Perspective on Banking Law

- May 2005 -

Bank Secrecy Act Enforcement Update

With the inception of the Bank Secrecy Act (BSA), all federally insured banks are required to maintain procedures designed to assure and monitor compliance. These policies and procedures must include customer due diligence practices, a fraud detection program, internal controls, management oversight and responses to law enforcement and regulatory requests. Examinations conducted by a federal banking agency must include a review of such policies and procedures.

If in the exam it is determined that the bank has failed to establish and maintain such procedures, or has failed to correct any problem with the procedures which was previously noted, then the agency shall issue an order to cease and desist from its violation. This provision is mandatory and requires the banking agency to issue the order. Examples of violations include:

• The BSA compliance program does not adequately cover all of the required program elements (internal controls, independent testing, responsible personnel and training);

• The bank fails to implement a written BSA compliance program;

• The existence of BSA compliance program deficiencies coupled with aggravating factors, such as highly suspicious activity creating a significant potential for (i) money laundering, (ii) potential terrorist financing, (iii) a pattern of structuring to evade reporting requirements, (iv) insider complicity, (v) repeat failures to file currency transaction reports or suspicious activity reports, or (vi) other substantial BSA violations;

• The bank fails to respond to supervisory warnings concerning BSA compliance program deficiencies previously reported to the bank, or continues a history of program deficiencies, even if the deficiencies are unrelated to those cited in the past;

• The bank engages in systemic or pervasive BSA reporting or record keeping violations, fails to respond to supervisory warnings regarding such violations, or continues a history of such violations, even when they are dissimilar to those cited in the past; or

• The existence of a one-time, non-technical violation that demonstrates willful or reckless disregard for the requirements of the BSA or that creates a substantial risk of money laundering or the financing of terrorism and such violation renders deficient an otherwise effective program.

In addition, the Federal Reserve Board recently imposed a civil money penalty of $10 million on one bank, in addition to issuing a cease and desist order, for its failure to maintain adequate policies and procedures as required.

When a federal banking agency notes BSA compliance program deficiencies that are not severe enough to cite as a violation, the agency will notify the bank of the deficiencies, which may include violations of those regulations regarding financial recordkeeping and reporting of currency and foreign transactions found at 31 CFR §§103 et seq, and will require timely corrective action by the bank. The federal banking agency’s requirement for corrective action may be included in the exam report as a matter requiring attention, or it may be in the form of a formal or informal enforcement action. In these circumstances, such actions are based on unsafe or unsound banking practices rather than based on a violation of the regulations prescribing the procedures for monitoring BSA compliance found at 12 CFR §21.21.

The form of enforcement action depends on the severity of noncompliance, the capability and cooperation of bank management, and the federal banking agency’s confidence that the bank will take appropriate and prompt corrective action. In all cases, bank examiners will monitor, document, and test the effectiveness of the corrective actions taken by the bank. In addition to issuing the cease and desist order, the banking agency may impose civil money penalties against the bank and even its directors and executive officers for non-compliance with the enforcement action.

Bank secrecy and money laundering have become a hot button item for bank regulatory agencies. Banks should review their procedures to ensure that they satisfy applicable laws and regulations in order to prevent mandatory sanctions by bank regulators.

Please contact a member of our Financial Institutions Practice Group if you need assistance in reviewing your policies and procedures or if you require assistance resolving enforcement issues with a federal banking agency.
 

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Banks And Bank Holding Companies’ Compliance With Sarbanes-Oxley Section 404

By William T. Harvey, Esq.

The Sarbanes-Oxley Act (SOA) was enacted on July 30, 2002. One of the most sweeping changes resulting from SOA - those in Section 404 - did not go into effect for most companies until 2003, and for some smaller companies, has not yet gone into effect.

Section 404 of SOA (like all of SOA) applies to each publicly reporting company. (Generally, a reporting company is a company that is already required to make annual and quarterly reports to the SEC).

Section 404’s requirements can be summarized as follows. The management of each publicly reporting company must include as part of its annual report a statement that management is responsible for making sure that the company has adequate internal controls and procedures in place so that management can be reasonably confident that the company’s financial statements accurately reflect the company’s financial condition, income and cash flow. In addition, the company’s independent auditor is required to provide an accompanying opinion that supports management’s statement or, if it cannot support management’s statement in its opinion, the independent accountant should indicate why the accountant can’t support management’s statement.

