-stage process of increasingly in-depth evaluation and analysis leading up to a proposed determination that a nonbank financial company could pose a threat to the financial stability of the United States. The first stage would involve a quantitative analysis by applying thresholds that related to the framework categories of size, interconnectedness, leverage and liquidity risk and maturity mismatch. A company will be evaluated further in stage 2 only if it both meets the total consolidated assets threshold ($50 billion in global consolidated assets for U.S. global financial companies or $50 billion in U.S. total consolidated assets for foreign nonbank financial companies) and any one of the other enumerated metrics. Stage 2 would involve a wide range of quantitative and qualitative industry-specific and company-specific factors. Stage 3 would focus on the company’s potential to pose a threat to the U.S. financial system. Comments are due by December 19, 2011. A copy of the proposed rule is available here.

PROPOSED LEGISLATION ON TO EXTEND DEADLINE FOR DERIVATIVES RULEMAKING:

A bill was introduced in the Senate to extend the deadline for rulemaking on derivatives to July 16, 2012. The Dodd-Frank Improvement Act of 2011 (S. 1650) would require the SEC, the CFTC and other relevant regulators to jointly adopt an implementation schedule for derivatives regulations by December 31, 2011, which would, among other things, specify schedules for publication of final rules and for the effective dates for provisions in Dodd-Frank on derivatives. The proposed bill would also allow the regulators to issue exemptions with respect to swap transactions, activities or persons from the Dodd-Frank Act derivatives provisions, would exempt end-users of swaps from margin requirements, would revise the definition of major swap participants to “prevent Main Street businesses that are using derivatives to hedge business risks from being regulated like swap dealers,” and would exempt inter-affiliate transactions from the definition of “swaps.” The bill would also create the Office of Derivatives within the SEC to “administer rules, coordinate oversight and monitor the developments in the market.” The text of the bill is available by clicking here.

PROPOSED LEGISLATION TO FREEZE REGULATORY RULEMAKING:

Two bills were introduced in the House of Representatives to freeze regulatory rulemaking actions during a “moratorium period” and to repeal certain existing regulations. The Job Creation and Regulatory Freeze Act of 2011 (H.R. 3194)would establish a moratorium period until January 20, 2013, prohibiting regulators from adopting any “covered regulations,” which would include final regulations that, among other things, would have an adverse effect on employment, economy or public health or are likely to “have an annual effect on the economy of $100,000,000 or more.” At the same time, the bill would allow rulemaking, to the extent necessary “due to an imminent threat to human health or safety, or any other emergency” or if it promotes “private sector job creation,” encourages economic growth or reduces “regulatory burdens.” The Stop the Regulation Invasion Please Act of 2011, or STRIP Act of 2011 (H.R. 3181) would also establish a two-year moratorium period for all new rulemaking, except in certain limited circumstances. In addition, that bill would repeal, with certain exceptions, all rules that became effective after October 1, 1991. The existing rules that would continue in effect would need to be justified before the Congress based on cost-benefit analysis. The H.R. 3194 is available by clicking here; and the H.R. 3181 is available by clicking here.

©2011 Greenberg Traurig, LLP. All rights reserved.

Anti-Money Laundering Compliance Costs

Recently posted in the National Law Review an article by Emily Holbrook of Risk and Insurance Management Society, Inc. (RIMS) regarding anti-money laundering  initiatives take more precedence in the corporate world:

 

Each year, anti-money laundering (AML) initiatives take more precedence in the corporate world, particularly within the financial industry. According to Celent, global spending on AML compliance, including operations and technology, will reach a staggering $5.8 billion within the financial sector by 2013.

Overall, the AML compliance burden is expected to expand at a rate of 7.8% annually while global spending on AML software is projected to expand at a rate of 10.4% per year. But what is the motivation behind such a drive? The research firm found that 42% of respondents cited regulatory requirements, and 25% pointed to reputational risk and brand protection as the main driver for AML compliance spending. And in further findings, financial institutions cited the integration of their AML and anti-fraud operations and technologies as a long-term goal.

“Although intuitively attractive, many institutions may find it difficult to build a business case for integrating AML with anti-fraud,” said Neil Katkov, senior vice president for Celent. “Fortunately, the compliance-driven development of modern AML software, analytics and case management has created a new generation technology that can often deliver better results than legacy anti-fraud systems.”

It seems it’s out with the old and in with the new — and expensive — AML

Risk Management Magazine and Risk Management Monitor. Copyright 2011 Risk and Insurance Management Society, Inc. All rights reserved.

