InfoBytes, Regulatory Restructuring Report, Issue Twelve December 21, 2009

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House of Representatives Passes Regulatory Reform Bill

On Friday, December 11, the House of Representatives passed H.R. 4173, the "Wall Street Reform and Consumer Protection Act of 2009," (the "Bill") which would comprehensively reform regulation of the financial services industry. The final legislation combines into various titles all of the disparate pieces of the regulatory reform package initially presented to Congress by the Obama Administration in [June]. Two of the titles in particular will, if enacted, have far-reaching effects on companies offering consumer financial products: one title creating the new consumer financial protection agency ("CFPA") to regulate and enforce consumer financial products and activities, and another title that inserts the language from the "Mortgage Reform and Anti-Predatory Lending Act," a separate bill that had passed the House of Representatives in May, that generally would require mortgage loan originators to exercise a "duty of care" and set up new underwriting requirements for mortgage lending. Aside from these two titles of the Bill, the Bill would also enhance and overhaul the regulatory structure applicable to numerous different aspects of the financial system, including thrifts, industrial loan companies, and other non-bank banks, over-the-counter derivatives, securities brokers and dealers and other securities intermediaries, and rating agencies. The bill would also create a new structure to monitor and regulate systemic risk issues, including entities considered "too big to fail." Below is a detailed summary of the various titles of the bill.



Consumer Financial Protection Agency Act (Title IV)



This title establishes the CFPA as a new agency tasked with writing regulations and enforcing federal laws governing consumer financial products and services. Generally, the CFPA applies to "covered persons" and "related persons" engaging in a "financial activity" or providing "consumer financial products or services." The CFPA will also have jurisdiction, including examination, rulemaking, and enforcement powers, to regulate certain "enumerated consumer laws," which include, among others, the Fair Credit Reporting Act, the Federal Debt Collection Practices Act, the Homeowners Protection Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the SAFE Act, the Truth in Lending Act, the Equal Credit Opportunity Act and unfair and deceptive trade acts and practices for mortgages.



"Covered Persons" are those who engage directly or indirectly in a financial activity, in connection with the provision of a consumer financial product or service. They would also include independent contractors, including attorneys, appraisers, or accountants, who knowingly or recklessly violate a consumer law or regulation or breach of duty. "Related persons" include, among others, directors, officers, controlling stockholders, shareholders, and joint venturers. The Bill also subjects "service providers" to CFPA oversight. A service provider means any person who provides a material service to a covered person in the provision of a consumer financial product or service, and includes persons who facilitate the design of, or operations relating to the provision of the product or service, have direct interaction with the consumer, or process transactions.



The Bill includes an extensive list of activities that are considered "financial activities" subject to CFPA jurisdiction. Among the activities are:

Deposit-taking activities;

  • Extending credit and servicing loans, including acquiring, purchasing, selling, brokering, or servicing loans or other extensions of credit;

  • Check cashing and check-guaranty services;

  • Collecting, analyzing, maintaining, and providing consumer report information or other account information by covered persons;

  • Debt collecting related to any consumer financial product or service;

  • Providing real estate settlement services;

  • Leasing personal or real property or acting as agent, broker, or adviser in leasing under certain circumstances;

  • Acting as an investment adviser (with some exceptions);

  • Acting as financial adviser (with some exceptions);

  • Financial data processing by any technological means, including providing data processing services (if the data is financial, banking or economic in nature);

  • Money transmitting;

  • Sale, provision or issuance of stored value products;

  • Acting as a money services business; and

  • Acting as a custodian of money or any financial instrument.

It also gives the CFPA the ability to define by regulation any other activity as covered by the definition of financial activity. Financial activity does not include, among other things, the business of insurance.



Initially the CFPA will be headed by a single director, but on the agency conversion date (i.e. 2 years after the transfer of functions to the CFPA), management responsibilities will transfer into a 5-member presidentially appointed commission. The Director (and subsequently, the Commission), will be advised by a Consumer Financial Protection Oversight Board on strategies, actions, and policies, including whether CFPA regulations are in line with prudential, market, or systemic objectives of the other regulators. Also within the CFPA will be a number of statutorily created offices and arms, including, among others:

  • A research arm to develop consumer education programs and monitor the consumer financial product marketplace;

  • A community affairs arm to provide information, guidance and assistance to traditionally underserved consumers and communities;

  • An Office of Financial Literacy;

  • Office of Fair Lending and Equal Opportunity to provide oversight and enforcement of federal fair lending laws and coordinating fair lending enforcement efforts of the CFPA with other federal and state agencies and regulators; and

  • A Consumer Advisory Board to advise and consult in the exercise of the functions of the CFPA and the enumerated consumer laws and to provide information on emerging practices in the consumer financial products or services industry.

