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I. THE HISTORY OF BANKING REGULATION IN AMERICA. A. The role of banks in early America [2] 1. Medium of payment [2] a. Money is at the center of banking. Banking involves at least the traditional sense, the transfer and storage of money, as well as the lending of that medium of exchange. b. What is money? - a medium of exchange or method of payment. Taken a lot of forms - coins, barter, paper money. c. "Legal tender" a specific type of money developed in Europe. It is a particular form of money or currency that a government has decreed must be accepted in payment of government or private debts. i. Called fiat money. This assures the govt. a central role in controlling the money supply. d. In Colonial America, there was no legal tender, no govt. issued currency. Barter, foreign coins, and bills of credit were used. i. Bills of credit - paper money issued by the colonies. They were unsecured obligations. The colony didn't have sufficient revenue backing. The colonies often over issued these bills, and it led to a decline in the value of the currency which led to price inflation. So there was no stable currency Colonial America. ii. Non-backed currency and massive inflation continued throughout the revolution. e. So after the Revolution was won, founders put in the Constitution that states were prohibiting from coining money or issuing bills of credit. Art. I § 10 no State "shall coin money; emit bills of credit; [or] make anything but gold or silver coin a tender in payment of debts ... " f. Craig v. Missouri [6] - upheld that certificates issued by MO were "bills of credit" and therefore prohibited by Constitution. 2. Lending money [8] a. Knights Templar earliest international banks b. Goldsmiths - first lending/checking accounts. c. These early bankers/lenders were unpopular because of the high rates of interest they charged. B. The Creation of Banks in America [9] 1. The Bank of the United States and early state chartered banks [9] a. After Revolution State banks began supplying money in America. They issued their own bills and notes. These became the currency of the states. b. Hamilton, who later became the first Secretary of the Treasury, was a strong advocate of a central bank. He was influenced by Adam Smith. i. Hamilton convinced GW to create a central bank. Jefferson was opposed to this – he was a strict constructionist, and thought the Constitution did not expressly authorize central bank. 1

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I. THE HISTORY OF BANKING REGULATION IN AMERICA.A. The role of banks in early America [2]

1. Medium of payment [2]a. Money is at the center of banking. Banking involves at least the traditional sense, the transfer and

storage of money, as well as the lending of that medium of exchange.b. What is money? - a medium of exchange or method of payment. Taken a lot of forms - coins, barter,

paper money.c. "Legal tender" a specific type of money developed in Europe. It is a particular form of money or

currency that a government has decreed must be accepted in payment of government or private debts. i. Called fiat money. This assures the govt. a central role in controlling the money supply.

d. In Colonial America, there was no legal tender, no govt. issued currency. Barter, foreign coins, and bills of credit were used.i. Bills of credit - paper money issued by the colonies. They were unsecured obligations. The

colony didn't have sufficient revenue backing. The colonies often over issued these bills, and it led to a decline in the value of the currency which led to price inflation. So there was no stable currency Colonial America.

ii. Non-backed currency and massive inflation continued throughout the revolution.e. So after the Revolution was won, founders put in the Constitution that states were prohibiting from

coining money or issuing bills of credit. Art. I § 10 no State "shall coin money; emit bills of credit; [or] make anything but gold or silver coin a tender in payment of debts ... "

f. Craig v. Missouri [6] - upheld that certificates issued by MO were "bills of credit" and therefore prohibited by Constitution.

2. Lending money [8]a. Knights Templar earliest international banksb. Goldsmiths - first lending/checking accounts.c. These early bankers/lenders were unpopular because of the high rates of interest they charged.

B. The Creation of Banks in America [9]1. The Bank of the United States and early state chartered banks [9]

a. After Revolution State banks began supplying money in America. They issued their own bills and notes. These became the currency of the states.

b. Hamilton, who later became the first Secretary of the Treasury, was a strong advocate of a central bank. He was influenced by Adam Smith.i. Hamilton convinced GW to create a central bank. Jefferson was opposed to this – he was a strict

constructionist, and thought the Constitution did not expressly authorize central bank. Hamilton thought it was an implied power in the Constitution. Washington agreed with Hamilton.

c. So the first Bank of the United States was created.i. It was a private corp.ii. Soon, state chartered banks started popping up.iii. The first Bank's Charter ran out. Jefferson was President at this time, and did not re-charter. So

1st Bank went away in 1811.d. Still no federal notes and state notes were primary source of exchange. Their value fluctuated

widely.e. War of 1812 created need for central bank.

2. The Second Bank of the United States [10]a. SO the 2nd Bank of the United States was created during Madison's term.b. States did not react favorably towards this institution, and 6 states tried to tax branches of the 2nd

Bank located within their borders.c. McCulloch v. Maryland [11]

i. First issue: Whether or not Congress had power to charter a national bank.


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1) Marshall said it was an implied power. Fed govt. is a govt. of limited powers, but supreme w/ in those powers. Even though Congress was given enumerated powers, and the Constitution doesn't expressly say that Congress can charter a bank, Congress can do so under their implied powers in the Necessary and Proper clause.

2) What are enumerated powers? Power to tax, power to raise revenue. If govt. has power to do this, it must have the means to collect and distribute the tax. Very expansive view. Marshall was a Federalist.

ii. Second issue: Can states tax the national bank?1) No. A tax on national bank is incompatible with Congress' power. The power to tax is the

power to destroy. The state could tax it out of existence.iii. Effects of McCulloch.

1) TN law is pre-empted. Fees for cashing checks not at your bank.2) CA -ATM fees. Using your card at another bank's ATM. You get charged a fee. San Fran tried

to outlaw those fees charged to non-customers. Law shot down - banks can charge fee.3) Predatory lending laws - loans to low income people w/ some equity in their house. Lenders

pray on these people and get them to re-finance and pay large fees until all the equity is sucked out of their house. Some states, including NC, passed laws regulating these predatory lenders. National banks do not have to comply w/ these laws unless the national bank is incorporated in that state.

3. The Fight Over the Second Bank of the U.S. [14]a. So the 2 Bank of the US survived after McCulloch.b. A financial panic in 1819 was blamed on the 2nd Bank. It came up for re-chartering in 1832, but

President Andrew Jackson vetoed a bill to re-charter. So the 2nd Bank went away and Jackson ordered all govt. funds to be pulled out and put into state banks that were politically aligned with Jackson.

c. As a result, the number of state banks doubled.d. Some states tried to impose regulations to deal with the ever increasing number of state banks. NY

was a leader. Early regulations included reserve requirements, an early form of deposit insurance, making banks report financial positions, NY set up a bank supervisory authority, etc.

C. The Civil War era [15]1. Bank currency [15]

a. By 1860 (Civil War), there was no federal currency. America's principal currency was bank notes issued by some 1600 state banks. The bank note currency was easily counterfeited, not uniform, and its values fluctuated greatly.

b. Marine Bank v. Fulton [16]: 1. Money collected by one bank for another, placed by the collecting bank with the bulk of its ordinary banking funds, and credited to the transmitting bank in account, becomes the money of the former. Hence, any depreciation in the specific bank bills received by the collecting bank, which may happen between the date of the collecting banks' receiving them and the other banks' drawing for the amount collected, falls upon the former.

2. Shinplasters and the Stamp Payments Act [17]a. Another problem with state bank note Currency shinplasters.b. Shinplasters were small denomination notes issued by banks that did not have reserves adequate to

back their issues. Because the notes were small, they were accepted without questioning the condition of the issuing bank.

c. So in 1862, to get this worthless currency out of our system, Congress prohibited shinplasters through the enactment of the Stamp Payments Act.

d. Van Auken [18]: Notes payable in goods are not “money”3. Greenbacks as legal tender [19]:

a. Congress created greenbacks in 1862 to fund the Civil War. A greenback was a note issued by the government that derived its name from the color of the back of the note. Congress made


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greenbacks legal tender, even though they couldn't be redeemed in specie (for gold or silver). Greenback values fluctuated greatly.

b. Legal Tender Cases [19]: The SC considered the legality of greenbacks in the "legal tender" cases. SC upheld the greenbacks (Congress has an implied power to create greenbacks, derived from Congress' express power to coin money and regulate the value thereof).

4. The National Currency Act and the National Bank Act [22]a. National Currency Act Adopted in 1863 to create a uniform system of national banks and a

uniform currency. National Banks could create money - called National Bank Notes - by depositing bonds at the U.S. Treasury. These notes were used until the Fed was created in 1900s.

b. National Bank Act Replaced the NCA. Adopted in 1864 and sets out much of the modern regulation of national banks. It's goal was similarly to create a uniform system of national banks and a uniform currency.i. The NBA put requirements and restrictions on nationally charted banks.ii. OCC was charged with administering NBA and regulating national banks.

c. To ensure a system of national banks and to drive state banks out of existence, the NBA imposed a tax of 2% on the notes issued by state banks to get state money out of the system. Tax raised to 10%.i. This tax was upheld in Veazie Bank v. Fenno [25]ii. But the tax did not drive state banks out of existence. States created checking accounts, a

profitable product, which allowed state banks to survive.iii. So a result of the NBA - dual banking system (i.e., a system of federally and state charted banks

co-existing) rather than a unified federal banking system. A dual banking system leads to a very complicated and redundant regulatory system.

5. Clearing houses and central banks [28]a. Philler v. Patterson [29]: This agreement among 38 national banks to make their daily settlements at

a fixed time and place each day, in the place of a separate settlement by each bank with every other made over the counter. All at the same place where the representatives of the several banks meet, and where all balances are struck and settled daily between the banks composing the association. The banks agreed that they would deposit in the hands of certain persons, to be selected by them, and to be called the ‘clearing-house committee,’ a sum of money, or its equivalent in good securities, at a fixed ratio upon their capital stock, to be used for payment of balances against them.

D. The Birth of the Federal Reserve System [30]1. Introduction.

a. Trust companies were popular business organizations used to avoid bank regulation. Knickerbocker Trust Co. failed in 1907 and created the financial panic of 1907. The treasury had no way of acting as a central banker and dealing with the panic. SO the private sector had to save itself. J.P. Morgan took action to stop the panic banks had suspended making payments.

b. The Monetary Commission was created by Congress to investigate the causes of the Panic of 1907 and prevent it from happening again. It was chaired by Senator Aldrich.

c. Aldrich met with a bunch of millionaires in Jeckyll Island, GA. He then proposed legislation to create a decentralized banking system that would be owned by private bankers to provide liquidity in times of stress.

d. Resuled in Federal Reserve Act of 1913. It created the Federal Reserve System.e. Federal Reserve System.

i. Decentralized system comprised of Board and member banks. Member banks are owned by their member banks.

ii. SO after this Act, national bank regulation split between the Treasury Dept. (Comptroller of the Currency) and the Federal Reserve System.

iii. The Fed was charged to:1) Check Clearing (Clearing House Function) [32]


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i. Process of clearing checks b/t banks that receive the checks and banks that pay the checks.

ii. Parallel system –NACHA – handles debits by phone, power and other vendors to bank accounts.

iii. American Bank & Trust Co. v. Federal Reserve of Atlanta [32]: The Fed has power to operate a clearing house

2) Create Currency - Federal Reserve Notes [33]i. The Federal Reserve Act sought to have its regional banks establish a more elastic

currency. The new currency was called Federal Reserve Notes that we use today.ii. Milam v. U.S. [33]: Congress is authorize to establish a national currency, either in coin

or in paper, and to make that currency lawful money for all purposes as regards the national government or private individuals.

iii. The Federal Reserve Act also rescinded the power of national banks to issue their own notes.

3) Administer U.S. Monetary Policy [34]i. Could use the tools we talked about last week.

ii. Raichle v. Federal Reserve Bank of NY [35]: Fed has power to control monetary policy.E. New Deal legislation [38]:

1. Creation of Federal Deposit Insurance [38]a. Stock Market Crash in 1929 lead to bank failures; 20% of banks failed due to bank runs.b. FDR declared a bank holiday and closed banks.c. Congress adopted Banking Act of 1933.

i. Adopted to strengthen the banking system and to allow the resumption on banking in the U.S. It changed banking industry in US

ii. Created the Federal Deposit Insurance Corporation (FDIC).1) Insures bank deposits up to certain levels ($250K/depositor now). Banks are the ones

insured. Banks pay premiums based on amt of deposits. FDR did not like deposit insurance b/c of moral hazard problem.

iii. Banks re-opened.d. Omit Hewitt v. U.S. [39]

2. Strengthening the Federal Reserve System [40]a. Banking Act of 1935.

i. Gave the Fed more power over regional banks. Made the Board of Governors the responsibility of administering the Federal Reserve System (ending the dispute b/t the Board in Washington and the NY Federal Reserve Bank.

ii. Gave the Fed power to regulate securities credit and brokers.1) Securities credit -loans from banks to brokers to carry stock. Banks and brokers were lending

too much money to leverage purchase of securities. Regulation U - limited the amt of loans banks can lend to brokers or brokers can lend to individual investors (up to 50% of the value of the stock you are buying).

iii. Made the FDIC a permanent government agency.3. Glass-Steagall Act Restrictions on Securities Activities [42]

a. 1902 Comptroller of the Currency ruled that a national bank could not act as an investment bank in underwriting securities. So to avoid this restriction, banks formed affiliates to act as securities dealers.i. Underwriting is the function of issuing stock to public. Underwriter uses its capital to buy stock

at initial auction, then sells stock to the public.ii. Banks' underwriting activities led to conflicts of interests b/t banking arm and I- banking arm.iii. These investment banking affiliates suffered large losses when the market crashed in 1929.

b. Glass-Steagall Act - Name given to a collection of parts of the Banking Act of 1933.


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i. Designed to address the public's perception that the securities activities of banks led to the stock market crash.

ii. Glass-Steagall separated commercial banking from investment banking.1) Commercial banks could no longer invest in or underwrite securities.2) Investment banks could not take deposits and make loans. But they could deal in securities.3) Result - breaking up of great banking houses such as J.P. Morgan.4) 80s and 90s - banks tried to find loopholes to get back into investment banking. So many

loop holes were created, that Graham Leach Bliley was enacted which repealed Glass-Steagall. So no more division b/t commercial banking and investment banking.

4. Glass-Steagall Act Restrictions on Interest Rates [44]a. The Banking Act of 1933 (i.e., Glass-Steagall Act) prohibited banks from paying interest on checking

accts, and limited the amount of interest that could be paid on other accts.b. Purpose - stop competition b/t banks to pay higher rates which could lead banks to taking riskier

and riskier investments to pay the high interest rates.c. The Fed implemented these statutory restrictions in Reg. Q.d. These restrictions went away in the 80s. The Fed still has a restriction on paying interest on checking

accts. though. However, you can get around this restriction with NOW accts.F. Limitations on Geographic Expansion [44]:

1. Unit Banking - one office. Many states used to require this. 2. These restrictions were sometimes evaded by using Chain Banking - banks owned by common owners. All

separate entities, but affiliated through common ownership.a. First National Bank in St. Louis v. Missouri [44]- State law requiring unit banking upheld.b. NC did not have any such restrictions. That's why banking industry grew here. Non-unit banking

allowed banks to diversify risk (allowed banks to go to different geographical areas that had different industries).

3. Congress adopted the McFadden Act in 1927 - allowed national banks to expand into cities to the same extent that state chartered banks could. So if a state had a law that said state banks could establish "inside" branches within the municipality of their main banking facilities, a national bank located in that state could do the same.a. By adopting the McFadden Act, Congress intended to create "competitive equality" b/t state banks

and national banks, so far as branch banking was concerned. Must have competitive equality in their activities.

b. First National Bank of Logan v. Walker Bank & Trust Co. [46] - SC upheld competitive equality.c. Note: The McFadden Act only authorized national banks to branch "within a state" to the same

extent as a state bank. National banks could not branch outside their home state.4. 1980s and 1990s: restrictions on branch banking went away. So now we have nationwide banking now.

a. 1 Response to unit banking laws - bank holding companies. BHCs could also own other types of businesses. Led to the Bank Holding Company Act of 1956 (BI-ICA). Purposes of the BHCA:i. To preclude banks from expanding geographically in contravention to the existing restrictions on

bank branching.ii. To limit the ability of banks to affiliate through common ownership with commercial enterprises

not related to banking.G. Regulation of Bank Holding Companies [49]

1. Activities Closely Related to Banking [49]a. The BHCA authorized the Fed to allow bank holding companies to acquire or retain ownership only

in companies whose activities were "so closely related to banking or managing or controlling banks as to be a proper incident thereto." Fed adopted Reg. Y to define such activities.

b. Note: The BHCA effectively brought bank holding companies under the regulatory authority of the Fed.

2. The Douglas Amendment and Geographic Expansion by Bank Holding-Companies [51]


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a. The Douglas Amendment, part of the BHCA of 1956, effectively precluded a bank holding company from owning banks in more than 1 state.

b. A BHC could only engage in inter-state banking if the state law where bank was located said that banks could have branches in other states.

c. This restriction has since been eroded and will be discussed later.3. Pressures on the Bank Holding Company Act [51]

a. Because the BHCA limited the activities of a company who owned a bank to activities that were "closely related to banking", the common ownership of banks and other commercial enterprises was precluded.

b. "Banking companies" could avoid the application of the BHCA, however, if the "bank" failed to meet the definition of bank i.e., if the "bank" accepted deposits, or made loans, but not both. Entities that did this are called "nonbank banks". Nonbank banks also avoided the Douglas Amendment's restrictions on interstate banking.

c. Congress then adopted the Competitive Equality Banking Act of 1987 (CEBA) to curb the use of nonbank banks by defining the term "bank". The Fed. followed by adopting Regulation Y to amend the test to determine what it means to be a bank.

H. Inflationary pressures [52]1. 1960s and 1970s - Inflation.2. This put pressure on bank interest rates, which were limited under Reg Q. Banks had a hard time attracting

enough deposits to meet their loan demand. This lead to disintermediation (the process of bank depositors' withdrawing their funds from accounts with low interest rates to put them into investments that pay higher returns) depositors withdrew funds from banks and S&Ls and invested in other investments not subject to Reg. Q caps, such as securities.a. Many people put money into money market funds. Money market funds are mutual funds that

invest in short term instruments, such as T-Bills, that pay interest at market rates. FDIC does not cover money market funds, but they have little or no risk of default because they are primarily invested in government securities.

b. Fed was losing control over monetary policy. Congress repealed Reg Q and no more restrictions on bank interest rates.

I. Geographic Barriers Fall [54]1. In the 80s and 90s, geographic barriers began to fall as the Douglas Amendment was chipped away.2. Regional reciprocal interstate banking compacts were adopted by groups of states to encourage interstate

banking within a defined region. These compacts basically said "Your banks can buy our banks, if our banks can buy your banks." So bank holding companies began expanding by buying banks in other states pursuant to these compacts, and this led to interstate banking on a regional basis. Interstate branching was still heavily restricted.

3. Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994.a. Repealed the Douglas Amendment and allowed BHCs to acquire banks in any state (so regional

compacts not needed anymore).b. Also, permitted interstate branching after 7/l/1997. SO now a BHC could consolidate banks in

different states under one charter. You could have one entity branching throughout all the states.J. The Changing Roles of Banks and BHCs [55]

1. Continuing competitive pressures.a. Financial assets owned by insured depository institutions continues to decline sharply.b. Commercial banks do less and less traditional bank functions. Rely on developing other financial

services.c. Number of banks declined sharply as a result of M&A. (Banks began consolidating.)d. Consolidation culminated in CitiCorp and Travelers Insurance Co. merger. It was illegal. Glass-

Steagall at the time prohibited it. Travelers owned Smith Barney (a brokerage/investment banker). Glass-Steagall required separation. But, under Bank Holding Co. Act, if you acquired these types of assets, you had 3-5 years to divest the securities assets. But in 1999, Graham-Leach-Bliley Act


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adopted which repealed Glass Steagall, so this merger was OK and the same entity could keep commercial and investment banking assets.

2. The Gramm-Leach-Bliley Act and Financial Holding Companies [57]a. GLBA-signed in to law in by Clinton 1999.b. Expanded powers of banks dramatically.

i. Repeals Glass-Steagall Act's separation of commercial and investment banking.ii. Repeals BHCAs separation of insurance and banking businesses.

c. Introduced functional regulation. The regulator of all entity is determined by the function of the entity, not the type of entity.

d. Created new financial entity - Financial Holding Company.i. A BHC can elect to become a FHC.ii. The Fed has authority over both BHCs and FHCs.iii. FHCs can engage in activity that is "financial in nature" or incidental thereto; while BHCs can

only engage in activities that are "closely related to banking" or incidental thereto.1) Example - real estate brokerage. BHCs can't do this, but its financial in nature, so FHCs can.

iv. As a result, GLBA effectively permits affiliation b/t BHCs, insurance companies, and securities firms all under the umbrella of a FHC.

v. GLBA does NOT permit affiliations b/t banking and commerce affiliations (i.e., affiliations b/t depository institutions and companies engaged in activities that are not financial in nature.

e. Expanded the permissible activities of a subsidiary of a national bank. A national bank can have operating subsidiaries and financial subsidiaries.i. Operating subsidiaries

1) Can only engage in businesses that the national bank itself could engage in, i.e., activities that are part or incidental to the business of banking.

2) Note: National banks could always have operating subs. GLBA just gave national banks the power to have financial subs.

ii. Financial subsidiaries 1) A financial sub can engage in any activity that either:

Is permissible for the bank itself; Is listed as "financial in nature" under GLBA; Has been determined by the Treasury to be "financial in nature" (and the Fed has not

disagreed); or Is "incident" to a financial activity.

2) A financial sub cannot engage in: Underwriting insurance or issuing annuities; Real estate development or investing; or Merchant banking.

3) As a result, a financial sub can engage in activities such as: Underwriting or dealing in securities; Organizing, sponsoring, or distributing a mutual fund; Selling insurance outside a "place of 5,000"; Engaging in real estate lease financing and real estate brokerage; Operating a travel agency; Providing management consulting services.

f. Allows state banks to own financial subs to, subject to state laws.g. Confers on the Fed the power to supervise BHCs, FHCs, and affiliates, other than functionally

regulated affiliates (i.e., affiliates regulated by the SEC, CFTC, or state insurance authorities.K. Post September 11 [61]

1. USA Patriot Act include anti-money laundering and anti-terrorist financing provisions; required greater lender disclosure

L. Financial Crisis and Dodd-Frank [61]


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1. Fed Funds rate reduced from 6.5% in 2000 to 1% in 2003; created easy credit and cheap money; spurred financial innovation and complex securitization; built on demand for real estate

2. CDOs [61 - 63]3. Bear Stearns4. Freddie and Fannie5. Lehman6. Merrill7. AIG8. TARP9. Dodd-Frank Act [65]

a. Created the Financial Stability Oversight Councilb. Vested orderly liquidation authority in the FSOC and FDICc. Gave Fed power over non-bank financial companiesd. Gave more power to Fed in Emergency lending situationse. Created Bureau of Consumer Financial Protection

M. Themes of banking regulation. [67]1. Reasons for major banking regulation.

a. In response to major financial calamity.b. In response to regulatory avoidance efforts (i.e., to close loopholes created by creative lawyers).

2. Themes inherent in banking legislation and regulation.a. Concerns about mixing banking and commerce.

i. Banks are creatures of limited powers.b. Limited entry.

i. Entry into the banking industry is limited. Not all charter applications are granted.c. Dual chartering and regulatory arbitrage.

i. Banks can freely switch b/t a national and federal charter. The result is regulatory arbitrage where the most favored regulator and most favored rules may be selected by the regulated entity.

ii. This can lead to healthy competition by the regulators to provide effective oversight, but can also lead to a race to the bottom.

d. Restrictions on geographic expansion.i. Geographic expansion was curtailed due to the limited monopoly afforded banks by limits to

entry. Geographic expansion has eroded though.e. Concerns about concentrations of economic power.f. Safety and soundness regulation.

i. Many regulations help minimize losses caused to the federal deposit system in the event of a bank failure. Bank regulators are concerned with minimizing bank risk and reducing the effect of bank failures.

g. Grandfather provisions.


Two characteristics that distinguish banks from other financial institutions: financial intermediation and transaction accounts.

A. Financial intermediation.1. Financial intermediation process of pooling funds from people who have excess funds and making them

available to people who need them.2. Two broad categories of financial intermediaries:

a. Depository institutions.i. Banks, thrifts, and credit unions.


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ii. ii. Principal source of funds is deposits; principal use of funds is to make loans.iii. They make money on the spread - difference b/t what they pay on their money and what they

earn on their money (spread b/t interest rates paid and interest rates charged). Now usually about 4%. The lower interest rates are spread tends to be higher.

b. Non-depository institutions.i. Insurance co.s, pension funds, finance co.s.ii. Principal source of funds is from other than deposits (insurance premiums, pension

contributions, etc.)3. Opposite of financial intermediation direct investment.

a. Disadvantages of direct investmenti. Need large amounts of money. Hard to loan small amounts of money out.ii. Need expertise.iii. Riskier than depositing in a bank

b. Advantages:i. Less transactional costs So higher return for lender; lower cost of funds for borrower.ii. Example: Merchant Banks. Merchant bankers make direct investments in other companies.

B. Transaction accounts.1. Originally this was a unique feature of banks/depository institutions They have checking accounts and

savings accounts that provide primary source of funds.a. Now all depository institutions offer transaction accounts

2. Checking accounts.a. Checking accounts are also known as demand deposit accounts (DDA) - funds repaid to customer on

demand. Or more broadly as transaction accounts -allow the customer to transact business by using a check to pay a 3rd party.

3. NOW Accounts.a. There is a federal law that prohibits paying interest on checking accounts. Banks get around this by

calling "checking accounts" NOW Accounts (Negotiable Order of Withdrawal). A NOW account is really a savings account. Banks have a right to demand a 7 day notice to give funds over for a savings account. But no bank will ever ask for this. No business NOW accounts, just personal NOW accounts. No limit on the amount of transactions per month.

4. Savings accounts.a. No transaction feature such as check writing privileges.b. As a matter of law, the institution may demand 7 days notice to withdraw funds. Reg. D, 12 CFR §

204.2(d)(1).5. Money Market Deposit Accounts (MMDA).

a. Not a transaction account, not a savings account.b. Allows limited transactions - usually up to 3 checks and 6 transfers per month.c. Why use these? Traditionally they pay a little higher interest than NOW Accounts.

6. Note: Because banks have transaction accounts, banks must have cash on hand.a. Federal Reserve requires minimum reserves.b. Reserves – portion of the bank's total transaction accounts. About 10% now. Reserves can be cash

on hand in the vault or on deposit at the Federal Reserve. Fed. can set the reserve requirement b/t 8% and 14% of the banks transaction accounts. 12 USCA § 461(b)(2).

c. Where does the rest of the non-reserved money go? Loaned out.d. Before reserve requirements and insurance, we used to have run on banks. People were afraid they

could not get their cash. No bank runs anymore because Fed created the FDIC.C. Monetary policy.

Monetary policy is the fiscal policy of the federal government administered through the Federal Reserve. There is a difference b/t fiscal policy and monetary policy. Fiscal policy is taxing and spending and budgeting - Congress and Executive do this. Monetary policy is money supply – Fed. Does this.


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1. Structure of the Federal Reserve System.a. The Federal Reserve System ("Fed") was created by Congress in 1913. Purpose – to administer

monetary policy of the nation. Not a part of any particular branch.b. The Fed is composed of 12 regional Federal Reserve banks and 25 Branch banks.

i. The Federal Reserve banks and their Branches are part government, part private entities. They are subject to oversight from Congress. All profits from the banks are paid to the US Treasury after paying the expenses of the banks.

c. The 12 Federal Reserve Banks are private corporations whose stock is owned by the member commercial banks.

d. The Federal Reserve System is governed by the Federal Reserve Board of Governors ("FRB"), which is the entity empowered with the authority and tools to establish and implement our country's monetary policy.i. FRB has 7 members.ii. FRB members appointed by the President and confirmed by Senate. Serve 14 year terms.iii. The Chairman and Vice-Chairman are designated by the President and confirmed by the Senate

for 4 year terms. 1) Dodd-Frank created a vice chairman for supervision and regulation of depository holding

companies and other financial firms.e. What does the Fed do??

i. Historical function - Maintains reserves of member commercial banks and financial institutions.ii. Operates nationwide check payment system. Most checks get processed through the Fed.iii. Distributes and issues currency and coin.iv. Supervises member banks and bank holding companies. After Dodd-Frank, the Fed is the

primary regulator of bank holding cos, financial holding companies, savings and loan holding companies, and systematically important non-bank holding companies. Dodd-Frank shifted consumer protection regulations to the Bureau of Consumer Protection.

v. Operates as the banker to the US Treasury Dept.vi. The Fed administers monetary policy through its banks.

Three tools are used by the FRB to implement monetary policy through banks: reserve requirements; open market operations; and the discount rate.

2. Reserve Requirements.a. Our banking system is called a Fractional Reserve System or Fractional Reserve Banking.b. Reserves allow banks to create money.

i. A deposits $500 at bank. 10% reserve requirement, so bank puts $50 on reserve (either as cash in their vault or as non-interest bearing deposits at the Fed). Bank has $450 left over.

ii. Bank loans out $450 to B. B deposits $450 in her bank. Bank has to keep $45. Bank has $405 left over.

iii. With a 10% fractional reserve system, $500 can create $5,000 in the money supply.iv. To how much money a deposit will create in a fractional reserve system, solve for A in this

equation: R x A = D, where R is the reserve ratio, and D is the initial deposit.c. What if the reserve requirement was increased to 20%? Then only $2,500 can be created. This

shows how big of an effect reserve requirements have on the money supply and monetary policy. An increase reserve requirements leads to a decrease money supply; A decrease in reserve requirements leads to an increase in money supply.

d. Prior to 1980, only Federal Reserve member banks had to abide by reserve requirement. (Note: All national banks are required to be members, state banks can if they want to (optional)).i. This created a problem. Put too many burdens on member banks and caused many banks to

leave the Federal Reserve System. Abiding by higher reserve requirements was costly for member banks.


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ii. Monetary Control Act of 1980 - required all depository institutions, whether members or not, to abide by reserve requirements. (The MCA did not require all banks to be members, just required all bank to abide by the Fed's reserve requirements.)1) First Bank and Trust Co. v. Board of Governors of Fed Reserve Held the MCA

constitutional.e. How reserve requirements are actually used by the Fed.

i. Because changes in reserve requirements can have such a dramatic effect on money supply, adjustments to reserve requirements are not well suited to the day-to-day implementation of monetary policy. When changes to reserve ratios have been used, they are typically offset by other monetary policy tools such as open market operations.

ii. Because changing reserve ratios screws up the bank's financial planning, they are rarely used and used only to supplement the effects of open market operations and discount policy.

iii. Changes in reserve requirements are also used for their announcement effect - i.e., to emphasize a particular direction of policy and to influence the public's perception of the thrust of monetary policy.

3. Open Market Operations.a. Involve the buying and selling of government securities by the Fed.b. These buying/selling transactions are settled by member banks. The Fed increases or decreases the

reserve account of the member banks.i. Basically, when the Fed buys, it is issuing a check on its self. When the seller deposits the check

at his bank, the bank presents the check to the Fed for payment. The Fed honors the check by increasing the reserve account of the seller's bank at the Federal Reserve Bank. Since the seller’s bank does not need to keep excess reserves, it can lend this money out.

ii. Just the opposite happens when the Fed sells securities. It decreases the reserve account or the buyer’s bank has less money to lend out.

iii. So if the Fed is buying, it injects money into system. Looser credit.iv. If Fed is selling, it decreases the amount of money in the system. Tighter credit.

c. Open market transactions are conducted on a daily basis.d. Open market operations are the most effective and flexible thing Fed can do in the short run.e. The Fed can theoretically use buy and sell any type of asset, but uses govt. securities b/c govt.

securities are traded in a broad, active market.f. The Fed can conduct open market operations in one of two ways:

i. Outright purchases/sales.1) Used when supply of reserves will need long-term, continuous adjustment.

ii. Repurchase agreements/Matched sale-repurchase transactions.1) Used when there is only a temporary need for adjustments in reserves.2) These temporary transactions are used much more frequently.3) Repurchase agreements - Basically, Fed buys security from a dealer, dealer agrees to re-

purchase at a specific date and price. Matched sale-repurchase transactions are the opposite.

g. Open market operations are conducted by the Federal Open Market Committee (FOMC). The FOMC is composed of the 7 members of the FRB; the president of the Fed Bank of New York is a permanent member of the committee and 4 other representatives of the Federal Reserve Banks who are elected annually by the boards of directors of the Federal Reserve Banks. The 4 representatives must be either presidents or vice presidents of their Federal Reserve Bank. (Note: presidents and VPs of Federal reserve banks are elected by the board of governors of each bank, but hold their office subject to the approval of the 7 members of the FRB)..

