Customer Due Diligence Rule — Key Practical Resources

FinCEN’s Customer Due Diligence Rule for Financial Institutions (the “CDD Rule”) became effective yesterday.  The rule, which was published by FinCEN on May 2016 (and slightly amended on September 29, 2017) is described in this Covington client alert.  It requires covered financial institutions to: (i) adopt due diligence procedures to identify and verify a legal entity customer’s beneficial owners at the time a new account is opened and (ii) establish risk-based procedures for conducting ongoing customer due diligence, including developing customer risk profiles and implementing ongoing monitoring to identify and report suspicious activity and, on a risk basis, updating customer information.

In the months leading up to the CDD Rule’s effective date, FinCEN, the FFIEC and other agencies released a number of documents that provide practical guidance on its implementation.  Those include:

  • Two new sections of the FFIEC’s BSA/AML Examination Manual, which focus on the CDD Rule and were publicly circulated yesterday in the form of an FDIC Financial Institution Letter.  This document will be used by federal bank examiners at the Fed, the OCC, the FDIC and the NCUA to guide their examination and supervision of financial institutions for compliance with the CDD Rule.
  • A FinCEN FAQ document, which was updated last month.  The updated FAQs — which supplement FAQs issued in July 2016 — address questions related to the CDD Rule’s identification and verification requirements and the Rule’s application to legal entity customers with complex ownership structures, among other issues.
  • A Regulatory Notice released by FINRA at the end of last year, which provides guidance on the application of the CDD Rule to broker-dealers.

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Release of 2017 HMDA Data

The Federal Financial Institutions Examination Council (FFIEC) released yesterday data on mortgage lending at institutions covered by the Home Mortgage Disclosure Act (HMDA) — a total of just under 6,000 banks, credit unions and non-bank mortgage lenders.  Concurrently, the Consumer Financial Protection Bureau (CFPB) released a “first look” report on mortgage market activity and trends based on a selection of the newly released data.

As the CFPB points out, this year’s release is notable for two reasons, among others:

  • First, it reflects recent changes to the CFPB’s Regulation C, which generally exempted institutions from HMDA reporting if, in either of the two preceding calendar years, they originated less 25 reportable home purchase loans (including refinancings).  This contributed to a modest 13% decline in the number of participating institutions.  (We previously discussed other aspects of the CFPB’s amendments to Regulation C, including in these posts.)
  • Second, it reflects the first year during which HMDA data will be available in a dynamically updated format through the FFIEC HMDA Platform.

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Australia and Malta Adopt Different Approaches to Cryptocurrency and Blockchain Regulation

The Australian Transaction Reports and Analysis Center (“AUSTRAC”) recently implemented a new regulation for digital currency exchange providers operating in Australia called the Anti-Money Laundering and Counter-Terrorism Financing (Digital Currency Exchange Register) Policy Principles 2018.  AUSTRAC is Australia’s financial intelligence agency and is responsible for the enforcement of Australia’s Anti-Money Laundering and Counter-Terrorism Financing Act (“AML/CTF”).

The new Australian regulation requires any digital currency exchange provider operating in the country to register with AUSTRAC and comply with the AML/CTF requirements.  It is intended to minimize the risk that criminals use cryptocurrencies like bitcoin to conduct money laundering, terrorism financing and cybercrimes.  According to the CEO of AUSTRAC, the regulation “will help strengthen public and consumer confidence in the sector.”

Australia’s regulation, focusing on financial crimes, is less comprehensive than the legal framework being crafted by Malta for cryptocurrencies and blockchain technology, which includes the Malta Digital Innovation Authority Bill, Technology Arrangements and Service Providers Bill, and the Virtual Currencies Bill.  Malta aims to position itself as the “natural destination” for businesses that operate in the blockchain space, according to Silvio Schembri, the Junior Minister for Financial Services in the Office of the Prime Minister of Malta.