The CFPA will be funded both by appropriations from the Federal Reserve Board as well as through an assessment system, which will be levied separately for depository and non-depository institutions based on the size, complexity, and compliance record of the institution.



The Bill grants the CFPA both general and specific powers. Among the general powers given to the CFPA are (1) the power to examine all covered entities (in coordination with examinations already conducted by the functional regulators and state bank supervisors), and (2) primary enforcement authority over the enumerated consumer protection laws, including the ability to take action based upon consumer complaints. In addition, the Agency has the authority to take action to prevent an unfair, deceptive or abusive act or practice related to the "offering" of a consumer financial product or service although such action must be consistent with the FTC Act. Notably, insured depositories and credit unions with assets under $10 billion will not be subject to CFPA-only examinations, but the CFPA may include an examiner in every aspect of the primary regulator examination, and the primary regulator must provide reports to the CFPA. The CFPA may also, under certain circumstances, remove the primary regulator from an enforcement action.



Exempt from enforcement authority are: (i) credit directly issued and debt directly collected by a merchant, retailer, or seller of nonfinancial services; (ii) qualified retirement or eligible deferred compensation plans and arrangements, (iii) accountants, tax preparers, attorneys, licensed real estate brokers and agents, auto dealers, and licensed pawnbrokers; and (iv) persons regulated by the SEC, CFTC, or any State securities or insurance regulator, although the SEC must consult and coordinate with CFPA regarding investment products or services that are the same, or compete directly with, a consumer financial product or service.

 

  • The Bill gives the CFPA the following specific powers and responsibilities:

  • The ability to prohibit or impose conditions or limitations on the use of mandatory pre-dispute arbitration clauses between covered persons and consumers if it is in the public interest and for the protection of consumers;

  • The ability to regulate consumer disclosures, including the costs, benefits, and risks associated with any consumer financial product or service;

  • Implement (within 1 year) a combined TILA/RESPA disclosure, unless HUD and the Fed do it first.

  • Implement rules governing duties owed by a covered person, its employees, agents and independent contractors to a consumer when that person deals or communicates directly with the consumer in the provision of a consumer financial product or service.

  • Regulate the manner, setting, and circumstances for sales practices.

  • Monitor compensation practices to promote fair dealing with consumers.

  • Conduct a negotiated rulemaking on appraisal independence requirements.

  • Rule-making authority for each of the non-bank products under its jurisdiction.

  • Rule-making authority to require banks to prominently display information regarding overdraft fees and charges.

The CFPA may not, however, require that any particular product or service be offered to any consumer.



Another significant section of the CFPA title makes significant adjustment to federal preemption standards for federally-chartered banks and thrifts and their operating subsidiaries. First, the Bill generally codifies the Barnett Bank standard for preemption of state laws for national banks and thrifts. Specifically, the Bill subjects national banks to state laws, unless (i) application would have a discriminatory effect on national banks in comparison with its effect on a state chartered bank; or (ii) the State consumer financial law prevents, significantly interferes with, or materially impairs the ability of a national bank to engage in the business of banking. As discussed further below, preemption determinations under this subparagraph may be made by a court or by regulation or order of the OCC in accordance with applicable law on a case-by-case basis (meaning, a determination made by the OCC, in consultation with the CFPA, concerning the impact of a particular state law on any national bank subject to that law). Second, the Bill would effectively repeal the Watters decision and remove preemption protection for operating subsidiaries of national banks and thrifts. Third, the Bill would codify the holding in Cuomo and expressly give state attorneys general visitorial powers over national banks and federal thrifts. The Bill also addresses other aspects relevant to the current state of preemption law, including:

  • Specifying that interest rate exportation of national banks is not affected;

  • Removing Chevron deference for OCC determinations relating to applicability of state laws, while generally preserving Chevron deference for interpretations of the National Bank Act; and

  • Clarifying that a state law is not inconsistent if it provides greater protection that what is provided under federal law.