Mortgage Industry to Face Centralized Repository for State Regulatory Enforcement Actions – Deadline for Comments is September 20, 2011

Posted in the National Law Review an article by attorney  Thomas J. McKee, Jr., Gil Rudolph and Michael R. Sklaire of Greenberg Traurig, LLP regarding State Regulatory Registry LLC (SRR);

 

 

Deadline for Comments is September 20, 2011

On July 22, 2011, the State Regulatory Registry LLC (SRR) issued a Request for Public Comments on a proposal to collect, centralize and publish all state regulatory enforcement information concerning mortgage loan originators. By creating a central source of investigation information, the SRR aims to provide a repository of background information for both consumers and other state and federal regulators. Before implementing, the SRR has asked for public comments to be submitted by September 20, 2011.

In 2008, the Nationwide Mortgage Licensing System & Registry (NMLS) was created under the federal Secure and Fair Enforcement for Mortgage Licensing Act (“SAFE Act”), with the purpose of “provid[ing] consumers with accessible information . . . regarding the employment history of, and publicly adjudicated disciplinary and enforcement actions against loan originators.” 12 U.S.C.A. § 5101(7). As part of implementing this purpose, the NMLS intended to use the SRR as the vehicle through which to include all regulatory actions taken by state regulators against companies and individuals that could be gathered and published. Previously, actions by state regulators could only be found, if at all, through a search of the individual state regulators’ websites.

The proposal to incorporate state regulatory reporting into the NMLS, which would take effect in Spring of 2012, consists of twelve major policies and processes, which include, among others:

  1. The state agency that took the action will be responsible for inputting such information into the NMLS. The SRR will not verify, validate, or amend any of the enforcement actions, as such information can only be changed by the inputting agency.
  2. Whether an action will actually be included in the NMLS can vary from state to state, depending on state-specific statutes and regulations. Further, each state will determine which actions will be shared only with other regulators, and those that will be made available to the general public.
  3. Reported actions will not be limited to those actions that are public. Instead, a regulator will have the ability, at their discretion, to include information that is to be shared only among regulators or among agency employees.
  4. A recommendation that any postings be made within five (5) days of receipt of a state agency’s final order.
  5. Provide a standardized set of information to be posted, including, for example, (a) the enforcing agency, (b) a description of the Order, and (c) the amount of any fine or other penalty.
  6. The SRR recommends that actions taken against companies should be posted on a prospective basis, while actions taken against loan originators should be posted as of the date each state’s SAFE Act became effective.
  7. All respondents named in an action will be included in any reporting, and the action will be tied to the records of both the named company and/or individuals.
  8. A company or individual will be notified of any posting in the system and will be able to view any publicly posted actions against it in the NMLS. The SRR proposal does not, however, contain a mechanism for a company or individual to learn of the non-public postings against it.
  9. State regulators will have the ability to post multi-state actions through NMLS. Each state involved in such an action is responsible for posting the action pursuant to its own reporting policies.

At first glance, the proposed registry presents a number of benefits to companies. For example, by having a central repository for all state regulatory actions, companies will have easy, up-to-date, access to the types of enforcement actions being pursued across the country, including the resulting fines and penalties assessed. Such information can be invaluable when defending an enforcement action and evaluating settlement proposals with state agencies. Companies will be able to see enforcement trends and use such information to modify their practices. The new system will greatly simplify a company’s ability to learn from the conduct of others.

Such benefits, however, do not come without a host of potential drawbacks. Specifically, while the system seeks to compile standard information regarding enforcement actions, it does not set forth a standard for reporting. Instead, its reliance upon individual state standards for reporting could lead to competitive disadvantages where, despite identical conduct, one company is tagged with a report while another is not solely due to a difference in state reporting standards.

The discretion given to regulators under the system could have similar effects. Giving regulators the discretion to input information (including non-adjudicated information) that will only be shared among regulators or agency employees could result in information being shared without verification, accountability, or opportunity to cure. Successfully defending an enforcement action would not necessarily preclude the sharing of negative comments about a company on the system. Companies will not be privy to such secret, albeit formalized, statements that could be prejudicial to how such entities are viewed and/or treated by other regulatory agencies. Nevertheless, the repository could be a potential treasure trove of information for future plaintiffs and will certainly be a frequent target of discovery in lawsuits.

Companies should carefully examine the potential ramifications each of the proposed policies may have on their business.

©2011 Greenberg Traurig, LLP. All rights reserved.