4. The Discount Rate and Federal Funds Rate.a. Banks (see below) sell assets (commercial paper) to the Fed on a temporary basis (the Fed will credit

the bank's reserve account for the amount the discounted amount of the commercial paper). The rate tile Fed charges on these loans is the Discount Rate.


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b. Banks can temporarily borrow from other member banks. The rate charged on these loans is the Federal Funds rate.

c. Before the MCA of 1980, only member banks could use the discount window. Now, any bank holding reserves subject to the Fed's reserve requirements has access to tile discount window.

d. The Fed's lending at the discount window serves 2 key functions:i. It compliments open market operations in managing the reserves market day to day and in

implementing longer-term policy goals.ii. It facilitates the balance sheet adjustments of individual banks that face temporary, unforeseen

changes in their asset-liability structure.5. Fed intervention to prevent systemic risk.

a. Systemic risks are risks to the entire banking system or entire financial systemi. Examples - Hunt brothers; Long Term Capital Management.

b. The Fed prevents systemic risk by intervening and acting as a lender of last resort during bank or other economic hazards. The Fed can step in during a financial crisis and provide liquidity to financial institutions to keep them afloat.

c. This creates moral hazard. Banks will take on bigger risks if they know Fed will bail them out. Creates the risk that the Fed is attempting to avoid. How does Fed deal with this? They don't always step in, and they let some failures occur. They also use vigorous investigations after financial disasters.

D. Dodd-FrankE. Characteristics of banks.

1. Banks may not operate without a government charter.a. National banks get their charter from the Office of the Comptroller of the Currency (OCC). The OCC

is an agency within the Dept. of the Treasury.b. State banks get there charter from the Banking Commissioner of their state.

i. State banks outnumber national banks, but national banks control 55% of all banking assets.2. The number of banks has declined in recent years (cut in half since 1976) due to M&A.3. The largest 1% of banks in the US control 2/3rds of all banking assets.4. Over 90% of all bank assets are under the control of holding companies.

F. Income statement.1. Traditionally, banks earn most of their income on interest charges on loans. Increasingly important part of

income is fees charged by banks.2. The basic business of banking is profitable when the bank's cost of funds (interest paid on deposits) is less

than it earns on those funds (interest charged on loans).a. S&L crisis in 1980s shows the instability inherent in this business model.b. Deposits are short term in nature, and the interest rate paid on them is variable (fluctuates with

market rate). The use of funds is often long term and fixed.c. So when interest rates are rising, like during inflation, banks lose money. So banks continually try to

find other, more stable sources of income.3. Financial ratios in evaluating a bank:

a. Net interest margin (or net interest income).i. Average rate earned on loans less average interest rate paid on deposits. Higher the better,

usually around 4%.b. Overhead efficiency ratio.

i. Non-interest expenses (salaries, operating expenses) / income. The lower the better. Efficient banks are around 35-40%; usually around 60-70% .

G. Balance sheet.1. Assets include cash, investment securities, real estate, loans. Loans are usually the largest asset.2. Liabilities include deposits - demand, MM and NOW, Time deposits.3. Banks are usually highly leveraged - have a lot of liabilities vs. the capital they have.4. ROE: income/equity capital (typically 15%)5. ROA: income/total assets (typically 1%)


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H. Challenges to the traditional business of banks.1. The traditional functions of banks - financial intermediation and provider of transaction accounts - has

become less important. Big borrowers can now go directly to the capital markets and borrow funds by using the commercial paper market (promissory notes with maturity within 270 days or less). Large borrowers can also securitize their assets instead of borrowing from a bank.

2. Knowledge that gave banks an edge (expertise in evaluating potential borrowers – knowledge that depositors don't have) has diminished with new and increased availability of technology.

3. There are more places to lend money - one of biggest lender is a non-bank (GE Capital).4. Banks no longer have a monopoly in providing transaction accounts. Brokerage firms will often have a cash

management accounts (pays rate of interest and works as capital account). Also, S&Ls often provide transaction accounts

5. Non-banks issuing credit cards (MBNA, American Express).6. What are the effects of changing roles on banks?

a. Pushing banks toward riskier businesses (more unsecured loans, revolving credit, etc.).b. Maybe lending at greater risk.c. Customers will suffer to from decreased competition.

I. 1. In 2003, investment bankers purchased $230 billion in subprime mortgage backed securities. Subprime loans utilized money raised by a lending offering short term rate CDO’s. The money so raised was loaned at long-term rates to subprime borrowers. Since long-term rates are typically higher than short term rates, lenders made money on the spread. This all changed when the Fed raised short term rates seventeen times between June 2004 and June 2006. The rate increases raised the payments required of subprime borrowers. In 2007 credit markets froze, and mortgage backed seurites could no longer be marketed and sold. This all hit Wall Street hard. The government allowed Lehman Brothers to fail. Meryl Lynch had to be rescued by Bank of America, which then had to be assisted. Disasterdly, Bank of America bought Countrywide which had made “stated income” or liars loans. Wachovia was brought down by its purchase of “Golden West” with its “pick a payment” loans and bought by Wells Fargo. The failure of Lehman Brothers resulted in a run on money market funds when the Reserve Primary announced it would “break the bank.” It stopped after the government stepped in and said it would guarantee [illegible]. 2 investment firms, Morgan Stanley and Godman Sachs converted to bank holding companies to qualify for government bailout. FDIC increased deposit insurance to $250k. TARP was created to inject capital into banks. Credit facilities were made available to commercial firms which could not market their commercial paper. Housing prices collapsed with foreclosures. New housing starts dropped to a 50 year low. The fed steped in to provide credit and liquidity wherever it was needed. From September 3, 2008 to December 17, 2008, the fed’s assets (loans primarily) increased from $907 billion to $2.26 trillian. Through various programs the Fed assisted money market funds, corporate issuers of commercial paper, banks, hedge funds, primary government securities dealer Frannie Mae, Freddie Mac, and Federal Home Loan Banks.

J. As a result the fed holds over $1.1 trillion in mortgage backed securities. The Fed provided targeted credit assistance which allowed J.P. Morgan Chase to acquire Bear Stearns, saved AIG from massive credit default swap exposure, saved Citigroup and Bank of America (see pages 885-6 for more on AIG’s role in credit default swaps). Congress responded to the financial crisis with the Dodd-Frank Act. Aid to individual companies as the Fed provided in the Great Recession is restricted by Dodd-Frank. Assistance to an individual company must now be part of a broad based program providing liquidity to the financial system. Emergency loans can be made but must be fully assured. The treasury must approve lending programs. In similar fashion, the FDIC can only provide assistance to banks as part of a broad based program which limits [illegible] to solvent institutions. Assistance is provided in the form of a guaranty of obligations of solvent depository institutions. The maximum amount of such a guaranty program is set by the President and approved by congress. The “next financial crisis” is supposed to be protected by the Financial Stability Oversight Council” which his chaired by the Secretary of the Treasury. FSOC members are heads of the Fed, OCC, FDIC, SEC, CFTC, Fed Housing Finance Agency, National Credit Union Administration, [illegible], and an independent member appointed by President expert in insurance. Council is to monitor and identify risks to the financial stability of the US. The council identifies companies as “nonbank financial companies” that are subject to regulation with the Fed and regulation by the [illegible]. The Fed can now examine these “nonbank financial companies” and establish risk standards for them


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or order them to divest some of their holdings. In a worst-case scenario, FSOC can order the liquidation of large ($50billion +) financial companies that pose a systemic risk. FDIC will be the receiver in such cases.

II. BANK REGULATION TODAY.A. Regulatory structure :

1. Banks can be state-chartered or nationally-chartered ("dual banking system") (185)a. Background (185)

i. only state charters were available until 1864 (National Bank Act)ii. state-chartered banks are still subject to federal regulation

b. National banks (187)i. created by National Bank Act of 1864ii. bank must apply to FDIC for deposit insuranceiii. primary regulator = OCC

c. State Banks (188)i. bank must apply for state charter

1) Farmers Deposit Bank v. Dep't of Banking and Securities (188) State req'ts

1. Financial standing, moral character and capacity of incorporators2. Reasonable assurance of success3. Public convenience and advantage

ii. bank must also apply for deposit insuranceiii. primary regulator (184-185) =

1) Member of Fed Reserve System: state regulator + Fed2) Non-Member of Fed. Reserve System (majority of state banks): state regulator + FDIC

d. Federal Financial Institutions Examination Councili. sets uniform principles for fed examination of financial institutions, promotes uniformity in

supervisionii. composed of:

1) Comptroller of the Currency2) Chairman of the FDIC3) Fed governor4) Director of the Bureau of Consumer Financial Protection (created by the Dodd-Frank Act)5) Director of the National Credit Union Administration6) Chairperson of the State Liaison Committee

e. FDICi. may only supply deposit insurance to a depository institution engaged in the business of

receiving deposits (186)ii. this includes state-chartered banks as well

B. Bank Powers (192)a. Banks are creatures of limited power they can only engage in activities authorized by its chartering

authorityi. National Bank Act (12 USC § 24) (Seventh):

1) National Banking Association shall have power - "to exercise . . . all such incidental powers as shall be necessary to carry on the business of banking" Then this section goes on to list certain powers.

a. Discounting and negotiating promissory notesb. Receiving depositsc. Buying and selling currencyd. Loaning moneye. Issuing and circulating notes


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b. Used to be that major factor in choosing state charter vs. federal charter was which charter allowed the most powers for banks. This was significantly reduced with Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991, which tried to limit state banks to those activities allowed for national banks.

c. Arnold Tours Inc. v. Camp (pg 192)i. issue: can national banks engage in the travel agency business?ii. holding: No, it is illegal under the NBA for a national bank to operate a full-scale travel agency.iii. analysis:

1) the National Bank Act permits banks to "exercise . . . all such incidental powers as shall be necessary to carry on the business of banking."

2) the "necessary" language in the NBA does not require a sine qua none standard. In other words, it does not have to be "indispensible" to the business of banking.

3) a national bank's activity is "necessary to carry on the business of banking" within the NBA, "if it is convenient or useful in connection with the performance of one of the bank's established activities."

4) Court of Appeals holds that while banks have often obtained transportation tickets for customers as a convenience, that is not comparable to the operation of a complete travel agency for profit.

d. NationsBank of North Carolina v. Variable Annuity Life Insurance Co. (pg. 197)i. issue: NationsBank sought permission to allow its brokerage subsidiary to act as an agent in the

sale of annuities. ii. holding: Yes, a national bank may operate as an agent in the sale of annuities.iii. analysis:

1) NBA § 24 grants banks "incidental powers . . . necessary to carry on the business of banking," and gives specific examples. The Comptroller found, and the Supreme Court agreed, that the powers specifically listed are merely examples, and are not exclusive. The "business of banking" language is an independent grant of authority not limited to the listed examples.

2) National banks are permitted to serve as agents for their customers in several respects, including investment products. Annuities are investment products, so the Comptroller reasonably determined that acting as an agent in the sale of annuities was "necessary" (meaning convenient or useful) to the "business of banking."

iv. second issue: deference to the decision of the Comptroller (Chevron analysis):1) first step: determine whether the "intent of Congress is clear as to the precise question at

issue." If so, then the question is answered.2) If the statute is ambiguous or silent as to the issue presented, then you ask "whether the

agency's answer is based on a permissible construction of the statute." If so, the administration's decision is given "controlling weight."

e. The test for determining whether an activity falls within the "business of banking"i. the NBA (12 USC § 24) should be construed broadly

1) "Necessary" = activities that are "convenient or useful in connection with the performance of one of the bank's established activities."

ii. "Incidental" = activities that are "necessary" to the "business of banking," including but not limited to (VALIC decision) the powers specifically enumerated in § 24.

1)3 factors helpful in determining if activity falls within 'business of banking'1. Whether activity in question is functionally equivalent to or a logical outgrowth of a

recognized bank power2. Whether activity benefits bank customers or is convenient or useful to banks

i. Increases service, convenience, or options for bank customersii. Responds to new customer needs or demands

iii. Lowers cost to banks of providing product or service


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iv. Enhances banks safety and soudness3. Whether activity presents risks of a type similar to those already assumed by banks

i. Big concern, courts will want to make sure bank not taking on too many risks2) 3 types of "incidental activities"

Facilitates operations of the bank as a business enterprise Enhances the efficiency and quality of the content/delivery of banking services or

products Optimizes the use or value of the bank's facilities and competencies, or allows the

bank to avoid economic waste.C. National Bank Act's Preemption of State Law (pg. 206)

a. Barnett Bank of Marrion County N.A. v. Nelson i. not really a incidental powers case, but express powers - starts with 12 USC 92ii. old part of NBA that allows national banks to own and operate insurance agencies in small

towns (concept was that these markets were under served in the insurance area)iii. Barnett Bank in FL had a national bank in a small town bought an insurance agencyiv. however, FL had an anti-affiliation statute that prohibited an insurance agent from affiliating

with a financial institutionv. so when bank bought agency, agents no longer recognized by FLvi. Barnett bank counters that state law is preempted by 12 USC 92vii. bank intended to sell insurance in that town and the sell it statewideviii. FL retorts that McCarter-Ferguson preempts 12 USC 92ix. this is a federal law that preserves to the states the regulation of insurancex. no insurance regulator on national levelxi. McCarren federal statute can't preempt state insurance law unless it specifically states its

intention to do so federal law has to specifically relate to the business of insurance to fall into the exception in this statute

xii. Court held that based upon plain reading, 12 USC 92 did fall in the business of insurance and thus federal law preempts state law and the federal law is not blocked by McCarren

xiii. GLBA codifies this decision so no question a bank can do thisb. Preemption of OCC's Visitorial Powers (213)

i. In 2004, OCC issued final rule stating that it had the exclusive power to enforce "a national bank's compliance with state law that would govern the content or the conditions for conduct of a national bank's Federally-authorized banking business."

Cuomo v. The Clearing House Association (pg. 214) Attorney Gen for the State of NY requested banks provide certain information about their

lending practices to determine if they had violated state's fair lending laws Issue: Is OCC's regulation saying it preempts state law enforcement a valid interpretation of the

National Bank Act? OCC's regulation says state officials can't exercise visitorial powers with respect to national

banks Supreme Court's analysis:

'visitorial powers' is ambiguous (first step of Chevron analysis) But, visitorial powers are different from the power to enforce the law, the National Bank Act only preempts the visitorial powers OCC's regulation says state may not enforce its valid non-preempted laws against national

banks - this is wrong (second step of the Chevron analysis, OCC's regulation is NOT a permissible interpretation of the statute, and so is not entitled to deference)

So, injunction can stay as far as it prohibits the Attorney General from issuing subpoenas (visitorial power)

BUT, injunction is wrong in that it prevents Attorney Gen from bringing judicial enforcement actions (enforcement)


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Dissent Says the statute is ambiguous, and OCC's interpretation is reasonable and entitled to

deference (Chevron analysis) Holding: State atty general may not issue subpoena to request info from national bank, but may

bring action to enforce any state law that applies to national banks and that has not been preempted

c. Diversity Jurisdiction (pg 218)i. Wachovia Bank v. Schmidt

Wachovia has its principal office in NC Citizens of SC sued Wachovia in SC state court Wachovia filed a petition in Federal district court in SC seeking to compel arbitration the Court of Appeals determined there was no diversity jurisdiction; held that a bank is located

in, and therefore is a citizen of, every state in which it maintains a branch office Supreme Court

§ 1348 deems national banks to be citizens of the state in which they are "located" determines that a bank is "located" in the state where it has its principal office (just like

corporations) otherwise, national banks would essentially be denied access to the federal courts

because they could never obtain diversity jurisdiction.D. Powers of State banks.

a. Powers of state banks are those granted by state statutes. Page 681 of Supplement has the banking laws of NY. Chapter 53 of NCGS has NC banking laws.

i. Page 703 has NY powers provision that is very similar to 12 USC 24(seventh)ii. NC has different take on powers provision "In addition to those powers conferred by law

upon private corporations, banks have the powers to ... "1) NC lawyers focused on the private corporations language to push bank powers in line with

private corporations. However, no incidental powers language in NC despite it being one of the most liberal banking states.

2) Moot point b/c this private corporation language probably expands NC bank powers beyond the business of banking/incidental two-step test.

b. FDICIA of 1991.i. Prior to this act, there was this race to the bottom

1) states tried to compete with national banks so they authorized state banks to do things that national banks couldn't do and might not have been safe to do. Trying to have most expansive state charter to attract banks to charter there.

2) Under FDICIA state banks limited in powers as principal to those given to national banks created parity in terms of state and national banks

3) State banks acting as an agent covered by state law, so agency activities of state banks is not restricted by FDICIA.

4) SEE 12 USC 1831aii. This led states to also level playing field in other direction wild card statutes in addition to

X powers, state banks can do anything a national bank can do BROAD powersiii. Neither NC or NY have these wildcard provisions even though they are the biggest banking

statesE. Bank subsidiaries. (223)

a. national and state banks are permitted to own the stock of subsidiary corps.b. subsidiaries are NOT chartered banks, may not accept depositsc. 3 types of subsidiaries:

i. Bank Service Corporation1) Bank Service Corporation Act2) provides services including:


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check and deposit sorting and posting computation and posting of interest and other credits and charges preparation and mailing of checks, statements, notices, and similar items any other clerical, bookkeeping, accounting, statistical, or similar functions

ii. Operating Subsidiary1) Watters v. Wachovia Bank (224)

Holding: the OCC supervises national banks and their operating subsidiaries, treating them as a single economic enterprise. Therefore, the operating subsidiaries of national banks are NOT subject to state supervision, because the OCC has the exclusive power to supervise national banks and their operating subsidiaries, pursuant to the NBA.

OVERRULED by Dodd-Frank Act.2) Dodd-Frank Act

Provides that "a state consumer financial law shall apply to a subsidiary or affiliate of a national bank . . to the same extent that the State consumer financial law applies to any person, corporation, or other entity subject to such State law."

overrules Wattersiii. Financial Subsidiary

1) created by the GLBA of 19992) may engage in "activities that are financial in nature" or "incidental" to a financial activity.

May engage in: ff. activities permissible for the subsidiaries of bank holding companiesgg. activities permissible for a bank holding company to conduct abroadhh. securities activitiesii. insurance agency activities

May not engage in:ff. insurance underwritinggg. annuity issuancehh. merchant banking

F. Corporate Governance (231)a. Sarbanes-Oxley Act applies to publicly-traded banks, savings associations, and bank holding companiesb. nonpublic banks with assets > $500 million must comply with banking laws and regulationsc. nonpublic banks with assets < $500 million

exempted from Sarbanes-Oxley Act and special banking law provisions but, FDIC believes these banks should also adhere to practices similar/identical to those in the Sarbanes-

Oxley Act.d. Dodd-Frank Act

adds additional corporate governance provisions SEC is required to promulgate rules requiring public companies to disclose in their annual proxy

statements why they have different persons/the same person serving in the role of the CEO and the chairman of the board.

also requires that public companies hold nonbinding votes to approve the compensation of key executives

-----------------------------------------------------SECTION 2-------------------------------------------------

G. Holding company regulation.1. Bank Holding Companies.

a. Looking at ways to expand beyond normal bank powers we have seen incidental powers and subsidiaries so far

b. Third way to do things beyond banking holding company structurei. BHC commercial corporation that controls a bankii. Control if defined in statute SEE 12 USC 1841(a)(1)


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iii. 90% of banking assets in US are owned by BHC’s, but this is changing now because BHC’s are changing to FHC’s

c. Fed is primary regulator of BHC’s and their non-bank subsidiaries even if bank is national or state nonmember

d. Under BHC structure, holding company can own one or more banks or any other company the business of which is so closely related to banking as to be a proper incident thereto (test)

e. Reg Y lists all permissible activities that can be done in BHC structure according to Fed.i. Prior to GLBA, BHC’s could apply to Fed for approval of additional activitiesii. Under GLBA list of permissible powers of BHC's frozen in time So Reg Y is all possible

powers for BHC's that are so closely related to banking ...

2. Financial Holding Companies. a. New type created by GLBA that allows BHCs to become FHC and engage in broader range of


b. Now can do things that are financial in nature or incidental to such financial activity or complimentary to a financial activity i. not limited to closely related to banking ii. statute does provide a list of examples, SEE 12 USC(k)(4)

1) like underwriting securities, insurance, and merchant banking, . . .

iii. To form a FHC, have to be well-capitalized, well-managed, and CRA of satisfactory or above

iv. Fed is primary regulator of FHCs

v. unlike BHC and Reg Y unnamed activities, list can be expanded (Reg Y frozen) 1) FHC can apply for a determination to see if an activity is financial in nature 2) application has to be made to Fed and Treasury

3) acting as a finder has been determined to be financial in nature by Fed (page 222-223) finder includes running call center, website, ... What about FHC buying Ebay sounds like finder activity

finder bringing parties together

what about real estate brokerage

aa. Fed proposed this, but created controversybb. seems like finder function of bringing together buyers + sellers cc. cc. move in Congress to pass law to tell fed that can't approve real estate

brokerage as financial in nature 4) small chart handed out listing activities and what entity can do it REFERENCE MATERIAL

c. Differences between subsidiaries of FHC and a financial subsidiary of a bank. i. Financial subsidiaries can't conduct activities complimentary to a financial activity

1) There are specific limitations put on financial subs - like they can't do insurance underwriting, issue annuities, or merchant banking, or real estate investment.

C. Additional Regulation for Systematically Significant Companies (p. 246)4. Dodd-Frank Act provides that “large, interconnected bank holding companies” should be subject to

enhanced supervision and prudential standards.c. In this category if bank assets exceed $50 billion


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5. However, Dodd-Frank has a “Hotel California” provision in § 117c. If the institution sold its bank subsidiary or converted it to an entity not considered a bank under the

BHCA, it would still be treated as a systemically significant nonbank financial company that would still be subject to Fed oversight and the heightened supervision and prudential stds.

6. Most significantly, under Dodd-Frank the Fed gains oversight over systemically significant nonbank financial companies that formerly escaped Fed purview since they were not bank holding companies.c. These companies are now subject to Fed registration, reporting, examination, and enforcement.

7. The new FSOC is charged with designating these nonbank financial companies.c. Requires a supermajority vote that must include the affirmative vote of the Treasury Secretaryd. Company must be “predominately engaged” in financial activities (85% of its revenues or assets

attributable to financial in nature activities)e. Intent is to ensure that entities like Bear Stearns, Lehman Bros. and AIG are subjected to heightened

supervision so that the Fed could forestall a crisis.8. Once designated by the FSOC as a nonbank financial company, the company has 180 days to register with

the Fed.c. Fed is required to implement “prudential standards” for these systemically significant bank holding

companies and nonbank financial institutions.d. Fed is given the discretion to impose additional heightened stds related to contingent capital,

enhanced disclosures, and short-term debt limits.9. Nonbank financial companies will not be subject to the general prohibition of the BHC prohibiting

participation in nonfinancial activities.c. But Fed may require that the nonbank financial company form an intermediate holding company,

that all financial activities of the company be placed under the immediate holding company, and that the intermediate holding company be subject to the BHCA.

3. Functional regulation. a. something that came out of GLBA as opposed to entity regulation

i. Functional regulation idea is that certain types of business should be regulated by what kind of business is being done as opposed to the type of entity doing activity

ii. securities sales under functional regulation it would be regulated by SEC regardless of the entity (broker, bank, ... )

iii. rationale

1) fairness - each entity face same regulation for same activity 2) consistency - can regulate the same things consistently 3) expertise - find regulator with most expertise and put them in charge

iv. other types of functionally regulated subsidiaries of banks regulated by SEC 1) broker-dealers (buy and sell stock) 2) investment advisers 3) investment companies (mutual fund - company the business of which is to own securities)

v. GLBA realized there would be new products Hybrid products - also regulated by SEC if they spin out of securities function

vi. other functional areas like insurance (regulated by states) and commodities dealers (CFTC will continue to regulate this area)

b. GLBA recognized the need to still have comprehensive regulation of banking companies i. GLBA wants one regulators to still see the big picture of an entity, despite different regulators

look at the different functions undertaken by the entity ii. FED still has regulator control over BHC's and FHC's as umbrella regulator


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iii. didn't do away with bank regulators like OCC, FDIC, and state regulators

c. Problems with this dual purpose regulation of functional and entity regulation i. turf battles cause this overlapping regulation

ii. some innovations don't fit into a single functional category 4. Commercial activities.

a. GLBA expanded scope of holding company activities from those closely related to banking to those that are financial in nature

b. Non-financial activities (commercial activities) are generally not permissible for FHC's i. prohibited by statute from doing this

ii. still a large number of business's grandfathered so there are some commercial companies that become FHC's and retain their commercial businesses for some time. SEE 12 USCA1843(n)(7) to qualify for grandfather provision must be "predominantly engaged in financial activities"

c. Does the distinction financial and non-financial still make sense? i. Gramm says he doubts that it will

ii. unclear if prohibition on commercial activity will remain in future d. one inroad was opened up in GLBA merchant banking

i. nothing more than banks or subsidiary of banks owning pieces (equity) of commercial businesses

ii. and these companies don't have to be financial in nature e. under GLBA FHC's and financial subsidiaries are allowed to invest commercial companies idea is

that the act of investing and managing the investment in financial in nature, not the target of the investment being financial i. there are limitations on how much banks can invest

ii. can't own majority interests (thus becoming a subsidiary)

f. is there a reason to keep this distinction between commercial and non-commercial activities? i. safety and soundness issue feel that bank owners will let commercial subsidiary slide on

credit standards and make loan to affiliated business that they wouldn't normally make (bank more likely to lose money on this)

ii. FDIC because banks have this insurance, they might go out and take on more risk because they have this backing (unwise investments in commercial businesses could increase bank failures)

iii. Aggregation of power and wealth banks have a lot of power in their balance sheets and lending power

g. Dodd-Frank imposed a moratorium on FDIC applications for deposit insurance filed after 11/23/2009, for an industrial loan company, credit card bank, or trust bank by a commercial firm that derives less than 15% of its consolidated revenue from financing activities.

5. Interaffiliate relations.

a. Affiliate transactions. i. Sections 23a and 23b of the Federal Reserve Act are intended to limit the risks to an insured


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depository institution from transactions with is affiliates. These sections also limit the ability of an institution to transfer to its affiliates the subsidy arising from the institution's access to the Federal safety net.

ii. These rules reflect the special place of banks in economy. iii. 23a achieves these goals in three ways

1) Limits the aggregate amount of an insured depository institution's covered transactions with any single affiliate to no more than 10% of the institution's capital and surplus.

2) Statute requires all covered transactions between the institution and its affiliate to be on terms and conditions that are consistent with safe and sound banking practices, and prohibits an institution from purchasing low-quality assets from its affiliates.

3) Extensions of credit be appropriately secured by a statutorily defined amount of collateral. applies to credit transactions between banks and affiliates anything that uses bank

credit for the benefit of subs

Covered transactions purchases of assets from affiliate, extensions of credit to the affiliate, guarantees issued on behalf of the affiliate, and other transactions that expose the institution to the affiliates investment risk.

iv. 23b more recent, requires affiliate transactions to be on an arm's lengths basis and have market comparable terms at least as favorable to the institution as those prevailing at the time for comparable transactions with unaffiliated companies.

v. 23a and 23b are implemented by a new Regulation Reg. W

b. In the Dodd-Frank Act, Congress amended 23A and 23B to limit the Fed’s unilateral authority to grant exemptions from the affiliate transaction restrictions.i. Fed is required to act with the FDIC and the primary regulator of the bank in issuing exemptions.ii. “Covered transactions” were expanded to include securities lending or borrowing transactions

with affiliates, all derivatives transactions with affiliates an expansion from just credit derivatives transactions, and eliminates the exception from the quantitative limits of 23A previously given to transactions b/w a bank and a financial sub of a bank.

c. Conflicts of interest.

i. use within the company of non-public information potential for conflicts increase as banks and their holding companies expand in size and engage in an increasingly broad

ii. Washington Steel Corp. v. Tw Corp.

1) Chemical bank loaned money to Washington and had non-public info about Washington - later TW asked for a loan from Chemical to purchase Washington

2) Washington sued saying Chemical had a duty to protect Washington

3) district court applied a per se rule Chemical could not use this information against customer

4) the appeals court reversed saying could not have a per se rule Largely decided on policy grounds – as a matter of public policy, not going to prevent

banks from dealing with competitors of their customers might limit amount of credit in the economy – just go out and get all banks on your side

and no one could come after you because they couldn’t get credit5) as a matter of policy, no problem with loan dept using information to make loan to TW


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6) exception is they felt only areas that had fiduciary duties (like trust) couldn't use info

d. Anti-tying.

i. Tying has to do with conditioning one service on another (I will give you this if you will take something else from me) 1) in banking Saying to a borrower I will make you a loan if you let me underwrite your next

securities offering

2) perceived to be anti-competitive and generally part of anti-trust laws 3) they don't say you can never tie bank product to another product

ii. can tie traditional products together like loans and deposits, package of products (trust services, safe deposit, account, credit card, ... ) - bank says you get a better rate on this if you take all this together - can do this package deal (can tie all sorts of things together now - and fall under traditional bank services rubric)

iii. Section 106 of Bank Holding Company Act of 1970 prohibits so called tying arrangements SEE 12 USCA 1972 & 1975

iv. Fed’s pending interpretation of prohibited ties as to borrowers:1) Insurance products2) Underwriting3) Sale of unrelated real estate

v. Mid-Atlantic .

