In April of 2016, the FFIEC released proposed new guidelines for rating compliance programs at financial institutions.   These guidelines have since been adopted and will commence in March of 2017.  The new compliance guidelines will represent a strong departure from the current system for rating.  In addition, these guidelines present a strong opportunity for financial institutions to greatly impact their own compliance destiny.   Although these new guidelines have been released with limited fanfare, the change in approach to supervision of financial institutions has been discussed for some time and is noteworthy.  The upcoming changes to the ratings for compliance programs, will put a premium on the overall effectiveness of your compliance management program.   The stronger the program for compliance, the less likely a single finding will impact the overall rating.   

Determining Effectiveness

Although it is easy to assume that “effectiveness” is in the eye of the beholder, there are some metrics that can be used to make this determination.   Some of the factors that the regulators will consider when assessing effectiveness include:

·         Ability to identify compliance risks at the institution – under the new ratings systems the risk assessment your institution prepares will be a critical document.  On a regular basis, it is necessary to identify all the risks associated with:

o   The products you offer

o   The customers you serve

o   The It systems you are using

o   The training program you have

o   The strength of the policies and procedures in place

o   Turnover at key positions

o   New and additional products offered

Regulators will expect the risk assessment process is comprehensive and robust and all potential problems are considered and addressed.  For each risk mentioned above there should be steps designed to reduce risk to an acceptable level.  In this case, the acceptable level should match with the risk appetite of the Board.  All financial activity has some level of inherent risk.  The risk assessment should detail how your institution has identified the risk and done all that it can to reduce the risk to the level the Board has decided they are willing to take. 

·         Appropriate resources to address and mitigate risks – One of the disconnects that often occur between the completion of a risk assessment and the ongoing operation of a financial institution is consideration of the resources that are available.  For example, it is one thing to develop comprehensive procedures for testing compliance with flood rules.  It is another thing altogether not to have sufficient staff to complete all the steps in the procedures.  Moreover, if the staff that are expected to follow the flood procedures are overburdened or under trained, your plans for mitigating risk will be thwarted.  The level and quality of resources directed towards compliance will be a key consideration for the overall compliance rating under the new guidelines.  Suppose your financial institution had a finding in the flood insurance area after an examination.  If the finding was caused by an oversight, that is unlikely to repeat, the impact of the finding will be minimized.  On the other hand, if the finding was created because there wasn’t enough time or staff to do a quality check, the issue looms large. 

·         Ongoing testing of the internal controls –  Much like the old saying “an ounce of prevention is worth a pound of cure” regular testing of compliance controls can greatly enhance the effectiveness of a compliance program.  The testing doesn’t have to be extensive, just consistent.  Take five of the most recent originated loans and make sure that the disclosures were completed timely and completely.  Do the same for deposit accounts that have been recently opened.  Complete a mystery shopping event to test employee’s knowledge of products and services.   By using ongoing testing, a compliance team can determine the areas of true weakness and address them. 

·         Training of staff- Most financial institutions rely on on-line training to meet the obligations of keeping staff informed about the applicable regulations.  On-line training is an extremely useful and cost effective manner to give staff members basic understanding.  However, effective compliance programs augment this training with in-person classes that allow staff to ask real world examples.  This reinforces the information and allows for a deeper understanding of the requirements of the regulations and how staff is critical for an overall strong program. 

Using Findings to your advantage

Maintaining an effective program does not mean that there won’t be ANY findings.  It DOES mean that when errors occur, the compliance team can determine the root cause of the problem and develop a plan to address it.   An effective compliance program will be able to use findings to strengthen the program itself in the long run.    

For a Complete Discussion of the New Compliance Ratings System, please visit our blog at www.VCM4you.com

There are lessons for All Financial Institutions in the Wells Fargo Case

Part Three- Turning Our Eyes to a Glaring Need

We have talked about the Wells Fargo case involved violations of Unfair, Deceptive Acts or Practices Act.  We noted that this is true because the practices of the bank forced extra accounts and products on customers who simply didn’t want them.  In addition to unwanted accounts were significant fees and charges.  In some cases, there were as many as 10 unwanted accounts for customers of Wells Fargo.

While this case continues to wind its way through various administrative hearings, news stories and the inevitable civil lawsuits, there is a strong irony in this case that can easily go unnoticed.  There can be no doubt that customers of the Wells Fargo were victimized by an abusive campaign.  However, while these customers can be considered OVERBANKED there are simultaneously millions of Americans are unbanked and underbanked. 