Section 404, as well as many other provisions of SOA, closely tracks requirements that had been imposed on financial institutions by FIRREA and FIDICIA. Immediately following the passage of SOA, commentators expressed hope that, because of the close relationship between SOA and the earlier banking laws that had been in effect for some time, the impact of Section 404 of SOA on financial institutions would not be too onerous.

However, on June 17, 2004, the SEC approved the Public Company Accounting Oversight Board’s Auditing Standard No. 2 that governs the application of Section 404. It outlined a set of requirements for internal controls, the documentation of those controls, and the responsibilities of the independent accountant in the auditing of those controls. The Auditing Standard was substantially more extensive than current requirements for financial institutions under the earlier enacted FIRREA and FIDICIA.

The cost of complying with SOA 404 has proven to be onerous, especially for smaller public financial institutions. Audit fees have increased significantly and the costs of establishing additional internal controls, and documenting those internal controls, have also increased substantially.

On November 17, 2004, in an effort to provide some minor relief to financial institutions, the FDIC issued FIL-122-2004, which sets forth the criteria that a financial institution may follow if it wishes to create and file a single report with both the SEC and the FDIC to satisfy SOA 404 and FDICIA 112 (the provision of FDICIA that corresponds with Section 404).

In addition, in a release issued on March 2, 2005, the SEC delayed the implementation date of Section 404, as it applied to smaller public companies (termed “non-accelerated filers” by the SEC) for an additional year. Therefore, non-accelerated filers do not have to provide management’s attestation of the company’s internal controls, and the independent auditors do not have to provide an opinion with regard to management’s assessment under Section 404, until the company’s annual report for their fiscal year ending after July 15, 2006.

Perhaps during the interim some additional relief may be given to smaller financial institutions. Stay tuned.

William T. Harvey is a shareholder in the firm’s Financial Institutions Practice Group. For more information on this topic, please contact Bill at 412.594.5550 or via e-mail at wharvey@tuckerlaw.com.

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Fiduciary Responsibilities of Directed Trustees
 

By William Campbell Ries, Esq.

The Department of Labor (“DOL”) issued Field Assistance Bulletin No. 2004-03 on December 17, 2004 (the “Bulletin”), which addresses the responsibilities of a directed trustee in connection with its obligations regarding the purchase and sale of publicly-traded securities. The Bulletin provides guidance with respect to the position of the DOL on the duties of a directed trustee in connection with Section 403(a)(1) of the Employee Retirement Income Security Act (“ERISA”) regarding the scope of a directed trustee’s fiduciary duties. While the Bulletin states the DOL’s position to its regional offices, it also provides guidance to directed trustees of DOL’s position on a directed trustee’s responsibilities.

The scope of a directed trustee’s responsibilities was called into question in connection with litigation involving Enron. The issue was whether the directed trustee should have ceased the purchase of Enron shares in a directed trust during a blackout period when the plan was changing administrators. The scope of a directed trustee’s duties has also come into question in other cases including FirsTier Bank, N.A. v. Zeller, 16 F.3d 907, 9110 (8th Cir.), cert. denied sub nom; Vercoe v. FirsTier Bank, N.A., 513 U.S. 871 (1994); and Herman v. NationsBank Trust Co., 126 F.3d 1354, 1361-62, 1370 (11th Cir. 1997).

The uncertainty of the scope of a directed trustee’s duties and responsibilities has limited its ability to act for fear of incurring liability to the extent that it exercises discretion not expressly granted to the Trustee under the terms of the governing instrument. For example, if the governing instrument directs the trustee to purchase shares of employer securities with contributions and the trustee refuses because it believes the purchase may be imprudent, the trustee can incur liability to the participants in the event that the value of the shares increases. Conversely, if the trustee follows the instructions of the named fiduciary and purchases the shares, the participants may seek to impose liability for the losses sustained if the value of the shares decreases.

The Bulletin interprets the DOL’s position on the application of Section 403(a); specifically, how to determine whether a direction is “proper” under Section 403(a) and whether such a direction is not contrary to ERISA.