1) this is a case where a tying argument was tried unsuccessfully 2) Mid had a revolving line of credit with the bank that was secured by trading assets

(receivables and inventory) 3) part of the agreement, where lending made against checks, bank required a lock box post

office box in borrowers name and only bank has access to it 4) argument failed because the lock box and block account are not services that anyone would

buy separately only exist in secured lending relationships 5) have to have to separate products that are sold to public individually

vi. Dibidale. 1) bottom line is that you had two affiliated banks through common ownership 2) P wanted loan from one of two, bank said ok if they used contractor who was indebted to

other bank this would help contractor pay back loan to second bank who really needed this

3) no explicit condition in agreement that it had to happen this way, implicit court held that enough had been alleged to make out a case for anti-tying laws

4) also held standard to be applied was not as strict as under other anti-trust laws don’t have to prove anti-competitive effect or market power just have to show it was conditioned and he would have had a better chance getting

credit.vii. Tying statute 106 of BHC – 12 USC 1971 & 1975 on page 589 of supplement

1) it applies to banks limits banks tying of products by bank or an affiliate of bank2) tying rules do not prevent a non-bank from tying3) what a bank can’t do it might be able to do it in another entity in BHC structure4) A CUSTOMER CAN TIE PRODUCTS TOGETHER – bank can’t

C. Privacy.1. Disclosure to the government.

a. The Right to Financial Privacy Act (RFPA) (SEE 12 USCA 3401) – limited the power of the federal


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government to obtain access to individual records. The Act prohibits financial institutions from releasing customer financial information to government authorities until the government complies with certain procedures.

i. Has to be for legitimate law enforcement inquiry ii. Financial institution has to give notice to the customer of the request

b. Adams . i. Example of how there is an exception in RFPA where financial regulators have access to personal

financial information in their supervisory role

ii. "Nothing in RFPA prohibits examination by or disclosure to any supervisory agency of monetary functions with respect to a financial institution." SEE 12 USC 3413(b)

c. Lopez .i. First Union made disclosures to government based upon verbal instructions to do so. ii. Have to have more than just verbal instructions - also have to give customer notice so they have

opportunity to object. 2. Disclosure to private parties.

a. Disclosure of financial information to credit reporting agencies was regulated by the Fair Credit Reporting Act of 1970 (FCRA) SEE 12 USCA 1681-1681(f).

i. Credit agencies companies that gather credit info from financial institutions and provide this info to banks, insurance agencies, employers, …1) they are big clearinghouses of information of your past credit history2) your bank is permitted to provide this info to credit bureaus with or without your consent3) reason for this is this is considered a valuable service safety and soundness of credit in


ii. This ability is limited1) Only can supply information for permissible purposes (loan decisions, employment

decisions, ... ).2) FCRA has protections for customers

info is obsolete after certain amount of time (bankruptcies over 10 years can't be shown) - adverse credit info drops off after time

you have right to get report for a fee and if you see mistake the credit bureau has to investigate (you can also put your own explanation that will go with report)

b. Disclosure of financial information to a financial institution's affiliates and non-affiliates is regulated by Title V of the GLBA SEE 15 USCA 6801-6827.

i. Title V pertains to disclosure of personal financial info to affiliates and non-affiliates

ii. It applies to financial institutions any institution engaged in financial activities1) brokers, insurances agents, ...2) are law firms included? FTC says yes, ABA says no

iii. In general under Title V , financial institution are entitled to disclose Non-public personal info (NPPI) with affiliates this includes personally identifiable financial info (PIFI)

1) PIFI is a subset of NPPI 2) The reason they can share PIFI and NPPI is to encourage cross-selling3) not permitted to share NPI with non-affiliates unless you give customers chance to opt out


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have to notify customer that your policy is to share PIFI with non-affiliates unless you say you don't want them to

some states went further and said we want opt-in states can go further than feds, but have to be consistent

4) Still many loopholes Financial institutions can share public information with non-affiliates and affiliates Problem is with aggregation - just because it is public doesn't mean that when aggregated together it could be a privacy concern. Also, derived from public info is excluded

5) some financial institutions have decided not to share NPI with no outsiders logistically it takes a ton of time and money to deal with these notices

iv. GLBA requires financial institutions to:1) have a privacy policy2) have to disclose this policy each time a customer obtains a service (at the outset of

relationship) and annually have to send it to them thereafter3) give right to opt out


1) Trans is a credit bureau attacking privacy provisions of GLBA2) Attacked FTC Jurisdiction on grounds the Credit Unions weren’t FI, attacked definition of

personal information, challenged the coverage of credit headers (saying not Financial info),, challenged restrictions on reuse, …

3) they have lost across the board4) why is credit bureau so upset?

their customers are banks the real reason is the use and reuse restrictions one way they make money is credit bureaus is by charging fees but big way is aggregation aggregate info from sources and come up with lists of

target customers and then sell to marketing companies GLBA’s limit on aggregation is what troubles credit bureaus

------------------------------------------------- SECTION 4 --------------------------------------------------

A. Technology, the Internet, and e-commerce. 1. Technology.

a. Three reasons Vice Chairman of Fed sees banks investing in tech: i. It lowers operating costs ii. Opportunities to serve their current customers and attract new ones by offering new products

and servicesiii. Risk management and information management systems and techniques

2. Internet banking. a. stand alone Net bank has not been a great success

i. Found that they still need brick and mortar type facilities, even if different than what traditional banks need.

ii. also raises issues of where bank is located for regulation and CRA b. what has happened is that brick and mortar banks have added on e-banking features to traditional

bank products i. has been an add on feature and not a replacement feature tor traditional banks ii. hasn't replaced brick and mortar banks yet


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c. risks of internet websitesi. potential liability/consumer violations for inaccurate/incomplete information on websites

ii. security risks if the website is not properly protectediii. potential liability for spreading viruses and other malicious code to computers communicating

with the institution's websitesiv. negative public perception if online services are disruptedv. authentication of customers who use internet banking, losses from fraud if customers are not

verified accuratelyvi. liability for unauthorized transactions.

3. E-commerce. a. other electronic issues

i. e-money - how do you pay for things over the web when you don't want to use credit card - still developing

ii. body of law on e-signatures UETA - Uniform Electronic Transactions Act b. risks of e-commerce

i. transaction/operations risks : risks from fraud, processing errors, system disruptions, etc.ii. credit risks : due to the increased risk of fraud in loan transactions when processed

electronically, a financial institution's credit risk could be increased if loans are approved electronically.

iii. liquidity, interest rate, and price/market risks : funding and investment-related risks could increase. Institutions can market their products and services globally. Internet deposits may attract customers who focus exclusively on rates.

iv. compliance/legal risks : rules and laws governing e-banking are still evolving.v. reputation risk : decision to offer e-banking services significantly increases its level of reputation


V. BANK ASSETS. (*CHAPTER 5 OF HORN BOOK) A. Non-loan assets.

1. Real estate. a. Although loans make up largest category of assets in any bank, the largest non-loan category of

assets is usually real estate b. National banks are permitted under 12 USC 29 to own real estate for limited purposes

i. for own premises i. the amount a bank may have invested in its premises may not exceed the amount of the

bank's capital stock ii. if banks can only hold these kinds of property, how do banks have these huge buildings like

skyscrapers? iii. primary reason to own this premise is for bank premises and can be landlords under the

idea that they will eventually expand into these other spaces ii. property from foreclosures

i. DPC property debts previously contractedii. also called OREO other real estate owned

iii. can own it for up to two years while trying to sell it plus they can apply to OCC for an additional 3 years this so banks can get reasonable price

2. Investments. a. In addition to loans and real estate, banks can hold certain types of securities subject to some

limitations. 3 types can be held: i. type I - most common, US government bonds or general obligation bonds of states and cities

(very low risk of default)i. under 12 USC 24 can be held without limit


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ii. general obligation backed by full-faith and credit of governmental unit (backed by taxing power)

ii. type II - revenue bonds by statesi. not backed by taxing power

ii. can own an amount up to 10% of capital and unimpaired surplus for any one issuer iii. type III - revenue bonds by municipalities and corporate bonds

i. not backed by taxing power ii. can own an amount up to 10% of capital and unimpaired surplus for any one issuer

iii. have to be investment grade by one of national rating agencies such as Moody’s or Standard and Poors.

b. Marx v. Centran Corp. i. P bought 200 shares of D. D’s had a plan to borrow money while interest rate declines for taking

leverage and taking this money to buy long term fixed rate obligationsi. they were betting interest rates were going to decline

ii. they were buying government obligations now, when rates went down these fixed rate securities would pay more than the market and would increase in value

iii. interest rates went up and they eventually had to liquidate portfolio, lost $50 millionii. court said he did have a cause of action for violation of 12 USC 24 iii. but concluded that the bank did not violate 12 USC 24, its investments were within the limits of

the statute as further defined by OCC regulations.iv. scheme was wild, but most of these securities were government securities which are type I and

can be held without limit - so P lost even though bank acted stupidly v. note: D bought excess reserves of other banks and repos. REVIEW QUESTIONS AND NOTES PPG

298 & 299c. U.S. v. Iguchi

i. Iguchi made a lot of bad deals, tried to conceal losses by selling unauthorized securities. Confessed to parent company (Daiwa), who told him to keep falsifying info. Iguchi then confessed to U.S. law enforcement. Iguchi was fined $2 million, although the record stated that he didn’t have the money to pay. Can an indigent D be fined an amount that he doesn’t have the money to pay?

i. Volcker Rule (as set forth in Dodd-Frank § 619). a) Restricts banking entities from proprietary trading. Exemptions (aka “permitted

activities”):i. Transactions in U.S. government obligations, GSE (e.g. Fannie Mae, Freddie

Mac) obligations, obligations of states/political subdivisionsii. Securities connected with underwriting or market-making activities consistent

with customers’ near term demandiii. Risk-mitigating hedging activities connected with the banking entity’s holdingsiv. Securities held on behalf of customers.

b) Bans relationships (esp. controlling influences) with hedge funds & private equity funds. Exemptions:

i. Banking entities can make de minimis investments as long as all investments is less than 3% of the entity’s Tier 1 capital.

ii. Banking entities can sponsor a p/e or hedge fund and serve as a general partner subject to certain limitations and the entity has equity interest less than the de minimis amount.

iii. Funds can only be offered to the banking entity’s customers.iv. Can invest in Small Business Investment Companies that are “designed primarily

to promote the public welfare.”ii. Sentencing court may impose a fine based on the realistic possible future earnings, esp. where

the crime is high-profile and he could generate income from books/movies.


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B. General regulation of loans. 1. Lending limits.

a. Bank laws limit the amount of credit that can be extended to a single borrower. For national banks, these limits can be found in 12 USC 84 and 12 CFR pt 32 i. The point is to make banks diversify their credit risks have to loan to numerous individuals

and somewhat diversify ii. This diversification is limited in the sense that they don't have to diversify across industries - just

by borrowers. b. 12 USC 84 cannot loan more than 15% of capital and surplus to any one individual

i. just have to look at the balance sheet to come up with this number ii. this is base rule, but there are exceptions to this:

i. can loan additional 10% if secured by readily marketable collateral (things that are easy to liquidate)

ii. another exception if loan fully secured by type I securities not included in 15% c. In addition to 15% limit, certain loans have to be aggregated together to count against limit

i. if different borrowers engaged in common enterprise, all loans have to be aggregated together to count against 15% limit

ii. can't get around lending limit by splitting up loans d. a number of states (36) have higher lending limits than under federal law

i. NC limit is identical to federal law ii. section in this N.C. statute that allows Board of Directors to adopt resolution to apply to

commissioner to get higher limit by up to 10% for 120 days iii. states do this for regulatory arbitrage make their charters more attractive than national

charterse. why are these limits important?

i. directors of national banks have personal liability for loans which exceed limits.ii. this gets directors' attention

f. EXAMPLE assume that bank has 10 million dollars of capital and surplus i. normal legal lending limit for this bank is 1.5 million ii. if bank makes a loan to a borrower for 1 million (and its unsecured) it is ok iii. if it makes a $2 million loan that is secured by real estate - over limit

i. real estate is NOT READILY MARKETABLE COLLATERAL iv. 2 mill loan and 500k of readily marketable collateral - within that additional 10% exception v. 3 mill loan with 1.5 million in readily marketable securities - violates top limit of 25% (the readily

marketable collateral exception (10% over 15% is all secured by RMC) vi. 3 loans of 750k each to A, B and C, but all going to same business = 2.25 million total.

i. not ok because as a whole it is more than 15% limit ii. this falls within aggregation rules of 12 USC 84

iii. Note there are exceptions to lending limits. See 12 USC 84 (c), p. 29 of Statutes Supplement.g. Del Junco – a/k/a what happens to directors who refuse to follow OCC requests for indemnification.

i. Idea that regulators enforce lending limits strictly ii. Issue: was there substantial evidence to support a finding that the $125k loan to the Treasurer

was “used for the benefit of the corporation”?iii. Court found that yes, the proceeds of the account were used to benefitiv. Court was not going to fashion remedies to protect directors from liability, but going to fashion

remedies that protect bank and its SH's. First loan (unsecured) had to be paid off first. 2. Dodd-Frank

a. Dodd-Frank § 610i. Defines credit exposure to include all purchases or investments in securities issued by a



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ii. Adds credit exposure from the following to the list of loans subject to national bank lending limits:

i. Derivativesii. Repurchase agreements

iii. Reverse repurchase agreementsiv. Securities lending transactionsv. Securities borrowing transactions.

b. Dodd-Frank § 611i. State banks can only transact derivatives if the chartering state’s lending limit law shows a

consideration of derivatives credit exposures.c. Dodd-Frank § 165(e), Title I

i. Systemically significant BHCs and nonbank financial companies can only expose up to 25% of their capital stock & surplus to any unaffiliated company.

ii. Will not become effective until 3 years after 7/21/2010 enactment of D-F.

3. Insider loans. a. Loans to insiders of the bank are permitted, but are subject to certain regulations.

i. Insiders executives, officers, principal SH's, ... ii. Rationale: we don't want banks become piggy banks for insiders iii. these limitations are found in 12 USCA § 375a and b and are implemented by Reg O

b. § 375a i. covers only loans to executives ii. requires terms to be same as given to non-execs and have to be disclosed to Board (not subject

to approval though), terms cannot be preferential, credit risk has to be normal for lender.i. Has to be such a loan as the bank would be authorized to make to another borrower

ii. Executive Officer defined as any person who participates or has the authority to participate in major policymaking functions, other than as director.

iii. Examples: Chairman, president, VPs, secretary, cashier, and treasurer c. § 375b (covers broader group)

i. covers loans made to executive officers, directors, and principal SH's (own more than 10% of any class of voting stock)

ii. Loans have to be on substantially same terms as given to other borrowersiii. have to be approved in advance by Board; if to a director. Director abstains from voting to

approve loan to them.iv. Loans to insiders must not exceed the amount of the bank’s unimpaired capital and surplus

d. De La Fuente v. FDICi. Procedurally, this was Fuente’s appeal of FDIC order removing him as a director of First

International Bank (“FIB”) and forbidding him from voting shares of a bank or serving on the board of directors of any federally regulated bank for life.

ii. FDIC found that on an aggregate basis Fuente controlled entities received loans in excess of applicable limits. 12 USC 375 (B) and Reg O was violated

iii. Fuente used family members, trusts, employees and corporations as “borrowers” from FIB.iv. FDIC “found” Fuentes “controlled” all borrowers, cited in case under Reg “O”, 12 CFR §

215.1 - .13.a) Fuentes was an “insider” under Reg O by virtue of being director of FIBb) Reg O defines insider to include an executive officer, director or principal shareholder

and includes a “related interest” of any of the foregoing;i. Own 25% or more shares of a corp.

ii. Has power to exercise a controlling influence over management or policies of a corp.

iii. At 10% ownership, rebuttable presumption of control exists


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e. American Bankers Mortgage (ABM) US Federal Home Loan Mortgage Corp. (Freddie Mac)ABM failed to properly report mortgage delinquencies as required by Freddie Mac Seller and Servicer’s Guide. If under reported past due mortgages. Freddie Mac terminated ABM as approved seller. Basically this would kill ABM as a going concern or business. ABM appealed decision to Freddie Mac which denied appeal in April 1992. ABM then sued and lost, then took appeal to U.S. Supreme Court, ABM raised 5th Amendment, due process clause (this applies only to the federal government Ct. held Freddie Mac was not a government agency even though it was chartered to pursue gov’t objectives.

4. Lender liability. a. Rubric under which bank liability falls

i. P's would use this to say bank had violated a number of duties (including good faith) ii. P's were successful for a while in arguing that bank breached good faith when it cut off line of

credit when bank thought risk too high b. in recent years P have had less success because banks have not done things that look bad in

hindsight and they spell things out better in terms of rights and remedies for the bank i. removed discretion in contracts and replaced it with specific events that trigger certain rights

and remedies for the bank ii. removes the ability of P's to use good faith - take away discretion

5. Environmental lender liability. a. special kind of lender liability that comes about by the lender taking contaminated property as

collateral for its loans i. Issue: who is liable to clean it up? ii. do banks that have lent against contaminated property are liable to clean them up

b. US v. Fleet Factors i. Fleet lending to company that contaminated property ii. company went bankrupt - Fleet came in as secured lender and sold everything iii. EPA comes in later and finds a ton of contamination

i. EPA cleans up and then sues owners and bank ii. got SJ against owners but tougher against bank

iii. court nailed fleet with liability iv. fleet's appeal was based on provision of CERCLA that was designed to protect secured lenders

from this - as long as not involved in management of company v. issue in case boiled down to whether Fleet was involved in management of facility so that it

was deemed an operator and not exempt vi. court says bank can be held liable if involvement with the management of the facility is

sufficiently broad to support the inference that it could affect hazardous waste disposal decisions if it so chose.

vii. the ruling had the effect of drying up credit to real estate lending due to threat of clean up costsviii. Congress negated the management participation theory of liability that came out of this case

c. ESA environmental sight assessment i. banks do this now to avoid getting involved in contaminated site (like Fleet) ii. banks still wary of environmental issues because it can still affect value of collateral dramatically

and that is why banks still do ESA's despite case being overruled 6. Accounting for loan loss reserves.

a. Loan Loss Reserves income statement item that reduces income i. you subtract LLR from net interest income to get you to non-interest income ii. number that can be manipulated thereby changing net income

i. amount that goes in for a period is up to management of bank ii. basically management can use this as cookie jar to get income by decreasing it or lowering

income by increasing iii. also a balance sheet item

i. current accumulated LLR over time


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ii. goes up and down by what happens to ALL on income statement iv. when a loan loss is actually experienced, the amount comes out of LLR v. if you get money on loan accounted for in account, amount in LLR goes up

b. Regulators want LLR tied to experience with troublesome loans i. SEC doesn't like these accounts to be manipulated they want disclosure ii. bank regulators would rather see big LLR's in case of loan losses iii. joint rule issued by all regulators:

i. set LLR based upon GAAP ii. but bank management can still use some judgment as to amount of these reserves

iii. GAAP sets outside limit but management discretion within these limits c. Fair Value Accounting

i. Aka “mark-to-market”ii. Fair value is noted in the footnotes of the financial statementsiii. Difficult to determine at times, depending on market; firms are sometimes forced to determine

“exit price” if they were to be sold in the current market (which has its own difficulties, especially in an illiquid market, as in times of financial crisis)

7. Fair Value Accounting. “market-to-market” accountinga. Current accounting rules report loans expected to hold to maturity at their amortized cost, subject

to loan loss reserve amount.b. FASB exposure draft proposes maintaining loan loss allowance accounts with changes flowing

through to earnings. Fair value is recourded in Other Compensation Income (OCI).C. Commercial lending concerns.

1. Loan participations and syndicated loans. a. Two main types of commercial loans that banks make:

i. Revolving Credit (revolvers) line of credit that can be drawn down by borrower, repaid, and re-borrowed, and so on ...

i. amount of line is set, but under that you can go up and down ii. typically used to finance a companies working capital (capital used in day to day operations -

accounts receivable is one piece of working capital) iii. payable interest only and principle at maturity

a) pay interest monthly on what used during month b) at date of maturity borrower repays outstanding principle c) LIBOR and prime rate are types of rates that revolvers are often tied to d) secured or unsecured (collateral or not) often secured by trading assets of company

(inventory and accounts receivable) e) lines of credit that are secured by trading assets are often called "Asset based lines of

credit" iv. short term less than year

ii. Term loans typically made for longer period i. amortizing paying some interest and some principle on these

ii. term loans are used to finance hard assets like real estate, machinery, ... iii. more frequently than revolvers have fixed interest rates

iii. Compare revolvers and term loans to consumer loans i. consumer analog to term loan is a home mortgage loan

a) why? payable over fixed time and payments of both principle and interest and used to finance a hard asset

ii. consumer analog to a commercial line of credit? a) credit card or home equity line of credit (typically these don't require payment of

principle) b. large commercial loans banks want to lay off some risk of these loans - can do this through loan

participations and syndications


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i. Loan participations the loan is negotiated between the borrower and the lead lender. The lead lender subsequently sells a percentage of the loan that has already been made to one or more participants.

i. Loan participant is considered to have a double-risk exposure - to the borrower and to the lead lender

ii. Lead bank only name on loan documents iii. pursuant to participation agreement and certificates lead bank sells off pieces iv. lead bank retains the servicing of the loan when it sells off participations and gets to collect

fees on these services offered ii. Loan syndications - each lender is a member of the syndicate and a party to the loan documents.

The borrower has a direct contractual relationship with each member of the lending syndicate. i. these are for really big loans, bigger than participations

ii. banks get together at the front end and all are on documents iii. if booking loan and simultaneously sell off participations can get around lending limit

because you never have more than legal limit of exposure because selling down at the same time

iii. question on 324 #2 small banks or large banks going to participate in loan participations? i. small banks are more likely to manage its lending limits than big banks

a) smaller bank may have a lower limit to manage but a big customer who needs a lot of money so they have to sell off to diversify risk or get down under limit

ii. syndications big banks - typically syndicated deals are very large borrowings and a few large banks a) the companies borrowing that much money are dealing with a small number of banks

that can meet these needs b) so these banks get into pattern and they have template documents they all use c) the larger the loan the more likely to be unsecured so creditworthy they can get a

bunch of money on an unsecured basis iv. Banco Espanol – example of participant trying to create a securities law violation

i. Facts D had line of credit with Integrated; D sold these loans to institutional investors who signed master participation agreement which set forth the terms of participation; purchaser represented in this document that it made its own credit decision when it bought the participation; D cut off Integrated when they got in trouble, while still selling participations; Integrated went into bankruptcies and investors sued on the theory that there had been a securities violation - failure to disclose

ii. Issue one definition of security is a note or certificate of participation of a note - is this loan participation a form of note that is subject to securities laws like disclosure?

iii. trial court through them out because not security but merely buying participations in commercial loans

iv. circuit court affirmsa) Reves test held that if the note in question bore a family resemblance to a non-

security then not covered by securities lawb) 4 part Reves test:

aa. motivations that would prompt a reasonable buyer and seller to enter into the transaction court found motivations to be the promotion of commercial purposes rather

than the investment in a business enterprisebb. the plan of distribution of the instrument

contract specifically prohibited the resale of the loan participations without written permission - prevented sale to general public

cc. the reasonable expectations of the investing public


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sophisticated buyers who knew these were loan participations and not investments in a business

dd. dd. existence of another regulatory scheme (or some other factor) significantly reduces the risk of the instrument court hung its had on 4th part that OCC regulated these and was not

treating it as security decides more like loans than securities 2. Secondary loan market.

a. Talking about loans where simple paradigm is bank loans money to borrower i. secondary loan market gets more complicated

1) secondary market market for loans that have already been made 2) loans are assets to banks and assets can be sold 3) oldest market and largest secondary market is the one for mortgage loans

b. Banks and thrifts are vulnerable to interest rate risk due to mismatch between short term floating rates all deposits (liability) as opposed to long term fixed rate loans (asset) i. risk is especially bad in mortgage lending because most loans are fixed rate and long term (30

years) ii. Banks and thrifts addressed this risk by selling these loans in the secondary market or

securitizing them c. Back in depression FHA stepped in and began to insure loans made by private lenders to make these

loans more marketable i. buyers wouldn't buy loan based on underlying credit alone, they needed reassurance ii. FHA created national mort. association to purchase these mortgages became Fannie Mae

1) partly owned by government and private 2) purpose of Fannie Mae was to buy insured home loans and pump money into home loan

market iii. 1968 divided into two companies Ginnie Mae and Fannie Mae

1) Ginnie is owned by government (w/I Dept of Housing and Urban Develop.) function of Ginnie is not to buy mortgages but to guarantee MBS serves role as guarantor of MBS issued by approved institutions

2) Fannie is a public company (3rd largest financial co in world) Fannie buys mortgages and not limited to those loans of special government programs

purchases loans on multi-family homes, Va and FHA loans, conventional non-guaranteed loans, second mortgages, ...

Fannie Mae also securitizes mortgages by issuing MBS seeks to ensure that money for mortgages is available to home buyers, does this in two

ways: aa. Fannie Mae pays cash for mortgages and hold these in a portfolio - the lenders

can in turn use that money to make more mortgages to home buyers bb. Fannie Mae issues MBS in exchange for pools of mortgages from lenders - this

provides lenders with a more liquid asset they can buy or sell (traded on Wall Street)

Both are considered GSE's special type of entity -federally chartered, exempt from SEC registration, line of credit at Treasury, not subject to state and local taxes

because they have these characteristics, they are widely viewed as having an implicit government guarantee

d. Dodd-Frank § 1074 requires Treasury to submit a report to the Senate Banking Committee and House Financial Services Committee on options for ending the government conservatorship of Fannie Mae & Freddie Mac while minimizing costs to taxpayers, to include:i. Gradual termination of such entitiesii. Privatization of such entitiesiii. Incorporation of functions into Federal agencies


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iv. Dissolving Fannie & Freddie into smaller companiesv. Any other measures deemed appropriate by the Secretary of the Treasury.

e. in 1970, Freddie Mac was formed i. buy conventional mortgages from federally insured financial institutions and packages them into

securities that can be sold to investors ii. doesn't have to be guaranteed by FHA or VA iii. same theory through its securitization process, Freddie Mac pumps money back into primary

market - gives banks money back so they can lend again f. Both Freddie Mac and Fannie Mae are regulated by the Office of Federal Housing Enterprise

Oversight (OFHEO) within the Dept of Housing and Urban Development i. As GSE's, Freddie and Fannie are able to raise money at lower rates than competing financial

institutions (b/c their debt is less risky because of the implicit federal guarantee) 3. Securitization.

a. In general. i. both Freddie and Fannie securitize their loans ii. package the loans into pools and issue securities backed by these loans iii. put the pool of loans into trust and this trust issues certificates bought by public

1) interests are called MBS 2) secured in payment of these assets 3) like bonds, debt securities that have interest rate on them and they are secured by the loans

in the pool - and Freddie and Fannie guarantee payment of the interest rate even if mortgages aren't paid back

4) so Freddie and Fannie subject to the interest rate risk falling rate everyone in pool refinances and that loan goes out of pool and these MBS

have fixed guaranteed rate for long term so Freddie and Fannie have to step up SEE Page two of handout on securitization

iv. Benefits of Securitization 1) Originators improves return on capital by converting an on-balance sheet lending

business into an off-balance sheet income stream that is less capital intensive (Banks) 2) Investors securitized assets offer a combination of attractive yields, increasing secondary

market liquidity, and generally more protection by way of collateral overages and/or guarantees. Also provide flexibility because their payment streams can be structured to meet investors' particular needs

3) Borrowers increasing availability of credit on terms that lenders may not have provided had they kept the loans on their balance sheet

v. Growth in securitization 1) First, businesses began to collateralize non-mortgage assets like auto loans.2) Next moved into bank credit card - showed that if the yields were high enough, loan pools

could support asset sales with higher expected losses and administrative costs than in the mortgage markets

3) Future area of growth will be in commercial loan securitizations - formula driven credit scoring and credit monitoring are now used but these loans are problematic because they are not as homogeneous as mortgage or retail portfolios

b. Mortgage-backed securities. i. Ginnie Mae guarantees securities backed by pools of mortgages called MBS, which are issued by

Ginnie May approved financial institutions 1) because of guarantee, investors are assured timely payment of principle and interest that is

due 2) Payments occur monthly and are called "modified pass-through payments"

money is passed from the borrower through to the investors


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It is modified because if the amount collected from the borrowers is less than the amount due, the issuer modifies the pass-through to add on an amount from its corporate funds to make the payment complete

If the issuer fails to make the payment, Ginnie Mae will make the payment to the investor (backed by FFC of US government)

ii. Because securitization is a way to recover your capital after you make a loan – it is a thing banks want to do as well not limited to GSE’s1) banks wanted to get involved and have assets that lend themselves to securitization what

they don’t have is a government agency securing payment.2) so banks have had to develop ways to accomplish the marketability of these things what

they came up with is this: take pool of assets that has large # of loans in it so that is has predictable characteristics take that pool and put it in a trust or limited purpose company that is not technically

owned by the bank (IMPORTANT) has to be bankruptcy remote entity (also called SPE's)aa. company that owns asset stream that can't be pulled back to the bank in

bankruptcy have to separate risk of SPE from the bank/originator bb. idea with bankruptcy remote is that if originator fails (bank) want pool of

contracts far enough away that they can't be brought back to originator in bankruptcy

3) bank will put assets in this SPE and this entity will issue securities to public and from these the bank is paid for the assets

4) trust is set up is to issue the certificates 5) bank often times retains the servicing rights to the loans: fee generating device 6) now moving to do this for other people (beyond bank's own assets like credit cards, auto

loans, ... ) structure of these get more complicated (chart in handout) 7) As a result of this securitization with regard to credit rating better than what the

originator would have gotten this happens through isolation of assets and securitizing them these rating translate into interest savings For example, say Bank A wants to raise $100 million of lending activities over the next 9

months. It has a number of options, but here are two: aa. It can issue bonds worth $100 million at say 10% to public investors bb. The separation of originator from receivables through securitization, allows

bank to obtain this $100 million from the SPE in exchange for a pool of loans. The SPE then issues securities and through this structure (bankruptcy remoteness) and use of large pool of loans (statistical analysis), the credit rating of the SPE will allow it to borrow funds from the investing public at a lower rate than Bank A would get on its own. Results in substantial savings.

c. Collateralized mortgage obligations.i. a. another way mortgages are securitized not buying an interest in pool but they are

derivativesii. Collateralized mortgage obligation (CMO) a security backed by a pool of pass-through rates,

structured so that there are several classes of bondholders with varying maturities, called tranches. The principal payments from the underlying pool of pass-through securities are used to retire the bonds on a priority basis as specified in the prospectus.1) CMO issuer begins with a large pool of home mortgages, often worth billions of dollars 2) Each pool of home mortgages generates two streams of income:

First stream is the aggregate of all interest payments made on the underlying mortgages Second stream is the aggregate of all principle payments made on the underlying



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3) These income streams are divided into numerous CMO "tranches" which are sold to investors

4) To determine what portion of the two income streams are received by an investor, each tranche has two unique formulae: one that determines the tranche's interest rate one that determines the tranche's repayment priority

aa. this determines when the tranche will receive principle payments made on the underlying mortgage

5) CMOs were particularly hard hit for a number of reasons Rise in rates extends average maturity of all CMO's Called "extension risk" when interest rates rise, the expected maturity of the support

tranche CMO increases d. Other asset-backed securities.

i. lots of types of assets you can securitize: 1) auto loans 2) auto leases 3) credit cards 4) Sallie Mae provides secondary market for student loans

e. Special concerns related to securitizations by banks. i. Can be very expensive way to do this in terms of transactions costs so complex ii. bank may, in order to get rating it needs, have to put up some kind of credit enhancement and

this has cost associated with it iii. If not treated as true sale, get stuck with value of retained interest iv. CMO's can be risky in unstable interest rate environments v. you lose control of assets when you sell these

f. What is the point of all this? i. flexible and economical forms of funding for institutions that need money, alternative to

borrowing ii. lower cost of funds than through bank loans and debt issuance ... iii. affords company access to capital markets and to institutional investors iv. Most important get capital back and get assets off of the balance sheets (has to do with

capital requirements to support assets you have – getting them off BS lowers capital requirement) if you can treat transfer of assets as a sale for accounting purposes - if not sale then you have retained interest that comes on BS

v. This puts more money into primary mortgage market that allows for more loans at lower cost to borrowers, even allows banks to make loans to lower income borrowers that they normally wouldn't make if they had to keep loan on its balance sheet

I. CONSUMER LENDINGA. Consumer Lending Revolution – Overview

1. Congress and state legislatures have adopted a number of laws to protect consumers from overreaching. 2. Positives of the consumer lending revolution

a. Greater availability of credit to a broader cross-section of the population3. Negatives of the consumer lending revolution

a. Higher debt loadsb. An increase in the average riskiness of consumer loan portfolios.

4. Five significant trends the FDIC believes led to the revolutiona. Deregulationb. General purpose credit cardsc. Credit scoringd. Pricing according to risk, and


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e. Securitization B. The impact of the Dodd-Frank Act on the Revolution

1. The Act created a Bureau of Consumer Financial Protection (“BCFP”)a. Headed by an independent director appointed by the President and confirmed by the Senate. b. BCFP will regulate the offering and provision of consumer financial products or services under the

federal consumer financial lawsc. And it will oversee enforcement of laws requiring nondiscriminatory access to credit for individuals and

communitiesi. Most rulemaking authority of the federal laws discussed in this chapter is transferred to the BCFP

d. BCFP can regulate nonbank entities that market similar products the same way it regulates their bank competitors.i. The Dodd-Frank Act exempts a number of entities from the BCFP’s authority, such as entities

regulated by the SEC, the CFTC, the Farm Credit Administration, and some automobile dealerse. State laws offering greater protection to consumers than BCFP rules are NOT preempted.

C. Usury1. In general

a. Usury regulation relates to the amount of interest a lender may charge a borrowerb. Modern usage equates usury with the charging of excessive interest as that has been defined by state

regulationc. Some states do not limit the rate of interest that may be charged on a loan

i. Reasoning – regulation is not needed in a market based economyd. Some states do limit the rate of interest that may be charged on a loan

i. Reasoning – borrowers need protection from lenders, in addition to disclosure of interest rates. Market competition is not enough protection

2. National Banksa. General Rule – a national bank may charge the rate of interest allowed in the state where it is located.

(12 U.S.C. § 85).b. The Act has been subject to much interpretationc. Tiffany v. National Bank of Missouri

i. Issue If MO law limits interest to 10% to all persons, except state banks can only charge 8%, then what interest can a national bank charge under the National Banking Act.

ii. Holding Congress intended for national banks to charge such interest as state banks may charge, and intended for them to be able to charge more if by the laws of the state more may be charged by natural persons.

iii. Reasoning The Act is an enabling statute, not a restraining one, except so far as it fixes a maximum rate in all cases where state banks are not allowed a greater rate.