A Forgotten Population

Wells and many other financial institutions continue to pursue practices that forced additional accounts on people who already had a banking relationship.  In the meantime, there are millions of potential customers who have no relationship at all as the FDIC showed inn their 2015 study of Unbanked and underbanked populations.

The FDIC has defined Unbanked and underbanked as follows:

“…… many households—referred to in this report as “unbanked”—do not have an account at an insured institution. Additional households have an account, but have also obtained financial services and products from non-bank, alternative financial services (AFS) providers in the prior 12 months. These households are referred to here as “underbanked.”^[1]

Per the Corporation for Enterprise Development, there are millions of unbanked and underbanked households across the country.  For example, in 2010 the same organization estimated that 20% of the households in New Jersey are underbanked.^[2].     The number of unbanked and underbanked people that live within the service areas of financial institutions presents both an opportunity and a level of risk.  As the FDIC pointed out in there May 2016 study “Bank Efforts to serve underbanked and unbanked Communities” the whole banking community is better served when the level of trust and participation is increased^[3].  

 

 

 

 

Why Unbanked and Underbanked?

The FDIC asks the same sorts of questions every year the answers have been consistent.  Here are some of the key observations:

·         The most commonly cited reason was “Do not have enough money to keep in an account.” An estimated 57.4 percent of unbanked households cited this as a reason and 37.8 percent cited it as the main reason.

·         Other commonly cited reasons were “Avoiding a bank gives more privacy,” “Don’t trust banks,” “Bank account fees are too high,” and “Bank account fees are unpredictable.

·         Perceptions of Banks’ Interest The 2015 survey included a new question asked of all households: “How interested are banks in serving households like yours?”

·          The survey results revealed pronounced differences across households.

·         Approximately 16 percent thought that banks were “not at all interested” in serving households like theirs, and the perceptions of the remaining 8 percent were unknown.

·         Unbanked households were substantially less likely than underbanked or fully banked households to perceive that banks were interested in serving households like theirs. More than half (55.8 percent) thought that banks were not at all interested, compared to roughly 17 percent of underbanked households and 12 percent of fully banked households.

While financial institutions are overbanking the customers they have, there are well over 50 million households in America that currently either don’t have a relationship with a bank or a minimal one. 

Why serve these communities?

In many cases, misperceptions from the point of view of customers and financial institutions keep them apart.  For far too long it has been an axiom that the costs of providing banking services for consumer accounts prevents an acceptable rate of return.  However, through the development and use of new technologies, the costs associated with consumer accounts has significantly declined. 

Without significant competition for the unbanked and underbanked households, financial needs are met by business that are predatory.  The number of financial institutions offering high cost loans has proliferated and the number of unbanked and underbanked families has grown.  

Advances in technology had made it possible for financial institutions to offer services to communities throughout the country and the world without needed to expand the branch system. Today’s digital wallet customer is tomorrow’s commercial loan. 

Compliance as an Asset

For the financial institution that considers offering new products and services using technology, a new approach to compliance must be pursued.   Currently for most financial institutions, compliance is viewed as a necessary evil expense that is at best, the cost of doing business.  However, suppose the role and function of the compliance department changed.  When the compliance department becomes fully versed in the requirements for offering Fintech products, the institution can become an active participant in the burgeoning market.  By putting resources into your institutions ability to assess and monitor risks, new products, partnerships and growth is possible.  Start thinking of compliance as an asset- it can be the gateway to new sources of income

Towards New Markets

The fact is that there are products that are available and cost effective while the market for these products is huge; there simply must be a willing spirit.  Rather than committing fraud, consider serving the unbanked and underbanked markets

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[1] FDIC survey of unbanked and underbanked households

[2] See https://cfed.org/assets/pdfs/Most_Unb anked_Places_in_America.pdf  June 2016 

[3]The FDIC recognizes that public confidence in the banking system is strengthened when banks effectively serve the broadest possible set of consumers. Accordingly, the agency is committed to helping increase the participation of unbanked and underbanked consumers in the banking system.  

There are lessons for all financial institutions in the Wells Fargo case

Part Two:  Management’s role in avoiding UDAAP violations

In the first part of this series we talked about the three prongs of the Unfair Deceptive Abusive Acts or Practices Act (“UDAAP”).  We detailed the three concepts that lead to violations and potential enforcement actions.  A brief description of the types of violations includes practices that are either:  

·         Unfair: Fees or costs that a consumer has to pay that are unfair

·         Deceptive:  Fees or costs that are not obvious in product disclosures  

·         Abusive:  Not helping the customer understand what it is they are getting into.  