Finally, the Bill clarifies that contracts already in place and relying on current preemption rules or guidance are unaffected by the Bill.



In arriving at the preemption standard enacted by the House, Chairman Frank included in his manager’s amendment a compromise with moderate Democrats. The compromise added to the preemption standard the words "materially impairs," which gives the Comptroller a broader basis for making a written finding (in consultation with the CFPA) that the state law is preempted. The compromise also removed language barring a Court from giving the OCC’s preemption determinations deference. Under the enacted standard the Court must examine the OCC determination by assessing its validity, the thoroughness of the OCC’s consideration, the consistency of the determination with other determinations and any other factors which the court finds persuasive.

 

Mortgage Reform and Anti-Predatory Lending Act (Title VII)



As mentioned, the language in this title is taken from H.R. 1728, a bill that originally passed the House on May 7, 2009. It would make significant changes to the regulation of the mortgage lending industry.



First, the Bill places new standards on the origination of mortgage loans. Specifically, the Bill would amend the Truth in Lending Act by requiring originators to adhere to a "duty of care" with respect to mortgage lending practices This standard generally requires that the originator (i) must be appropriately licensed or registered; (ii) present consumers with a range of products for which the consumer likely qualifies; (iii) make full disclosures regarding the comparative costs of each product offered or discussed; (iv) certify to any creditor that the originator complied with this section; and (v) include NMLS unique identifies on all loan documents. The Bill also sets forth new underwriting requirements to ensure the loan meets the requirements of the foregoing "duty of care" standards, subject to a "presumption" of compliance for certain low-risk "qualified mortgages" (as defined in the statute).



The Bill also imposes new minimum standards for mortgage loans. Under the Bill:

  • Creditors must make a determination that there is a reasonable ability to repay the loan and, for refinances, that there is a net tangible benefit to the consumer, and establishes remedies for violations by creditors. The remedies include the right to rescind the loan, and the remedy can be enforced against assignees and securitizers. However, assignees and securitizers are given a 90-day cure period, and have a rebuttable presumption that both standards are met if the loan is a "qualified loan."

  • Certain practices are prohibited for all loans, including assessing prepayment penalties, single premium credit insurance, mandatory arbitration clauses, waiving statutory causes of action, and negative amortization (other than reverse mortgages) without certain disclosures and required housing counseling for first-time buyers.

  • For "high cost mortgages," the Bill prohibits loan flipping, balloon payments, recommending default, late fees over 4%, acceleration clauses, financing points and fees, modification or deferral fees, and requires that a creditor obtain a certification from an approved housing counselor that the borrower received pre-loan counseling.

Additionally, lenders must make certain new disclosures. For instance, creditors or servicers must provide a six-month notice before a hybrid adjustable rate mortgage is reset, along with an explanation of the formula and how the new rate will be determined. Also, the Bill prescribes new creditor disclosures for residential mortgage loans (relating to the aggregate amount of settlement charges, the fees paid to the originator, and the amount of interest paid over the life of a loan), variable rate loans for which an escrow account is established (relating to the initial and fully-indexed amount of payment) and for periodic statements for mortgage loans (including, among other things, the amount of principal, the interest rate, any applicable reset date).



The bill also includes new requirements for mortgage servicers. Among other things, the bill would:

  • Establish new requirements relating to escrow accounts, including that escrow or impound accounts must remain in existence for at least five years and until the borrower has enough equity that private mortgage insurance is no longer required (or the loan is terminated);

  • Require that disclosures be provided to the consumer regarding mandatory escrow or impound prior to consummation of the transaction, and requires that consumers who waive escrow services be provided timely and adequate disclosures;

  • Prohibit obtaining force-placed hazard insurance unless there is a reasonable basis to believe the borrower has failed to comply with the loan contract requirements, and prescribes certain notice and non-response requirements necessary to obtain force-place insurance;

  • Impose prompt crediting of payment requirements; and

  • Require that all repayment analyses include escrow payments.