3. Marquette National Bank of Minneapolis v. First of Omaha Service Corp.a. Facts

i. Omaha Bank was issuing credit cards to customers in Minnesota.ii. Nebraska law allowed interest rates of 18% and Minnesota law allowed 12%

iii. Section 85 allows national banks to charge rates of the state where it is located, so the issue here turns on whether Omaha Bank is located in Nebraska.

b. Issue Does Section 85 of the Act allow a national bank based in one state to charge its out-of-state credit card customers an interest rate on unpaid balances allowed by its home state, when the rate is higher than allowed by the state of the bank’s non-resident customers?

c. Holdingi. Omaha Bank was located in Nebraska and can therefore charge the higher Nebraska rate to

Minnesota customers. ii. Policy requires this interpretation because the Act was meant to increase competition between

state and national banks. 4. Smiley v. Citibank (South Dakota)


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a. Petitioner was a resident of California that held a credit card by a national bank (Citibank) located in South Dakota.

b. The late fees on petitioner’s card was permitted by South Dakota law, but not by California law. c. Issue does the Marquette holding apply to late-payment fees that are lawful in the bank’s home state

but prohibited in a state where a cardholder resides?d. Holding the Comptroller of the Currency’s definition of “interest,” which included late fees is

controlling and therefore the bank may charge South Dakota’s late fees to a California residenti. “interest” includes compensation for extending credit, making available a line of credit, or any

breach of condition by the borrowerD. State Banks – Usury Laws

1. Greenwood Trust v. Commonwealth of Massachusettsa. Note this case was decided BEFORE Smiley and under a comparable provision to Section 85 that

applies to state banksb. Facts

i. Greenwood offers an open end credit card (the Discover Card) to customers nationwide. ii. Greenwood is a Delaware bank that is insured by the FDIC

iii. The Discover Card charged a default fee that was allowed in Delaware, but not nationwidec. Issue does “default fees” or “late fees” fall under the definition of “interest” under 12 USCA Sec.

1831d, and if so then the competing Massachusetts law would be preempted and the Discover Card provision would be acceptable?

d. Holding “interest” includes late fees and therefore state law is preempted and the Discover Card fee’s are allowed.

E. Truth in Lending Act (“TILA”)1. Background

a. Purpose of TILA is to require creditors to disclose to consumers the true cost of creditb. Prior to the Dodd-Frank Act these TILA regulations were collectively referred to as “Regulation Z” but

now Dodd-Frank transfers TILA rulemaking authority to the BCFP.2. Open-End vs. Closed-End Credit

a. Benion v. Bank One, Dayton, N.A.i. Facts

1) Mr. and Mrs. Benion bought a satellite dish from Superior Satellite, an authorized EchoStar dealer. Dish price = $3000 Programming = $1000/year

2) Benion’s issued an EchoStar credit card with a limit of $45003) The first use of the card must be for the dish4) Interest rate on an unpaid balance was 19%, which was disclosed5) The total finance charge roughly equaled the dollar amount of the interest that the credit card

holder would incur if the debt were paid off at the minimum rate permitted. (This was NOT disclosed)

6) Became a class action suitii. Issue

1) Were the disclosures made to the users, or lack thereof, concerning the cost of credit in violation of the TILA?

2) If the credit card was “closed-end” instead of “open-end” then there would be a violationiii. Holding

1) the defendant complied with the letter of the law but regulatory changes are needed to close this loophole

2) the defendants were trying to evade the TILA requirements by conditioning the first use of the card on the purchase of the big-ticket item and then limiting subsequent purchases to products related to the initial purchase.


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3) This is an abuse of the open-end credit provision of the TILA and should be curbed by amending the regulations to specify a minimum ratio of subsequent purchases to original purchases.

3. Fair Credit and Charge Disclosure Acta. Law was enacted to amend TILA in 1989 to protect consumers who previously were not receiving full

disclosure of the credit terms on their cards until after they had received a credit card accessing the account

b. Act now requires card issuers to provide early disclosure of rates and other costs to potential card holders

c. BUT, when no specific costs are stated, the law does not require any other cost informationd. TILA now requires more disclosures when creditors aggressively market their productse. And, creditors must now provide advance notice of any significant term changes 15 days prior to the

changes taking effect. 4. Credit Card Accountability, Responsibility, and Disclosure Act of 2009 (“CARD”)

a. Purpose is to protect consumers from hidden and excessive feesi. Previously disclosures were hard to comprehend and poorly organized and prevented consumers

from understanding the disclosuresb. Extension of TILAc. Credit card issuers are required to apply the amounts in excess of the minimum payment to the highest

interest rate balancesd. CARD Act prohibits universal default clausese. Retroactive interest rate increases are prohibited except in certain conditions

i. Exception = if the cardholder fails to make a minimum payment within 60 days after the due datef. Prohibited from increasing the APR in the first year of the account, except for promotional ratesg. Late payment deadlines must be shown in a clear mannerh. Prohibits double cycle billingi. Over-the-limit fees are prohibited unless the cardholder opts in

5. Fair Credit Billing Acta. American Express Co. v. Koerner

i. Issue1) What is the proper procedure for the correction of billing errors when both a corporation and an

individual officer are liable for the debt? 2) Does the TILA provision concerning the creditors procedure for responding to billing errors apply

to this situation?3) Was a “consumer credit” line extended here which would make the TILA provision apply?

ii. Facts1) Dispute was over $552) AMEX never responded to the company’s request to correct a billing error

iii. Holding1) AMEX did not extend a “consumer credit” in this transaction because “consumer credit” only

applies to credit extended to a “natural person” and the company in question with the AMEX card is not a “natural person”

2) Therefore AMEX does not have to comply with the TILA billing error provision.

b. First National City Bank i. The express intent of the Congress in enacting the TILA was to protect the consumer or cardholder

against charges for unauthorized use of his CC, and to limit his liability for such unauthorized use to a maximum of $50. If card issuer fails to comply with certain conditions precedent as set forth in 15 USCA § 1637, no liability for cardholder.


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ii. 15 USCA § 1643 the burden of proof is on the card issuer to show that the use was authorized or, if the use was unauthorized, then the burden of proof is on the card issuer to show that the conditions of liability for the unauthorized use of a credit card have been met. See Page 380 for list (including debt <$30, D accepted card, unauthorized use happened before card issuer notified, …)

6. Home Equity Loan Consumer Protection Act (HELC).a. Consumers Union of the U.S., Inc. v. Federal Reserve Board:

i. Issue: Appellant challenged the regulations issued by the Board of Governors and the Federal Reserve System that implemented the amendments to the Truth in Lending Act concerning open-end home equity loans. Appellant's dispute centered on the flexibility that banks would have in tailoring loans to particular customers whose high credit rating, ownership of other accounts with the bank, or other attributes, enabled them to receive more favorable terms. The district court found in favor of appellees. The appellate court affirmed a majority of the lower court's opinion but remanded the issue of appellee Board's decision to exercise its exception power. Appellee Board asserted that the exception power was appropriately exercised when it required lenders to tell consumers that the percentage rate was offered at a discount and was not the actual rate. The court believed appellee Board should be afforded the opportunity to explain its position on the issue.

ii. Outcome: Appellate court affirmed in part, reversed in part, and remanded for further proceedings when court found it needed to afford Federal Reserve Board great deference in interpreting Truth in Lending Act but remanded issue of Board's use of its exception authority to contravene directly the terms of the authorizing statute.

b. HELC was a set of amendments to TILA concerning open-end home equity loans. i. Open-end home equity loans (HELs) are a line of credit secured by their residence.

ii. HELs differ from traditional mortgage loans that are closed ended where the borrower takes out the entire sum at the outset and then makes interest and principle payments on that fixed amount over the life of the loan.

iii. They increased in popularity in 1986 when tax reforms made interest deductions on personal loans unavailable except with respect to residential housing indebtedness.

c. Structure of HELs i. The interest on the amounts advanced under an HEL is known as the APR and is the sum of two

elementsii. Index which can be one of several available proxies for the bank’s cost of funds, that is, the

current interest rate iii. Margin fixed percentage generally designed to cover the bank’s expenses and allow for a profit

on the loan. iv. The index fluctuates with the changes in the interest rate but the margin stays constant at the level

set in the HEL contract. v. To guarantee the consumer against unlimited rises in the APR, the agreements must provide for a

ceiling which the APR can’t exceed regardless of the rise in the index, see 12 USC § 38067. Rights and remedies.

a. Rescission.i. TILA affords a homeowner an absolute right to rescind nay transaction – such as HEL – where the

home is taken as. 15 USCA § 1635(a). If the TILA disclosures were not properly made this right can extend up to 3 years. 15 USCA § 1635(d).

ii. The right to rescind the consumer credit contract does not extend to a credit transaction financing the purchase of a home.

iii. After rescission, the lender loses its lien on the property which deprives lender of right to foreclose for nonpayment and the lender is required to return all finance, interest and other charges with the account all but loan principle

b. Damages.i. TILA provides three remedies for violations of its provisions.

1) TILA empowers the Federal Trade Commission as its overall enforcement agency


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2) TILA imposes criminal liability on persons who willfully and knowingly violate the statute. 3) TILA creates a private cause of action for statutory damages, which may be assessed in addition

to any actual damages. 15 USCA § 1640(a)(1) and 15 USCA § 1640(a)(2) ii. TILA provides a ceiling on statutory damages in a class action arising out of TILA to prevent big

awards for technical violations while allowing actual damages to insure people are fully compensated.

iii. For actual damages, consumer must demonstrate detrimental reliance in order to be eligible for actual damages have to be aware of violation and rely on it. Turner1) Turner v. Beneficial Corp

Summary: Prompted by a newspaper ad, plaintiff bought a satellite dish system that was to be financed by defendant bank through a credit card agreement. When the dish was delivered, the invoice reflected a higher monthly bill than the newspaper ad had reflected, and the credit card had an additional balance. The credit card came with a disclosure statement, but plaintiff alleged defendant failed to provide a disclosure statement that complied with the requirements of the law under the Truth in Lending Act (TILA), The circuit court held that detrimental reliance is an element of a TILA claim for actual damages, and that plaintiff failed to present evidence to establish a causal link between the bank's noncompliance and her damages. It found that plaintiff conceded that she did not read defendant's disclosure statements at the time of receipt, and therefore did not rely on them.

iv. Koons Buick Pontiac GMC, Inc. v. Nigh1) Summary: Plaintiff consumer attempted to purchase a truck from defendant dealer. He sued

for a violation of the Truth in Lending Act (TILA), 15 U.S.C.S. § 1601 et seq., and was awarded $ 24,192.80. The United States Court of Appeals for the Fourth Circuit affirmed the award holding that his recovery under 15 U.S.C.S. § 1640(a)(2)(A)(i) was not capped by § 1640(a)(2)(A)(ii). The dealer filed a petition for a writ of certiorari. The Fourth Circuit's holding created a split with the Seventh Circuit which had previously held that the cap on recovery in § 1640(a)(2)(A)(ii) did apply to awards under § 1640(a)(2)(A)(i). The controversy arose from a 1995 amendment which added § 1640(a)(2)(A)(iii) containing higher minimum and maximum awards for closed-end mortgages. The Court agreed with the Seventh Circuit because: (1) the word "subparagraph" was generally used to refer to a subdivision preceded by a capital letter, and the word "clause" was generally used for a subdivision preceded by a lower case Roman numeral; therefore, "under this subparagraph" in § 1640(a)(2)(A)(ii) applied to all of § 1640(a)(2)(A); (2) there was scant indication that Congress meant to alter the meaning of clause (i) when it added clause (iii) to provide increased recovery for real property loan TILA violations; and (3) it would have been strange for Congress to cap recovery in connection with a closed-end, real-property-secured loan at an amount substantially lower than the recovery available when a violation occurred in the context of a personal-property-secured loan or an open-end, real-property-secured loan.

c. Arbitration.i. Greentree Two cases that deal with the issue of whether an arbitration agreement in a consumer

credit contract, pursuant to the Federal Arbitration Act violates the TILA. 1) GTFC Alabama v. Randolph: Petitioner financing companies' petition for writ of certiorari to the

United States Court of Appeals for the Eleventh Circuit was granted in a case involving a trial court order compelling arbitration and dismissing respondent purchaser's claims challenging the parties' financing agreement for the purchase of a mobile home.The lower court had concluded that the trial court's order compelling arbitration between respondent purchaser and petitioner financing companies and dismissing respondent's claims was appealable under 9 U.S.C.S. § 16 of the Federal Arbitration Act (FAA), but that the arbitration provision was unenforceable due to potentially prohibitive costs. The court concluded that the trial court's decision ordering arbitration and dismissing respondent's claims for relief was appealable because it was a final


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decision under 9 U.S.C.S. § 16(a)(3) in that it plainly disposed of the entire case on the merits and left no part pending before the trial court. The court rejected the independent/embedded proceeding distinction for purposes of determining whether a decision was final within the meaning of § 16(a)(3). However, the lower court erred in determining that the arbitration was unenforceable because the record did not contain sufficient information related to respondent's costs if the matter was arbitrated. Thus, the risk that she would have been saddled with prohibitive costs in enforcing her statutory rights was too speculative to justify invalidating the arbitration agreement.

2) Randolph v. GTFC Alabama: Plaintiff filed a putative class action against defendants for alleged Truth in Lending Act (TILA) and Equal Credit Opportunity Act violations. The United States District Court for the Middle District of Alabama ordered the parties to proceed to arbitration. The appellate court reversed, holding the arbitration agreement was unenforceable. The United States Supreme Court reversed and remanded to the appellate court. In reversing the appellate court's holding, the Supreme Court explicitly declined to reach plaintiff's argument that the arbitration agreement was unenforceable on the alternative ground that the agreement precluded plaintiff from bringing her TILA claims as a class action. The question had been properly raised in the district court, but the appellate court had not passed on it. Accordingly, the appellate court considered plaintiff's position and found that plaintiff could not carry her burden of showing that either Congress intended to create a non-waivable right to bring TILA claims in the form of a class action, or that arbitration was inherently inconsistent with the TILA enforcement scheme. Nothing in the text of the TILA or its legislative history would have rendered the arbitration clause unenforceable. Accordingly, the appellate court affirmed the district court's judgment.

ii. SC held in another case that all statutory claims may not be appropriate for arbitrations, having made the bargain to arbitrate, the party should be held to it unless Congress itself has evinced an intention to preclude a waiver of judicial remedies for the statutory rights at issue.

iii. Thus, only if Congress specifically precluded arbitration in TILA can P get out of bargained for arbitration agreement.

iv. SC notes that TILA specifically mentions class actions as right of P. But SC holds that there is a difference between availability of class action tool to vindicate a statutory right and possession a blanket right to that tool under any circumstance.

v. SC holds that no showing that Congress intended to create a non-waivable right to bring TILA claims in the form of class actions or that arbitration is inherently inconsistent with the TILA enforcement scheme.

vi. Dodd-Frank sec 10281) Bureau of Consumer Financial Protection [BCFP] was directed to conduct a study on the use of

mandatory pre-dipute arbitration in the connection with offering or providing a consumer financial service.

2) After conducting the study the BCFP may prohibit or restrict pre-dispute arbitration agreements that are connected with the providing of consumer financial products or services.

3) The BCFP cannot restrict a consumer from entering into a voluntary arbitration agreement after a dispute has arisen.

F. Equal Credit Opportunity Act (ECOA).1. ECOA (15 USCA § 1691-91f) prohibits discrimination in extending credit on the basis of sex, marital status,

race, color, religion, national origin, age, public assistance income, or exercise of rights under the Consumer Credit Protection Act. Prohibited Basis’s – can’t discriminate on a prohibited basis

a. Reg B implements requires an adverse action notice to be given when credit is declined b. What this does is it tells you why you were turned down Can’t be one of these reasons

2. Markham a. Issue: Whether the D’s failure to aggregate the income of joint non-married applicants was a violation of



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b. Court held that D treated P’s differently – that is, refused to aggregate incomes – solely because of their marital status, which is precisely the sort of discrimination prohibited by 15 USCA § 1691(a) on its face.

3. Latimore v. Citibank Federal Savings Bank: Plaintiff loan applicant filed a racial discrimination action in the United States District Court for the Northern District of Illinois, against defendants, bank and individual employees, under federal civil rights laws. The district court granted summary judgment for the bank and its employees. The applicant appealed. The applicant, a black woman, sought a $ 51,000 loan from the bank, secured by her home. She satisfied the bank's standards for creditworthiness, but was turned down because her home was only appraised at $ 45,000. The applicant provided the bank with another recent appraisal of her home at $ 82,000, but the bank still refused to extend the loan. The applicant obtained a $ 45,000 loan at a higher interest rate with another institution, which appraised her home at $ 79,000. The applicant argued that there was sufficient evidence of racial discrimination to withstand summary judgment, including her expert appraiser's report valuing her home at $ 62,000. The court disagreed, finding that the McDonnell Douglas burden-shifting analysis did not apply because the applicant's prima facie case lacked any comparison between the treatment of blacks and the treatment of whites. The fact that the bank's appraisal was lower than another appraisal did not create an inference of discrimination. Although the bank was required to retain the notes from the appraisal under 12 C.F.R. § 202.12(b)(1)(i), the inadvertent failure to comply was not a violation. 12 C.F.R. § 202.14(c).

4. Dodd-Frank sec 1071:a. Amended the ECOA to require that creditors determine in an application for credit from a small

business, whether it is women or minority owned. b. This info is submitted to the BCFP and may, in the aggregate, be publicly disclosed.

CHAPTER SEVEN: Bank Liabilities and Capital

I. Deposits [465]A. Types of Deposit Accounts [465]

a. Demand deposits are non-interest bearing transaction accounts (i.e. offering check-writing privileges), typically held by business customers who are precluded from opening interest-bearing transaction accounts. Interest bearing transaction accounts available to individual customer are called NOW (negotiable order of withdrawal) accounts. Under savings account – also MMDA – limited transactional ability

b. Core deposits [430] are stable deposits that are unlikely to leave the bank for a higher interest rate elsewhere. They are declining for most banks due in part to customers shifting funds from bank products to higher-yielding investments offered by others. Banks have been forced to increase their reliance on wholesale funding sources – with higher interest rates that core deposits.

2. Lifeline or Basic Accounts [466]: 2009 FDIC survey said 7.7% of American households do not have bank accounts; proportionally minorities are less likely to have bank accounts

3. Certificates of Deposit [467]: CD’s evidence the deposit of funds in the bank for X period and Y interest rate. CD’s are only redeemable at maturity when principle and interest are paid to customer.

a. Marine Bank v. Weaver [467]: Issue: Is a CD a “security” and thus subject to the anti-fraud provisions of the Securities and Exchange Act of 1934. Definition of security in the Act is quite broad – includes “the many types of instruments that in our commercial world would fall with the ordinary concept of a security” Definition of security in the Act provides that an instrument which seems to fall within the broad sweep of the Act is not to be considered a security if context otherwise requires. Supreme Court held that CD is different from a debt obligation (a security) because CD’s are subject to extensive federal regulation and deposit insurance – thus unnecessary.

4. Discriminatory Account Policies: Truth in Savings Act [469]: a. Garcia-Harding v. Bank Midwest [469]: Pursuant to the Truth in Savings Act of 1991,

contained in the Federal Deposit Insurance Corporation Improvement Act of 1991, 12


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U.S.C. § 4301 et seq., and Regulation DD promulgated thereunder, depository institutions must provide certain disclosures to consumers so that they may make meaningful comparisons among depository institutions and informed decisions about accounts at those depository institutions. Among other things, depository institutions are required to disclose minimum balance requirements to open an account. Although the record is unclear on this point, the Court assumes for purposes of this Memorandum and Order that Bank Midwest's disclosures under Regulation DD provide that Bank Midwest does not require a minimum deposit to open an account.

B. Regulation of Deposit Accounts [471]: 1. Deposit Account Fees and ATM Fees [471]: Banks increasingly rely on deposit related fees as

additional sources of income. Banks impose maintenance fees on certain types of accounts and assess fees on extraordinary events (like stop check, checks written against insufficient funds…).

a. Biggest source of fee revenue: overdraft charges; average around $30.b. In setting reasonable non-interest charges and fees, the OCC’s regulation at 12 C.F.R. §

7.4002 requires a bank to consider the costs (including its profit margin) in providing the service, the deterrent effect on customer behavior, the enhancement of the bank’s competitive position in accourdance with its marketing strategy, and the maintenance of the safety and soundness of the institution.

c. State laws that obstruct, impair, or condition a national bank’s ability to fully exercise its Federally authorized deposit-taking powers are not applicable to national banks. 12 C.F.R. § 7.4007(b)(1).

2. Perdue v. Crocker National Bank [471]: CA court found that banks imposition of $6 fee for insufficient funds check could constitute price unconscionability. Bank ended up settling with all such customers at a multi-million dollar price tag. Argument: no reasonable connection between cost to bank and fee charged.

3. Video Trax v. Nationsbank [472]: Issue: whether Overdraft fees from a check drawn on insufficient fees constitutes interest: arguing fees were disguised interest charges. Looked back at Smiley case and late charges on credit card. Court there said a late fee was an extension of credit and therefore interest. Overdraft fees are interest under Bank Act definition of interest – but that only applies when there is an extension of credit. Here the fees arise from the terms of the deposit agreement and this is covered by 12 CFR § 7.4002. § 7.4002 says a bank can charge non-interest fees if they consider factors like cost incurred by bank, deterrence of misuse by customers, safety and soundness. Court finds these fees are non-interest and the Bank properly used these factors. OCC again preempting. Section allows banks to profit from these fees as well. Check: is a contract in writing by which the drawer contracts with the payee that the bank will pay the payee therein the amount designated on presentation

4. BofA v. San Francisco [478]: San Francisco tried to enact a city ordinance prohibiting fees for non-depositor ATM withdrawals; Ninth Circuit ruled that San Francisco’s law is preempted by Home Owners’ Loan Act and the Office of Thrift Supervision regulations which already set limitations on banks ability to collect fees for provision of electronic services

a. Holding: San Francisco’s ordinance is struck down5. Check 21 [487]: The Check Clearing for the 21st Century Act (Check 21) removes the

requirement that banks process and route original checks and permits banks to transfer electronic images of checks. Banks are not required to transmit or receive electronic images of checks, but if they cannot accept a digital image of a check they are required to accept an Image Replacement Document (IRD), which is also referred to as a “substitute check” and is a paper print out of the document’s image. Check 21 also facilitates remote deposit capture in which a user scans checks it receives and transmits the scanned images to its bank for a digital deposit. The advantages of remote deposit capture are obvious for the user. A risk, however, is that the user or the bank presents multiple images of the same check for payment.

6. Deposit Interest Rate Regulation [487]:


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a. After stock market crash in 1929, Congress attempted to quell what it viewed as potentially ruinous competition among banks based on interest rates paid to customers. Congress forbade the payment of interest on demand deposits and placed a ceiling on the rate of interest that could be paid on savings accounts. When inflation exceeded these interest rate ceilings – disintermediation occurred. Customers withdrew their money from banks and put then in places not subject to these ceilings, like MMMF. Congress removed these ceilings in 1980, allowed payment of interest on NOW accounts (not for business customers though).

b. CF Industries v. IRS [488]: Cash management services to corporations are big business for banks; Point of this case is an example of cash management see 488

C. Deposit Insurance [490]1. In General: Federal deposit insurance was enacted in the Banking Act of 1933 to prevent bank

panics. Any system of insurance creates moral hazard: taking excessive risks because the loss will not be borne directly by the risk taker, but by the insuring entity. Federal deposit insurance also reduces monitoring of bank by depositors because they are covered by insurance. Allows banks to obtain funds by offering a risk-free rate of return, even as the bank engages in risky behavior. Insurance schemes address moral hazard through risk-adjusted premiums: which were finally introduced for banks federal deposit insurance in 1991. Because most failed banks are bought by other banks, those who have excess of 100k limit usually end up getting repaid.

2. Amount of Coverage [491]: Federal deposit insurance is required for national banks and state member banks. State nonmember banks are not required but all elect to do so. The Emergency Economic Stabilization Act (EESA) that passed on October 3, 2008 temporarily raised Federal Deposit Insurance to $250,000. Then Dodd-Frank made the $250,000 limit permanent in § 335.

3. FDIC Reserves [492]: Prior to 2006, the FDIC was required to maintain a reserve equal to 1.25% of all insured deposits. Dodd-Frank increased the minimum reserve ratio from 1.15% to 1.35% of estimated deposits or comparable asset-based assessment amount. § 334.

4. Deposit Insurance Assessments [494]: The FDIC reserve fund is replenished by deposit insurance premiums referred to as “assessments.” Prior to 1991, banks paid a flat rate of 12 cents per $100 of deposit for deposit insurance. For a twenty year period before the FDI Reform Act of 2006, almost 95% of banks did not pay any deposit insurance assessment because the FDIC held a reserve amount equaled to the required 1.25% of all insured deposits. Dodd-Frank requires the FDIC to amend its regulations to redefine the assessment based upon which it calculates the required deposit insurance premiums from insure deposits to an institution’s average consolidated total assets less its average tangible equity. This change will most likely mean that larger institutions that rely more heavily on non-deposit funding sources rather than smaller institutions will bear a proportionally greater charge for FDIC insurance since the assessment is based on assets rather than deposits.

5. Who is Covered [495]: Deposit insurance is currently provided up to $250,000 per depositor at an institution. Federal Deposit Insurance coverage per person is unlimited. One person who has deposits in excess of $250k can place them at different institutions and will be totally insured. IF the depositor doesn’t do this and has multiple accounts at one institution, the are aggregated for purposes of deposit insurance. Joint accounts: each holder receives up to 250k in deposit insurance. Deposit insurance only applies to deposits: not other products like mutual funds or brokerage balances through a bank affiliate.

6. FDIC Guarantees [496]: Dodd-Frank specifically authorized the FDIC, after consultation with the Fed, to “create a widely available program to guarantee the obligations of solvent insured depository institutions” or their solvent holding companies “during times of severe economic distress” § 1105.

D. Brokered Deposits [496]


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1. Brokered deposits come to a bank from a deposit broker who is seeking to split a customer’s deposits among institutions to obtain full FDIC coverage and to earn highest interest rates possible.

2. Called “hot money” because not stable source of funds. Likely to be withdrawn if higher interest rate elsewhere.

3. Gary Plastic Packaging Corp. v. Merrill Lynch [497]: Issue: whether a CD sales program run by Merrill is within the compass of Federal securities laws; Analysis: Marine Bank held that a conventional CD purchased from an issuing bank is not a security under the antifraud provisions of the federal securities laws. Unlike Marine Bank, Merrill is alleged to have characterized the CD created and sold through the CD program as a wholly different from an ordinary certificate of deposit.; Holding: Merrill’s CDs had no protection other than the securities laws

4. FAIC Securities v. U.S. [500]: Deposit brokers assist two types of investors in placing deposits: 1) Large institutional customers to deposit millions of dollars of funds, in CD’s, none of which, in any single financial institution, exceeds the value of 100k—called deposit splitting; and 2) Participating CDs: broker solicits money from small individual investors and then broker purchases a CD. Allows broker to place small investors money in far away bank with higher interest rates. Banks have to be well-capitalized to accept deposits from deposit brokers.

E. Set-Off [503]:1. General rule: when a depositor is indebted to a bank and the debts are mutual (debt and

deposits in same name), the bank may apply the deposit to the payment of the debt due by the depositor, provided there is no express agreement to the contrary. Majority rule is that this is at the option of the bank. Mutuality of obligations is the key to set-off rights (bankers’ liens)

2. Minority rule: that if bank holds note, on which there are endorsers or sureties or other parties not primarily liable, bank is obligated to use the depositors funds for the protection of these parties. Some go further and say if bank doesn’t surety is released.

3. Farmers Natl v. Jones [503]: Banks should be given ability to chose to set-off or not – due to customer relationship; Banks have common law right to set-off; Doesn’t apply to trust accounts, IRA accounts, … Social Security Administration had law passed to say

F. Escheat Laws [505]: State escheat laws provide that bank deposits, dividends, interest, and securities that remained unclaimed for a certain period of time and after reasonable efforts to find the owner, escheat to the state rather than remain in the hands of the intermediary

1. Delaware v. New York [505]: Supreme Court rejects using principle place of business (although this is state where most of benefits given to customers) as state where money escheats to. Supreme Court holds the money escheats to the state where the financial intermediary is incorporated.

II. Non-Deposit Liabilities [508]A. Federal Funds Bought [508]: Federal funds bought are recorded as liabilities on the bank’s balance sheet

representing the bank’s borrowing from another bank’s excess reserves at the bank’s regional federal reserve bank

B. Repos [508]: 1. SEC v. Miller [508]: A Repo is a short-term transaction involving a sale with an agreement to

repurchase government securities between two financial institutions and carried about by the Fed; Is essentially a short-term collateralized loan; each agreement may also be viewed as comprising two distinguishable transactions, which, although agreed upon simultaneously, are performed at different times: (1) the borrower agrees to sell, and the lender agrees to buy, upon immediate payment and delivery, specified securities at a specified price; and (2) the borrower agrees to buy and the lender agrees to sell, with payment and delivery at a specified future date or, if the agreement is “open,” on demand the same securities for the same price plus interest on the price

a. Why not straight loans? threefold: (1) certain regulations of the Federal Reserve Bank (the “Fed”), which treat repos differently from ordinary loans; (2) a desire to circumvent


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the U.C.C. requirements and other legal obstacles to using ordinary collateralized loans; and (3) market convention; Why short term? Since reserve deficits and surpluses can often be brief, most member banks prefer to borrow or lend reserves for relatively short periods, usually overnight, which is possible since such loans are effected over the federal wire.

2. Manufacturers Hanover Trust v. Drysdale Securities [514]: Important difference between government securities transactions in (1) the “securities” or “cash” market, in which securities are straight-forwardly purchased and sold at market prices, and (2) the “repo market,” in which government securities are purchased and sold pursuant to repo or reverse repo transactions. In the securities market, the price of a government security, such as a United States Treasury note, includes the market price of a particular issue and the accrued “coupon interest” on the security (i.e., the value of government payments due on the security at the time of the sale). In the repo market, the accrued coupon interest is paid only on the repurchase (or resale) transaction; the initial “loan” of the security is made at a price that includes only the market value of the security. Before the security is repurchased, its price will be “marked to market” periodically to reflect changed value.

3. Orticelli Note on Bear Stearns [516]: Bear's financing structure. As an investment bank, Bear relied on short-term (usually overnight) loans called repurchase agreements (“repos”) to finance its daily activities and liquidity demands. Repos are secured by collateral (including MBS) that the borrowing institution promises to buy back at a specified date and at a specified price, “which typically includes interest at an agreed upon rate.” In essence, because repos were vital to Bear's daily operations, they left Bear at the mercy of lender sentiment. Thus, when the subprime mortgage crisis unfolded, lenders grew more fearful of entering into collateralized loans with Bear given the firm's large exposure to mortgage products. Instead, lenders hoarded their liquidity, uncertain about the health of their own balance sheets and those of their counterparties. “And it was the [eventual] refusal of Bear's repo lenders to extend overnight loans that confirmed that Bear had a liquidity crisis [in mid-March 2008].”

4. Note [517]: In this market, a firm holding a security can make money on it (without parting with it for good) by pledging it as collateral for a loan. Due to market convention, the loans are styled as back-to-back purchase and sale agreements, typically for a term of one day that gets rolled over into a longer effective term. The deal liquifies the security by letting the cash borrower convert the security to cash for the term of the loan, thereby enhancing the borrower's own funding liquidity. Especially for investment banks with large securities portfolios, the repo market is one of their most important ways of funding their activities day to day because repo (and reverse repo deals that are the mirror image of the transaction) let the firm reduce the carrying costs of their securities portfolios.

5. Note [518] Dodd-Frank Act on Repos: DFA limits credit exposure for systemically significant financial companies to any unaffiliated company to 25% of capital stock and surplus (or any lower amount set by the Fed). Credit exposure includes repurchase agreements; securities borrowing or lending; guarantees, acceptances, or letters of credit. DFA § 165.