The Wells Fargo case is the most recent and one of the most newsworthy cases of a financial institution being cited for violations of UDAAP.   The actions of the bank in this case are obviously egregious and for the most part it is fairly clear that customers were mistreated.    However, there are several places where potential violations of UDAAP lurk that are not nearly so obvious.   The warning signs for potential UDAAP problems are not always obvious.   Senior management must play a significant role to when it comes to avoiding UDAAP.   

UDAAP – A Different Approach

One of the vexing aspects of UDAAP violations is the manner in which they occur.  In the UDAAP world, technical compliance with a regulation is not nearly enough.   Violations are most often found in the outcome experienced by a customer of a financial institution.   While a disclosure may meet all of the requirements of the Truth in Savings Act, if fees are not explained in a manner that details the “worst case scenario” for the consumer, the disclosure might be misleading.     When considering your overall compliance program for UDAAP, it is important to consider your institutions overall level of transparency.  Marketing, disclosures and information packages must allow a consumer to understand everything that they are getting into and how much it will cost.  Financial institutions have greater resources than the customers they serve and the idea behind UDAAP is with those additional resources, your institution should do all that it can to make sure the customer understands things like overdraft fees are very expensive. 

 Management’s Role

One of the many lessons from the Wells Fargo case is that management must play a significant role in addressing potential UDAAP issues.   An excellent source of information to determine potential problems is the customer complaints log.   By keeping track of the complaints from customers and following up on those complaints, management can get an early warning that customers experience does not match what they thought they were getting.   Compliant logs should be reviewed and considered as part of ongoing compliance committee meetings. 

Another area for management to consider is large increases in non-interest income that far exceeds projections.  Put another way, when overdraft fees become a significant part of your income, there is strong potential for a UDAAP concern.   Management must keep a close watch for unintended consequences.

 

UDAAP Pitfalls

Here is a list of practices that have come under scrutiny for UDAAP consideration

•       Overdraft programs

·           Excess Flood Insurance

•       Debt collection Practices

•       Loan payment processing

•       ATM fees

•       Loans with balloon payments

•       Credit life and disability insurance sales

•       Rewards programs

•       Gift card sales

•       Credit Card programs

 

This is not to say that any of these programs are forbidden or even a bad idea.  Instead, what is necessary is to make sure that as you offer these programs or products, the disclosures about them are both clear and consistent. 

Taking the followings steps when assessing overall UDAAP potential problems at your bank may reduce risk: 

 

1.     Review all of the product features of consumer products at your bank.  For all products that have the potential to add fees or costs (such as early withdrawal penalties), review for potential UDAAP concerns;

 

2.     Have several members of staff review product features to determine whether the potential for misunderstanding exists;

 

3.      Review the revenue streams for consumer products and look for increases of more than 1% per quarter.  In the event that revenue has increased, determine the reason for the increase;

 

4.      Review the written and oral disclosures given to customers to ensure they are consistent and correct;

 

5.      Review current agreements with third party servicers to make sure there is a clear understanding of the services being provided: 

 

6.      Conduct thorough and regular due diligence on third party servicers; 

 

7.      Complete a regular check to ensure the language on all mediums of communication with the public is consistent (a maintenance fee is a maintenance fee);

 

8.       Evaluate customer complaints for signs of more serious systemic problems

 

***For a more complete discussion of UDAAP concerns please visit us at www.VCM4you.com***

There are lessons for all financial institutions from the Wells Fargo case

A Three Part Series- Part One- Understanding the Power of UDAAP

The recent news about a huge fine levied against Wells Fargo financial institution presents a cautionary tale for all financial institutions regardless their size.  The law and regulation that were used to construct the enforcement actions against the financial institution and the subsequent fees and fines come from the Unfair, Deceptive, Abusive Acts or Practices Act (“UDAAP”).   UDAAP is an extremely powerful regulation and it is important to remember that with these types of violations the considerations are different from other areas.   A product or a practice can be technically in compliance with the spirits of a regulation, but still have UDAAP implications.  