OFAC Settles Alleged Sanctions Violations for $88.3 million

Posted in the National Law Review an article by Thaddeus Rogers McBride and Mark L. Jensen of Sheppard Mullin Richter & Hampton LLP regarding OFAC’s settlements with financial institutions:

 

On August 25, 2011, a major U.S. financial institution agreed to pay the U.S. Department of Treasury, Office of Foreign Assets Control (“OFAC”) $88.3 million to settle claims of violations of several U.S. economic sanctions programs. While OFAC settlements with financial institutions in recent years have involved larger penalty amounts, this August 2011 settlement is notable because of OFAC’s harsh—and subjective—view of the bank’s compliance program.

Background. OFAC has primary responsibility for implementing U.S. economic sanctions against specifically designated countries, governments, entities, and individuals. OFAC currently maintains approximately 20 different sanctions programs. Each of those programs bars varying types of conduct with the targeted parties including, in certain cases, transfers of funds through U.S. bank accounts.

As reported by OFAC, the alleged violations in this case involved, among other conduct, loans, transfers of gold bullion, and wire transfers that violated the Cuban Assets Control Regulations, 31 C.F.R. Part 515, the Iranian Transactions Regulations, 31 C.F.R. Part 560, the Sudanese Sanctions Regulations, 31 C.F.R. Part 538, the Former Liberian Regime of Charles Taylor Sanctions Regulations, 31 C.F.R. Part 593, the Weapons of Mass Destruction Proliferators Sanctions Regulations, 31 C.F.R. Part 544, the Global Terrorism Sanctions Regulations, 31 C.F.R. Part 594, and the Reporting, Procedures, and Penalties Regulations, 31 C.F.R. Part 501.

Key Points of Settlement. As summarized below, the settlement provides insight into OFAC’s compliance expectations in several ways:

1. “Egregious” conduct. In OFAC’s view, three categories of violations – involving Cuba, in support of a blocked Iranian vessel, and incomplete compliance with an administrative subpoena – were egregious under the agency’s Enforcement Guidelines. To quote the agency’s press release, these violations “were egregious because of reckless acts or omissions” by the bank. This, coupled with the large amount and value of purportedly impermissibly wire transfers involving Cuba, is likely a primary basis for the large $88.3 million penalty.

OFAC’s Enforcement Guidelines indicate that, when determining whether conduct is “egregious,” OFAC gives “substantial” weight to (i) whether the conduct is “willful or reckless,” and (ii) the party’s “awareness of the conduct at issue.” 31 C.F.R. Part 501, App. A. at V(B)(1). We suspect that OFAC viewed the conduct here as “egregious” and “reckless” because, according to OFAC, the bank apparently failed to address compliance issues fully: as an example, OFAC claims that the bank determined that transfers in which Cuba or a Cuban national had interest were made through a correspondent account, but did not take “adequate steps” to prevent further transfers. OFAC’s emphasis on reckless or willful conduct, and the agency’s assertion that the bank was aware of the underlying conduct, underscore the importance of a compliance program that both has the resources to act, and is able to act reasonably promptly when potential compliance issues are identified.

2. Ramifications of disclosure. In this matter, the bank voluntarily disclosed many potential violations. Yet the tone in OFAC’s press release is generally critical of the bank for violations that were not voluntarily disclosed. Moreover, OFAC specifically criticizes the bank for a tardy (though still voluntary) disclosure. According to OFAC, that disclosure was decided upon in December 2009 but not submitted until March 2010, just prior to the bank receiving repayment of the loan that was the subject of the disclosure. Although OFAC ultimately credited the bank for this voluntary disclosure, the timing of that disclosure may have contributed negatively to OFAC’s overall view of the bank’s conduct.

This serves as a reminder that there often is a benefit of making an initial notification to the agency in advance of the full disclosure. This also serves as reminder of OFAC’s very substantial discretion as to what is a timely filing of a disclosure: as noted in OFAC’s Enforcement Guidelines, a voluntary self-disclosure “must include, or be followed within a reasonable period of time by, a report of sufficient detail to afford a complete understanding of an apparent violation’s circumstances.” (emphasis added). In this regard, OFAC maintains specific discretion under the regulations to minimize credit for a voluntary disclosure made (at least in the agency’s view) in an inappropriate or untimely fashion.

