Financial Services Alert - December 14, 2010

The Financial Crimes Enforcement Network ("FinCEN") issued a proposed rule (the “Proposed Rule”) that would subject non-bank residential mortgage lenders and originators to the anti-money laundering (“AML”) and suspicious activity reporting (“SAR”) requirements of the Bank Secrecy Act (the “BSA”).  FinCEN issued the Proposed Rule to close a “regulatory gap” that FinCEN believes exists between the BSA’s coverage of depository institutions and residential mortgage lenders and originators that prevents regulatory and law enforcement partners from obtaining a “more complete picture” of mortgage-related financial crimes.

The Proposed Rule is part of a larger, incremental effort by FinCEN to implement AML and SAR regulations for non-bank loan and finance companies.  FinCEN views residential mortgage lenders and originators—the primary providers of mortgages to consumers—as being in a “unique position to assess and identify” AML risks and fraud in the mortgage industry.  FinCEN believes that the Proposed Rule, taken together with the nationwide licensing system and registry currently under development as a result of the Secure and Fair Enforcement for Mortgage Licensing Act of 2008, will help ensure that residential mortgage lenders and originators properly identify and address money laundering, fraudulent activity and other financial crimes.

The Proposed Rule is based in large part on the advance notice of proposed rulemaking, titled “Anti-Money Laundering and Suspicious Activity reporting Requirements for Non‑Bank Residential Mortgage Lenders and Originators,” which was discussed in the July 21, 2009 Alert, and the public comments thereto.

Residential Mortgage Lenders and Originators Subject to the Proposed Rule.  The BSA defines the term “financial institution” to include, in part, “a loan or finance company.”  Banks or other functionally-regulated financial institutions, which are already subject to AML program and SAR reporting requirements are not loan and finance companies, but FinCEN recognizes that the term could conceivably extend to any other business entity that makes loans to or finances purchases on behalf of consumers and businesses.

The Proposed Rule would apply only to loan or finance companies which are either “residential mortgage lenders” or “residential mortgage originators,” although future rulemakings may cover other types of loan or finance companies.

• A “residential mortgage lender” would be defined as “[t]he person to whom debt arising from a residential mortgage loan is initially payable on the face of the evidence of indebtedness or, if there is no such evidence of indebtedness, by agreement, or to whom the obligation is initially assigned at or immediately after settlement.” 
• A “residential mortgage originator” would be defined as “[a] person that takes a residential mortgage loan application and offers or negotiates terms of a residential mortgage loan for compensation or gain.”

In both of these definitions “residential mortgage loan” is a key term.  Such a loan would be any loan “that is secured by a mortgage, deed of trust, or other equivalent consensual security interest” on a 1-to-4 family residential structure or real estate on which a residential structure will be built.  FinCEN explained that this definition is intended to encompass any loan secured by residential real property, regardless of whether the borrower is purchasing the residential real property as a primary residence, vacation home or investment, is refinancing a purchase-money mortgage loan to obtain a more favorable rate and/or terms, or is obtaining a mortgage loan for another purposes, such as debt consolidation or mobilization of home equity.

The definition of “residential mortgage lender” would specifically exclude an individual who finances the sale of his or her own dwelling or real property.  In addition, definitions of “residential mortgage lender” and “residential mortgage originator” would not cover persons who are solely responsible for administrative functions that support or facilitate residential mortgage finance transactions.

AML Program Requirement.  Under the Proposed Rule, residential mortgage lenders and originators would be required to establish risk-based AML programs designed to prevent the facilitation of money laundering and terrorist financing.  The AML program must be in writing, approved by senior management, designed to ensure compliance with the BSA and made available to FinCEN upon request.

At a minimum, similar to other financial institutions subject to AML program requirements, the AML program of each residential mortgage lender or originator would need to include the following elements:

• Policies, procedures, and internal controls based on the residential mortgage lender’s or originator’s assessment of the money laundering and terrorist financing risks associated with its products, customers, distribution channels and regimes.  The policies and procedures should also include provisions for complying with the BSA and FinCEN’s regulations thereunder; integrating agents and brokers; and obtaining all relevant customer-related information necessary for an effective AML program.
• Designation of an AML compliance officer responsible for administering the AML program.
• Ongoing training of appropriate personnel concerning their responsibilities under the AML program.
• Independent testing of the AML program on a periodic basis to ensure that it complies with the requirements of the rule and that the program functions as designed, including testing to determine compliance of agents and brokers with their compliance obligations under the program.

FinCEN would be responsible for examining residential mortgage lenders and originators for compliance with the AML program requirement.

SAR Requirement.  The Proposed Rule would require residential mortgage lenders and originators to report suspicious transactions that are conducted by, at or through the residential mortgage lender or originator which involve or aggregate to at least $5,000 in funds or other assets.  As with other categories of financial institutions, the types of activity that would trigger the obligation to submit a SAR would include knowledge or suspicion of a transaction that (i) involves funds that are derived from or are intended to obscure illegal activity, (ii) is designed to evade BSA requirements, (iii) has no business or apparent lawful purpose and there exists no reasonable explanation for the transaction after due examination or (iv) involves the use of residential mortgage lenders or originators to facilitate criminal activity.