A brief description of UDAAP

At the end of the Great Depression, there was a public outcry for changes in regulations that dealt with all manner of financial institutions.  During the financial crash consumers found many of the promises that had been made by business were not kept.  Insurance companies did not pay as promised, department stores that had promised refunds for returns reneged, financial institutions closed overnight and business in general were able to avoid payments to consumers that they promised.    Neither state governments nor individuals had many options when they found they had been misled or defrauded.   A consumer who was defrauded often found fine print in the contract immunized the seller or creditor. Consumers could fall back only on claims such as common law fraud, which requires rigorous and often insurmountable proof of numerous elements, including the seller’s state of mind. Even if a consumer could mount a claim, and even if the consumer won, few states had any provisions for reimbursing the consumer for attorney fees. As a result, even a consumer who won a case against a fraudulent seller or creditor was rarely made whole. Without the possibility of reimbursement from the seller, consumers could not even find an attorney in many cases.  [1]

Among the changes being requested were laws that prevented practices that were deceptive or fraudulent.  Eventually it fell to the Federal Trade Commission, FTC, to write regulations for consumer protection on a federal level.  Unfair and Deceptive Act statutes were passed in recognition of these deficiencies. States worked from several different model laws, all of which adopted at least some features of the Federal Trade Commission Act by prohibiting at least some categories of unfair or deceptive practices. But all go beyond the FTC Act by giving a state agency the authority to enforce these prohibitions, and all but one also provides remedies consumers who have been cheated can invoke.  In addition to the FTC regulations, state laws and court decisions help to shape the definition of unfair or deceptive business practices.  

The Predecessor

The original UDAP (with one “A”) Unfair, Deceptive Acts or Practices is derived from Regulation AA, also known as the Credit Practices Rule.   The regulation was divided into two subparts;  

·         Subpart A outlines the process for submitting consumer complaints to the Board of Governors of the Federal Reserve System’s Division of Consumer and Community Affairs

·         Subpart B puts forth the credit practice rules pertaining to the lending activities of financial institutions. It defines certain unfair or deceptive acts or practices that are unlawful in connection with extensions of credit to consumers

·         Certain provisions in their consumer credit contracts, including confessions of judgment, waivers of exemptions, assignments of wages and security interests in household goods unfair or deceptive practices involving co-signers

·         Pyramiding late charges, in which a delinquency charge is assessed on a full payment even though the only delinquency stems from a late fee that was assessed on an earlier installment

 

Through the last half of the 20th century, UDAP regulation was largely the purview of the Federal Trade Commission.  Financial institution regulatory agencies generally issued guidance for financial institutions to follow and some the practices that we mention above were specifically prohibited.   However, the truth of the matter was that UDAP enforcement was not exactly a matter of grave concern in the financial institution industry. 

UDAAP-Supercharged

The financial meltdown of 2009 lead to many changes in regulations including the passage of the Dodd-Frank Act.  Among the changes brought about by Dodd-Frank, was the supercharging of UDAP.  The regulation became the Unfair Deceptive Abusive Actions, Practices, or UDAAP.  

UDAAP with two ‘A’s goes beyond extensions of credit and introduces an enterprise-wide focus on all the products and services offered by your institution.   The CFPB has been given the authority to bring enforcement actions under UDAPP.    Considered at a high level, UDAAP is more of a concept than an individual set of regulations.   The idea is that dealings with the public must be fair and that financial institutions should in fact look after the best interests of its customers. 

Another key difference is that UDAAP coverage makes it unlawful for any provider of consumer financial products or services to engage in unfair, deceptive or abusive act or practices; therefore, this regulation may be applicable far beyond financial institutions.

Under the new UDAAP regime, financial institutions can be liable for the actions of the third party processors that they hire.  This is one of the many reasons why vendor management has become such an important area. 

Even though there a great number of laws that deal with required disclosures on financial products such as loans and certificates of deposit, these laws generally do not deal with the fairness of the terms or the possibility that a consumer may unwittingly agree to additional fees and terms that go well beyond the agreed to interest rate.   UDAAP is designed to address this problem.  

The Basics

What is “unfair’?

·         The practice causes or is likely to cause substantial injury.

·         The injury cannot reasonably be avoided.

·         The injury is not outweighed by any benefits.

 

Briefly, what this means is if a customer has to pay fees or costs because of some act by the financial institution that is deemed unfair, then a substantial injury has occurred.  The description of the regulation does say the injury does not necessarily have to be monetary, it can be emotional.  However, there are no current examples of this second form of substantial injury.   This is the section of the regulation that is most often applied to overdraft programs.  Even in the cases where financial institutions allow overdrafts only after getting a customer’s permission and providing monthly statements that show the amounts of overdraft fees that have been paid, a substantial injury can be found.

What is “deceptive”?

·         The practice misleads or is likely to mislead.

·          A “reasonable” consumer would be misled.

·         The presentation, omission or practice is material.

According to the CFPB, to determine whether an act or practice has actually misled or is likely to mislead a Consumer, the totality of the circumstances is considered. Deceptive acts or practices can take the form of a representation or omission. The Bureau also looks at implied representations, including any implications that statements about the consumer’s debt can be supported. Ensuring that claims are supported before they are made will minimize the risk of omitting material information and/or making false statements that could mislead consumers.