C. Bankers’ Acceptances [518]: A bankers’ acceptance is a negotiable instrument issued in the form of a draft, which is simply an order to pay a stated amount of money to the holder of the draft on a specific date; can be “sight” draft payable on presentation or “time” draft payable after a specific number of days

1. U.S. v. Dougherty [519]: A bankers acceptance is a negotiable instrument, governed by 12 U.S.C. § 372 and applicable regulations and rulings of the Federal Reserve Board, which define and interpret the “eligibility” of the financing instrument (Anderson 10). An “eligible” bankers acceptance is one which the Federal Reserve has authority to purchase (Anderson 10). Eligible bankers' acceptances ordinarily, and for purposes of this case, are used to finance shipments of goods between foreign countries (Anderson 12–13). The typical transaction involves an exporter who proves in some manner to the bank that he has a given amount of product which


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will be shipped to a foreign country. He must have goods or a firm contract at least equal to the amount of financing. The shipment must be consummated in 180 days or less. The bank may then agree to finance for whatever period of time the shipment will require by taking the exporter's promise to pay in the form of a written draft. The bank stamps the word “accepted” on the draft, and the authorized officer signs or initials the item. The document will provide for a given sum to be due on a given date, correlating with the completion of the shipment. An authorized officer then places on the face of the instrument an eligibility clause, describing the international transaction in goods which is represented by the acceptance. The proceeds of the shipment then are to be used to liquidate the transaction, without expectation of resorting to collateral or other security. (Anderson 25, 31; T. 613.) The bank may choose to hold the acceptance until maturity, at which time the customer pays the bank. More commonly, however, the bank sells acceptances at a discount on the secondary market, with the bank paying the holder in the face amount upon maturity (Anderson 44–49). The market maintains a high interest in the instrument because it is a secure, no-risk investment due to the bank's absolute obligation to pay upon maturity, regardless of the customer's ability to pay the proceeds from the transaction

D. Letters of Credit [521]: A bank service which functions as a guarantee of payment. If a bank is called upon to pay a letter of credit, a loan relationship with the account party arises, pursuant to a prearranged agreement permitting the bank to be reimbursed by the account party on whose behalf the bank issued the LOC. Note: LOCs are off-balance sheet items until the LOC is paid and a debt obligation is created for repayment by the customer.

1. FDIC v. Philadelphia Gear Corp [521]: A standby letter of credit backed by a contingent promissory note does not give rise to an insured deposit. This has been the FDIC's longstanding interpretation, and such interpretation is consistent with Congress' purpose in creating federal deposit insurance to protect the assets and “hard earnings” that businesses and individuals have entrusted to banks.

2. Centrifugal Casting Machine v. American Bank and Trust [524]: “[A] letter of credit involves three parties: (1) an issuer (generally a bank) who agrees to pay conforming drafts presented under the letter of credit; (2) a bank customer or ‘account party’ who orders the letter of credit and dictates its terms; and (3) a beneficiary to whom the letter of credit is issued, who can collect monies under the letter of credit by presenting drafts and making proper demand on the issuer.”

First, “[t]he simple result [of a letter of credit] is that the issuer substitutes its credit, preferred by the beneficiary, for that of the account party.” The issuing bank thus pays the beneficiary out of its own funds, and then must look to the account party for reimbursement.

Second, the issuer's obligation to pay on a letter of credit is completely independent from the underlying commercial transaction between the beneficiary and the account party. Significantly, the issuer must honor a proper demand even though the beneficiary has breached the underlying contract, even though the insolvency of the account party renders reimbursement impossible and notwithstanding supervening illegality, impossibility, war or insurrection,

This principle of independence is universally viewed as essential to the proper functioning of a letter of credit and to its particular value, i.e., its certainty of payment.

III. Payment Methods [528]: Demand deposits and NOW accounts; credit cards; debit cards; stored value or smart cards; electronic money

A. Credit and Debit Cards [528]1. National Bancard v. VISA [528]: As in the case of the check, the bank credit card system is

principally a four-party payment arrangement. It involves: (1) cardholders who use bank credit cards to purchase goods and services; (2) merchants who accept bank credit cards in exchange for goods and services; (3) financial institutions (issuer banks) which issue cards to, and contract with, cardholders; and (4) financial institutions (merchant banks) which contract with merchants


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to accept the bank credit card and thereafter manage the bank credit card accounts of these merchant clients.

*see [530] for description of card transaction

2. In re VISA/MasterCard Antitrust Litigation [532]: When a cardholder makes a purchase with his or her Visa or MasterCard payment card at a merchant's store, the acquiring institution reimburses the merchant the purchase price less a “discount fee” and the acquiring institution pays the card-issuing institution an “interchange fee.” The interchange fee is set by Visa and MasterCard, and the discount fee is based largely on the interchange fee. Wal-Mart causing this.

A debit card is an access device which enables a cardholder, among other things, to withdraw cash from his or her bank account at an automated teller machine and to make purchases at a point of sale (“POS”) which are debited against the cardholder's bank account. POS debit card transactions can either be “on-line” or “off-line.” In an on-line debit card transaction, the cardholder enters his or her “personal identification number” (“PIN”) into a PIN pad and then, during the retail transaction, the card-issuing institution verifies that there are sufficient funds in the cardholder's account and electronically puts a hold on the funds needed for the transaction. Within a day, the funds are moved from the cardholder's account to the retailer's account. In contrast, in an off-line debit purchase, the cardholder signs a slip authorizing the purchase (rather than entering a PIN), the card-issuing institution does not necessarily verify that there are sufficient funds or put a hold on those funds, and the funds take approximately one to seven days to be moved to the retailer's account.

MasterCard and VISA settled the litigation including terms that “honor all cards” would no longer be required, the signature debit transaction fees would be reduced by one third and a $3billion settlement fund.

Section 1075 of Dodd-Frank amended the Electronic Funds Transfer Act to direct the Fed to adopt rules defining permissible interchange fees. Fees must be reasonable and proportional in relation to the actual costs incurred by the issuer.

B. Smart Cards or Stored Value Cards [536]: 1. Holley Note [536]: A “one-card” is a multifunction identification card issued by an institution

designed to combine that institution's various card-related functions onto a single plastic card. In the United States, the one-card has found its greatest success in academia. There are two types of university one-card systems currently in use. The first is the magnetic stripe, or “mag-stripe,” technology found on the back of all credit and debit cards. Approximately sixty-percent of United States checking account customers possess debit cards based on mag-stripe technology. The second type of university one-card system is based on “smart chip” technology, which implants a miniature microchip into the card. Many smart cards often feature a mag-stripe in addition to the smart chip. A “smart card” is a traditional plastic card containing an imbedded ultra-thin microchip. The chip on a smart card typically holds one thousand bytes of data, in comparison to a mag-stripe card, which usually has three sub-tracks holding 226 bytes total.

2. FDIC Opinion on Stored Value Cards [538]: Stored value products, or “prepaid products,” may be divided into two broad categories: (1) Merchant products; and (2) bank products. A merchant card (also referred to as a “closed-loop” card) enables the cardholder to collect goods or services from a specific merchant or cluster of merchants; it is a gift card. Bank cards (also referred to as “open-loop” cards) provide access to money at a depository institution. When a cardholder uses the card, the merchant is not paid through a depository institution. On the contrary, the merchant has been prepaid through the sale of the card. In the absence of money at a depository institution, no insured “deposit” will exist under section 3(l) of the FDI Act. A bank card provides access to money at a depository institution that can be access through point of sale terminals or ATMs. Bank cards are treated as federally insured deposits to the extend


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that the funds have been placed at an insured depository institution. Stored value cards are not deposits.

C. Electronic Transfers [539]: the Electronic Funds Transfer Act of 1978 requires customers to be provided with documentation of electronic fund transfers, and limits their liability where a breach of security in an electronic funds transfer results in losses. Electronic payments among institutions in the Federal Reserve System are allowed by the Depository Institution Deregulation and Monetary Control Act of 1980.

1. Bisbey v. DC National [540]: Private right of action under EFTA of 1984; section 915 of the Act. That section provides that “any person who fails to comply with any provision of [the Act] with respect to any consumer, except for an error resolved in accordance with section 908, is liable to such consumer” for actual damages or for a symbolic award. Thus, under the plain terms of the Act, civil liability attaches to all failures of compliance with respect to any provision of the Act, including section 908.

2. Eisenberg v. Wachovia [541]: Bank Non-customer brought negligence claims against Wachovia for bank’s part in fraud perpetrated by bank’s customer; Regulation J, Subpart B preempts all state law claims as to conduct involving Fedwire funds transfers.

IV. Bank Capital [545]: Regulatory capital requirements impose a limit on the amount of debt a bank may have on its balance sheet by mandating that certain minimum capital levels be maintained. A bank’s capital serves as a cushion out of which any losses are taken. The FDIC is keenly interested in a bank’s capital cushion because if the bank fails the FDIC must pay the depositors and then try to recoup cash from the bank’s assets.

A. Evolution of Bank Capital Requirements1. Inadequate Capital as an Unsafe and Unsound Practice [546]

a. FNB Bellaire v. OCC [546]: Unsafe and unsound banking practices “encompass what may be generally viewed as conduct deemed contrary to accepted standards of banking operations which might result in abnormal risk or loss to a banking institution or shareholder.” OCC opinions on safe and sound banking practices are subject to review.

b. FDIC v. Bank of Coushatta [550]: Congressional answer to Bellaire; The FDIC's authority to issue capital directives is one of its regulatory tools for dealing with troubled banks. Most of these methods are set forth in 12 U.S.C. § 1818; however, authority for a directive is found in the International Lending Supervision Act of 1983 (ILSA), 12 U.S.C. § 3907, which provides in part:

(a)(1) Each appropriate Federal banking agency shall cause banking institutions to achieve and maintain adequate capital by establishing minimum levels of capital for such banking institutions and by using such other methods as the appropriate Federal banking agency deems appropriate.

(2) Each appropriate Federal banking agency shall have the authority to establish such minimum level of capital for a banking institution as the appropriate Federal banking agency, in its discretion, deems to be necessary or appropriate in light of the particular circumstances of the banking institution.(Emphasis added.) Moreover, failure to maintain the requisite capital “may be deemed by the

appropriate Federal banking agency, in its discretion, to constitute an unsafe and unsound practice....” 12 U.S.C. § 3907(b)(1) (emphasis added). If a bank fails to maintain the required capital, the agency may issue a directive

Purposes: Section 3907 was enacted to provide “a stronger, unambiguous statutory directive to the regulators to strengthen banks' capital positions.” The [Senate Banking and Finance] Committee's amendment explicitly makes failure to maintain established capital levels an “unsafe and unsound practice....” The amendment requires regulators to demand that institutions below the required capital levels submit and


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adhere to an acceptable plan to achieve prescribed levels. In response to this court's decision in First Nat'l Bank of Bellaire; Congress was concerned that Bellaire “clouded the authority of the bank regulatory agencies to exercise their independent discretion in establishing and requiring the maintenance of appropriate levels of capital.”

2. Capital Ratios and the Basel Accord [551]: the Bank of International Settlements through its Basel Committee set an international framework for bank capital standards; it’s the backbone of capital ratios required for U.S. banks; Two main improvements: i) put assets into four different risk categories and ii) required certain off-balance sheet activities be included in capital adequacy calculations. Contemplates two different capital ratios — Tier 1 capital to risk-adjusted assets of at least 4% and a total capital ratio of at least 8%. Tier 1 capital includes stockholders’ equity, preferred stock and retained earnings. Tier 2 capital includes the allowance for loan losses, cumulative perpetual preferred stock and subordinated debt.

a. Fed Board of Govs Manual on Capital Adequacy [553]: The risk-based capital measure focuses primarily on the credit risk associated with the nature of banking organizations’ on- and off-balance-sheet exposures and on the type and quality of their capital.

i. Tier 1 capital represents the highest form of capital, namely permanent equity and is generally defined as the sum of core capital elements less any amounts of goodwill, certain other intangible assets, disallowed deferred tax assets, interest-only strips, nonfinancial equity investments, investments in financial subsidiaries that do not qualify within capital, and any other investments in subsidiaries that the Federal Reserve determines should be deducted from tier 1 capital.

ii. Tier 2 capital consists of a limited amount of the allowance for loan and lease losses, perpetual preferred stock that does not qualify as tier 1 capital, mandatory convertible securities and other hybrid capital instruments, long-term preferred stock with an original term of 20 years or more, and limited amounts of term subordinated debt, intermediate term preferred stock, unrealized holding gains on qualifying equity securities, and unrealized gains (losses) on other assets

3. Basel I - 19884. Basel II - 2004 [554]: Based on three pillars—minimum regulatory capital charge, supervisory

review, and market discipline. Not fully adopted by the United Statesa. Tier 1 ratio = 4%b. Total Capital Ratio = 8%

5. TARP [556]: While the Basel II Accord was being debated the financial crisis occurred and TARP requirements replaced Basel; Congress' initial legislative response to the financial crisis was the Emergency Economic Stabilization Act of 2008 (EESA), enacted on October 3, 2008. The $700 billion in funds authorized by Congress in EESA to assist in the financial crisis clean-up, labeled “Troubled Asset Relief Program” (TARP), were quickly diverted by then-Treasury Secretary Henry Paulson from buying troubled mortgage-related assets held by banks to purchasing preferred, non-voting stock in banks under what is now called the Capital Purchase Program (CPP). The new Obama administration announced on February 10, 2009, the Financial Stability Plan - its new name for TARP - that would fund additional bank stock purchases under a new program called the Capital Assistance Program (CAP).

a. The statute did require that certain executive compensation arrangements for CPP recipients would be limited. Institutions accepting preferred stock investments by the United States also are required to pay quarterly dividends to the United States of five percent per year for the first five years of the investment and nine percent per year thereafter.


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b. The Obama Administration's Treasury Secretary Timothy Geithner announced on February 10, 2009, the outline of the administration's plans for the use of the second tranche of TARP funds authorized in the EESA, or Tarp 2.

c. “Financial Stability Plan” calls for a “stress test” of the nineteen financial institutions whose assets exceed $100 billion, with commitments of additional capital to those of the large institutions identified as needing additional capital under the stress test scenarios. These institutions account for approximately two-thirds of all bank holding company assets.

d. Stress tests [559]: 5 banks required capital injections; seemed to restore market confidence

e. Repayment: on June 9, 2009, JPM, MS, BKNY, GS, STT, AMEX, and BBT were allowed to repay their TARP loans

6. Financial Crisis and Basel III [561]: Change of focus from Basel II to Basel III—turned from reducing capital requirements for large complex banks based on their ability to model internally to requiring more and higher quality capital

a. Basel III [562]:i. Tier 1 - increased from 4% to 6%ii. Minimum Total Capital - 8% with 2.5% added in periods of growth

7. Dodd-Frank Act [562]: Created FSOC; FSOC to make capital recommendations to the Fed; Fed required to limit the leverage of systemically important financial companies to 15 to 1; Fed is directed to required countercyclical capital requirements so that the amount of capital required to be maintained by a company increases in times of economic expansion and decreases in times of economic contraction; Collins Amendment requires BHCs to be subject to the same capital requirements as their FDIC insured subsidiaries—effect is to reduce BHC holding hybrid securities like trust-preferred securities; Fed must stress-test all systemically significant institutions under a range of scenarios

a. Trust preferred securities [563] i. Small bank exemption?

B. Special Issues [565]: 1. Merchant Banking [565]: bank’s ability to hold equity in companies that are not publicly traded;

GLBA authorized this for financial holding companies but initially wanted 50% capital charge; FHC’s complained this would discourage activity because too costly. New rule says: if merchant capital investment less than 15% of Tier 1, 8% charge

2. Securitizations [565]: Banks sponsoring asset backed commercial paper programs are allowed to exclude those ABCP program assets consolidated from the sponsoring institutions risk weighted asset base for determining capital.

a. ABCP program assets that are consolidated onto the bank’s balance sheet under GAAP may no longer be excluded from the bank’s risk-based assets

3. Subordinated Debt [566]: borrowings by the bank – debt bank (issuer/borrower) owes to one creditor (purchaser) that is contractually subordinated to the claims of other creditors. This gives subordinated debt holders strong incentives to monitor the financial solvency of the bank. Some recommend that big banks hold some capital in subordinated debt. Believed to be much more straight-forward. Interest rate charged to bank would seem to be a good proxy for market’s judgment regarding the riskiness of this institution’s practices.

a. Fed: Mandatory Subordinated Debt [566]


1. Based on safety and soundnessa. Safety and soundness consist of five components:

i. Federal deposit insurance, to reduce the likelihood of bank runs and panics


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ii. Deposit interest ceilings, to reduce the costs of bank deposits and weaken banks’ incentives to invest in risky assets

iii. Regulatory monitoring, to ensure that banks do not invest in excessively risky assets, have sufficient capital given their risk, have no fraudulent activities, and have competent management

iv. Capital requirements to provide incentives for banks not to take excessive riskv. Portfolio restrictions to prohibit investment in risky assets

2. Banks are required to submit quarterly financial date to their regulator. 12 USCA §161(a)&(c) [national banks]; 1817(a)&(c) [state banks]

3. Banks usually get an on-site examination once a year…some small, well-managed banks may only get examined once every 18 months, however

4. Dodd-Frank requires banks with assets over 10m to get annual internal stress testing, e.g. for baseline, adverse, and severely adverse scenarios

a. National banks = OCC examinesb. State member banks = FDIC and state regulatory authority alternatec. State non-member banks = Fed and state regulatory authority alternate (as long as FDIC

has certified the state authority as providing good exams)d. Savings institutions = OTS (Office of Thrift Supervision) examines…now the OCCe. Bank holding companies = Fed…Fed also has regulatory authority over BHC’s

nonbanking subsidiaries5. GLBA

a. FUNCTIONAL REGULATION authorityb. Gave the Fed umbrella supervision over FHCsc. For companies under 10b in assets, Bureau of Financial Consumer

6. Dodd-Frank gave Fed additional regulatory power over nonbanking/non-depository subsidiaries of FHC

7. Bureau of Consumer Financial Protection, created by Dodd-Frank, has broad enforcement powers over non-depository subsidiaries of depository holding companies

B. CAMELS Rating System1. Four major purposes of bank examination

a. Maintenance of public confidence in the integrity of the banking system and in individual banks

b. Periodic on-site examination provides the best means of determining the bank’s compliance with laws and regulations

c. Protecting the financial integrity of the deposit insurance fundd. Gives examiners understanding of the nature, relative seriousness, and ultimate cause

of a bank’s problems, and thus provides a factual foundation to soundly base corrective measures, recommendations and instructions

2. Uniform Financial Institutions Rating System (UFIRS)a. Each financial institution is assigned a “composite” rating based on an evaluation of six

essential components of financial operationb. Each composite is scored from 1 to 5, with 1 being the highest rating and 5 being lowest

(indicating weak performance, inadequate risk management, and highest supervisory concern)

c. Composite rating is NOT derived by computing an arithmetic average of the component ratings…each component rating is based on qualitative analysis of factors and their relationship with other components…some components may be given more weight than others depending on the situation at the institution

d. Assigned composite and component ratings are disclosed to the institution’s board of directors and senior management


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e. Composite 1 – financial companies in this group are sound in every respect and generally have components rated 1 or 2…any weaknesses are minor and can be handled in a routine manner within the company

f. Composite 2 – financial institutions in this group are fundamentally sound…generally, no component ratings worse than a 3…only moderate weaknesses are present and are well within the institution’s capabilities and willingness to correct (most well-maintained banks get this rating)

g. Composite 3 – financial institutions in this group exhibit some degree of supervisory concern in one or more of the component areas…they exhibit a combination of weaknesses that may range from moderate to severe…however, the magnitude of deficiencies generally will not cause a component to be rated more severely than a 4…management may lack the ability/willingness to correct weaknesses within appropriate timeframes

h. Composite 4 – financial institutions in this group generally exhibit unsafe and unsound practices or conditions…there are serious financial or managerial deficiencies that result in unsatisfactory performance…problems range from severe to critically deficient…weakness are not being satisfactorily addressed or resolved by management

i. Composite 5 – financial institutions in this group exhibit extremely unsafe and unsound practices or conditions…exhibit a critically deficient performance and often contain inadequate risk management practices relative to the institution’s size, complexity, and risk profile…greatest supervisory concern…volume and severity of problems are beyond management’s ability/willingness to correct

3. CAMELS components (these are the components that examiners evaluate in developing their composite ratings)

a. Capital Adequacy – expected to maintain capital commensurate with the nature and extent of risks to the institutions and ability of management to identify, measure, monitor, and control such risks…evaluation based partially on the effects of credit, markets, and other risks…capital adequacy is rated based upon:

i. Level and quality of capital and overall financial condition of the institutionii. Ability of management to address emerging needs for additional capital

iii. Nature, trend, and volume of problem assets, and the adequacy of allowances for loan and lease losses and other valuation reserves

iv. Balance sheet composition, including the nature and amt of intangible assets, market risk, concentration risk, and risks associated with nontraditional activities

v. Risk exposure represented by off-balance sheet activitiesvi. Quality and strength of earnings, and reasonableness of dividends

vii. Prospects and plans for growth, as well as past experience in managing growthviii. Access to capital markets and other sources of capital, including support

provided by a parent holding companyb. Asset quality – reflects the quantity of existing and potential credit risk associated with

the loan and investment portfolios, other real estate owned, and other assets, as well as off-balance sheet activity…also reflects ability of management to identify, measure, monitor, and control credit risk…evaluation of asset quality should consider the adequacy of the allowance for loan and lease losses and weigh the exposure to counterparty, issuer, or borrower default under actual or implied contractual agreements

c. Management – reflects the capability of board of directors and management, in their respective roles, to identify, measure, monitor, and control risks of an institution’s activities and to ensure the institution’s safe, sound, and efficient operation in compliance with applicable laws and regulations…directors need not be involved in day-


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to-day operations, but they must provide clear guidance regarding acceptable risk exposure levels and ensure that appropriate policies are in place…senior management is responsible for developing and implementing policies that reflect the board’s goals and risk limits

d. Earnings – reflects not only the quantity and trend of earnings, but also factors affecting the sustainability or quality of earnings…excessive or inadequately managed credit risk may result in loan losses and require additions to the allowance for loan and lease losses, or by high levels of market risk that may unduly expose an institution’s earnings to volatility in interest rates…quality of earnings may also be diminished by undue reliance on extraordinary gains, nonrecurring events, or favorable tax effects…future earnings may be adversely affected by an inability to forecast or control funding and operating expenses, improperly executed or ill-advised business strategies, or poorly managed exposure to other risks

e. Liquidity – reflects current level and prospective sources of liquidity compared to funding needs, as well as the adequacy of funds management practices relative to the institution’s size, complexity, and risk profile…funds management practices should ensure that an institution can maintain a level of liquidity sufficient to meet its financial obligations in a timely manner and fulfill community banking needs…should reflect institution’s abilities to manage unplanned changes in funding sources or ability to quickly liquidate assets with minimal loss…also, liquidity shouldn’t be maintained at a high cost, or through undue reliance on funding sources that may not be available in times of financial stress

f. Sensitivity to market risk – reflects the degree to which changes in interest rates, foreign exchange rates, commodity prices, or equity prices can adversely affect a company’s earnings or economic capital…consideration given to management’s ability to identify and control market risk, institutional size, nature and complexity of activities, and adequacy of its capital and earnings in relation to its level of market risk exposure

4. Also done to evaluate strength of insurance coverage5. CAMELS ratings may be shared with management and directors, but NOT SHARED WITH

INSURANCE COMPANIESC. Holding company regulation/rating system

1. Fed ratings tend to emphasize RISK MANAGEMENT in supervision of any BHC2. Old Fed components for rating BHC (BOPEC system):

a. Bank subsidiariesb. Other subsidiariesc. Parentd. Earningse. Capital

3. BOPEC system did NOT emphasize risk management4. New Fed components rating system of BHC (RFI/C(D) system):

a. Risk managementi. Board and senior management oversight

ii. Policies, procedures, and limitsiii. Risk monitoring and management information systemsiv. Internal controls

b. Financial conditioni. Capital

ii. Asset qualityiii. Earningsiv. liquidity


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c. Potential impact of parent company and nondepository subsidiaries on subsidiary depository institutions

d. Depository institution (mirrors the primary regulator’s assessment of the subsidiary depository institutions)

5. Each BHC is assigned a composite rating (C) based on the above factors…each subcomponent rating is assigned based on the 1-5 numeric scale

6. Dodd-Frank explicitly states that the Fed’s exams of depository holding companies and their subsidiaries should inform the Fed about risks to the stability of the national financial system

7. Systemically Significant Financial Institutionsa. Financial Stability Oversight Council is charged with identifying systemically significant

financial institutions, which includes both nonbank financial companies (e.g. AIG) AND large, interconnected depository institution holding companies with consolidated assets in excess of 50b

b. Fed gets supervisory authority over these companies now under Dodd-Frank…now requires higher prudential standards for capital, leverage, liquidity

c. SSFI now subjected to annual stress testing, and they must prepare bank resolution plans (aka “living wills”), which will provide a roadmap for a rapid and orderly resolution of the company in case it fails

d. SSFI also have to conduct their own, internal stress tests twice a yeare. Dodd-Frank establishes office of Complex Financial Institutions (CFI) to provide

continuous review of SSFI and BHC with more than 100b in assets…also gives FDIC expanded examination authority over systemically significant financial institutions regarding orderly liquidation of such institution

D. Enforcement powers1. History of enforcement activities

a. Before 1966, regulators had 2 powers:i. Moral suasion ("jawboning")

1. Regulator's effort to persuade the bank to undertake more rigorous practices

ii. The "death penalty"1. Ending existence of bank (revoking charter, ending FDIC coverage,

receivership, entering conservatorship/appointing a conservator to run the institution, etc.)

b. 1966 – Financial Institutions Supervisory Act (FISA)i. Gave federal regulators the authority to issue cease and desist orders and

modified the regulator's removal powers…extended power to cover national and state banks

c. 1974 – Fed received similar authority over BHCsd. 1978 – Financial Institutions Regulatory and Interest rate Control Act (FIRA)

i. Extended bank regulator's jurix to individual, officers, directors, officers, employees, agents, and "others participating in the affairs of the institution." Just people within the institution.

ii. Fed regulators could also use civil money penalties (CMPs)e. 1989 – S&L crisis – Financial Institutions Reform, Recovery, and Enforcement Act of

1989 (FIRREA)i. Authorized the Resolution Trust Corporation – receiver of a failed banks

ii. Consolidated enforcement authority previously found in FDIAiii. FDIC was given back up enforcement authority over all federally involved

depository institutions (FDIC has yet to use this authority)iv. Allows actions to be brought against institution AND affiliated parties –

accountants, lawyers, appraisers, etc…expands powers to outsiders


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f. 1990 – Comprehensive Thrift and Bank Fraud Act (part of Comprehensive Crime Control Act)

i. Provided authority for attachment and injunctive reliefg. 1991 – FDIC Improvement Act (FDICIA)

i. Regulatory scheme based on "prompt corrective action"…can use PCA when capitalization gets down to a low level…can force bank to take action to increase capitalization

ii. Purpose was to lessen the overall loss suffered by the FDIC by allowing regulators to address capital deficiencies prior to technical insolvency…banks w/ inadequate capital had to complete a capital restoration plan

h. 1992 – Annunzio-Wylie Money Laundering Act of 1992i. Separate grounds for removal of officers and directors involved in money

launderingi. In the 2000s, banks have been increasingly willing to settle regulatory actions to provide

certainty, put a ceiling on their potential liability, and to move forward with reputations intact

j. Also, increased enforcement activity by the SEC, criminal investigations and proceedings by DOJ, and actions by state attorneys general

2. Types of enforcement actionsa. FIRREA extends liability to directors, officers, controlling shareholders, and agents, but

can also including ANY shareholder, consultant, joint venture partner, attorney, appraiser, or accountant who knowingly or recklessly violates the law/breaches fiduciary duty/engages in unsafe and unsound practices that are likely to cause more than minimal loss to the insured depository institution

b. Informal supervisory and enforcement actionsi. Regulator's report of examination should identify any problem areas to put the

bank's directors on notice as to potential corrective actionsii. Can either outline steps banks should take, or require written commitments

from bank's management to address identified problems, adopt specific resolutions, or draft a memo of understanding (MOU)

c. Formal enforcement mechanismsi. Examination Report

ii. Consent Order1. Most small community banks in NC operate under CO2. An order by the regulatory agency to cease and desist3. Banks board enters into this order on behalf of the bank4. Violations of consent orders can result in civil money penalties (CMP)

against directors and other affiliated partiesiii. Cease and Desist Order

1. Same legal effect as a consent order, but it is imposed on an involuntary basis after issuance of a Notice of Charges, a hearing before an administrative law judge, and a final decision and order issued by the agency

2. Reviewable by US court of appeals3. May require offender to cease and desist from the identified activity,

take action to correct the adverse conditions of such activity, make restitution, or indemnify or guarantee the institution against loss if the offender was unjustly enriched by the improper activity

iv. Temporary Cease and Desist Order1. Interim order issued by agency used to compel immediate action

pending resolution of cease and desist order


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v. Removal and Prohibition Order1. Only made if a three-part test is satisfied: (1) specific act; (2) effect; and

(3) intent2. The specific act MUST be a violation of law/regulation (including a cease

and desist order, a condition/agreement with the agency, unsafe or unsound practice, or an act/omission that constitutes a breach of fidelity)

3. Effect realized from the specific act must be that the institution has suffered/is likely to suffer loss or damage, the interests of the depositors have been prejudiced, or the offender received some financial gain/benefit from the improper act

4. Intent requires either personal dishonesty or willful/continuing disregard for the safety and soundness of the institution

5. Removal and Prohibition Orders might include an industry ban on participating in the affairs of any depository institution…may also prohibit solicitation or vote of any proxies, prevent offender from voting for directors, or prohibit offender from serving as an institution-affiliated party

vi. Formal Written Agreement1. Agreement between bank and agency similar to consent order2. Violation may result in CMP against directors and other affiliated parties3. Unlike consent orders, FWAs are not enforceable through federal courts

vii. PCA Directive1. Prompt Corrective Action scheme2. Vehicle through which discretionary actions are imposed on the bank3. Insured banks are subject to mandatory and discretionary actions,

depending on their capital category under the scheme4. Mandatory restrictions are effective upon the bank’s receipt of notice

certifying which capital category it falls underviii. Safety and Soundness Order

1. If a bank fails to meet required safety and soundness standards, agency may send it a notice…if bank doesn’t submit an adequate plan or implement an approved plan, the agency may require the bank to correct any deficiencies

ix. Capital Directive1. An order issued without a hearing before an administrative law judge2. Directive sets a capital level for a bank and may require certain actions

relating to the bank’s capital3. Rarely used since most banks with capital problems have already been

dealt with through other enforcement mechanismsx. Civil Money Penalty

1. Strengthened under FIRREA…three different tier penalties2. Tier 1 – up to 5k per day for violation of any law/regulation, agency

order, or agreement3. Tier 2 – up to 25k per day for commission of Tier 1 violation, recklessly

engaging in an unsafe/unsound practice, or breaching fiduciary duty…act must be part of a pattern of misconduct that has caused/is likely to cause more than minimal damage to institution, resulting in pecuniary gain to the officer


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4. Tier 3 – up to 1m per day for commission of Tier 2 violation, but with a knowing or reckless state of mind, causing substantial loss to a depository institution or substantial gain to offender

xi. Divestiture of Assets1. If Fed finds that a systemically significant financial institution poses a

grave threat to nation’s financial stability, the Fed may require company to sell or transfer assets or off-balance sheet items to unaffiliated entities

xii. Withdrawal of Federal Insurance1. Extremely rare

d. Conduct of the administrative processi. Process of seeking enforcement against a depository institution is governed by

the Administrative Procedures Act…sequence of events is as follows:1. Agency files Notice of Charges or Intent to Remove2. Defendant responds w/in 20 days3. Limited discovery4. Hearing before administrative law judge (ALJ) who is familiar with bank

enforcement matters5. 30 days after hearing, parties submit to ALJ proposed findings of fact,

conclusions of law, and proposed orders6. ALJ must file a record of the proceedings as well as his recommendation

to agency head7. Agency head makes a final decision w/in 90 days of when the record is

complete…agency head can accept reject or modify the ALJ's recommendation

8. Parties can file an appeal with a federal ct. of appeals within 30 days of agency’s decision

9. Appeals ct, can only overturn the agency head's decision only if it is capricious, an abuse of discretion, not in accordance with law, not based on substantial evidence, or the decision is in excess of the agency head's authority

e. Matter of Seidman (1994) i. Petition for review of cease and desist order from the OTS, following alleged

unsafe and unsound practicesii. Petitioner promised to give out a loan in conflict with the company’s policy of

prohibiting purchase money loans on the security of real property in which a company officer had an interest

iii. Another company officer then obstructed OTS investigation by soliciting false testimony from an employee

iv. Statute 1818(e) does not define “unsafe and unsound”v. “Unsafe and unsound” is a flexible concept, which may include any

action/omission which is contrary to generally accepted standards of prudent operation, the possible consequences of which could be abnormal risk or loss or damage to an institution or its shareholders or the insurance agencies

vi. Court synthesizes various rules and says that “unsafe and unsound” means an imprudent act that poses an abnormal risk to the financial stability of the banking institution

vii. Examples include:1. Paying excessive dividends2. Disregarding borrower’s ability to repay3. Careless control of expenses