In addition, this title includes new requirements on appraisals. Specifically, the Bill would prohibit the extension of a subprime mortgage without an appraisal by a qualified appraiser and the appraisal meeting certain conditions. It also makes certain actions, including coercing (or attempting to coerce) appraisers, mischaracterizing the appraised value of a property, seeking to influence an appraiser, or threatening to withhold payment for an appraisal, subject to enforcement under unfair and deceptive act or practices. It also prohibits appraisers from having conflicts of interest in the property or transaction. Additionally, the bill would set up minimum qualifications for "appraisal management companies" and minimum standards for automated valuation models. Finally, the Bill would prohibit the practice of using broker price opinions as the primary valuation of a property.



Finally, the Bill excludes one important provision that was included in H.R. 1728 as passed by the House in May 2009. The repeal of the RESPA Reform rule was omitted by the Rules Committee and is not part of the Bill passed by the House.



Financial Stability Improvement Act (Title I)



In general, this title addresses the issue of systemic risk in the financial system and how to deal with large institutions that present systemic issues. The Bill would subject entities that are identified as systemically risky to increased scrutiny and regulation, and sets up a process for resolving systemically risky institutions in case of a failure. This title:

  • Establishes the Financial Services Oversight Council, overseen by the Comptroller General, to advise Congress on domestic and international regulatory issues (including insurance, accounting, and financial markets), to monitor the financial markets, to identify potential threats to financial stability and develop plans for dealing with such threats, to subject certain financial institutions and activities to increased prudential standards, to facilitate information sharing and coordination among federal and state banking regulators, and to resolve jurisdictional disputes among regulators;

  • Sets up a framework whereby the Council can assess and recommend that regulators impose stricter prudential standards on specific companies, and gives authority to the Federal Reserve Board (the Board) and functional regulators to implement and enforce the standards, and gives the Board authority to take prompt corrective action on such entities. Notably, the Bill states that prudential standards recommended by the Board or the Council do not supersede consumer or investor protection standards;

  • Requires the Board to adopt regulations that would restrict the credit exposure of entities subject to stricter standards to less than 25% of any unaffiliated company and the limit on short-term debt, and to maintain a level of long-term hybrid debt;

  • Permits the Council to take certain actions to mitigate the systemic risk posed by a financial holding company, including modifying prudential standards, terminating activities, restricting ability to offer products or activities, or selling or divesting business units, assets, branches, etc.; and

  • Gives the FDIC the authority to set up a program to avoid an economic crisis by guaranteeing obligations of solvent companies.

This title also addresses so called "gaps" in regulation of financial institutions. Among other things, it would merge the OTS and OCC and create within the OCC a new division dedicated to thrifts. It would also create a new supervisory structure for industrial loan companies and other non-bank banks.



In addition, the title imposes various restrictions on activities with potential systemic risk implications, including:

  • Eliminating exceptions for transactions with financial subsidiaries and enhancing restrictions on bank transactions with affiliates;

  • Requiring new regulations that will require a creditor that makes a any loan to retain an economic interest "in a material portion of the credit risk" of any loan that the creditor sells, transfers or conveys (at least 5%, unless both the loan characteristics and the credit underwriting meets certain standards prescribed by the CFPA) and will prohibit a creditor or securitizer from hedging or transferring the credit risk;

  • Requiring the SEC to adopt regulations on the use of representations and warranties in the asset-backed securities market that would require disclosure on fulfilled repurchase requests across all trusts aggregated by an originator that allow investors to identify asset originators with underwriting deficiencies;

  • Providing for the resolution of large, interconnected financial companies, with the FDIC acting as receiver; and

Corporate and Financial Institutions Compensation Fairness Act (Title II)



This title imposes new restrictions and disclosure requirements on executive compensation. Among the various provisions, the Bill:

  • Requires separate shareholder vote on executive compensation and golden parachutes at annual shareholders meetings (but that such vote is nonbinding).

  • Prohibits exchanges form listing any security of an issuer who does not meet certain requirements, including maintaining an independent compensation committee and compensation consultants.

  • Directs federal regulators to prescribe regulations requiring each covered financial institution to disclose the structures of all incentive-based compensation arrangements sufficient to determine whether the compensation structure: (1) is aligned with sound risk management; (2) is structured to account for the time horizon of risks; and (3) meets other criteria appropriate to reduce unreasonable incentives offered by such institutions for employees to take undue risks.