 Any programs that have the possibility of late fees or additional fees as the result of balances, usage charges or any fees that are in addition to the initial fees all have the possibility being misleading.  We have found this section is most often cited when the language used in disclosures does not match the language in advertisements or on the website.  For example, in one case, a financial institution called a fee a “maintenance fee” in its advertisements, but called the fee a “monthly” fee in the disclosures  it gave customers at the time they opened the accounts.   This was cited as a deceptive disclosure.  

What is “abusive”?

·         The practice materially interferes with the consumers ability to understand a term or condition of a product or service.

·         The practice takes unreasonable advantage of a consumer’s lack of understanding of the risk, costs and conditions of a products or service.

The CFPB description of this portion of the regulation notes a consumer can have a reasonable reliance on a financial institution to act in his or her best interests.   This means for products or services which are offered that have the ability to add fees or costs, there is an affirmative duty to make sure the customer knows what it is they are getting into.  It is also critical to pay particular attention to the second part of rule which defines abusive; a practice that takes advantage of a customer’s lack of understanding of fees and costs of a product.   This part of the rule requires Financial institutions to be vigilant not only about disclosures they give to customers, but also about the level of fees being charged to the customer.   An add-on interest charge may make economic sense.  It may also be designed with a legitimate business purpose in mind.  The fee can be applied to all customers that have a specific type of account and therefore, not a violation of fair lending or equal credit opportunities laws.  However, these types of fees can adversely impact customers of limited means.  As a result, these sorts of additional charges on an account can represent a UDAAP concern. 

 

Part Two-The role management must play in preventing UDAAP violations  

 

For More information on UDAAP and ways to avoid penalties, Contact us at WWW.VCM4you.com

The Beneficial Ownership Rule- A Two Part series
Part Two – Due Diligence-the Fifth Pillar 

The Beneficial Ownership Rule- A Two Part series

Part Two – Due Diligence-the Fifth Pillar   

In the first part of this series we described the new beneficial ownership rule.  We talked about the reasons that the rule was passed and we noted that the central idea of this rule is making sure that financial institutions get complete information when an account is opened for a legal entity.   This is especially true when a legal entity has a complex ownership structure.    There is a second aspect of the rule that changes the due diligence process for legal entities to a dynamic one.   This portion of the rule is being called the “fifth pillar” of BSA/AML compliance programs.  

Due Diligence

Under the new Beneficial Ownership rule, the definition of due diligence is essentially changed, especially for accounts that are opened for legal entities.   The rule specifically requires institutions to obtain background information on any person that owns, or controls the legal entity.  For purposes of this rule, ownership is defined as anyone who maintains an ownership stake of 25% or more of the entity.  Control means anyone who has a significant responsibility to manage or direct the entity.  A controlling person could have zero ownership interest in an entity.  

Currently information about the persons who control or own legal entities is not necessarily required, although as a best practice, this information should often be considered important to the due diligence process.   The Beneficial Ownership rule makes obtaining the ownership and control information a requirement of the account opening and due diligence process.  The rule also requires that financial institutions should write policies and procedures that reflect these requirements.     The rule notes that the policies and procedures should be risk based and should detail the various steps taken based upon the risk rating of the account.   The types of documentation that can be considered acceptable for meeting the requirements of the rule are described.   

Due Diligence as a dynamic process

When developing your compliance program to meet the requirements of the new rule, consider that due diligence for legal entities should become a dynamic process.  It won’t be enough to obtain ownership and control information at the time the account is opened and then stop.  There must be ongoing monitoring of accounts for changes in the ownership or control and analysis of what those changes mean. 

In recent years, one of the tactics that money launders have employed is to take over legitimate long standing business to hide “dirty money”.   For example, in late 2014, the Los Angeles area garment industry was overrun by a scheme known as “Black Market Peso Exchanges.   Drug money was used to purchase goods and then the goods were shipped to other countries where they were resold and converted back to cash.  In many cases, the reason that this scheme was able to proceed was that the person or persons that desired to launder the money became a part owner of what was once a legitimate business. 

In a similar manner, when a person who has bad intentions is able to control an entity, then the possibility that suspicious activity might occur goes up exponentially.   An important part of ongoing monitoring for suspicious activity must be continuing due diligence on both the ownership and controlling persons of an entity.   