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4. Excessive advertising5. Inadequate liquidity6. Poor state of loan portfolio7. Insufficient capital and reserves8. Transfer of assets to troubled subsidiaries (since it would disregard the

parent’s separate status and would amount to a wasting of parent’s assets and violate duties to shareholders)

9. Obstructing an OTS investigationviii. Unsafe and unsound does NOT necessarily include:

1. Breach of contract that shakes public confidence in institution2. Merely “imprudent” action that does not create abnormal risk3. Contingent, remote harms that could ultimately result in “minor

financial loss”ix. Court says that petitioner did act imprudently by committing itself to the loan,

because at the time the commitment was made, petitioner couldn’t be sure that the company was actually able to make the loan…however, imprudence alone is insufficient for unsafe and unsound, and petitioner attempted to get out of the commitment when he realized it was risky

x. Officer’s obstruction of investigation was unsafe and unsound, but did not satisfy the culpability elements required of a removal and prohibition order

E. Orderly Liquidation Authority for Systemically Significant Financial Companies1. Dodd-Frank requires systemically significant nonbank financial companies identified by the FSOC

to prepare an “orderly liquidation” plan without any possibility for reorganization, with the FDIC as receiver

2. Orderly Liquidation Authority is available to those willing to fund it, and to systemically significant financial companies with assets exceeding 50b

3. FDIC Financial Crisis Inquiry Commissiona. Large financial services organizations can create systemic risk simply by virtue of their

extensive counterparty exposures…these exposures may not be readily apparent prior to failure

b. Large institutions can also be difficult to resolve because they have fewer potential acquirers and may have franchises whose value dissipates quickly following failure

c. Complexity of a large institution’s structure and operations also makes resolution difficult

i. Large financial firms are highly interconnected and operate through financial commitments and operational dependencies both within the conglomerate structure and through connections with other firms

ii. These firms operate through a web of trading, credit, and liquidity relationships in exchanges, clearing houses, custodians, lines of credit, securities settlement structures, and other market infrastructure elements

iii. These firms operate across national borders and conduct business around the clock

d. US bankruptcy problem is ineffective for dealing with large financial institutionse. FDIC act provides a sound framework to resolve banks, but there apparently was no

such similar framework for the liquidation of holding companies and their nonbank subsidiaries

f. Dodd-Frank provides such a framework to nonbank financial firms, which can prevent disorderly collapse and can insulate taxpayers from any future bailouts

g. Two vital components of this framework:


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i. Supervisory and regulatory powers giving the FDIC and other regulators information and cooperation from the largest financial firms essential to future liquidation/orderly dissolution

ii. Critical legal powers for an effective liquidation process modeled after the FDIC’s framework for banks

h. These components enhance market disciplinei. Dodd-Frank requires periodic reporting of detailed information and submission plan for

rapid and orderly resolution in event of financial distress or failureF. Failed Bank Resolution

1. Banks, savings institutions, and credit unions cannot file for protection under federal bankruptcy code…instead, insolvent banks and savings institutions are resolved by the FDIC (credit unions are resolved under the NCUA)

2. Open Bank Assistancea. FDIC may offer financial assistance (open bank assistance) to a bank before it becomes

insolventb. No request for assistance will be granted unless FDIC determines "the financial impact

on executive management, directors, shareholders and subordinated debt holders is comparable to what would have occurred if the bank had actually closed”

c. Very rare3. Prompt Corrective Action

a. 1983 – International Lending Supervision Act (ILSA)i. Granted agencies the authority to issue capital directives to depository

institutions w/ declining capital positionsb. 1991 – FDICIA provided a new regime for dealing with deteriorating capital positions by

instituting enforcement based on prompt corrective action (PCA)i. Capital zones:

1. Well capitalized2. Adequately capitalized3. Undercapitalized4. Significantly undercapitalized5. Critically undercapitalized

ii. Bank agencies may bring more severe measures to bear on a bank whose capital is falling from well capitalized to critically undercapitalized

iii. Actions under the PCA regime:1. Minimum action required is that the institution develop a

recapitalization plan2. Agency may also restrict the institution's activities and require a

management improvement (i.e., agency can dismiss and replace management and Board members)

3. If leverage ratio (BV assets/BV capital) is less than 2%, a receiver may be appointed even though the bank still has positive capital and is not technically insolvent.

iv. PCA does NOT apply to the systemically significant financial institutions subject to the Fed’s heightened prudential standards after Dodd-Frank, but a comparable system imposes early remediation requirements on such institutions

4. Closure of Banka. Decision to close a bank is made by the bank’s primary regulatorb. Bank shareholders are not entitled to any pre-closure noticec. Grounds for closure:

i. Bank is insolvent based on balance sheet (e.g. liabilities exceed assets)


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ii. Bank is insolvent based on liquidity (e.g. cannot meet obligations as they become due)

iii. Bank’s capital position is at 2% or below, even though it is not technically insolvent

iv. Charter provision for voluntary dissolutionv. Creditors asserting unpaid judgments against bank

d. FDIC is receiver or conservator of a failed bank5. Resolution Methods for when Bank actually Fails

a. Resolution must be “least costly to the deposit insurance fund of all possible methods for meeting the FDIC’s obligations”

b. Methods for resolution:i. Liquidation of the institution

1. Risk of loss is on uninsured depositors, non-deposit creditors, and the FDIC if liquidation cannot recoup FDIC for the amts paid to the insured depositors, uninsured depositors, non-deposit creditors, etc.

ii. Purchase and assumption transaction with another institution purchasing the failed bank’s assets and assuming its liabilities

1. Risk of loss is on FDIC and bank shareholdersiii. Assistance provided by the gov’t to return the bank to solvency, in cases where

the bank is deemed “too big to fail” and is subject to the systemic risk exceptionc. Generally, FDIC will only protect insured depositors…however, if the FDIC, the Fed, and

the Treasury all agree that a bank's failure poses a serious systemic risk, the FDIC is permitted to protect uninsured depositors and creditors

6. Bank insolvency risks: Challenges to limited liability in the BHC structurea. Approx. 75% of insolvent banks have been resolved by a purchase and assumption

transactionb. Recently, purchasers of insolvent banks have not assumed the liabilities of non-deposit

creditors, but have assumed deposit liabilitiesc. Bank insolvency is borne by shareholders and FDIC, and possibly to third/counterparties

depending on the severity of the bank’s insolvency7. Example from 2009

i. BB&T purchased 22 out of 25b worth of insolvent Colonial Bank of Alabama’s assets, and entered into a loss-share agreement with FDIC over a portion of those assets…the arrangement ultimately cost the FDIC 2.8b, but was deemed the least expensive resolution

8. FDICIA passed in 1991 which provided the “too big to fail” exception to the “least cost” method for troubled bank resolution, subject to approval by Treasury in consultation with the President

9. Wachovia – Alvarez Testimony before the Financial Crisis Inquiry Commissioni. Wachovia financial holding company had 95% of its assets (nearly 800b) in its

commercial bank and two insured thrift subsidiaries…had been profitable for more than a decade

ii. Then, in the first half of 2008, company posted losses of 9.6b, reflecting write-downs on securities and high provisions for loan losses

iii. These losses reflected significant expected losses on option ARMs which Wachovia had acquired in its purchase of a federal thrift holding company, as well as losses from the decline in value of commercial real estate mortgages originated and held by Wachovia

iv. When FDIC had to seize and sell WaMu (the second largest holder of option ARMs), creditor concerns about the health of Wachovia mounted (since it was the largest ARM holder), and the company’s stock prices slumped and credit default swap spreads on its debt surged


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v. Wachovia depositors accelerated the withdrawal of funds from their accounts, as did wholesale funds providers, which diminished the company’s liquidity

vi. Citigroup and Wells Fargo both investigated into purchasing Wachovia, but FDIC at that point assumed that any assistance required for a purchase of Wachovia by either company would be more costly than it would be simply to liquidate Wachovia

vii. However, the systemic risk doctrine suggested that a Wachovia failure or liquidation would lead investors to doubt the financial strength of other organizations in similar situations (since Wachovia was originally assumed to have been well capitalized)

viii. Creditors would also be concerned about direct exposures of other firms to Wachovia liquidation, which could “break the buck” in money market mutual funds and place further stress on funding markets

ix. Other concerns about shaking up household and general consumer confidence in banks led FDIC to reconsider liquidating Wachovia

x. Thus, FDIC entertained bids from Wells Fargo and Citigroup…at first, Wells Fargo’s bid required a greater amt of FDIC assistance than Citigroup’s did, so FDIC began working out its deal with Citigroup

xi. Then Wells Fargo realized that a tax benefit would allow it to acquire Wachovia without any FDIC assistance…thus FDIC handed the deal over to Wells Fargo

xii. Citigroup believed this violated their exclusive dealings with Wachovia, but the Fed facilitated negotiations to keep legal quarrels from further undermining consumer confidence in the safety of the financial system

10. Cross-guarantees, the Controlling Company Guarantee Provision, and Source of Strength.

i. Cross-guarantees:

1. In 1989 as part of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), Congress added to the Federal Deposit Insurance Act a “cross-guarantee” provision, which provides that commonly controlled depository institutions must pay to the FDIC the amount of loss that that the FDIC suffers or expects to suffer as the result of the insolvency of the depository institution.

2. Depository institutions are "commonly controlled" if they are controlled by the same holding company and treated as branches of the same bank. So basically brother/sister banks.

3. A guarantor bank's cross-guarantee liability is subordinate to all other liabilities of the bank except for liabilities owed to affiliated institutions.

4. Purpose - risk shifting. Assures that the assets of a healthy institution within the same structure will be available to the FDIC to offset the cost of resolving the failed institution.

ii. Controlling Company Guarantee Provision:1. The Federal Deposit Insurance Corporation Improvement ACT (FDICIA) was enacted in late 1991. One proposal set forth in the FDICIA was the extension of the cross-guarantee provision to bank holding companies (BHCs).

This was basically an attempt to codify the Fed's "source of strength" regulation, Regulation Y (aka Reg Y) which provides that a “bank holding company shall serve as a source of financial and managerial strength to its subsidiary banks.”


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2. The issue remains, however, as to whether the source of strength regulation exceeds the Federal Reserve Board’s statutory authority. The regulation’s validity remains unresolved despite Supreme Court review of the case in which the question was raised.

iii. But Congress did not extend the cross-guarantee provision to BHCs. Instead, in 1992, Congress provided for a limited guarantee by the BHC parent.

A. If a bank is undercapitalized, it must submit a capital restoration plan (see above). A condition of the FDIC’s approval of the plan is that its controlling company guarantee that the undercapitalized institution will comply with the plan until the institution is adequately capitalized for 4 consecutive quarters.B. A controlling co. liability is limited to the lesser of:

1. the amount need to bring the institution into compliance with all capital standards as of the time the institution fails to comply with its restoration plan, or2. 5% of the institution's assets at the time it became undercapitalized.

C. Purpose of the controlling company guarantee is to induce a parent company to decide promptly whether to recapitalize the institution or sell it.D. If the controlling co. enters bankruptcy, the FDIC's claim on the guarantee will be given priority over other unsecured creditors of the controlling co.

Note – the FDIC can use both a cross-guarantees along with a controlling company guarantees. So the FDIC could get reimbursement from the controlling company or a sister bank, or both.

11. Creditors and priorities: There are special rules under bank insolvency law for dealing with the claims of creditors of an insolvent institution. These rules often differ from rules under the Bankruptcy Code. For instance, some of these differences are as follows (from Peter Swire Bank Insolvency Law Now That It Matters Again).

i. In comparison with traditional bankruptcy trustees, banking agencies. First, the

12. Liability of Institution-affiliated Parties (incl. officers, directors, and attorneys). i. The most notorious use of enforcement authority against an institution-

affiliated party occurred in connection with the failure of Charles Keating’s Lincoln Savings and Loan Assn and the subsequent order brought by the OTS against Lincoln’s law firm, Kaye Scholer.

Kaye, Scholer and the OTS: Did Anyone Go Too Far?1 argues that the reason Lincoln Savings was not closed earlier when it should have been, was not b/c of Kaye, Scholer, but because of the ineptitude and political corruption of bank regulators. Kaye, Scholer was just a scapegoat to improve the image of OTS.

13. Actions by Conservator or Receiver to Recover Losses from Officers or Directors.i. Resolution Trust Corp. v. Walde 2

During the 1980s savings & loan crisis, Congress created the Resolution Trust Corp. (RTC) as part of FIRREA. Under this statute, the Director of the Office of Thrift Supervision may appoint the RTC as conservator of failed savings and loans institutions (S&Ls). RTC has the same powers as the FDIC in these situations.

In this role, RTC is to preserve and conserve the assets and property of failed institutions. To accomplish this, it is empowered to avoid

1 Casebook p. 6122 Casebook p. 615.


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fraudulent asset transfers, assert claims against an S&L's officers and directors, seek a court order attaching assets, and issue administrative subpoenas duces tecum.

In this case, RTC served a subpoena duces tecum on William Walde, the founder of Trustbank Savings. When Trustbank was declared insolvent, the RTC launched an investigation to determine whether Walde and other former Trustbank officials might be liable to the RTC as a result of the operation of their company. In its subpoena on Walde, RTC called for the production of any documents relation to the operations or management of Trustbank as well as extensive personal financial information. At issue was RTC’s statutory authority to subpoena personal financialy data not directly related to the management of Trustbank.

The court held that Congress did not intend RTC to have such an intrusive grant of authority.

Rules from this case: Any personal financial information subpoenaed from officers

and directors must be relevant to the issue of liability. The RTC cannot subpoena personal financial information from

officers or directors if the RTC does not have an articulable suspicion to believe that the officer or director is liable to the S&L.

The RTC cannot subpoena personal financial information from officers or directors for the purpose of assessing the cost-effectiveness of prospective litigation.

14. Special Standards of Professional Negligence Actions brought by Conservators or Receivers.i. A Political Economy of the Business Judgment Rule in Banking: Implications for

Corporate Law: Implication for Corporate Law3

Previous duty of care standard for bank directors was the care which ordinarily prudent and diligent men would exercise under similar circumstances, taking into account the restrictions of statutes and the usages of business (Briggs v. Spaulding, 1891).

However, this was basically too high of a standard, and courts started second-guessing business judgments with the aid of hindsight. So courts grafted the business judgment rule (BJR) onto bank directors' duty. But then the bank failures in the 1980s caused courts to greatly curtail the BJR.

Now bank directors face regular negligence liability for inadequately secured loans, over reliance on risky collateral, failures to perfect security, defective internal controls, etc. As a result, the duty of care has reduced Board discretion to approve bank loans.

In addition, for the first time ever courts held financial inst. Directors liable for defective internal controls. Federal agencies are the main people suing bank Boards, not SHs. Federal

regulators can regulate in federal court, so federal courts are now the main forum for bank director liability cases. SO the authority for defining the BJR has moved from state courts to federal courts.

The most important recent holdings in this regard penalize directors for eschewing or ignoring loan underwriting standards, for not analyzing borrower credit profiles, and for lax administration of loans and other

3 Casebook p. 619. 65

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investments. Thus, in banking law, the common-law duty of care has significantly reduced board discretion to approve bank loans.

The move toward federalization has also been fueled by the fact that federal bank agencies (such as the FDIC), rather than shareholders, depositors, and state court receivers, are now most likely to sue bank directors for negligence. Since federal regulators can regulate in federal court, federal courts are now the main forum for bank director liability cases. Thus, the authority for defining the scope of BJR has moved from state courts to federal courts.

• Atherton v. FDIC: Held sate common law should be applied to determine the legal standard of care that should apply to bank officers and directors, as long as the state standard is stricter than that of the federal statute. The federal statute sets a ground floor. So state common law trumps a federal statute, as long as the state common law has a stricter standard.

O’Melveny & Meyers v. FDIC (cited in Atherton): holds that state common law, and not federal law, will be applied to determine the tort liability of attorneys who provided services to a failed bank. So state common law trumps any “federal common law.”

15. Criminal Sanctions.i. Examining the Increase in Federal Regulatory Requirements and Penalties: Is

Banking Facing Another Troubled Decade?4 Criminal sanctions available for use against bank officers and directors have

increased significantly since the 1980s. This is significant due to the unique nature of banking it is complex

and the regulatory burden is enormous. Even with the most diligence, inevitably, loans will go unpaid, and violations will result from mistake, oversight, and errors in business judgment.

The Money Laundering Control Act of 1986: Increased fines and prison sentences for money laundering activities.

FIRREA 1989: Increased fines and prison sentences for violations of Title 18. Increased fines and prison sentences for violation of an agency order. Increase fines and prison sentences for knowing violations of statutes with

intent to deceive, defraud, or personally profit. Amended RICO, so now all RICO fines and penalties are available to

prosecutors investigating bank officers and directors for fraud. Congress increased the statute of limitations to 10 years for violations of

Title 18. The Crime Control Act of 1990:

• Increased prison terms further.• Requires courts to order criminal forfeiture of property traced to money received from banking violations.• Prohibits engaging in a continued financial crimes enterprise.• Prohibits knowingly concealing assets from insurance or regulatory bodies acting as a receiver or conservator, or impeding the functions of these bodies.• Prohibits obstructing the examination of a financial institution.• Creates a system for special rewards for information relating to certain financial institution offenses.

4 Casebook p. 624.


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Since the 1980s, those convicted of federal crimes are sentenced under the US Sentencing Guidelines. Imprisonment, fine, penalty, etc. determined in light of the characteristics of the D, the crime, and its impact on the victim and society.

16. Claims by Debtorsi. The FDIC, as receiver, often brings an action against a borrower based on

nonpayment of a loan. If the borrower raises the defense that the loan agreement was not documented, therefore not valid, the FDIC can defeat this defense with their "D'Oench superpower."

ii. Bank Insolvency Law Now That It Matters Again:5

This ‘superpower’ comes from 3 interrelated sources of law: First, the D'Oench case established the equitable doctrine that prevents a

person doing business with a bank from benefiting from any secret undocumented loan not discoverable by bank regulators.

Second, section 1823 (e) of Title 12, a strict statutory version of the D’Oench doctrine, creates a specialized statute of frauds that defeats all claims or defenses against bank except for those based on contemporary approval by the bank’s board of directors.

Finally, the “federal record holder in due course” doctrine has developed judicially to allow agencies to win in related cases even where D’Oench and section 1823(e) may not apply.

iii. Motorcycle of Jacksonville, LTD. V. Southeast Bank, N.A. Ruled that Congress did not intend for FIRREA to overrule the D’Oench doctrine.

The D’Oench doctrine is a firmly established piece of federal common law. The rationale is based on a policy of protecting the FDIC from misrepresentations,

fraud, etc.


Most restrictions on bank location have been removed since the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, but historical limitations help explain our current banking markets. In other countries, banking is dominated by a few large institutions, here we have thousands of separately incorporated banks. Increased mergers recently have led to some consolidation of the banking industry.

A. Geographic Expansion.1. The history of in-state branching prior to Riegle-Neal.

a. Some states prohibited branching (sometimes called unit banking), while other states allowed state charted banks to establish branches to differing degrees (some states limited branches to certain geographic areas; other states allowed state-wide branching). NC allowed state-wide branching, primarily because there were multiple cities, no single big one like Atlanta, GA

b. NBA provided no authority for national banks to branch.c. So to prevent national banks from converting to state charters to be able to branch, Congress

enacted the McFadden Act in 1 927 which allowed national banks to establish charters anywhere within the state it was located if state law granted a state bank the authority to establish a branch in that location.

d. McFadden Act limits general business of a national bank to its HQ and any branches permitted under §36. §36 permits a national bank to branch in its home state to the extent state banks are allowed to under that state's law. Branch is defined to include any branch bank, branch agency, additional office, or any branch place of business at which deposits are received, or checks paid, or money lent.

5 Casebook p. 629. 67

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e. So what is "branch banking under McFadden Act?i. First National Bank in Plant City v. Dickinson .

1) Bank operated an armored car service and picked up customer deposits at remote locations to deliver them to the bank. Contract (K) b/t bank and customer that moneys did not become deposits or bank property until delivered to the bank.

2) This was a form of branching that violated the McFadden Act. Ks were irrelevant. Ct. focused on the fact that operating this service gave national banks an advantage over state banks. Policy of competitive equality should be upheld. Congressional policy of competitive equality with its deference to state standards is not open to modification by the Comptroller of the Currency.

ii. Clarke v. Securities Industry Ass 'n . (1987)1) National bank wanted to start discount brokerages (low cost broker - no investment advice,

just execute orders) at home office and other sites. Comptroller's office approved. Are discount brokerage offices branches under § 36?


3) SC said no, discount brokerage offices are not branches, therefore, not limited to the branching restrictions in § 36. Policy of competitive equality only applies to core banking functions. The operation of a discount brokerage service is not a core banking function. Ct noted prior to 1927 banks sold securities on an interstate basis.

f. In-state branching finally opened fully.i. Many courts did not interpret the McFadden Act's definition of "state bank" to include state

charted thrift institutions b/c they did not offer checking accounts and commercial loans and thus were not considered “state banks.” However, under the Monetary Control Act of 1980 and the Garn-St Germain Act of 1982 thrift institutions were authorized to exercise bank-like powers and many national banks were able to use this opportunity to expand. Most states allowed state charted thrift institutions to branch state-wide. Therefore, national banks could branch state-wide too under McFadden Act. Some state chartered banks were still limited though, and were thus at a competitive disadvantage. Therefore, all states finally allowed state-wide branching for regular state banks as well. So now everyone can branch state-wide.

2. The history of interstate branching prior to Riegle-Neala. Prior to 1994, interstate branching available only in limited circumstances:

i. McFadden Act only contemplated in-state branching. So national banks pretty much couldn't branch except obscure 30-mile rule (see below).

ii. Some states legislatively allowed an out-of-state bank to establish a branch in-state if the other state granted reciprocity. Few states had these provisions, so little practical effect.

iii. 30-mile main office location change.1) 12 USC § 30(b) permitted a bank to change the location of its main office to any location not

more than 30 miles from the city where the main office was located, and still keep the current main office as a branch. SO bank's with a main office w/in 30 miles of a state line could branch interstate.

b. Conference of State Bank Supervisors v. Office of Thrift Supervision 1992 OTS permitted federal thrifts to exercise interstate branching powers. Thrifts are under different rules. So Thrifts could branch in 1992, and banks couldn't branch until 1994. OTS's reasons for adopting this rule:i. It has authority to do so;ii. Interstate branching of federal savings associations will enhance safety and soundness by

facilitating geographical diversity in both the operation and loan portfolios of insured institutions; (S&L’s were in financial trouble, OTS hoped appeal of interstate branch would cause strong S&L’s to buy the weak)

iii. Rule will allow federal savings associations to reduce operating costs by increasing efficiency and developing economies of scale, such as consolidating personnel and operations functions;


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iv. Interstate branching will stimulate and increase healthy competition;v. Increase in competition will improve customer service;vi. Increase financial stability will decrease risk to SAIF (insurance I presume);vii. The rule will not have any impact on small entities for purposes of the Regulatory Flexibility Act.

c. Even though interstate branches were limited as described above (brick-and-mortar interstate bank branching), modem technology such as ATMs permitted many banking functions to take place on an interstate basis.i. Originally ATMs were treated as branches. Makes sense, they do all regular functions of banks.

In 1996 Congress amended statute to say ATMs were not branches.ii. Bank One Utah N.A. v. Guttau .

1) Utah national bank wanted to set up ATMs in Iowa. IOWA EFT Act had an in-state office requirement for the establishment of ATMs. So only

Iowa banks could have ATMs. So D was using state EFT law, not state branching law to try to exclude these out-of-state ATMs. Also, Iowa limited advertising on ATMs. Therefore, the question is whether ATMs are a “branch” and subject to Iowa’s restrictions?

National Bank Act gives national banks the authority to exercise all incidental powers necessary to carry on business of banking, but says that national branches are subject to state law. Amendment to § 36 of NBA says that ATMs are not branches.

Therefore Iowa state law is pre-empted, and national banks can set up ATMs in states besides their home state. ATMs are exempt from geographical branching requirements. ATMs ≠ Bank Branching. ATMs were therefore permitted in Iowa even without a bank HQed there and they were also not subject to Iowa’s advertising restrictions.

Dissent argues that while it has been decided that ATMs are NOT branches and not subject to geographical restrictions, they should still be subject to the advertising restrictions if the state banks are b/c this would give national banks and advantage and is at odds with the principle of competitive equality.

3. The history of interstate banking prior to Riegle-Neal.a. Interstate banking in the holding co. context. Douglas Amendment says BHCs can own banks in

other states to the extent law of the state permits it.b. Regional Reciprocal Compact there were banks in different regions who realized they couldn't

grow big enough to compete with big banks in cities. They thought there would be a big relaxation of branching restrictions one day and big banks would take over the country.i. So tried to use the Douglas Amendment to create regional compacts. First happened in

northeast. Each state adopted a law that said they would allow a BHC in another state in the region to acquire bank in that state if acquiring state had a reciprocal law.

ii. Big money center banks didn't like that they were being excluded from these compacts.(Citicorp)

c. Northeast Bancorp Inc. v. Fed .i. BHCs in New England wanted to acquire some other banks in New England outside of their

home state.ii. BHCA.

1) Defines "bank" as an institution that accepts deposits and makes commercial loans. Defines "BHC" as a firm that owns a bank or BHC.

2) BHCA regulates the acquisition of state and national banks by BHCs. As originally enacted, the BHCA prohibited interstate bank acquisitions. The Douglas Amendment said a bank or BHC could acquire another bank or BHC in

another state only if the laws of the target bank 's state permitted it. State's started enacting various laws to lift the ban on interstate acquisitions. Many

states, like Mass. and Conn., enacted statutes to lift the ban on a regional and reciprocal basis.


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iii. Holding: States are not required to lift the ban on interstate acquisitions on an all or nothing basis. They are allowed to enact statutes that just partially lift the ban like Mass. and Conn. Such partial bans comply with the Douglas Act, and are the types of statutes contemplated by the Act. You are allowed to have degrees of interstate banking.1) Policy rationale -promote pluralistic banking system, not a concentrated one.

iv. Given that holding, is the Douglas Amendment constitutional, or do partial ban lifting statutes burden interstate commerce by discriminating?1) It's constitutional under the Commerce Clause, the Compact Clause and the Equal

Protection Clause.v. Is it a violation of the compact clause? No. Classic indictia of prohibited contract not present: no effect to increase political power of states to encroach on Federal power.

d. Effects of Northeast Bancorp.i. Many BHCs took advantage of their new power to purchase banks in other states and created

regional reciprocal compacts in other regions.ii. One of the effects of the regional limitations contained in many states' laws was to permit

regional BHCs to grow large enough to be able to compete with banks in NY, CA, IL; and TX.B. The Riegle-Neal and Beyond

1. Intro - The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994a. The Act struck down federal restrictions on interstate banking and branching. Removed remaining

barriers to interstate branching and banking. Did this in 2 ways - repeal of Douglas amendment and branching (see below).

b. Why?i. Americans have become more mobile and technology and communications have improved.ii. States loosened geographic constraints by regional compacts; this brings federal law up to speed

with state laws.c. Benefits:

i. Banks can structure themselves to be more efficient by eliminating duplicative functions and expenses.

ii. Promotes a safer and sounder banking system.iii. Promotes customer convenience.iv. Encourages competition.

2. Repeal of the Douglas Amendment. (it was replaced with a provision allowing acquisition of out of state bank w/o regard to state law restriction)a. Riegle-Neal repealed the Douglas Amendment to the NBA. So BHCs are allowed to acquire banks

outside of their home state w/out regard to other state's laws (laws prohibiting acquisitions by out of state banks or laws creating regional reciprocal interstate banking compacts).i. As a result, the regional compacts were repealed. But it didn't matter. The regional banks were

able to grow by this point.ii. Permitted an interstate bank merger so long as the resulting bank continued to be “adequately

managed upon the consummation of the merger.”b. Dodd-Frank increased the post-merger condition following an interstate bank merger to “well

capitalized and well managed.”i. Removed the remaining state control over interstate branching that was permitted in the Riegle-

Neal Act:1) A national bank or state insured bank is permitted to branch in a new state so long as the

law of the state in which the new branch is located would permit establishment of the branch if the bank attempting to branch were a state bank chartered in that state.

c. Banks can still pass a law prohibiting the acquisition of one of its banks by an out of state bank if the target bank is a new (or de novo) bank. But these "state age laws" will only be honored up to a max age for the target bank of five years.

d. Most states have since repealed their "age laws".


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3. Interstate branching.a. Riegle-Neal authorizes two methods of inter-state branching, subject to some state control in the

form of state "opt-in" or "opt-out".b. Method # 1.

i. BHCs with "adequately capitalized and adequately managed" bank subs can merge their existing banks in different states and operate the interstate offices as branches. Dodd-Frank changes this to: “well capitalized and well managed”

ii. This authority was subject to state opt-out laws. Only 2 states exercised this option TX prohibited interstate branching until 9/1999 and MT until 10/2001. so, as of now , it is no longer an issue.

iii. Many states merged their banks into 1 or 2 bank subs (usually keeping 1 sub in a state w/out credit limits from which to issue CCs).

c. Method #2.i. Application for a de novo branch or acquisition of an existing bank branch.ii. This authority was subject to state opt-in laws.

1) This allowed states to protect their in-state banks from being gobbled up. Required outside banks to come in and be there for like 5 years before it started buying banks.

d. Riegle-Neal Clarification Act of 1997.i. Permitted state banks to exercise the powers granted by their home state at interstate branches

in host states, but only to the extent that national banks or the host state's state banks could exercise the same powers.

ii. Host state laws only apply to the interstate branches of out of state state banks to the same extent that host state laws apply to interstate branches established by out of state national banks.1) Purpose ensure national banks did not have an advantage over state banks in establishing

an interstate branch.e. Limitation on interstate banking/branching The ban on interstate branching for deposit

production.i. Riegle-Neal prevents an out of state bank from establishing a branch just to pull deposits out of

the community and loan those funds somewhere else (the out of state bank's home state for example.

ii. Regulators will review the branch bank's loan portfolio if the ration of in state loans to in state deposits is less than half of the state average, bank subject to sanctions.1) Purpose to make sure the branch adequately meets the needs of the community it serves.

f. Where is a bank located for diversity jurix? R-N says a bank is located in the state of its HQs.C. Bank Mergers and Acquisitions.

1. Intro.a. Tremendous consolidation of banks in America. The number of banks was been cut in half b/t 1980

and 2000. But there are still about 9,000 banks. So still room for more acquisitions.b. Financial giants that emerged Bank of America; JP Morgan Chase; Wells Fargo; Citigroup.

2. Form of combination (based on corporate law).a. Methods:

i. Merger. Not many of these with banks b/c BHCs are doing the merging. BHCs usually use triangular mergers.

ii. Reverse or forward triangular merger.1) Done for tax reasons and dissenters' rights reasons.2) Target survives forward.3) Sub Shell survives reverse.

iii. BHC could just go buy banks directly and have a multi-bank HC structureiv. Two BHCs merge and operate separately or as one.


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v. Form a new holding company to purchase 2 existing banks and operate separately or merge as one bank.

vi. Purchase a bank through a purchase and assumption transaction.Purchase of assets, assumption of liabilities (deposits)

vii. Tender offer. Most bank tender offers go uncontested. Very rare to see a hostile takeover in the banking business. When Wachovia sold, First Union and Sun Trust fought over it.

b. Mergers raise regulatory concerns - SH approval and proxy solicitation under state corp laws. Securities laws must be complied with.

3. Business issues.a. Valuation.

i. I-bankers determine value. They issue "fairness opinions" on the fairness of the proposed purchase price. Don't need these, but good to get.

ii. I-bankers use objective measures such as PE ratio, ROE, and EBITA; as well as intangible factors such as access to new markets.

b. Funding the acquisition.i. Exchange of stock or cash purchase? If cash, what will be the source of funds and how will it

effect the acquirer’s financial position?ii. Tax issues.