3. Size of the penalty. The penalty amount—$88.3 million—is substantial. Yet the penalty is only a small percentage of the much larger penalties paid by Lloyds TSB ($350 million), Credit Suisse ($536 million), and Barclays ($298 million) over the past few years. In those cases, although the jurisdictional nexus between those banks and the United States was less clear than in the present case, the conduct was apparently more egregious because it involved what OFAC characterized as intentional misconduct in the form of stripping wire instructions. The difference in the size of the penalties is at least partly attributable to the amount of money involved in each matter. It also appears, however, that OFAC is distinguishing between “reckless” conduct and intentional misconduct.

4. Sources of information. As noted, many of the violations in this matter were voluntarily disclosed to OFAC. The press release also indicates that certain disclosures were based on information about the Cuba sanctions issues that was received from another U.S. financial institution (it is not clear whether OFAC received information from that other financial institution). The press release also states that, with respect to an administrative subpoena OFAC issued in this matter, the agency’s inquiries were at least in part “based on communications with a third-party financial institution.”

It may not be the case here that another financial institution (or institutions) blew the proverbial whistle, but it appears that at least one other financial institution did provide information that OFAC used to pursue this matter. Such information sharing is a reminder that, particularly given the interconnectivity of the financial system, even routine reporting by financial institutions may help OFAC identify other enforcement targets.

5. Compliance oversight. As part of the settlement agreement, the bank agreed to provide ongoing information about its internal compliance policies and procedures. In particular, the bank agreed to provide the following: “any and all updates” to internal compliance procedures and policies; results of internal and external audits of compliance with OFAC sanctions programs; and explanation of remedial measures taken in response to such audits.

Prior OFAC settlements, such as those with Barclays and Lloyds, have stipulated compliance program reporting obligations for the settling parties. While prior agreements, such as Barclay’s, required a periodic or annual review, the ongoing monitoring obligation in this settlement appears to be unusual, and could be a requirement that OFAC imposes more often in the future. (Although involving a different legal regime, requirements with similarly augmented government oversight have been imposed in recent Foreign Corrupt Practices Act settlements, most notably the April 2011 settlement between the Justice Department and Johnson & Johnson. See Getting Specific About FCPA Compliance, Law360, at:http://www.sheppardmullin.com/assets/attachments/973.pdf).

Conclusions. We think this settlement is particularly notable for the aggression with which OFAC pursued this matter. Based on the breadth of the settlement, OFAC seems to have engaged in a relatively comprehensive review of sanctions implications of the bank’s operations, going beyond those allegations that were voluntarily self-disclosed to use information from a third party. Moreover, as detailed above, OFAC adopted specific, negative views about the bank’s compliance program and approach and seems to have relied on those views to impose a very substantial penalty. The settlement is a valuable reminder that OFAC can and will enforce the U.S. sanctions laws aggressively, and all parties—especially financial institutions—need to be prepared.

Copyright © 2011, Sheppard Mullin Richter & Hampton LLP.

 

Seeking Corporate Dissolution: One Way to Turn Up the Heat on a Deadbeat Debtor

Posted in the National Law Review an article by Jeffrey M. Schwartz of Much Shelist Denenberg Ament & Rubenstei P.C. regarding a seldom-used remedy that can significantly increase your chances of recovering a debt:

Put yourself in the place of a creditor. One of your customers, an Illinois corporation, owes you money. The customer does not dispute the debt and has even admitted it in writing. However, you can’t get the customer to pay. You have tried everything. First, you are told “the check is in the mail” and of course, it does not show up. The customer then agrees to a payment plan but fails to make the required payments. Finally, the customer promises to “pay next month when we have the money.” Still no check. In a last ditch effort, you call repeatedly, but the customer has now gone incommunicado. It has become obvious that the only way to collect the debt is to file a lawsuit.

You are hesitant, however, because of the time and expense it will take to obtain and enforce a judgment. After all, the customer will likely go to great lengths to delay the lawsuit and hold you at bay for as long as possible. From the customer’s point of view, the worst case scenario is that it will have to pay you the money it has already admitted it owes. Is there anything you can do to minimize the time and expense of obtaining and enforcing a judgment?

You may want to consider a seldom-used remedy that can significantly increase your chances of recovering a debt. Under the Illinois Business Corporation Act, a creditor may seek to have its claims against an Illinois corporation satisfied by bringing an action for dissolution in the state’s circuit court. By adding a cause of action for corporate dissolution to a collection lawsuit, creditors may increase pressure on the debtor to pay what is owed or resolve the dispute in a timely, cost-effective manner. In essence, this alternative remedy can change the dispute from a simple beach of contract or collection matter to a scenario where the customer risks losing control of the corporation and must fight for its very existence.