Asking the second Question

Once information is obtained about the owners and/controllers of a legal entity there is an additional review process that should occur.   Does the owner or controller of the legal entity increase the likelihood or potential for money laundering?  In the alternative, does the information that you have obtained about the owner or controller leave more questions than answers?  For example, suppose your corporate customer runs a small flower shop on main street.  One day, a 30 % interest in the flower shop is purchased by a man who is the owner of the local casino.  Why would the owner of a casino want a flower shop business?  Since a casino is a high cash, high risk, business, and people do still buy flowers with cash, there is an increased risk that the new controlling person may try to move some of his money through the deposits of the flower shop.  In this case, the best practice would be to find out all that you could about the new owner and why this controlling interest makes sense.   Moreover, now is the time to determine whether or not your BSA department still has the capability to monitor the flower shop now that it has a new owner.  Do you have the ability to determine whether suspicious activity might be occurring?  Not only should due diligence be dynamic, it should also include the analysis necessary to make the most efficient use of the information obtained.

The Beneficial Ownership Rule- A Two Part series

Part One - What is the rule and What Does it mean to Me?  

On May 11, 2016, the Financial Crimes Enforcement Network (“Fincen”) announced its final rule strengthening the due diligence requirements for covered financial institutions.  This rule is generally known as the “beneficial ownership rule”.   This rule represents a significant change in the overall administration of Bank Secrecy Act/Anti-Money laundering (“BSA/AML”) compliance programs.   The purpose of the change was made clear in Fincen’s announcement of the final rule”

“Covered financial institutions are not presently required to know the identity of the individuals who own or control their legal entity customers (also known as beneficial owners). This enables criminals, kleptocrats, and others looking to hide ill-gotten proceeds to access the financial system anonymously. The beneficial ownership requirement will address this weakness^[1]

Put another way, the purpose of this rule is to address one of the biggest weaknesses in the current system for identifying suspicious activity.   The fact that that financial institutions have been required to obtain information about a legal entity without considering the ownership and /or control of the legal entity has allowed many a “bad guy” to effectively hide his/her illicit activity.   The preamble to the rules lists out several examples of how legal entities have been taken over by criminals in an effort to launder money.  Some of the more interesting examples included: 

• A series of shell companies that were used to take over and loot a publicly traded mortgage company. 
• Using a series of small legal entities to cover a drug smuggling ring 
• Using a series of companies that were ostensibly for movie production to hide large amounts of cash that was being used for human trafficking

In all of the cases that were cited, the common feature was the ownership and control of the legal entities was obscured by a complex holding structure.   The beneficial ownership rule is designed to addresses this practice.   The rule requires that a financial institution doing business with a legal entity should know who owns and controls the entity.   This is the enumerated requirement. However, it should be the understood that simply knowing this information is not enough.  Once the due diligence information is obtained, it is critical to ensure that it makes sense in context.   For example, does it really make sense that a flower shop owner also owns a casino?  These business are entirely unrelated except for the fact that they are both often cash intensive businesses.   

The Rule Itself 

The final rule creates a “fifth pillar” in the standard group of expectations for a comprehensive BSA/AML compliance program.  Ongoing and risk based due diligence for customers will now be considered an essential part of the compliance program.   The rule makes due diligence a dynamic process rather than the traditional process that essentially ended at the time the account was opened.  Financial institutions are expected to stay abreast of who the beneficial owners of a legal entity are and how their ownership might impact ongoing monitoring of the account.   As the beneficial owners change, then the manner in which the account is viewed should change accordingly. 

Beneficial Ownership is a broad definition that includes both ownership and control.  

Ownership – is denied as any person who directly or indirectly owns more than 25 percent of the equity of a legal entity

Control – The term “beneficial owner” means a single individual with significant responsibility to control, manage, or direct the legal entity customer (e.g., a Chief Executive Officer, Vice President, or Treasurer).

These two prongs are critical because there are many times when a person or persons could actually have a minimal ownership stake in a firm or even no actual legal ownership, but still have the ability to control the firm.   The rule requires all covered institutions to obtain information on all people who own or control a legal entity.  

Financial institutions are expected to design policies and procedures that detail how staff will use their best efforts to establish and maintain written procedures that are reasonably designed to identify and verify beneficial owners of a legal entity customer. The procedures must allow the financial institution to identify all beneficial owners of each legal entity customer at the time of account opening unless an exclusion or exemption applies to the customer or account.  ^[2]

Why Wait?

The rule requires all covered institutions to be in compliance by May of 2018.  Covered institutions in this case means:

“For purposes of the CDD Rule, covered financial institutions are federally regulated banks and federally insured credit unions, mutual funds, brokers or dealers in securities, futures commission merchants, and introducing brokers in commodities” ^[3]

Though this rule only technically only applies to covered institutions, it will be prudent for all financial institutions to become familiar with the requirements of the regulations and to apply the standards enumerated therein.  Financial institutions will expect that their Money Service Businesses meet the same standards because the risks for undetected suspicious activity is the same.    