Bureau of Consumer Financial Protection Amends Timing Provisions of Federal “Know Before You Owe” Rule

On April 26, 2018, the Bureau of Consumer Financial Protection (the “Bureau”) finalized an amendment to the “Know Before You Owe” mortgage disclosure rule (also known as the TILA-RESPA Rule), which it proposed in July 2017 and which we previously described in this blog. The amendment eliminates uncertainty regarding a timing restriction in the TILA-RESPA Rule, specifically whether and when a creditor may use a Closing Disclosure to communicate increased closing costs charged to consumers.

The TILA-RESPA Rule requires a creditor to provide a good faith estimate of loan terms and closing costs on a Loan Estimate, which must be delivered or placed in the mail to a consumer no later than three business days after the consumer submits a loan application. In certain circumstances, the creditor may use a revised estimate, as opposed to the estimate originally disclosed, as the good faith estimate. If the creditor uses a revised estimate, the creditor must provide the consumer with a new Loan Estimate reflecting the revised closing costs within three days of receiving information that prompts the revised estimate.

The existing TILA-RESPA Rule contained restrictions on the timing of providing a Loan Estimate: (i) the consumer must receive any revised Loan Estimate no later than four business days prior to consummation; and (ii) the creditor cannot provide a revised Loan Estimate on or after the date it provides the Closing Disclosure to the consumer, which must be at least three business days prior to consummation. However, if there were less than four days between the time the revised estimate is required to be disclosed and consummation, then the TILA-RESPA Rule provided that the creditor could include the revised closing cost estimates in the Closing Disclosure.

These restrictions created a “black hole” period during which a creditor could learn of closing costs not initially disclosed on a Loan Estimate that could be included in a revised estimate, but would be unable to provide a revised estimate on either a Loan Estimate or Closing Disclosure. For example, under the existing TILA-RESPA Rule, if a creditor provided the Closing Disclosure to the consumer and an event subsequently occurred that caused an increase in closing costs, the creditor could not disclose such costs on a revised Loan Estimate. Moreover, the existing TILA-RESPA Rule did not specify whether a creditor could revise the Closing Statement to reflect the newly incurred costs if there were more than four business days between the time the creditor was supposed to provide the revised version of the disclosures and consummation.

The Bureau’s April 26, 2018 final rule specifically provides that a creditor may use a Closing Disclosure, instead of a Loan Estimate, to reflect changes in closing costs for the purpose of determining whether an estimated closing cost was disclosed in good faith, regardless of when the Closing Disclosure is provided relative to consummation. The final rule is generally consistent with the July 2017 proposed rule.

The final rule will go into effect 30 days after publication in the Federal Register.

Cboe Contributes to Ongoing Discussion Regarding Cryptocurrency ETPs

Last month, Cboe Global Markets, Inc. (“Cboe”) responded to a staff letter on cryptocurrency funds and related investment products published by the SEC earlier this year.

The SEC staff letter recognized that proponents of cryptocurrencies have identified a range of potential benefits and that innovation is important, but the SEC also identified a number of risks associated with such investment products and raised a number of questions regarding how such assets would satisfy the ‘40 Act and its rules. The SEC’s letter invited interested sponsors to engage with the SEC in detail on these issues.

Cboe’s response to that letter specifically encourages the SEC to permit cryptocurrency exchange-traded products (“ETPs”). Cboe discussed the SEC’s concerns, and concluded that while cryptocurrency holdings do present some unique issues, many of the risks associated with cryptocurrency ETPs could be addressed within the existing framework for other commodity-related funds. Cboe added that, where it could be reasonable for an investment portfolio to provide exposure to cryptocurrency, an ETP would provide a more transparent and accessible vehicle to gain such exposure. Cboe concluded that, in light of that fact, where the market and infrastructure for the underlying asset and its derivatives do not cause significant concerns regarding the issues raised in the Staff letter, “the Commission should not stand in the way of such ETPs coming to market.”