The Illinois Business Corporation Act, which has little case law interpreting it, does not require much. The statute provides that in an action brought by a creditor, a circuit court in Illinois may dissolve a corporation if it is established that:

  1. The creditor’s claim has been reduced to judgment, a copy of the judgment has been returned unsatisfied and the corporation is insolvent; or
  2. The corporation has admitted in writing that the creditor’s claim is due and owing, and the corporation is insolvent.

(Note: Many other states have similar statutes that allow a creditor to satisfy a claim against a corporation through dissolution or liquidation. Accordingly, if your customer is not an Illinois corporation, you should check to see if its state of incorporation has a similar statute.)

One advantage of using this statute is that it does not actually require a creditor to obtain a judgment. The creditor need only show that the debtor has admitted in writing that it owes the money and that the corporation is insolvent. The written admission can come in a variety of forms. For example, the debtor may have sent a letter or e-mail admitting that it owes the debt or may have acknowledged the debt in a forbearance or settlement agreement. In addition, the admission need not be made directly to the creditor. According to People Ex Rel. Day v. Progress Ins. Ass’n, a 1955 Illinois Appellate Court decision, it may be sufficient that the indebtedness is recognized in the debtor’s books and records. Furthermore, the insolvency requirement is satisfied if the corporation is “unable to pay its debts as they become due in the usual course of its business,” as stated in the Illinois Business Corporation Act.

The statue also allows the circuit court, as an alternative to dissolution, to (1) appoint a custodian to manage the business and affairs of the corporation to serve for the term and under the conditions prescribed by the court; and (2) appoint a provisional director to serve for the term and under the conditions prescribed by the court. Like the prospect of dissolution itself, these alternatives put the debtor at risk of losing control of the company.

While your customer may be willing to take the chance that a judgment will be entered against it after extensive litigation and delay, it may not be willing to risk dissolution or loss of control of the corporation. Therefore, adding a count for corporate dissolution to a collection lawsuit can alter the playing field and give you—the creditor—significant negotiating power to resolve the dispute quickly and on better terms.

© 2011 Much Shelist Denenberg Ament & Rubenstein, P.C.

 

 

NYC Condo Refinance Collapses Because There Was No "Meeting of the Minds"

Recently posted in the National Law Review an article by Eric S. O’Connor of Sheppard Mullin Richter & Hampton LLP wherein  plaintiffs sought damages arising out of their attempt to refinance a mortgage loan with the defendant bank:

In Trief v. Wells Fargo Bank, N.A., Index No. 105280/09, — N.Y.S.2d — (Sup Ct, NY County, Apr. 4, 2011) (“Trief”), the plaintiffs sought damages arising out of their attempt to refinance a mortgage loan with the defendant bank (the “Bank”), for breach of contract and violation of New York’s Unfair and Deceptive Practices Act, N.Y. General Business Law (“NYGBL”) § 349. Justice Charles Edward Ramos granted the Bank’s motion for summary judgment on both counts. The parties actually proceeded to closing when plaintiff walked away from the refinancing of a luxury midtown condominium located at 15 West 53rd Street, New York, NY – seemingly over a $518.75 dispute.

The main lesson is that all parties, especially when communicating via more informal modes of communications like email, must clarify and confirm an “agreement on all essential terms” or else a valid contract will not be formed.

The facts – negotiation, informal communications, the exchange of standard loan forms, etc… – follow a seemingly common pattern. A mortgage consultant from the Bank filled out the refinance application on the Triefs’ behalf by telephone and then sent an e-mail attaching a Good Faith Estimate of Settlement Charges (the “GFE”). The GFE proposed a 5.125% interest rate and a standard provision indicating that the “fees listed are estimated – the actual charges may be more or less.” The cover email asked to “let me know if you would like me to lock you in for 60 days”, which Mr. Trief responded “sure.” After a small dispute about the rate, the Bank faxed a Conventional Commitment Letter (the “Letter”) to the Triefs confirming the rate and other details. Despite language in the Letter that “You must sign and return this commitment letter within that period to ensure receiving the terms specified”, neither party signed the Letter. At the scheduled closing, the Triefs refused to proceed because the Bank sought to charge them a rate lock extension fee of $518.75, which the Triefs claim was never negotiated or agreed to.