1) Usually just swap stock - tax free exchanges.iii. Stock price fluctuations while you are waiting for SH and regulatory approval.

1) Some agreements include "walkaway provisions'" that allows either party to cancel the transaction if difference in the 2 banks' stock prices is too disparate that the deal is no longer economically viable.

c. Political issues.i. Which CEO and Board will lead the new entity?ii. Which name to keep.iii. Location of HQs.iv. Dual CEO’s don’t work.

d. Pre-merger issues.i. Initial agreement will be memorialized in a "letter of intent", followed by a definitive merger

agreement.ii. Proxy materials must be prepared.iii. Regulatory approval must be received.iv. Due diligence investigations. Inspect books, important assets, loans, liabilities for contracts,

including employment contracts.e. Post -merger issues.

i. How to combine record keeping, computer systems, check clearing functions, etc. to save $$$.ii. Lay offs .iii. Duplicate branches may need to be closed or consolidated (i.e. 5 into 3)

f. Accounting issues.i. Pooling of interests or Purchase method?ii. Purchase method recognize GW and amortize. Could negatively effect income statement

going forward. Max amortization period was 40 years.iii. Pooling of interests no goodwill, just combine balance sheets. Not allowed anymore.iv. New FASB rule eliminates pooling method, but also eliminates the requirement that goodwill

has to be amortized. It just stays on acquiror's books, but must be evaluated every year and charge against income if it's impaired. Can be significant: AOL/Time Warner deal not successful- resulted in $56 billion charge> earnings in2002.

4. Regulatory approvals.a. 3 different regulatory schemes BMA, state authority (if state bank), and Fed (if BHC)b. Bank Merger Act.


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i. Requires the prior written approval by the responsible bank regulatory agency. The responsible agency is determined based on the surviving bank. If national OCC; if state member Fed; state nonmember FDIC; savings association OTS.

c. If state bank involved, state regulator must approve.d. BHCA also requires the Fed to approve any combination involving a BHC.e. Approval standards under BMA and BHCA:

i. The effect of the combination on competition (antitrust analysis);ii. Consideration of financial and managerial resources.iii. Consideration of the convenience and needs of the community to be served. Dodd Frank adds

Consideration of the risk to the stability of the US banking or US financial system.f. Change in Bank Control Act When another group of people want to gain control of a bank. Low

threshold (5 or 10% change in control).

1. Section 3: Bank Mergers and Acquisitions.a. C. Regulatory Approvals (p666)

(1) 3 different regulatory schemes:(a) BMA, state authority (if state bank), and Fed (if BHC)

(2) Bank Merger Act.(a) Requires the prior written approval by the responsible bank regulatory agency. The responsible

agency is determined based on the surviving bank. (i) If national - OCC; (ii) if state member - Fed; (iii) state nonmember - FDIC;(iv) savings association - OTS.

(3) Dodd-Frank Act adds a further requirement that the responsible agency consider the “risk to the stability of the US banking or Financial system(a) The Fed must consider the extent to which the acquisition, merger, or consolidation “would result in

greater or more concentrated risks to the stability of the US banking or financial system”(4) If state bank involved in the combination, the state banking regulator must also approve the transaction. (5) Bank Holding Act also requires the Fed’s prior written approval of any combination involving a bank

holding company(i) Approval standards are based on analysis of competition and the convenience and needs of the

community (comparable to those under the BMA)(6) Approval standards under BMA and BHCA:

(a) The effect of the combination on competition (antitrust analysis);(b) Consideration of financial and managerial resources.(c) Consideration of the convenience and needs of the community to be served.

(7) Change in Bank Control Act (a) When another group of people want to gain control of a bank. Low threshold (5 or 10% change in

control).2. Section 4: Antitrust Review.

Intro. (p667)

(1) The standards for a bank regulator’s antitrust review under BMA and BHCA are identical to the antitrust provisions in the Sherman Act and the Clayton Act:(a) A regulator may not approve a combination “whose effect in any section of the country may be

substantially to lessen competition.” [this is basically § 7 of Clayton Act](i) Exception, agency can approve a transaction that lessens competition if the anti-competitive

effects of the combination are outweighed by public interest in having the combination better meet the convenience and needs of the community to be served. So regulators have a lot of flexibility?


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1. You might have a poorly banked community that really needs a good bank. That good bank might dominate, but its better than have just the crappy current banks that are there.

(2) If regulator approves, the merger is stayed for 30 days pending a second review by DOJ.(a) DOJ has 30 days. If DOJ denies, affected bank can seek judicial review, and review will be de novo.

(3) If regulator denies approval, the affected bank can seek judicial review.(4) When doing an antitrust review, the regulator and the DOJ must consider the section of the country

(geographic market) and the line of commerce (product market) in which competition is likely to be foreclosed by the competition. (p668)(a) Geographic market – area where merger partners are located.(b) Product market – line of business in which those partners are engaged.(c) Antitrust review involves an analysis to determine the extent to which competition in either of those

markets will be substantially lessened by the combination.(5) Hart-Scott-Rodino Antitrust Improvements Act of 1976.

(a) Requires notification to DOJ and FCC.(6) GLBA extended application of Hart-Scott-Rodino to acquisitions of nonbank companies by financial

holding companies and other transactions that do not require the prior approval of bank regulators(7) Dodd-Frank still requires exclusive Hart-Scott-Rodino review for acquisitions of nonbank entities by

financial holding companies w/ assets of less than $10 billion(i) BUT Dodd-Frank also requires that acquisitions of companies that engage in financial in nature

activities with more than $10 billion in assets be subjected to premerger approval by the Fed, as well as Hart-Scott-Rodino review

a. Premerger notice for these large acquisitions must include an evaluation of competitive concerns as well as an evaluation of systemic risk as required by Dodd-Frank

(8) Dodd-Frank provides that non-bank merger transactions initiated by the FDIC are subject to Hart-Scott-Rodino review, but that asset sales of nonbank entities may go forward w/o any approval or consent, mirroring the Hart-Scott Rodino Act’s exemption from review for transfers to or from a federal agency

a. Definition of the relevant market.(1) US v. Philadelphia National Bank . (p669)

(a) Merger of 3 large Philly banks denied. (b) Facts:

(i) The proposed merger by appellee banks was enjoined because the proposed merger was unlawful under § 7 of the Clayton Act, 15 U.S.C.S. § 18, because it had the effect of substantially lessening competition in the relevant market.

(ii) The United States charged appellees with violations of the Sherman Act, 15 U.S.C.S. § 1, and the Clayton Act, 15 U.S.C.S. § 18.

(iii) The Court held that § 7 of the Clayton Act, 15 U.S.C.S. § 18, was applicable to bank mergers and that the specific exemption for acquiring corporations that were not subject to the Federal Trade Commission's jurisdiction excluded from coverage only asset acquisitions by such corporations when not accomplished by merger.

(iv) The proposed merger was unlawful because the effect of the merger was to substantially lessen competition in the line of commerce in a section of the country.

(v) The Court determined that appellees' business justifications for the merger were unwarranted.(c) Relevant product market

(i) Just look at possible anti-competitive effects on commercial banking, not commercial banking and other savings and credit institutions. Commercial banks provide a unique cluster of services that sets them apart from other institutions. Commercial banking is a distinctive line of commerce. So commercial banking is the relevant product market. Just look at the cluster of products and services offered by commercial banking institutions.

(d) Relevant geographic market (i) must be drawn narrowly to encompass the area where the effect of the merger on competition

will be direct and immediate. Take into account local nature of the demand for most bank


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services. Concentrate on the area in which the seller operates, and to which the purchaser can predictably turn for alternatives.

(2) US v. Conn. National Bank . (p673)(a) Followed Philadelphia National Bank.

(i) Facts:1. Petitioner United States brought a civil antitrust action challenging, under § 7 of the Clayton

Act, 15 U.S.C.S. § 18, the consolidation of two nationally chartered commercial banks operating in adjoining regions of the state.

2. The district court dismissed petitioner's complaint. 3. The United States Supreme Court vacated the judgment. 4. The Court held that the district court erred in its definition of product and geographic

markets when it sought to determine the legality of the geographic market extension merger by the two commercial banks.

5. The Court held that the district court was mistaken in including both savings and commercial banks in the same product market.

6. The Court held that commercial banking was a distinct line of commerce because commercial banks offered products and services that savings banks did not.

7. The Court also held that the district court erred when it ruled that the relevant geographic market was the state as a whole.

8. The Court held that the relevant geographic market of the acquired bank was the localized area in which that bank was in significant, direct competition with other banks. The Court remanded the case for reconsideration.

(ii) Product market is just commercial banking market, not S&Ls.1. Relevant product market may be expanded to include other savings and credit institutions if

these institutions start offering same services as regular banks, particularly banking services to commercial enterprises.

(iii) Geographic market is just small section of Conn. Banks only did business in that small area.(3) What is included in relevant product market now? (p676)

(a) thrift institutions are usually included now because power of thrifts have increased since the 80s(b) OCC—includes all “depository institutions” in the product market.(c) FDIC—includes thrifts in the product market.(d) Fed—normally includes only 50% of the thrift institution deposits in product market.(e) DOJ—separates consumer (retail) market from business (wholesale) market. Also applies 2%

commercial loan to asset ratio test. If ratio is less than 2%, the bank or thrift is not included in the product market.

(4) **** Very few merges get enjoined. Regulators find a way to make it happen. They do that through convenience and needs analysis.*****

b. Convenience and needs of the community.(1) County National Bancorporation v. Fed . (p676)

(a) Facts:(i) Petitioner-CNB applied to respondent for approval of application to acquire an unaffiliated bank

holding company (bank). (ii) Petitioner-CNB proposed to accomplish the acquisition through the merger of the bank into

petitioner's subsidiary, a non-operating company formed to carry out the merger. (iii) Respondent denied petitioner's application. (iv) The appellate court held that the convenience and needs of the community, as the term was

used in § 3(c) of the Bank Holding Company Act, 12 U.S.C.S. § 1842(c), did not include consideration of any anticompetitive effect that a proposed bank holding company transaction might have, but that the application of a standard stricter than the antitrust standards was too rigid an evaluation of the transaction to effectuate Congress' banking policies.

(v) Respondent was limited to consideration of the antitrust standards contained in §§ 3(c)(1), (2).


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(b) Fed denied approval of a merger under BHCA.(c) RULE: First, must determine the anticompetitive effects of a merger

(i) Ie apply HHI.1. If this says “no go” then move on to the next step and see if the exception applies

(d) Then apply the convenience and needs exception – (i) If the anticompetitive effects are clearly outweighed by the public interest b/c the merger will

likely further the convenience and needs of the community, the merger should be approved. Some mergers that violate the antitrust laws are nevertheless in the public interest and strict application of the antitrust laws is inappropriate.

(e) Regulators are much more flexible now than they were 20 years ago(2) Jerry w. Markham—Regulating Credit Default Swaps in the Wake of the Subprime Crisis (p681)

(a) Community Reinvestment Act of 1977 required bank to make subprime loans to minorities in their service area as a condition for receiving regulatory approval for bank mergers

1. Did not do much b/c bank merger activity was slow in the 70s(b) Clinton administration sought to increase homeownership by increasing availability of subprime

mortgages(i) Led to an 80% increase in number of subprime mortgages

(c) Banks had largely stayed out of subprime lending until gov’t pushed them into it(i) From 1994 to 2000, subprime lending quadrupled

(d) But banks were still worried about the high credit risk of subprime lending(i) 1995—Clinton administration amended CRA, allowing CRA based subprime loans to be

securitized(ii) This led to mortgage backed securities (iii) The warehousing operations (selling MBS) became a part of an unregulated “shadow banking”

systemc. Market concentration. (p684)

(1) Concentration happens when mergers occur, and more concentration means less competition.(a) The more concentrated a market is, the more likely it is that one participant or a small group of

participants could successfully exercise market power(2) Tests/factors to help determine whether a bank merger will lessen competition:

(a) Market share figures (of merger parties and other participants in the relevant market). Market share figures reflect the extent to which the market is concentrated. The more concentrated the market, the more likely it is that one participant could successfully exercise market power.

(b) Barriers to entry.(3) In 1984, DOJ developed the Herfindahl-Hirschman Index (HHI) to set merger guidelines

(a) HHI measures market concentration (i) Step 1: Determine the market share of each firm in the market.

1. Approximate Market Share = the % of deposits held by each bank in the relative geographic market

(ii) Step 2: square the market share(iii) Step 3: Add them up.(iv) Result: the pre-merger HHI.(v) Step 4: Do the same thing post-merger and compare the post-merger HHI to the pre-merger

HHI.(b) DOJ will challenge a bank merger if:

(i) the HHI increased more than 200 basis points; AND(ii) the overall post-merger HHI is over 1800 (these are slightly lower figures than the DOJ uses for

other industries besides banking).(iii) However, the guidelines do provide that DOJ CAN challenge a merger if HHI increases 50 basis

points AND HHI is over 1800(4) FTC uses HHI too…FTC and DOJ revised HHI threshold in 2010


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(a) FTC and HHI will challenge mergers if :(i) HHI increased over 200 points; AND (ii) post-merger HHI is over 2500 points.

(b) 2500/200 is SUBSTANTIALLY more favorable to merger participants than the prior DOJ standard of 2000/50

1. HOWEVER, an interagency agreement between banking regulators and DOJ issued in 1995 is still valid and that document still finds a market to be highly concentrated if its HHI exceeds 1800 and CAN SCRUTINIZE the merger if it increased the HHI in the market by 200 points.

(5) HHI is not static. Can argue that merger should be approved anyway. You can be creative like NationsBank and say you must look to the future (FL was expanding) not just current HHI. Or you can go to mitigating factors below. (a) In 1995 there is a shift in how regulators look at S&Ls

(i) In BB&T and Southern National that regulators bought it1. End result was there was a lot less divestiture of branches

(6) Can also look at the following factors to determine whether a merger is okay—these are factors considered in evaluating competitive effects of proposed horizontal bank mergers and acquisitions. (see p685-687 for an in depth description of each factor and how it is applied)

1. Initial screening of structural effects a. Look at this first and apply the HHI. Only go on to other factors if structural effects

suggest an adverse effect on competition. A merger that fails to pass the HHI market screen may nonetheless be approved b/c other information indicates that the proposal would not have a significant adverse effect on competition.

2. Potential competition a. Only attach weight to this factor if there are limited barriers to entry into the relevant

market.3. Thrift institutional competition 4. Competitive viability of the firm to be acquired

a. If the target bank is a weak competitor, the significance of the structural index is diminished.

5. Economic conditions in the market and the need for exit a. Structural considerations are given less weight if the economic conditions in a market

are deteriorating. Like rural markets.6. Competition from other financial institutions in the market

a. If competition from other depository institutions is great, lends more weight towards approval.

7. Competition from out-of-market financial institutions a. Same as above.

8. Financial weakness of the firm to be acquired a. If target is going to fail, this lends weight towards approval.

9. Market shares of leading firms 10. Post-merger level and trends in market competition

a. If post merger HHI is very high, the increase in HHI doesn’t matter that much.11. Economies of scale in small mergers 12. Other factors unique to the market

(b) EVERY proposed merger is subjected to an initial screening in which structural effects are examined. (i) Any or all of the remaining eleven factors are considered ONLY in instances where the structural

effects of the merger suggest that the effect on competition may be substantially adverse.(9) Federal Reserve Board of Governors Order Approving the Merger of Bank Holding Companies , 84 Fed.

Res. Bull. 129. (1997)….(p687)


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(i) NationsBank, a bank holding company under the Bank Holding Company Act (BHC Act), requested Fed approval to merge w/ Barnett, thereby acquiring Barnett’s subsidiary banks, Barnett Bank and Community Bank

a. NB also requested approval to acquire Barnett’s nonbanking subsidiaries…thereby engaging NB in nonbanking activities

(ii) NB Facts1. NB is 5th largest commercial bank in US, controlling 5% of total banking assets2. NB engages in a number of permissible nonbanking activities

(iii) Barnett facts1. 23rd largest commercial bank in US, controlling 1% of total banking assets in the US

(iv) Result of merger1. NB would become 3rd largest commercial bank, controlling 5.9% of total banking assets2. NB would also control 29.6% of total deposits in FL3. NB would also control 18.4% of total deposits in GA

(v) Riegle-Neal Act allows Fed to approve application by a bank holding company to acquire control of a bank located in a state other than the home state of that bank IF certain conditions are met.

a. For purposes of BHC Act, home state of NB is NC and Barnett has ops in FL and GAb. NB/Barnett proposal would combine 2 bank orgs that compete in a large number of

banking markets in FL…they are among the largest providers of banking services in these markets and have a significant competitive effect in many market.

c. Fed took into particular account that Florida and the markets affected by this transaction are among the fastest growing and most attractive locations for entry by banking organizations in the US

(vi) The Fed and the courts have consistently recognized that the appropriate Product Market for evaluating the competitive effect of bank M & A is the cluster of products and services offered by banking institutions1. HHI levels are only guidelines used by the Fed, DOJ, and other agencies to help identify

cases in which a more detailed competitive analysis is appropriate to assure that the proposal would have a significantly adverse effect on competition in any relevant market

(vii) Fed said this was a difficult case that highlights some of the complexities of analyzing the competitive effects of mergers that affect a large number of local markets

a. Fed’s experience in handling these cases suggests that in future cases, increased importance should be placed on a number of factors where the proposal involved a combination that exceeds the DOJ guidelines in a large number of local markets

b. In these cases, the Fed believes that it is important to give increased attention to: i. The size of the change in market concentration as measured by the HII in highly

concentrated market;ii. The resulting market share of the acquirer and the pro forma HHIs in these markets;iii. The strength and nature of competitors that remain in the market; andiv. The strength of additional positive and negative factors that may affect competition

for financial services in each marketd. Mitigating Factors. (3 Ways to fix potentially anti-competitive merger) (p690)

(1) Bank mergers that do not meet the HHI Merger Guidelines can gain Fed approval by using divestitures, mitigating factors, or a combination.

(2) Divestiture (a) can lower the HHI.(b) Ie sell branches.

(i) Bank of America runs into it1. If want deposits, just really lower rates

(3) Mitigating factors:(a) Number of competitors in the market.


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(i) Look at number, nature, and size of competitors in the market.(b) Market’s attractiveness for entry.(c) The amount the post-merger HHI exceeded Merger Guidelines.(d) Number of credit unions, savings, thrift associations in the market.

e. Deposit Caps and Liability Concentration Limits. (p693)(1) Another potential obstacle for bank mergers – deposit caps.(2) Riegle-Neal prohibits acquisitions that would cause the acquiring bank to control more than 30% of total

in-state deposits or 10% of all deposits nation wide.(3) Dodd-Frank amended the Bank Merger Act to provide that an interstate bank merger may not be

approved if after consummation the resulting insured depository institution (including all insured depository affiliates) would control more than 10% of the total deposits of all insured depository institutions in the U.S.

(4) Dodd-Frank also addressed excessive concentration for financial companies by imposing a 10% limit on the consolidated liabilities of the resulting entity.(a) For this purpose, “financial companies” are defined to include insured depositories, depository

institution holding companies, and the systemically significant nonbank financial companies that are supervised by the Fed

1. Consolidated liabilities are defined as the risk-weighted assets minus regulatory capital 2. The FSOC must prepare a study regarding how this concentration limit will affect financial

stability, moral hazard, efficiency and competitiveness of US Financial Firms, and the cost and availability of credit

f. Director Interlocks. (p695)(1) Same people sitting on Boards of different companies.(2) BankAmerica v. US.

(a) Court holds that 4th paragraph of section 8 of Clayton act does not bar directors of banks from also serving as a director of a competitor insurance company.

(b) Depository Institution Management Interlocks Act prohibits management officials of a depository institution with total assets over 2.5 billion (large banks) from serving as a management official of any non-affiliated depository institution having assets in excess of 1.5 billion. Can still sit on different Boards of your affiliates. Implemented by Reg L(i) Policy reasons why you don’t want interlocks?

1. Conflicts of interest. Personal gain.2. It’s anticompetitive if you know what your competition is doing. Or you can keep your

competitor from being competitive with you.(3) Congress later amended the Clayton Act and dropped the provisions in Section 8 that are referred to in

the BankAmerica case and which were specifically addressed to bank interlocks. (p698)(a) That legislative action was taken after the enactment of the Depository Institution Management

Interlocks Act (DIMI Act) which prohibited management officials (including an employee or officer w/ management functions or a director) of a depository institution with total assets in excess of $2.5 billion from serving as a management official of any nonaffiliated depository institution having assets in excess of $1.5 billion

(b) The systemically significant nonbank financial companies that are overseen by the Fed following Dodd-Frank will be treated as bank holding companies and subject to the restrictions of the DIMI Act.

(c) Further, the statute provides that the Fed may not exercise its authority under that Act to permit a management official of a systemically significant nonbank financial company overseen by the Fed from also serving as the management official of nay bank holding company with consolidated assets exceeding $50 billion or with any other nonaffiliated systemically significant nonbank financial company overseen by the fed.

(4) Section 32 of the Glass-Steagall Act prohibited interlocking directors between banks and brokerage firms (p699)


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(a) That provision was repealed by the Gramm-Leach-Bliley Act (p699)(b) Restrictions in the Investment Company Act of 1940 continue to limit the number of bank directors

on the boards of affiliated investment companies because they are viewed as “interested” directors.(c) The SEC finalized rules to provide greater independence for boards of funds that rely on certain

exemptions to permit transactions that would otherwise be conflicts on interest between the fund and its management company


1. Many banks operate trust departments. a. National banks - get trust powers from 12 USCA §92(a) (Fed Reserve Act of 1913), which

says national bank can operate a trust department in States where state law allows bank competitors (trust co's., other banks, etc.) to operate trust departments. So its like the branching laws - look to state law. Trust powers implemented by the OCC.

b. State banks - get their trust powers from state law. Many states also give non-banks trust powers.

2. First national Bank of Bay City v. Fellows . a. Challenge to national bank trust powers on constitutional grounds. b. SCOTUS said banks are permitted to exercise trust powers under state laws, and

Congress acted constitutionally in giving national banks trust powers. c. Per Mcculloch and Osborn, Congress has power to organize bank and give them public

and private functions, ability to operate a Trust being one so long as not contradictory of state law, which it is not

3. American Trust Co. v. South Carolina State Board of Bank Control . a. NCNB Corp., a NC BHC, owned NCNB, a national bank. NCNB had a trust department w/

a lot of SC customers. SC law said out of state corps could not act as trustee in SC. b. So NCNB Corp. formed American Trust Co., a SC corp. SC changed its laws again and said

a SC corp. that is controlled by an out of state corp. can't act as a trustee within the state.

c. Is state law constitutional? Yes. The SC ban of foreign testamentary trustees applies equally to both state and national banks located in NC. Neither one can operate trust services in SC. So it passes commerce clause test.

4. 2001 - OCC did not like this decision. It changed it trust regs to permit national banks to conduct multi-state trust operations in any state where the state allows its own banks to conduct trust operations. The national bank just has to give notice to OCC if they intend to do this. So state can only limit the trust activities of national banks to the same extent that they limit the trust activities of their own state banks. State cannot impose any restriction on national bank that it does not also impose on its own state banks. OCC has pre-emptive power. These regs reverse the ATC case.

5. Common trust funds. a. An investment pool of assets that come from different trust accounts. Invest funds as a

whole. Benefits to bank b/c economies of scale. Trust accounts will own interest of trust funds instead of owning stocks and bonds. Like a mutual fund.

b. Note: A common or collective investment trust fund is like a mutual fund, except: i. With a trust fund, a B must abide by trust instrument and can't liquidate or

control investments like a mutual fund investor can. Mutual fund shares are liquid, shares in common trust fund are not liquid (must get a distribution from the trustee).


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ii. Also, regulatory differences SEC regulates mutual funds (mutual funds are separate companies); bank regulators oversee collective investment trusts (common trust funds are not separate entities separate from bank).

iii. Mutual funds are more targeted (long term, high growth, large cap, etc.). iv. Trustees of common trust fun must adhere to limitations in trust instrument. v. Common trust funds are insured by FDIC. SIPC insures mutual funds.

c. Mullane v. Central Hanover Bank & Trust . i. NY statute allowed common trust funds a trust co. could pool all of its small

trusts into one fund for investment administration. All income, gains, losses, expenses, etc. are shared on a pro rata basis, based on original contribution, by the constituent trusts. Neither the trustee or beneficiary have ownership over any particular property in the common fund.

ii. The statute also called for a judicial accounting every so often. iii. Case said proper notice of the judgments in these accounting actions had to be

mailed to the trust beneficiaries; notice by publication was not adequate. iv. Takeaway from case: good description of how common trust funds work.

B. Fiduciary standards. 1. Trustees can only invest in certain things:

a. English Trustee could invest in RE, joint stock cos. like East India Co., but due to the South Sea Bubble, new restrictions by courts in England limited investments to government securities.

b. America "Prudent Man" rule - Harvard College v. Amory - A trustee must exercise sound discretion, conduct himself faithfully, and manage funds entrusted to him as men of prudence, discretion, and intelligence would manage their own affairs. Courts were split as to whether investments in common stock or other equity investments met this prudent man standard.

c. This led some states to adopt "legal lists" that specified which securities were prudent investments for trustees. Legal lists continued to expand to include common stock and common trust funds.

d. After WWII, restrictions relaxed. 22 states enacted the Model Prudent Man Investment Act which allowed investments in common stock.

e. So 3 basic standards of care - prudent man, legal list, and modern portfolio theory (see below).

2. Another issue are trustee's investments looked at individually or as a whole? Old way – look at individually (this is a very tough standard - trustee could be individually fins for 1 bad investment even though whole portfolio increased). See cases below.

3. In re Bank of NY . a. Guardian ad litem (inspected trust fund to see how trustee performed) challenged some

individual investment decisions made by Bank of NY's trust department in a common trust fund.

b. Adhered to old rule the mere fact that a portfolio shows an overall gain is not enough to prove that a trustee acted prudently and in good faith with respect to an individual investment(s) within the portfolio. Must look at each investment individually. So overall increase in portfolio did not insulate trustee.

c. But still, trustee not liable here b/c he acted in good faith here and made prudent decisions. You can't use hindsight to challenge mere error in investment judgment if trustee acts in good faith as a prudent man. Here there was no evidence of attention and consideration with regard to each investment decision.

d. Trustee acted in good faith and did not fail to exercise “such diligence and such prudence in the care and management of the fund as in general prudent men of


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discretion and intelligence in such matters, employ in their own like affairs.” (Prudent man standard defined)

4. Matter of Onbank & Trust Co . a. Can a trustee of a common trust fund invest in mutual funds? b. No.

i. Common law and state banking laws require trustees to maintain management control of common trust fund investments. However, investing in a mutual fund does not assign these management responsibilities. The trustee still has discretion to pick mutual fund, sell etc.

ii. However, the reason a trustee of a common trust fund cannot invest in mutual funds is b/c of the mutual fund fees. State laws said the trustee cannot pay any fees, commissions, etc. out the common fund for management. A mutual fund fee satisfies this, so no investing in mutual funds. The bank here tried to argue that a mutual fund fee is like the internal management costs of a regular company, but the court didn't buy it. Court countered that trust was essentially paying for same service twice (trustee fee coupled with mutual fund fee).

iii. Note : NY changed its laws after this case and said it was OK for a trustee to pay mutual fund fees out of the common trust funds.

iv. So now its OK for trustees to invest in mutual funds. 5. First AL Bank of Montgomery N.A. v. Martin .

a. P complaining about investments that bank trust division made. In both cases, investments were made contrary to bank policy/standards:

i. Equity fund bank bought cheap, high growth/risk companies instead of solid established companies.

ii. Bond fund bank invested in REITs. Pools of income producing real estate. b. Bank was speculating, not investing. They violated fiduciary duty and prudent man rule.

17 out of 24 stocks did not perform well. REITs lost half of their value. Also, bank failed to follow its own guidelines.

c. Battle of the experts, but court differentiates between investing and speculating. Trustee must exercise only sound discretion, but cannot speculate where intent of trust is safe, long term investment.

d. Note : Modern portfolio theory poses new challenges for trustees. The theory says that you can't beat the market as a whole, so you should diversify and invest passively to match the market. Modem portfolio theory says market is an efficient market - there is enough info and activity to cause prices to reflect their actual value. Therefore, a money manger should not be judged on the basis of individual investments, but on the performance of the portfolio as a whole. These previous cases we looked at all judged individual investments, not overall portfolio performance.

i. What value does fiduciary bring then? Why pay him fees if he just buys index funds and passively invest?

d. Court upheld the findings of the trial court. The purchase of 17 out of 24 equity funds was imprudent. The sale of 5 of the remaining 7 was held to be imprudent.

5. Central National Bank of Mattoon v. US Dept. of Treas .a. Discusses efficient market theory.b. OCC revoked P's trust powers because of many improper practices, but in particular one transaction:

D put 20% of its common trust fund assets into Eagle Bancorp, a thinly traded, small company in the business of buying small banks, that P's president and director had a significant financial interest in.

c. Court identifies three types of riski. Market Risk


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ii. Insolvency Riskiii. Diversification Risk

d. This violated the state's prudent man rule, not because Eagle was not a blue-chip stock (why -market adjusts the price of a risky stock so it's the same investment as a more secure stock - so quality of company doesn't matter b/c quality is built into the price), but because 1) it severely limited the funds diversity, 2) it was not worth the $11/sh that the P paid for it, and 3) self-dealing and 4) it was thinly traded - so efficient market theory does not work. Some state's prudent man rule imposes on trustees a duty to diversify, but IL's statute here didn't. But the lack of price/value investigation, the self dealing, and the thinly traded stock was enough to violate the prudent man rule.

e. Petition to set aside the OCC’s revocation of trust authority is denied.i. The bank’s failure to take reasonable steps to determine whether $11 was a fair price and

because the bank was engaged in self-dealing purchase was imprudent6. The OCC has proposed a new rule to adopt uniform standards of care for trust departments of banks.

D. Custodial Services1. Not a trust activity or a fiduciary activity, but it is related2. Services = settlement, safekeeping, and reporting or marketable securities and cash; holding customer’s

assets in safekeeping3. OCC, Currency Services: Comptroller’s Handbook

a. Segregation of funds is required; Intended to protect customer assets from the claims of general creditors in the event of bankruptcy of the regulated entity and to prevent futures commission merchants from using customer funds for their own purposes, such as securing loans.

4. Grede v. Bank of New York Mellona. Extended a line of credit to Sentinel; Sentinel solely managed investments, its income came only

from management fees. Sentinel used BNY’s custodial services and lending services; Sentinel secured its debt with certain securities; In order to transfer securities, Sentinel had to issue a desegregation instruction.

E. Pension fund management.1. Bank trust depts. often manage pension funds. Pension funds controlled by ERISA.2. Employment Retirement Income Security Act of 1974 (ERISA).

a. Enacted to regulate employee benefit plans and protect the funds invested in such plans.b. Imposes fiduciary duties, based on the common law of trusts, on the fund's managers, trustees, etc.

Imposes the prudent man standard - so trustee must use proper methods to investigate, evaluate, and structure the investment and must use independent judgment. It's a test of prudence, not a test of fund performance.

c. Secretary of Labor implements regulations under ERISA. Regulations say a fiduciary must act as a prudent man based on the modern portfolio theory, not the common law of trust standard of looking at individual investments.

d. In addition to following ERISA fiduciary guidelines, investment managers also have a duty to invest according to the documents and instruments governing the plan, as long as plan provisions are consistent with ERISA.

3. Laborer National Pensions Fund v. Northern Trust Quantitative Advisors a. Fund sued ANB for breach of fiduciary duty under ERISA for investing in interest-only mortgage-

backed securities ("interest only strips") (IOs).b. An IO is a right to receive a portion of the interest generated from payments on mortgage loans.

When interest rates decrease, people refinance and therefore the yield in IOs decreases. When interest rates increase, however, so does the yield on IOs. Conversely, mortgage-backed securities decline as interest rates increase, therefore, IOs are a good hedge.i. Purpose: providing benefits to participants and their beneficiairies and defraying reasonable

expenses of administering the plan


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ii. Conduct: A fiduciary must act “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character with like aims.

iii. Test: Whether the individual trustees, at the time they engaged in the challenged transactions, employed the appropriate methods to investigate the merits of the investment and to structure the investment.

c. Ct. held that investing in IOs did not breach fiduciary duties. Must use modern portfolio theory and look at portfolio as a whole (not individual investments).