SEC Proposal Dives Into Long-Standing Debate About the Duties of Investment Professionals

On Wednesday, April 18th, the SEC introduced a much-anticipated package of proposed rules and formal guidance concerning the standards of conduct for financial professionals. The more than 1,000-page proposal, which emerged eight years after Congress required the agency to conduct a study on the topic, addresses whether investment advisers and broker-dealers should have identical or different standards of conduct vis-à-vis their retail customers. This alert takes a look at the four key parts of the SEC’s proposal.

Read the full alert here.

FSOC to Consider First Case Under Dodd-Frank’s Hotel California Provision

The Financial Stability Oversight Council (“FSOC”) has announced that on Thursday, April 12, 2018, it will consider a “potential application” from a bank holding company or its successor to be de-designated as a systemically important financial institution under section 117 of the Dodd-Frank Act.

Sometimes known as the “Hotel California” provision,[1] section 117 of Dodd-Frank provides that any institution that was a bank holding company with $50 billion or more in total consolidated assets as of January 1, 2010, participated in the Capital Purchase Program of the Troubled Asset Relief Program, and ceases to be a bank holding company, will presumptively be treated as a nonbank systemically important financial institution (“nonbank SIFI”) and continue to be supervised and regulated by the Federal Reserve.  Such an institution may appeal its designation as a nonbank SIFI to FSOC, which may grant the appeal by a vote of two-thirds or more of its voting members, including an affirmative vote by the Chairperson (the Secretary of the Treasury).

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FTC Files Comments with CFPB on CID Processes

On March 26, 2018, the staff of the Federal Trade Commission’s Bureau of Consumer Protection (“BCP”) filed a comment in response to the Consumer Financial Protection Bureau’s Request for Information on the procedures for issuing Civil Investigative Demands.

In large part, the comment summarizes the BCP’s experience with its own CID program and highlights the BCP’s recent reform efforts. However, the FTC staff comment also provides recommendations to the CFPB, several of which are summarized here:

  • The comment notes that the CFPB Director, Assistant Director, and Deputy Assistant Directors of the Office of Enforcement all have the authority to issue CIDs, whereas this authority at the FTC is limited by statute to the FTC Commissioners themselves, who review and often modify CIDs or even decline to issue them. FTC staff suggest that review by a “very senior official” is appropriate because of the seriousness of a CID and that the CFPB may wish to consider revising its delegation of authority accordingly. Moreover, the comment emphasizes that agency-head approval “ensures that there will be an independent assessment of the costs and benefits of the CID by someone who is not conducting the investigation.”
  • FTC staff also recommend applying an oversight approach to opening and closing investigations that is more consistent with the FTC’s. The heads of both agencies delegate the authority to initiate investigations. At the FTC this delegation includes delegation to managers in the BCP, led by the BCP Director. The comment notes that the BCP Director meets “regularly” with the Commissioners to maintain a close understanding of their enforcement priorities and objectives. In turn, the BCP Director must ensure that the other BCP managers make decisions about opening, furthering, or closing investigations consistent with those priorities and objectives.
  • The comment suggests that the CFPB use its response to the RFI to publicly “ratify” the agency’s recently adopted policy that CIDs include a more specific description of the relevant investigation and how the requested information is connected to that investigation. The comment notes that the CFPB’s new policy brings it in line with FTC practice.
  • FTC staff also suggest that the CFPB pair its meet-and-confer requirement with delegated authority to enforcement staff allowing the staff to modify the time and manner of complying with a CID, contingent on a CID recipient demonstrating progress toward compliance with the information demands.
  • The BCP staff also recommend that the CFPB shorten and simplify the production requirements for electronically stored information. The comment notes that the BCP’s guidelines are “significantly shorter and less complex.”

