When negotiating bank third party vendor contracts it is not unusual to ask the vendor to acknowledge in the contract that bank regulators might exercise some sort of supervision over the vendor.
Vendors will oftentimes push back on that point, claiming that since they are not a bank the FDIC has no jurisdiction over their affairs. We typically respond that “if the shoe fits, wear it.”
The fit arises because of the definition of “institution-affiliated party” (“IAP”). The definition was added under FIRREA when the regulatory agencies were seeking additional authority to impose sanctions against lawyers, accountants and appraisers whose negligence may have contributed to the failure of a bank. The language added to the statute is broader than just those professionals and covers any shareholder, consultant joint venture party, any other person determined by the appropriate federal banking agency (by regulation or case-by case) who participates in the conduct of the affairs of the bank and any independent contractor who knowingly or recklessly participates in any violation of law or regulation, any breach of fiduciary duty or any unsafe or unsound practice which caused or is likely to cause more than a minimal financial loss to the bank. (12 USC 1813(u))
The practical application of being designated an IAP was recently driven home in an enforcement action the FDIC took against Bank of Lake Mills, Freedom Stores, Inc. and Military Credit Services, Inc. All three parties entered into Consent Orders with the FDIC. The Bank agreed to fund restitution of $3,000,000 and to pay a civil money penalty of $151,000 while Freedom Stores, Inc. agreed to pay a penalty of $54,000 and Military Credit Services agreed to pay a penalty of $37,000.
The FDIC determined that Bank of Lake Mills, Freedom Stores, and MCS violated federal law prohibiting unfair and deceptive practices by, among other things:
- Charging interest to consumers who paid off their loans within six months when the loans were promoted as six-month interest free;
- Selling add-on products in conjunction with loans originated by the bank without clearly disclosing the terms of those products; and
- Failing to provide consumers the opportunity to exercise the monthly premium payment option in conjunction with the purchase of optional debt cancellation coverage on loans originated by the bank through the Freedom Stores and MCS channels.
The Consent Orders also require Bank of Lake Mills, Freedom Stores, and MCS to take affirmative steps to ensure compliance with the FTC Act.
The FDIC underscored the IAP status of the two vendors in the Consent Orders by identifying each entity as “an institution-affiliated party of Bank of Lake Mills.
As we noted in the series of articles we posted last year titled Reviewing Third Party Vendor Service Contracts, a best practice is to go ahead and incorporate a provision in vendor contracts whereby the vendor acknowledges the federal banking agency regulatory oversight. When a vendor pushes back on such a provision you should probably hit “pause” and consider what it is the vendor is trying to say. You need to understand whether the vendor is saying we don’t agree with the statement or if they would simply prefer not to acknowledge the fact in writing. We think that a bank wants to be doing business with a vendor who understands the relationship among the bank, the FDIC and themselves, and is thus more sensitive to the legal and regulatory issues presented by selling new products and services to the bank’s customers.