F. Safe deposit boxes. (not safety deposit boxes)1. Banks lease or rent these. They provide security you don't have in your home.2. Usually 2 keys, 1 with the bank, 1 with the customer, and box can't be opened without both.3. Boxes used to be used to hold street name securities, but no one uses these any more, so use of safe deposit

boxes has declined. But stocks are now held in book entry form. Banks are heavily involved in custodial and transfer activities for securities though, so this has not hurt their business.

4. Issues regarding liability when they are robbed or when owner dies. What is relationship b/t bank and customer? K is usually called a lease. SO is this L/T? No, typically a bailment relationship regardless of what K says. You are not leasing space, you are turning over possession of goods for bank to hold.

5. SO what kind of responsibilities does that impose? See Morgan case.6. National Safe Deposit Co. v. Stead .

a. IL law seals safe deposit boxes of renters for 10 days after the renter dies. This includes boxes to which the renter held jointly with others (this is a common provision. NC has a similar law - seal and inventory boxes after death. Why? Probate process and account for all assets. Protects assets. In addition - taxes - account for all assets so taxes can properly be assessed). Nothing could be removed from the boxes except after notice to officers designated by the state (clerk of court will come in and inventory the box). Even then, the Deposit Co. is to retain enough assets to pay the renter's state taxes.

b. State claims the relationship b/t renter and Deposit Co. is a bailment relationship. Deposit Co. said this violates their 14th Amend. b/c no bailment relationship and the law forces them to control property that is not theirs and not in their possession.

c. IL SC said the relationship is a bailment relationship, and that determination is controlling.d. However, the relationship b/t renter and Deposit Co. doesn't matter. The statute does not violate

the 14th Amend., the Deposit Co's charter, or the Deposit Co's K with its renters. This was the Deposit Co's business and these are the duties/risks they have assumed.

7. Morgan v. Citizens Bank of Spring Hope . (1925) Supreme Court of NCa. The relationship b/t a bank lessor and customer lessee of a safe deposit box is that of bailor/bailee.

Not landlord/tenant. It is a bailment for mutual benefit, therefore bailor bank must exercise ordinary care to safeguard the property that had been turned over and return property to bailor upon request. The bailor bank is not an insurer.

b. The safe deposit box was robbed. Stole bonds. Bank used reasonable care and was not negligent, so no liability to bank.

G. Fund Transfer Services.1. Electronic (wire) transfers of funds.2. Fedwire system- real-time payment system that is operated by the Fed for banks that have reserve or

clearing accounts with a regional Fed Reserve Bank. One of 2 big wire transfer system in the US. Other one is CHIPS.

3. SWIFT - Society for Worldwide Interbank Financial Telecom - messaging system that facilitates transactions and communications.

4. This is how money is transferred in commercial transactions. Used a lot. Its very efficient way of transferring large amts of money.

5. Art. 4A Fund Transfers - governs wholesale wire transfers. This excludes consumer transfers which are covered by federal EFT.


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6. Problems when 1 party goes broke or insolvent. Money gets sent and you can't get it back b/c they are in bankruptcy.

7. Fed bankruptcy law modified so you can net obligations arising from wire transfers. You can net obligations and don't have to send your bankrupt party the full amount of the K price, just the net amount.

8. Banca Commerciale Italiano NY v. Northern Trust Int'l Banking Corp .a. Sender became insolvent. Case turned on the fact that bank sending funds had agreed to release the

receiving bank.

H. Letters of Credit.1. National banks not allowed to issue guarantees, but can issue letters of credit2. Letter of credit/standby letter of credit/guaranty letter of credit Instruments issued by banks that act very

much like a guarantee of payment. If a bank is called upon to pay upon a letter of credit, a loan relationship arises immediately with the party who arranged for the bank to issue the letter of credit. Buyer goes to his bank and gets a letter of credit issued for the benefit of seller.

3. Letter of credit is a 3 party relationship. Letter of credit substitutes credit of bank for credit of an obligor.a. Issuer - bank.b. Beneficiary - person who gets benefit of letterc. Account party - person whose account gets credited with the letter. Person who needs credit.

4. Two types:a. Documentary letter of credit (aka Direct pay letters of credit) intended to be drawn by B. Serve as

a payment function. Lays out terms of transaction. Serves as a payment vehicle. LoC will require B to show a bill of lading, etc. or something else to prove delivery was made and payment is owed. B must also present a draft (this is vehicle for drawing). Look to letter for specifics. Independence principle Letter is independent obligation from underlying transaction. Doesn't matter what is going on with the underlying transaction. So the letter must be complied with exactly. So banks will require the LC to be adhered to exactly before it will pay one.

b. Standby letter of credit serves a guarantee function. Not intended to be drawn as a payment vehicle unless there is a default. LoC will require the B to present proof of default. B must also present a draft (this is vehicle for drawing). Look to letter for specifics. See independence principle, etc., from above.

5. Distinguish commercial letter of credit seller obtains payment from bank directly, does not go to purchaser first. I think this is the same thing as a documentary letter of credit.

6. LCs governed by Art. 5 of UCC. Also governed by guidelines established by International Chamber of Commerce.

7. FDIC V. Philly Gear Corp .a. A letter of credit, even if it is coupled with w/ a promissory note from buyer, is not an insured

deposit. So if Bank issues letter, then goes insolvent, and a seller presents a letter of credit, FDIC won't pay it and seller is screwed.

b. Look at policy, not exact language of statute.8. Centerfugal Casting Machine Co. v. American Bank & Trust Co .

a. 1st Gulf war - Iraqi assets frozen in US.b. Ct. said the funds paid under LC are not Iraqi assets but funds of the bank that paid it.c. Also emphasized independence principle.d. READ THIS STUFF IN THE BOOK.

9. LCs are off-balance sheet items. Amounts are usually disclosed in a footnote though a. Should they be contingent liabilities? I don't know, but they are not.

10. Banks charge fees for these too. Usually 1%.


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XIII INSURANCE.A. Introduction to insurance.

1. The business of insurance.a. You can use insurance to guard against any number of risks health, life, property, etc.b. Spreading risk of loss over a large enough pool of people so loss experience is less than premium

income + investment income.c. Distinction:

i. Underwriting actual business of issuing policies, receiving premiums, assuming risk associated w/ insurance, investing, etc. The risk side of the business.-Calculating life expectancy, expected loss rates, etc.

ii. Agency strictly sales piece of the business. Agents sell insurance, sell policies. Agents make money from transactional commissions, not on premiums + investments. Not involved in the risk side of the business. Agent can be independent or captive.

d. NY Life Insurance Co. v. Statham .i. D had a life insurance policy. K said the policy would be forfeited if premium payments were late.

D stopped paying premiums during Civil War, then died, and now he wants the policy revived.ii. Holding - no. Time is of the essence w/ insurance Ks. The insurance business works on the law of

averages and spreading risks, so cts won't interfere with a K provision that makes time of the essence. Premiums priced based on timely payments, estimates, etc. Also, it would be unfair to insurance co. here to revive policy - people who came back from the war alive would not seek to revive insurance Ks (they would just go out and get cheaper ones). Only people who died would seek to revive Ks and collect on the policies. Again, this messes with the insurance co's risk averaging calculations. Decision in part based on fairness to insurance company.

iii. Relief – allow D to recover equitable value of previous premiums2. Regulation of Insurance - Background and history.

a. Early history.i. Insurance industry grew rapidly after Civil War. Insurance cos amassed large reserves of capital.

This brought them in close connection to commercial and investment banks. Insurance cos required by state law to hold certain amount of reserves.

ii. People were very critical of the insurance industry. Concerns over concentration of wealth and power. This led to the Armstrong Committee in NY, which concluded that the insurance industry should be kept separate from the securities and banking industries. NY legislation prohibited insurance cos from investing in stock or underwriting securities. As a result of the prohibition on owning stock, insurance cos could not affiliate w/ banks

iii. 1929 crash insurance cos were not devastated by the crash or depression (couldn't invest in securities), they were not subject to the pervasive regulation that was enacted during this period, and they disclaimed any responsibility for the crash. Insurance company reserves were adversely impacted.

1) FDR's Temporary National Economic Committee (TNEC) found that insurance co's assets were highly concentrated in industrial bonds (b/c of restrictions on equity ownership), and this concentration skewed and leveraged corporate balance sheets by encouraging debt over equity. The Committee’s work did not lead to any Federal legislation regulating insurance companies.

b. State regulation of the insurance business.i. Insurance is essential and affects the public welfare, therefore it is generally recognized that

insurance should be regulated.ii. States should regulate insurance, not federal government.iii. Paul v. Virginia (1869) 7 SC held that issuing an insurance policy “is not a transaction of

commerce” and is “governed by local law.” So a state law regulating insurance does not violate the Commerce Clause. (Note: case was about an agent trying to get out of a fine for selling insurance in a state where the agent was not licenced.)


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1) So from 1869-1944, Congress didn't think it had the power to regulate insurance, and insurance regulation was left exclusively to the states.

iv. US v. Southeastern Underwriters (1944) SC held that insurance cos are engaged in interstate commerce and are therefore subject to federal antitrust laws.

1) This was seen as a threat to the states' power to tax and regulate insurance.v. So Congress enacted the McCarran-Ferguson Act regulation of insurance is generally a matter

for the states, Insurance cos still subject to Sherman Act/Clayton Act to the extent not regulated by state law. See p. 910. State insurance regulators pushed for “McCarron-Ferguson Act” to protect their turf.

1) Congressional intent give support to the existing and future state systems for regulating and taxing the insurance industry.

3. Insurance expands its borders.a. After WWII, people started investing in securities and mutual funds instead of traditional fixed

annuity life insurance Ks.i. Fixed annuity Paid the same amount to annuitant each year for life. Annual payment based on

annuitant's life expectancy and assumed rate of return on the annuity's purchase price.ii. Prevented the insured from outliving his assets, but inflation could change this.iii. Problem value of fixed payment could be severely undercut by inflation.

b. So insurance industry created the variable annuity K.i. Investment type product that competes with securities.ii. Purchaser makes a series of payments to insurance co. until retirement. Funds are invested. Upon

retirement, purchaser receives a stream of payments for life.iii. Amt of payments based on annuitant's life expectancy and the amount of funds accumulated and

increases/decreases from the investment of those funds.iv. SC declared the variable annuity a security, so subject to SEC regulation. This threw insurance cos

back into the finance activities that the Armstrong Committee had forbidden.c. Insurance cos also tried to get into the business of banking through loopholes in federal statutes.

i. S&L Holding Company Act (parallel to BHCA) unitary thrift exception - allowed a company, including an insurance co, to own a single thrift provided the thrift was a "qualified thrift lender" (QTL). A QTL has 65% assets devoted to housing or consumer lending

ii. Operation of a "nonbank bank" (a bank that either accepted deposits OR made commercial loans, not both) This loophole closed in 1987, but some nonbank banks grandfathered in.

iii. Operation of a limited purpose entity a trust co is not considered a "bank" under the BHCA if it functions solely in a trust or fiduciary capacity.

B. Bank Insurance Activities Prior to GLB.1. Introduction.

a. As insurance cos tried to get into the bank business, banks sought entry into insurance business to get the fees and underwriting commissions.

b. Brandeis, as part of the Armstrong investigation, was appalled at the high premiums and low policy values of the life insurance industry. His plan for a Savings Bank Life Insurance (SBLI) system was enacted in 1907.

i. Three states adopted SBLI systems - NY, CT, and MA. Still operate today – insure 1M people and w/ over $50B in insurance dollars.

c. Problems with traditional life insurance system Traditional insurance system relies on agents. It's a very inefficient system.

i. Declining sales. Insurance cos must compete with securities and other investment vehicles available to consumers.

ii. Declining sales productivity Annual policies sold/agent is declining.iii. Expensive distribution system 2/3 of traditional life insurance co's expenses are for distribution.iv. Declines in agent recruitment and retention.


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d. Access to life insurance is critical to society. About 104M Americans are w/out life insurance, compared to 37M who are without health insurance. So we need about $5 trillion more in life insurance in this country, so lots of sales to be made.

e. Banks should sell insurance to fill this void b/c of the advantages they have over traditional insurance agencies:

i. Customer affinity for and proximity to banks.ii. More frequent contact w/ customers, and access to broader range of customers.iii. Banks are at the point of customer needs origination financial transactions create insurable

interests. Mortgage loan requires need for homeowner' insurance; business loan creates need for employee protection. Same thing with marriages, getting a student loan, starting your own business, etc.

iv. Banks are better able to coordinate their marketing efforts traditional agents have to do their own marketing.

v. Banks use database marketing, segmented customer base, target markets, customer files, etc.vi. Banks can earn a larger margin on insurance by using more effective and lower cost distribution

strategies.2. National banks.

a. Saxon v. Georgia Assoc. of Insurance Agents .i. Comptroller made a ruling that national banks could sell insurance under their incidental powers.

Bank sold insurance in Georgia. Insurance industry sued.ii. NBA

1) §24(7) grants national banks all incidental powers necessary to carry on the business of banking.

2) §92 national banks located in a community w/ a population of less than 5 thousand people can act as an insurance agent (not underwriters) to the extent that State allows state banks to act as insurance agents. Small town exception. Purpose - allow people in small towns to be better served by local banks rather than

large out of town insurance cos that did not go into small towns.iii. Comptroller claimed national banks got power to sell insurance from §24(7) incidental powers.iv. 5th Cir said no, §92 1imits that power. Before passage of §92, national banks had NO power to sell

insurance, so §92 is just a limited grant of power. Otherwise, §92 would mean nothing.b. Independent Insurance Agents of America v. Ludwig .

i. §92 see above.ii. 12 CFR §7.7100 the branch of a national bank located in a community w/ a population of less

than 5,000 ("small town") can sell insurance even if the bank's principal office is located in a larger community.

iii. Issue does § 92 impose any geographic limits?iv. No. So a bank or branch located in a small town can sell insurance to existing or potential

customers ANYWHERE, not confined to the small town. This is a reasonable interpretation of statute. If this is a bad interpretation, it’s for Congress to fix, not the courts.

c. Aftermath of Ludwig - states try to fight back.i. Many people thought the original intent of §92 was to give small town banks another source of

income, not to give large banks the ability to sell insurance nationwide. The logic of this position is compelling.

ii. Barnett Bank of Marion v. Nelson SC ruled that state legislation could not restrict national banks from selling insurance. Even though states have power to regulate insurance, §92 regulates insurance as well and therefore pre-empts state law. (The whole case is not in the casebook, it is mentioned on p. 919-920)

1) FL had an anti-affiliation law that said banks cannot be affiliated w/ insurance cos.2) SC struck this down. Federal law pre-empts state legislation like this.


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iii. 1996 OCC advisory letter saying state laws that treat national banks who sell insurance differently than other insurance agencies would be "problematic".

1) Letter broadly construed the "located and doing business in" a place of > 5,000 people language of §92 very broadly (OCC had implicit power from Congress to do this b/c statute did not define it).

2) Based on the language of §92, legislative history, and the practices of banks and insurance cos in 1916 when §92 was enacted, a national bank insurance agency located in a place w/ less than 5,000 should be permitted the same marketing range and be able to use the same marketing tools and facilities that are other insurance agencies in the state are allowed to use.

3) Permissible activities for banks under §92: First, the agency located in the small town must be "bona fide".

aa. I.e., agents must be managed from the location, the location must the location for licensing purposes, the location must be responsible for collecting premiums, processing applications, paying commissions, delivering policies, keeping business records.

If so, agency can market the same way non-bank agencies market.aa. Sales and solicitations can occur outside the small town.bb. Advertising mailings can originate from inside or outside the small town.cc. Personnel of bank branches outside the small town can make referrals.dd. Can use telemarketing and cybermarketing, whether it originates from inside or

outside the small town.ee. Bank may use a 3rd party to help them with all this marketing.

4) Basically, if a non bank insurance co can do it, a bank affiliated insurance co can do it.d. More expansion.

i. OCC eventually approved underwriting of title insurance and credit life insurance, as well as agency for the sale of insurance, credit life insurance, municipal bond insurance, and mortgage reinsurance.

ii. NationsBank of NC v. Variable Life Insurance Co . (US 1996) SC held banks could sell fixed and variable rate annuities. Annuities are financial products, not insurance products. The brokerage of variable annuities by national banks is an incidental power.

iii. American Deposit Corp. v. Schacht (US 1996) However, annuities are insurance products for purposes of the McCarran-Ferguson Act so their sale is subject to state insurance regulation.

1) Bank offered Retirement CDs to customers in IL. Purchaser deposits money, selects a maturity date (usually retirement). Interest collects

tax free. Upon maturity, depositor gets a lump sum up to 2/3 total balance, and receives the remainder in periodic payments for the rest of his life - basically a lifetime annuity. If you die early, your estate gets lump sum payment of the balance.

Note: IRS started taxing these, so they are not around anymore.2) IL tried to stop bank from selling these b/c state said the Retirement CD was insurance and

the bank never got licensed to sell insurance.3) McCarran-Ferguson Act state laws enacted for the purpose of regulating the business of

insurance do not yield to conflicting federal statutes unless the federal statute specifically provides otherwise. Purpose NOT to insulate state insurance regulation from all federal law, but protect

state regulation against inadvertent federal intrusion (i.e., through a federal statute that describes an affected activity in broad general terms.

4) Issue # 1 is Retirement CD the "business of insurance"? Yes. The spreading and underwriting of a policy holder's risk is an indispensable

characteristic of insurance.


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Basically, an annuity is just the flip side of a regular insurance policy. W/ insurance policy, issuer bets that policy holder will live longer than expected, continuing to pay premiums above the amt the issuer is bound to pay upon the issuer's death. W/ an annuity, issuer bets that policy holder will live shorter than expected, so issuer doesn't have to pay the full amount of the annuity. Both have mortality risk.

SC held variable annuities are not insurance though. But Retirement CD is not a variable annuity. It spreads risk. So it's the "business of

insurance" for purpose of McCarran-Ferguson Act.5) Issue #2 is the Bank Act specifically related to the business of insurance?

No. Therefore, McCarran-Ferguson Act applies, and state law wins and it can regulate the

sale of Retirement CDs.6) Different result than VALIC, but it's a different product (fixed, not variable).

iv. 1999 GLBA allows financial subs of "well capitalized and well managed" national banks to engage in a wide variety of insurance activities as both agent and broker.

v. Independent Bankers Assn. of America v. Heimann national banks can offer credit life insurance. (mentioned only)

Product that names bank as B, not the customer, and is basically a form of security for consumer loans

vi. Independent Insurance Agents of America Inc. v. Hawke. 1) OCC issued a letter ruling that said national banks may offer multiple peril crop insurance

and hail/fire insurance. Basically, if farmer's yield falls below the insured level, banks pays. OCC's rationales for saying crop insurance was within the "business of banking" or at least incidental thereto (NBA §24): Crop insurance similar to credit life insurance (if loan defaults, insurance co will pay

bank); Crop insurance benefits banks b/c it protects them against risk; Risks are similar to those already born by banks under NBA §92.

2) Ct says no, selling crop insurance is not within "business of banking" or incidental thereto. If §24 was that broad, there would be no need for §92 or GLBA provision above. Also, this is the type of general insurance that was prohibited by Saxton.

3) In the end, this holding might not mean much. It just says §24 does not give power to banks to generally sell insurance. Just go qualify as a financial sub of a well capitalized, well managed bank and you can sell insurance.

3. State banks. a. Many states allowed their state-chartered banks to provide insurance services. DE and SD led the

way. FDIC tried to propose rules to limit state bank insurance activity, but it never happened. No systemic failures from offering insurance ever occurred.

b. NC has liberal laws letting banks engage in insurance business. BB&T in Winston- one of the most successful marriages of banking and insurance. Its one the seventh largest retail insurance brokerages in the US.

c. Citicorp v. Fed . –a turf battle case. The Fed ordered Citibank of Delaware to terminate insurance activities conducted through its operating subsidiary, Family Guardian Life Insurance Company.

i. Example of state bank engaging in insurance. Citicorp had DE state bank sub that had an insurance sub. Is insurance sub subject to Fed.? NO

ii. BHCA §3 says BHCs must get Fed approval to acquire a bank. Anti-competitive review from earlier chapter. §4 says 1) BHC may not own a non-bank and 2) BHC can only engage in banking activities, or activities closely related to banking.

iii. Insurance Agents of America Inc. v. Fed BHCA does not preclude bank subs of a bank holding co. from selling insurance. BHCA §4 says BHC must engage in banking or closely related to banking


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activities, but the activities its subsidiary banks engage in is up to the authority who granted the subsidiary’s charter - Fed can't regulate the sub.

iv. Issue But does BHCA extend the regulatory authority of the Fed to the sub of a bank holding company's sub?

v. Fed regulates BHCs. They tried to regulate subsidiarys of banks which were owned by BHC’svi. No. The Board's "generation skipping" approach is not logical. Only regulator of bank sub is the

regulator that regulates that bank. Fed can't reach down into the BHC structure and regulate subs.d. Congress didn't like this holding, so 1991- FIDICIA.

i. State bank as principal - limited to those activities permissible for national banks. More activities could be permitted to the state bank acting as agent if permitted by state law and the state bank was well capitalized and no risk to the safety and soundness the federal deposit insurance fund.

ii. State bank as agent - only limited to what the bank's state allowed either by state statute or state banking regs.

iii. State as insurance underwriter -limited to those activities permitted for national banks. Prohibited underwriting by state banks except to the extent national banks allowed.

e. States continued to expand state banks' powers to engage in insurance agency activities. Some enacted "wild card" statutes to allow state bank to engage in all activities permissible for national banks. Between 1995 and 1998 states allowing banks to operate insurance agencies increased from 22 to 40.

f. Massachusetts did not allow any state chartered banks to engage in any insurance activity. 4. Non-banking subsidiary of a Bank Holding Company.

a. BHCs could undertake activities "closely related to banking" through their non-banking subs. Prior to 1982, BHC subs were engaging in all sorts of insurance activities.

b. 1982 Garn-St. Germain Act it is not "closely related to banking" for a BHC to provide insurance. Exceptions:

i. Grandfather provisions for activities authorized before 1982. ii. Small town exception (like NBA §94). iii. Exception for small BHC w/ assets of less than $50M.

C. The Gramm-Leach-Bliley Act. 1. In general.

a. GLBA significantly expanded the ability of banks to engage in insurance activities. b. Citibank/Travelers merger - approved on the condition that the new Citigroup divest itself of the

Travelers insurance underwriting unit b/c of the restrictions on BHCs from engaging in insurance underwriting. Put pressure on Congress to repeal restrictions on underwriting activities. Citi knew it had 2 years plus up to 3 one-year extensions to keep business and get legislation in place.

c. GLBA creates idea of activities financial in nature as the test for permissible activities of a FHC. FHC is an entity that can engage in things that BHCs cannot. BHC permissible activities frozen as of right before GLBA.

d. GLBA specifically say insuring against loss, etc are all activities that are financial in nature. So a FHC is authorized to conduct insurance activities.

e. BHCs can't do this. Most BHCs have converted to FHCs to take advantage of this. f. Insurance activities permitted under GLBA include underwriting. Before this, banks could only

underwrite credit and title insurance in some instances. 2. Non-banking subsidiary of a holding company.

a. A FHC may engage in activities that are: i. Financial in nature or incidental to such activity; orii. Complimentary to financial activity, and do not represent a substantial risk to the safety and

soundness of the depository institution or the financial system. b. 12 USCA §1843(k)(1) insurance activities are "financial in nature". c. SO if BHC wants to underwrite insurance, qualify as a FHC and operate underwriting business in a

sub of the FHC.


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3. National banks and national bank subsidiaries. a. Under GLBA, neither a national bank nor its sub may underwrite insurance unless underwriting was

permitted by an Office of the Comptroller of the Currency (OCC) ruling as of 1/1/1999. i. OCC permits underwriting credit-related insurance products – Credit Life, Credit Disability. ii. GLBA still prohibits underwriting of title insurance or annuity Ks even if previously approved by

OCC. b. Financial subs of national banks can engage in activities that are financial in nature, or incidental

thereto (like FHCs). However GLBA says financial subs of national banks are NOT permitted to engage in insurance underwriting, annuity issuance, RE investment and development, and merchant banking, even though FHC subs are allowed to. So FHC can underwrite, but the FHC's bank sub cannot. But FHC non-bank sub can underwrite.

i. This was a compromise b/t Fed and OCC. ii. Want to protect soundness of banks. Poor underwriting could cause a bank or bank sub to fail.

c. §92 of NBA not repealed by GLBA. So national banks may still conduct insurance agency activities in small towns.

i. Financial subs not subject to small town limitation, and can conduct insurance agency activities everywhere.

ii. Do we need this anymore? No b/c financial sub of a national bank is not subject to 5,000 limitation. So just put your insurance business in a financial sub.

d. GLBA forbids the sale of title insurance by a national bank unless authorized by state law for state-chartered banks.

i. Again this doesn't apply to financial subs of national banks, so just transfer this activity to your sub to get around rule.

ii. Grandfather provisions too.e. Bank Agency? Yes. Underwrite? No (except credit)f. Financial sub of a bank same.g. Financial sub of a FHC Underwrite? Yes. Agency? Yes.h. Title insurance sales national bank can only do this if state bank can. But again, a financial sub of a

national bank can sell title insurance. 4. State banks and state bank subsidiaries.

a. Federal Deposit Insurance Corporation Improvement Act (FIDICIA) says that state banks cannot engage in insurance underwriting except to the extent national banks can. Therefore, the GLBA restrictions on insurance underwriting restrictions activities for national banks also effects state banks. FIDICIA has exceptions, however, as to when a state bank may engage in insurance underwriting even if a national bank cannot.

i. So neither national banks or state banks can underwrite. Can only do it through a non bank financial sub.

b. Agency activities state banks still allowed to do this to the extent allowed by state law. c. GBLA prevents national banks from issuing annuities. However, it is unclear whether state banks

may do so. d. FIDICIA only limits a state bank's insurance activities as principal. Therefore, if a state authorizes title

insurance sales for state banks, those activities may continue after GLBA. National banks may therefore sell title insurance to the same extent that state banks can.

e. A state bank may own a subsidiary that engages in activities comparable to those permitted by GLBA for a national bank's financial subs (as long as permitted by state law as well).

5. State regulation of insurance. a. GLBA continues the McCarran-Ferguson Act's requirement that insurance be regulated at the state

level. All insurance activities will be "functionally regulated" by the states regardless of the nature of the entity engaging in the activity. McCarran -Ferguson Act remains good law.

i. Exception GLBA § 104 preemption standards.


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1) Prohibits a state from restricting any affiliation b/t BHC subsidiaries that is authorized by the GLBA.

2) Nondiscrimination preemption standards - a state cannot treat a bank engaging insurance differently than non-banks engaging in insurance companies. Prohibit a state from regulating insurance activities authorized by GLBA in a manner that; Discriminates against a depository institution engaged in insurance activities as opposed

to and other persons engaged in insurance activities. Prevents a depository institution from exercising its powers under GLBA Conflicts with the purposes of GLBA.

3) So apply Barnett pre-emption standards - states cannot "prevent or interfere" with the ability of a depository institution or affiliate to engage in any insurance sales, solicitation, or cross-marketing activity. SO states can regulate insurance, but can't discriminate against banks. If they discriminate, GLBA will pre-empt the state law. This applies to both national and state banks. However, this preemption does not apply to the consumer protection safe harbor

provisions below. 4) 13 safe harbor provisions permit a state to impose restrictions that are substantially the

same but no more burdensome than the safe harbor provisions. Any state law that falls within a safe harbor cannot be pre-empted. (See safe harbors pp.937-938) These are areas were states can regulate and their regulations cannot be pre-empted by federal law under Barnett.

b. B/c of these safe harbors and the fact that litigation might arise from these, GLBA also establishes new expedited dispute resolution process for disputes b/t state insurance commissioner and federal banking regulators (including issues of whether something is pre-empted). Parties can go to Federal Cir Ct and get a determination w/ in 60 days and parties have a right to appeal to SC.

c. In addition to safe harbors above, GLBA also includes several consumer protection requirements that apply to insurance activities of all insured depository institutions. Directed bank regulators to come up with customer protections for sales of insurance by banks. Informs bank customers that insurance products of banks are not FDIC insured, prevents banks from tying insurance products, etc. (See the minimum federal consumer protection p. 939)

i. These federal minimum consumer protection provisions do not limit state insurance regulatory authority in anyway. State can always provide more consumer protection, and a state can opt out of the federal minimum standard by saying that the state standard should apply in lieu of the federal standard.

d. GLBA also reduces the burdens of multi-state licensing. i. National Associations of Registered Agents and Brokers (NARAB).

1) Voluntary licensing clearinghouse for brokers and agents seeking licensing in states where they are not residents.

2) First, get licensed in your own state. 3) Then apply for NARAB membership. National Association of Insurance Commissioners

(NAIC) establishes conditions for NARAB membership. 4) NARAB acts as a clearing house for getting the agent/broker his licenses in other states.

ii. However, if 29 states enact fully uniform or reciprocal licensing statutes w/ 5 years, NARAB will not come into existence. States do not want NARAB b/c it's a threat to their state-regulated insurance regulatory system. Enough states have adopted this, so NARAB will not come into existence.

iii. National banks using §92 power need to get licensed now (functional regulation). Before GLBA, they didn't have to.

e. In re Lutheran Brotherhood Variable Insurance Products Co. Sales Practice Litigation . i. P policy holders sued D insurers. Ps held variable life policies. Ps want to litigate in state court.

Claimed Congress wanted all insurance regulation left to states, so should be in state court.


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ii. Federal law - Securities Litigation Uniform Standards Act of 1998 (SLUSA) makes federal courts the exclusive forum for class actions involving "covered securities".

iii. Purpose of GLBA was to allow the combination of the banking and financial industry. However, GLBA stated McCarran-Ferguson Act was still good law and states still bear the primary responsibility of regulating insurance no federal law will be read to preempt a state insurance law, unless the federal law "specifically relates to the business of insurance".

1) 3 factors determine whether a federal statute preempts state insurance law - the Fabe Factors: whether federal statute specifically relates to the business of insurance; whether the state law was enacted for the purpose of regulating the business of

insurance; whether a proposed reading of the federal statute would supercede state law.

iv. Holding: McCarran-Ferguson Act does not bar application of SLUSA here b/c the Fabe factors are not met.

1) Variable insurance policies are not insurance products (SEC has consistently regulated them as securities).

2) Ps are not relying on any state insurance law here, and McCarran-Ferguson Act only deals with preventing inadvertent federal pre-emption of state insurance laws. Ps only allege common law torts of fraud, etc.

v. So cases will be heard in federal court. 6. Following GLBA, very few FHCs have combined insurance underwriting and banking. Except for Citigroup.

Many banks are expanding into insurance business by acquiring agencies, not underwriters. a. Rationales profits are not there. Banks can get better returns in other businesses. b. Banks have been able to cross sell insurance products without having to acquire the whole

insurance agency. 7. Many insurance cos have entered into strategic alliances with banks to cross-sell their products, instead of

undertaking joint ownership. 8. American Bankers Insurance Assoc. wants a federal charter option for insurance cos. Wants them regulated

by a new Treasury Dept agency - the Office of the National Insurance Commissioner. 9. Also VSI and forced place CPI insurance suits. And case- BB&T Insurance. What was the most famous class

action securities firm that got nailed for having “paid plantiffs”?D. The Dodd Frank Act

1. AIG casualty of financial crisisa. Was not financial holding Company so not regulated by Fed

i. AIG’s Financial Products Subsidiary was leading underwriter of credit default swapsii. AIG guaranteed the CDS underwritten by its sub.iii. AIG suffered further losses from its securities lending operation.

b. Faced with imminent failure of AIG, Fed exercised its authority under Sec. 13(3)i. Made an emergency loan of 85 Billionii. Total gov’t assistance reached 182 billion

c. After Dodd Frank, the Financial Stability Oversight Council ( FSOC) may designate non-financial institutions as systematically significant, thus subject to Fed. Oversight and regulation.

d. Also subject to Orderly Liquidation Authority 2. Dodd-Frank created new Federal Insurance Office (FIO) in treasury Dept.

a. Monitors aspects of ins. Industryb. Identifies issues that could pose systematic risk(ACT 502)

i. Excludes health care ins.ii. Some long term care ins.iii. Crop ins.

c. May preempt state laws that discriminate against foreign insurance companies, but substantive state insurance regulation is otherwise preserved.