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Treasury Releases Recommendations to Reform CRA Framework

On April 3, 2018, the Department of the Treasury (“Treasury”) released its much-anticipated recommendations to reform the Community Reinvestment Act (“CRA”). The report, which is addressed to the federal banking agencies, outlines a number of proposed regulatory and administrative changes to (i) the CRA’s performance evaluation criteria, and (ii) the federal banking agencies’ approach to examining banks’ CRA performance. Treasury’s recommendations focus on four “key areas”:

  • Assessment Areas: Treasury recommends expanding the definitions of geographic assessment areas to extend beyond a financial institution’s physical footprint and account for areas where the financial institution “accepts deposits and does substantial business.” According to Treasury, this expansion would account for “the changing nature of banking arising from changing technology, customer behavior, and other factors.”
  • Examination Clarity and Flexibility: Treasury also recommends enhancing flexibility in the CRA performance evaluation process, including by establishing clearer CRA examination guidance and streamlining recordkeeping procedures. According to Treasury, if implemented, these recommendations would “increase the transparency and effectiveness of CRA rating determinations,” and would result in more consistent application of the CRA framework across regulators. In addition, these recommendations, if implemented, would expand the types of products eligible for CRA credit.
  • Examination Process: Relatedly, Treasury recommends improving the federal banking agencies’ examination processes. For example, Treasury found that the CRA examination process, including the process for drafting and publishing a performance evaluation, has become “excessively long.” To shorten the time between examination periods, Treasury recommends that the federal banking agencies standardize CRA examination schedules. Treasury also calls for statutory changes, if necessary, that would enable more timely performance evaluations and ratings.
  • Performance: Finally, Treasury recommends several improvements to CRA performance evaluation ratings. Most notably, Treasury recommends that the federal banking agencies implement uniform guidance to determine if there is a “logical nexus” between a CRA rating and evidence of discriminatory or other illegal credit practices. In the report, Treasury states that “a UDAP violation for a credit product that was not considered as part of a bank’s CRA performance” would not meet the logical nexus test, and therefore should not negatively impact a financial institution’s CRA rating. In contrast, Treasury states that the federal banking agencies should consider a violation of consumer law involving substantial evidence of redlining. As discussed in a prior post, the Office of the Comptroller of the Currency (“OCC”) has already implemented guidance on CRA rating downgrades for consumer compliance violations.

In the coming months, we expect the OCC to release an advanced notice of proposed rulemaking (“ANPR”) that will propose potential reforms to the CRA. This ANPR may be issued jointly along with the Board of Governors of the Federal Reserve (“Federal Reserve”) and the Federal Deposit Insurance Corporation (“FDIC”). Because Treasury’s recommendations are largely in line with the Comptroller of the Currency Joseph Otting’s public statements on CRA reform, we expect significant overlap between the forthcoming ANPR and Treasury’s recommendations. When the OCC releases the ANPR, financial institutions and other industry leaders will have the opportunity to comment on these recommendations and provide suggestions for additional improvements to the CRA framework.

CFPB Issues Request for Information on Its Consumer Financial Education Programs

On April 4, 2018, the Consumer Financial Protection Bureau (“CFPB”) released its latest Request for Information (“RFI”), which seeks comments on the “overall efficiency and effectiveness” of the CFPB’s consumer financial education programs. Generally, the CFPB is requesting comment on its focus on various topics, programs, and delivery channels and methods (presumably to identify if those are the right topics and tools); its use of technology in delivering financial education; and the procurement process it uses to support this work. More specifically, the CFPB is requesting suggestions on ways to:

  • Improve existing consumer financial education programs, including delivery mechanisms for such programs;
  • More effectively evaluate and measure the effectiveness of the CFPB’s financial education work; and
  • Eliminate or minimize the overlap between the CFPB’s consumer financial education programs and the work that other agencies perform.

Notably, financial education was the first topic discussed in the CFPB’s recent semi-annual report and appears to be an area on which the CFPB is quite focused. The CFPB will accept comments for 90 days after the RFI is published in the Federal Register.

The RFI on consumer financial education programs is the eleventh in a series of RFIs issued under the direction of Acting Director Mick Mulvaney. Covington has published a number of blog posts that discuss these RFIs, all of which can be found on the Cov Financial Services Blog. In the press release announcing this RFI, the CFPB stated that it will issue another RFI regarding consumer inquiries next week.