The main issue was whether a contract was formed. The Court explained the classic rules that a plaintiff must establish an offer, acceptance of the offer, consideration, mutual assent, and an intent to be bound. Kowalchuk v. Stroup, 61 A.D.3d 118, 121 (1st Dept 2009).  Mutual assent means a “meeting of the minds” and must include agreement on all essential terms. Id. The Court held that there was not a meeting of the minds on all of the essential terms of a final contract for refinancing. The two key pieces of evidence – the email from the Bank asking to “let me know if you would like me to lock you in for 60 days” and the standard GFE language that terms were subject to change – were only seeking an acceptance to lock in the rate for a fixed period of time, rather than a final agreement to refinance. Further, the Real Estate Settlement Procedure Act(“RESPA”) shows that the legislature did not intend for the GFE to bind a lender to a final loan agreement. See 24 CFR § 3500.7 [a], [g] (the “GFE is not a loan commitment. Nothing in this section shall be interpreted to require a loan originator to make a loan to a particular borrower.”).

Finally, the Court also rejected the Triefs claim under NYGBL § 349. A claim for violation of GBL § 349 is based upon consumer-oriented conduct that is materially misleading, causing a plaintiff injury. The Court held that the Triefs failed to even identify consumer-oriented conduct on the part of the Bank because private contract disputes, unique to the parties, generally do not fall within the scope of the statute. The Triefs failed to demonstrate injury because they refused to close on the loan refinancing and did not pay any fees to the Bank.
Copyright © 2011, Sheppard Mullin Richter & Hampton LLP.

Troubled Loan Workouts: Qualified Professionals Can Help Maximize Recovery for All Parties

Posted in the National Law Review an article by Norman B. Newman of Much Shelist Denenberg Ament & Rubenstein P.C. regarding workout of a financially troubled loans:

The workout of a financially troubled loan requires the participants—typically the lender, the borrower and the guarantors—to be well versed in legal and business principals, coupled with an ability to understand the emotional aspects of the situation. The primary goal of a troubled loan workout is to maximize the recovery to all parties involved. That end result is best achieved when each party is represented by qualified professionals, including a loan officer who is familiar with the situation, as well as experienced attorneys and workout consultants. Collectively, these resources offer a vast network of appraisers, real estate and business brokers, buyers, prospective lenders and other contacts—all of whom are familiar with financially troubled business matters.

From the lender’s side, a loan workout officer will bring to the table a thorough understanding of the loan documents and know what collateral has been pledged, as well as the extent of the perfection of the security interests granted to the lender. The loan officer will be able to communicate with the borrower and the guarantors with respect to the existing defaults under the loan documents. This individual will also know the lender’s rights in light of the default and whether the lender is choosing to presently exercise its rights under the loan documents or reserve exercising them until a future date.

From a legal prospective, it is essential that all parties involved in a troubled loan workout be represented by attorneys experienced in handling financial distress matters. The lender’s attorney will review the loan documents, examine collateral perfection issues and assist in providing updated UCC, tax lien and judgment lien searches. This attorney will also be able to advise the lender as to the various remedies available in the exercise of its rights against the borrower and the guarantors, including in-court and out-of-court options.

The other parties should also turn to legal counsel for advice regarding their rights, remedies and obligations under the operative documents. Attorneys for the borrower and guarantors will advise their clients how best to cooperate with the lender in a consensual workout scenario or what defenses might be available in an adversarial situation. This advice will also cover in-court and out-of-court options, including the availability of bankruptcy relief as part of a consensual loan workout.

Assuming the lender does not need to take immediate action to get control over or liquidate its collateral, most troubled loan workouts involve some period of forbearance that affords the borrower additional time to resolve its financial problems. Under a limited forbearance arrangement, the lender gives up little, while both the borrower and the lender have an opportunity to pursue various benefits. At this stage, the parties should involve experienced workout consultants who, for example, will help analyze the borrower’s business and provide advice regarding the profitability and viability of the enterprise. They often help prepare short-term and long-term cash flow projections and budgets or test such projections and budgets when they are prepared by the borrower. Additionally, they typically play a role in determining the best way to maximize the recovery to all parties, whether it be a reorganization of the borrower, a sale or an orderly liquidation of the borrower’s assets. If a restructure or reorganization is the chosen solution, workout consultants will help determine what additional funds might be necessary to accomplish the desired result.

The workout of a financially troubled loan involves complex legal and business issues, as well as the emotions of the business owners or the guarantors of the borrower’s indebtedness. Partnering with experienced attorneys and other workout professionals is an essential step towards navigating these difficult waters and ensuring a successful outcome for all of the parties involved.

© 2011 Much Shelist Denenberg Ament & Rubenstein, P.C.