  • Requires such regulators to prescribe jointly regulations that prohibit any compensation structure or incentive-based payment arrangement that encourages inappropriate risks by financial institutions that could: (1) threaten the safety and soundness of covered financial institutions; or (2) present serious adverse effects upon economic conditions or financial stability.

  • Exempts covered financial institutions with assets of less than $1 billion from these compensation arrangement disclosure requirements.

  • Prohibits any such regulation from requiring the recovery (clawback) of incentive-based compensation under compensation arrangements already in effect on the date of enactment of this Act, if such an agreement is for a period of no more than 24 months.

Capital Markets (Title V)

This title generally enhances regulation of participants in capital markets. Among other things, the Bill requires previously unregulated hedge funds, private equity company, and other pools of capital to register their private advisers. Investment advisers to private funds with over $150 million in assets under management will be registered with the SEC. Venture capital companies are exempt from registration, but new recordkeeping and reporting requirements are imposed on them.



This title also creates an office in the SEC to regulate nationally recognized statistical rating organization ("NRSRO"), including adding disclosure requirements on structured securities, increased corporate governance and independence requirements, and restrictions on conflicts on interests with regards to compensation and independent directors. Additionally, the Bill removes references to credit ratings in federal statutes currently under the jurisdiction of the House Financial Services Committee. It also provides for a private right of action against NRSROs.



Another section in the Capital Markets title relates to investor protection with respect to investment advisors. The Bill creates an "Investor Advisory Committee" tasked with advising the SEC on securities investor issues. The Bill creates a fiduciary duty to the investor for brokers, dealers and investment advisors. It also, among other things:

  • Includes protections and creates additional rewards for whistleblowers;

  • Exempts public companies with less than $75 million in market capitalization from Sarbanes-Oxley external audit of internal control requirements;

  • Enables the SEC to restrict or prohibit the use of mandatory arbitration clauses in contracts with broker-dealers;

  • Increases the enforcement authority of the SEC, including, among other things, imposing penalties for aiding and abetting violations of the Investment Advisers Act, imposing civil penalties in cease and desist proceedings, and enhanced application of anti-fraud provisions; and

  • Reforms the Securities Investor Protection Act, including increasing cash advance limits, increasing the minimum assessments paid by SIPC members and expanding SIPC’s borrowing authority.

Over-the-Counter Derivatives Markets Act of 2009 (Title III)



This title generally overhauls the regulation of swap markets and transactions. The bill clarifies government oversight responsibilities in the swap market by giving the SEC authority over securities-based swaps, such as equity and credit-default swaps, and giving to the Commodity Futures Trading Commission (CFTC) the authority to regulate all other swaps, such as interest-rate and currency-based swaps. The bill also clarifies that the CFTC and SEC do not have any power to exercise authority over an "identified banking product." Among other things, this title would coordinate regulation between the CFTC and the SEC and repeal exclusions form CFTC regulation of derivative transactions, electronic trading facilities, swap transactions, and other transactions in exempt commodities. It also requires the CFTC to monitor and regulate swap transactions, subjects swaps and securities-based swaps to oversight by federal banking agencies, and establishes registration requirements for swaps and swap dealers and participants.



Miscellaneous Issues



The Bill also imposes new requirements and regulations on various other activities related to financial services. Among other things, the Bill:

  • Creates a Federal Insurance Office to monitor the insurance industry and identify issues or gaps in the regulation of insurers that could contribute to a systemic crisis in the insurance industry or the United States financial system (Title VI of the Bill). The FIO could also recommend that a particular entity be subject to stricter prudential standards.

  • Addresses the handling of non-admitted insurance premiums and the ability to apply credit for reinsurance (Title VIII of the Bill);

  • Requires that servicers and lenders participating in the Home Affordable Modification Program provide data to Treasury regarding the number of requests for mortgage modifications received, processed, approved, and denied. Treasury must make available to the public data tables at the individual record level.

  • Directing $3 billion in TARP funds to the Emergency Homeowners’ Relief Fund, which will go toward insuring emergency loans or advances of credit made by lenders with respect to eligible mortgages.

  • Requires state-level data reporting for participants in the Helping Families Save Their Homes Act; and

  • Allows state regulators of loan originators to review applicants and grant case-by-case exceptions to the minimum standards, but only to the extent the exception otherwise complies with issuance of license rules.

A copy of the bill as introduced is available here.



A list of the amendments submitted for consideration can be found here.


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