The SAR would need to be filed within 30 days after the residential mortgage lender or originator becomes aware of a suspicious transaction.  The obligation to identify and report a suspicious transaction would rest with the residential mortgage lender or originator involved in the transaction, but multiple entities involved in the same transaction would be permitted to file joint SARs.

A residential mortgage lender or originator which files a SAR would be required to maintain copies of the SAR and underlying related documentation for five years from the date of filing.  Supporting documentation would need to be made available to FinCEN and law enforcement and regulatory authorities, upon request.

As with other financial institutions subject to SAR reporting requirements, residential mortgage lenders and originators would be obligated to keep SARs confidential.  A SAR and any information that would reveal the existence of a SAR must be kept confidential and may not be disclosed except under certain circumstances authorized by the Proposed Rule, such as disclosure to FinCEN, law enforcement or regulatory authorities.

Compliance Date.  Under the Proposed Rule, a residential mortgage lender or originator would be required to develop an AML program by the later of six months from the effective date of the final rule or six months after the date on which the residential mortgage lender or originator is established.  The SAR reporting requirement would apply to transactions occurring after the date on which the residential mortgage lender or originator is required to establish its AML program. 

Comments on the Proposed Rule are due by February 7, 2010.

The OCC, FRB, FDIC, OTS and NCUA (the "Agencies") jointly adopted Interagency Appraisals and Evaluation Guidelines (the “Guidelines”) that describe “the elements of a sound program for conducting appraisals and evaluations and address supervisory matters related to real estate appraisals and evaluations used to support real estate-related financial transactions.”  The Agencies said that the Guidelines incorporate the Agencies’ recent supervisory issuances regarding appraisals, and that the Guidelines discuss the Agencies’ expectations regarding a financial institution’s appropriate use of analytical methods and technological tools in developing evaluations.  The Guidelines also stress that financial institutions must maintain strong internal controls to ensure the reliability of appraisals and evaluations.  Furthermore, the Agencies note that the Guidelines may need to be updated after the Agencies adopt regulations to implement the Dodd-Frank Act.

The Board of Directors of the FDIC today approved the following: (1) an interagency notice of proposed rulemaking to implement certain provisions of Section 171 of the [Dodd-Frank Act] (commonly known as the Collins Amendment), including the establishment of risk-based capital floors for large financial institutions; (2) an interagency notice of proposed rulemaking to revise the risk-based capital guidelines regarding market risk; and (3) a final rule to set the deposit insurance fund’s designated reserve ratio at two percent of estimated insured deposits.  Please see future editions of the Alert for additional details on these issuances.

The SEC approved rule changes proposed by the New York Stock Exchange that extend to April 11, 2011 the pilot programs for circuit breakers applicable to certain stocks and exchange‑traded funds (as discussed in the June 15, 2010 and September 21, 2010 Alerts) and rule amendments designed to clarify the process for reviewing trades in exchange-traded securities to determine whether they are clearly erroneous and should be cancelled (as discussed in the June 22, 2010 and September 21, 2010 Alerts).  The pilot programs were set to expire on December 10, 2010.  The SEC releases are available here and here.

On December 8, 2010, in the context of oral argument at the U.S. Supreme Court (the “Court”) involving whether a credit card bank’s increase in the interest rate on a consumer’s credit card constitutes a violation of the Truth In Lending Act and the FRB’s Regulation Z thereunder, the Court heard argument on whether the Court should give deference to a legal brief by the FRB that interprets Regulation Z.  Counsel to the bank argued that the FRB’s brief should be considered by the Court because it articulated positions that are consistent with explanations given by the FRB during its four-year rulemaking process.  Counsel to the consumer, however, argued that the FRB brief should not be given judicial deference because no interpretation is required in the area as, he asserted, the language of Regulation Z in this matter is unambiguous.  (Chase Bank USA N.A. v. McCoy, U.S. 09-329, argued 12/8/10.)

The CFTC issued releases proposing rules relating to (a) real-time public reporting of swap transaction data, (b) swap data recordkeeping and reporting requirements, (c) reporting, recordkeeping and daily trading records requirements for swap dealers and major swap participants and (d) real-time public reporting of swap transaction data correction.   Comments on the proposals are due by February 7, 2011.

The CFTC issued a release proposing rules that would implement the whistleblower incentives and protections of Section 748 of the Dodd-Frank Act relating to certain judicial and administrative proceedings brought by the CFTC.  Comments on the proposed rules are due by February 4, 2011.  The CFTC must adopt final implementing rules by April 17, 2011.  Section 748 is not effective until the later of July 16, 2011 or 60 days after the publication of final implementing rules.

Comments are due by January 24, 2011 on the SEC’s proposed rules with respect to new Investment Advisers Act registration exemptions, revisions to Form ADV and related matters under the Dodd-Frank Act.  The SEC is posting comments it receives on the proposals here and here.  For more information on the proposed rules, please see our November 19, 2010 and November 24, 2010 Client Alerts and the December 7, 2010 Alert.