There is absolutely no reason to wait to implement the principals detailed in the rule.  By developing policies and procedures that are able to determine beneficial ownership, a financial entity can have more effective risk mitigation of its customer base.  At the end of the regulatory day, knowing your customers and what it is that they do is the heart of any string AML Compliance program

 

In Part Two- we will discuss the details of a strong beneficial ownership program. 

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[1] www.federalregister.gov/articles/2016/05/11/2016-10567/customer-due-diligence-requirements-for-financial-institutio

[2] These excluded entities include banking organizations; entities that have their common stock listed on the New York, American, or NASDAQ stock exchanges; SEC-registered investment companies and advisers; CFTC-registered entities; state-regulated insurance companies; foreign financial institutions established in jurisdictions that have beneficial ownership reporting regimes; and legal entities with private banking accounts subject to FinCEN rules

[3] FIN-2016-G003  questions

Advertising and Fair Lending – A balancing test

 

When reviewing the overall effectiveness of your fair lending program, one of the areas that can often be overlooked is the area of potential discouragement.  This area requires a great deal of empathy at best, and knowledge of the community and the history of the community at a minimum.  Discouragement can be a matter of interpretation; one persons’ joke can be another’s insult.  Moreover, discouragement can often be difficult to recognize.  After all, discouraged persons are unlikely to have contact with the financial institution and it is difficult to know about the people who do not apply for services.  Preventing discouragement is not only a good compliance policy; it also helps a financial institution reach out to potentially large pockets of customers. 

Advertising is one of the more important areas of fair lending to review.  An advertising campaign can be published with the greatest of innocent intent and still have the effect of discouraging members of a community from participating in the financial institution.  When this issue comes up it is often in the context of a financial institution using testimonials from people in its advertising.  Several financial institutions have been admonished to make sure that the people used in advertising are diverse.  The thinking here is that the more diverse the people in the advertisements, the more open the financial institution will appear to be.  However, even when widely using people from various ethnicities in advertising, it is possible to discourage potential customers with advertising. 

 

Fair Lending Laws

Discouragement is generally reviewed as part of the fair lending audit performed by the regulators.  Fair lending is a combination of a set of regulations that are brought together to make a determination of how a financial institution avoids overt and unintentional discrimination.  The laws that combine to form fair Lending include

·         The Equal credit opportunity Act (Regulation B)

·         The Fair Housing Act

·         The Truth in Lending act

·         Unfair Deceptive Abusive Acts or Practices Act (UDAAP) 

Of these regulations, the Equal Credit Opportunity Act specifically prohibits discouragement of applicants.  Section 202.4b says specifically:  

Discouragement. A creditor shall not make any oral or written statement, in advertising or otherwise, to applicants or prospective applicants that would discourage on a prohibited basis a reasonable person from making or pursuing an application.

 

Fair Lending laws specifically establish groups of people who are specifically protected.  The rationale for these groups is that there have been documented instances in the past where financial institutions engaged in behavior that directly discriminated against them.  When congress was considering these laws there were several studies performed and hearings conducted that showed that certain practices by financial institutions had to be limited.  The US Supreme Court has also added to the purview of the fair lending laws by adding definitions for the way financial institutions practices might be interpreted as violating fair lending laws.  The Supreme Court has established that there are three types of discrimination that can occur under fair lending laws: 

·         Overt Disparate Treatment- a lender discriminates on a prohibited basis.  For example, only making loans to men, or only to Christians  

·         Comparative Evidence of Disparate Treatment – a lender treats two sets of people who are similar in different ways.  For example, a male lender receives assistance with the completing of his application while a female applicant is left to complete the application on her own  

·         Evidence of Disparate Impact –a policy that is neutral on its face but impacts protected groups unequally.  For example, a lender decides that it will not count part time income as income for purposes of loan underwriting.   Although this policy might be applied equally to all applicants, since most part time employees are women and minorities, the policy would have a harsher impact on these groups. 

Discouragement Comes in Many Forms

Based upon the definitions given by the court, discouragement can take on many different forms.  For example, suppose a loan officer made a statement to borrowers that they “really don’t want to make home loans to women, but the law says we have to”.  This sort of statement would be the overt disparate treatment type of discouragement.  Very few women who heard such a statement would continue with the loan process.  The fact that the loan officer is naming a protected class with their statements makes the discouragement the type that falls under overt disparate treatment.