WHEN IS A DIRECTION “PROPER?”

The Bulletin provides that a directed trustee may not follow a direction “that the trustee knows or should know is inconsistent with the terms of the plan.” The Bulletin further provides that in order to make this determination, the directed trustee must request and review “all the documents and instruments governing the plan that are relevant to its duties as directed trustee.” It states that if the directed trustee fails to request or review such relevant documents and as a result, follows an improper direction, the directed trustee could incur liability. It cites the example that if a directed trustee follows the directions of a named fiduciary that is contrary to the plan’s investment policy, the directed trustee may be liable because the direction may not be proper. However, the Bulletin goes on to state that if the plan is silent with respect to a matter and does not prohibit following the named fiduciary’s direction, the direction will be deemed to be consistent with the terms of the plan. In the event that a direction is ambiguous, the directed trustee should obtain clarification.

NOT CONTRARY TO ERISA

In addition to being “proper,” a directed trustee may only follow a direction that is not contrary to ERISA. For example, the Bulletin states that a directed trustee may not follow a direction that would cause the plan to engage in a prohibited transaction. It states that if a responsibility is imposed on the named fiduciary, a directed trustee does not have an independent obligation to determine the prudence of that transaction. In other words, the directed trustee does not have to “second guess” the determination of the plan’s fiduciary who has authority over that determination.

DUTY TO ACT ON NON-PUBLIC INFORMATION

The Bulletin clarifies that a directed trustee does not have to act on material non-public information in violation of 10b of the Securities Exchange Act of 1934 (the “34 Act”). The Bulletin states “if a directed trustee has material non-public information that is necessary for a prudent decision, the directed trustee, prior to following a direction that would be affected by such information, has a duty to inquire about the named fiduciary’s knowledge and consideration of the information with respect to the direction.” The Bulletin further recognizes the propriety of a Chinese wall in an organization.

HOW TO AVOID LIABILITY?

• Make sure the governing instrument does not impose discretionary authority on the directed trustee with respect to the purchase or sale of employer securities.

• Request and review all relevant documents and instruments governing the plan that relate to the duties of the directed trustee.

• Review your policies governing the establishment and maintenance of a Chinese wall between your trust department and other departments or affiliates who may obtain material nonpublic information.

• Consider conducting a review of significant public information which may give rise to refusing to follow the direction of a named fiduciary, such as, a bankruptcy filing by the employer.

• Review your policies and procedures involving your duties and responsibilities when a co-fiduciary is acting.

• Review all of your policies and procedures relating to the purchase and sale of employer securities.

WARNING: Please keep in mind that the Bulletin is the DOL’s position on the duties of a directed trustee under ERISA. While the courts generally defer to agencies in the interpretation of the statutes they administer, it may not agree with that position in certain circumstances.

William Campbell Ries is Co-Chair of the firm’s Financial Institutions Practice Group. For more information on this topic, please contact Bill at 412.594.5646 or via e-mail at wries@tuckerlaw.com.

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In each issue, we introduce a member of the Financial Institutions Practice Group.
In this issue, we spotlight...

ERIC M. SCHUMANN

Mr. Schumann, a shareholder in the Business and Finance Department and Co-Chair of the Financial Institutions Practice Group concentrates his practice on the representation of lenders in commercial and corporate finance transactions.

In addition, Eric has documented various types of credit accommodations, including secured and unsecured loans, term and revolving credit facilities and lease financing. The secured loans have been supported by a wide range of collateral, including real estate interests and tangible and intangible personal property.

Eric has documented and reviewed multi-bank credit facilities, including participations and loan syndications.

This representation has involved acquisition financing transactions, including both the documentation and closing of the loan transactions and the performance and supervision of the due diligence review.

In addition, Eric works with other members of the Financial Institutions Practice Group in the review and documentation of structured finance facilities, bond transactions, synthetic leases and other off-balance sheet transactions.

Eric graduated from Pennsylvania State University in 1987, and from the University of Pittsburgh School of Law in 1990, where he was awarded the Order of the Barrister. He is a member of the Association of Commercial Finance Attorneys.
 

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