When lenders advertise and use people in their advertisements, they run the risk of comparative evidence of disparate treatment.  Advertising that excludes certain members of a community or implies a preference of one group over another can also be a form of discouragement.  This area of fair lending laws is nuanced and requires some level of empathy to navigate successfully. 

One case that we came across was particularly instructive.  A financial institution had prepared an advertising campaign that focused on the history of the financial institution.  Included in the advertisement were various pictures from the time of the formation of the financial institution which in this case was pre-civil war.  The ad campaign was designed to focus on the significant people in the financial institutions history such as the founder of the financial institution and his descendants who ran the financial institution throughout the years.  The financial institutions' compliance staff had reviewed the campaign and approved it.  Senior management at the financial institution was quite proud of the campaign.   Imagine the surprise of management when they were informed by the regulators that the posters amounted to a form of discouragement! 

As it turned out there were two factors that played into the regulators decision.  First, the history that was described in the timeline of the advertising campaign was painful for many of the people of color within the financial institutions’ service area.  Unfortunately, during the same time period that financial institution was growing, many hurtful things were happening to members of the community.  This was not to say that the financial institution was in any way involved in the terrible things that had happened.  However, an advertising campaign that highlighted the time when these things happened was at a minimum, insensitive.  The other factor that played into the judgment of the regulators was that the demographic make-up of the financial institution’s service area had significantly changed since the opening of the financial institution.  Therefore, the people depicted in the advertisement did not represent the current universe of potential clients.  

In another example, in 2010, the Federal Reserve ordered a financial institution in Oklahoma to take down advertisements that included a cross, a bible verse and the statement “Merry Christmas, God is with Us”.  In this case, the advertisement was interpreted to discourage people who were not Christian from applying at the financial institution.  [1]

As you might imagine, in both of the cases described above the management teams were stung and upset.  In the Oklahoma case, the management of the financial institution went to their members of Congress and did eventually get the decision reversed, but it did not end the scrutiny of the financial institution’s policies and procedures.  

Discouragement can cause Economic Pain to Financial Institutions

As we mentioned at the outset, discouragement is an area that can be difficult to discern.   Of course, the common approach has been for financial institutions to avoid all uses of people in advertising and to limit publications to basic information about the financial institution.  The truth is that even using this approach can result in a finding of discouragement.  For example, in the case of USA V First American Financial institution, one of the practices that were specifically pointed out was:

The Financial institution has also consistently directed its print media advertising to daily newspapers of general circulation and neighborhood and suburban weekly newspapers serving largely non-minority city neighborhoods and suburbs in the Chicago MSA. Until at least December 2002, the Financial institution had never advertised in minority-focused publications, many of which have larger circulations than some suburban newspapers the Financial institution has used.[2]

 

Excluding advertising from publications in the service area can also be a form of discouragement.  In the case of First American, this was one of the factors that contributed to the penalties and fees that assess to the financial institution. 

Reducing the Possibilities of Discouragement

Avoiding publications that cater to specific segments of a community is the same as missing opportunities for growth.   Advertising strategy should be aggressively inclusive of the various businesses social and ethnic groups that make up the communities that surround your financial institution.  To take on such a strategy, we recommend the following steps:

 

1.        Know the Players:  As part of your community reinvestment act program, the institution should make attempts at outreach to the various service groups within the assessment area.  It is critical that this effort should include identification of the most influential of the community groups and the ways in which the financial institution may partner with these groups

2.       Know the History of the Area:   The historical development of an area is often overlooked when developing advertising and products at financial institutions. It is important to know and understand both the good and the bad history of your area.  In this manner, you can prepare the financial institution for potential complaints and make your outreach more effective

3.       Test the Staff:  It is an excellent idea to get “mystery shoppers” to test staff on the presentations being made to the general community.  A quick and simple review of customer experiences can be illuminating.  Often times, misunderstandings of policy can result in fair lending issues that are much unexpected. 

4.       Training: It is a best practice to conduct interactive training that is designed to assist staff in their understanding of the history of and intentions of fair lending regulations.  When staff understands its role in an overall larger scheme, compliance becomes most effective. 

 

 

 

** For more information about methods to avoid discouragement and ways to enhance your fair lending program, please contact us at www.VCM4you.com**

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[1] Feds Force Okla. Financial institution To Remove Crosses, Bible Verse Federal Examiners Say Religious Decoration Inappropriate

Read more: http://www.koco.com/Feds-Force-Okla-Financial institution-To-Remove-Crosses-Bible-Verse/10744952#ixzz3A3NxbtKf

[2] CIVIL ACTION NO. 04C 4585 Consent order