Three bills – H.B. 2368, H.B. 2369, and H.B. 2370 – that greatly expand the regulatory and enforcement tools available to the Pennsylvania Department of Banking and Securities ("Department"), bring Pennsylvania law into compliance with the Dodd-Frank Act and modernize, where necessary, Pennsylvania’s Banking Code, became effective on December 24, 2012. Key changes that institutions, credit unions, licensees, and the officers, directors and employees of those entities should be aware of:
Amendments to the Department of Banking and Securities ("DOBS") Code, 71 P.S. § 733-1 et seq.
1. Expanded enforcement authority of the Department
H.B. 2369 amended the DOBS Code to grant the Department the authority to impose a civil money penalty of up to $25,000 per violation against an institution, or any of its officers, employees, directors, or trustees for: (i) violations of any law or Department order, (ii) engaging in any unsafe or unsound practice, or (iii) breaches of a fiduciary duty in conducting the institution’s business. This is a significant enforcement tool that the Department can use against institutions that violate Pennsylvania law.
Another very significant amendment to the DOBS Code is the repeal of the requirement that the Department issue prior warning to an institution, or its officers, employees, directors or trustees, before initiating an enforcement action. Thus, the Department can issue an order against an officer, employee, director, or trustee of an institution for a violation of law, engaging in an unsafe or unsound practice, or breaching a fiduciary duty. In addition, the Department can immediately suspend those individuals if the Department believes that the institution, its shareholders, or depositors have suffered or may suffer significant financial harm or other prejudice from that individual’s continued involvement with the institution. Should the Department prevail at a post-removal due process hearing, the individual could be disqualified from working not only for the institution he or she was removed from, but from working for any Pennsylvania institution, credit union or licensee, for a period of time to be determined by the Department. While the initial removal order will remain confidential, any final order issued will likely be published on the Department’s website.
Third, the amendments to the DOBS Code clarify the Department’s authority to issue "orders" such as cease-and-desist orders, orders to show cause, consent agreements and orders, and notices of fines pursuant to five of the 12 statutes under the Department’s jurisdiction, which, as codified, do not provide the Department with the ability to "order" corrective action or money penalties for violations of those acts. See the Check Casher Licensing Act, 63 P.S. § 2304; the Consumer Discount Company Act, 7 P.S. § 6212; the Credit Services Act, 73 P.S. § 2190; the Money Transmitter Act, 7 P.S. § 6110, and the Pawnbroker License Act, 63 P.S. § 281-8. New section 202.D provides the Department with "order" authority so that it can better enforce the laws under its jurisdiction and no longer has to rely on the attorney general, district attorneys or other law enforcement authorities to initiate enforcement actions to enforce those statutes.
Fourth, the DOBS Code was amended to permit the release of certain information with the public regarding institutions and credit unions similar to the 2008 amendment to the DOBS Code, which permitted the Department and its employees to share certain information to the public (such as enforcement orders) without violating the confidentiality provisions of section 302. In addition, the institutions themselves will be permitted to disclose formal enforcement actions similar to orders issued by the Federal Deposit Insurance Corporation or the Federal Reserve Board without making a prior written request to the Department.
2. Compliance with Dodd-Frank
The DOBS Code amendments expand state "visitorial powers" over national banks to comply with Dodd-Frank’s codification of the U.S. Supreme Court’s opinion in Cuomo v. Clearing House Association, 129 S.Ct. 2710 (2009). The Supreme Court held that the New York attorney general’s law enforcement power – for example, the power to enforce non-preempted laws such as New York’s fair lending law – is distinguishable from the supervisory power over national banks, which is a power exclusive to the Office of the Comptroller of the Currency ("OCC"). Dodd-Frank codified the Cuomo opinion and provides that state attorneys general may initiate civil actions against national banks and federal savings associations in order to enforce regulations of the Consumer Financial Protection Bureau ("CFPB"), certain other applicable federal laws, and state laws not preempted by federal law. However, such power does not extend to enforcing Dodd-Frank in general, except as noted.
Accordingly, Pennsylvania’s attorney general can initiate civil actions against national banks, federal savings banks, and state-chartered institutions with respect to Pennsylvania’s non-preempted laws, as well as to enforce Title X of Dodd-Frank and regulations promulgated by the CFPB. It will be interesting to see if the attorney general attempts to initiate such actions against national banks, especially when Pennsylvania’s Democratic attorney general is sworn into office in January 2013.
The attorney general’s ability to initiate civil actions against financial institutions, credit unions, licensees, foreign financial institutions, national banks, federal savings associates or their subsidiaries will be subject to approval of, or brought at the request of, the Department. If the attorney general refuses to initiate an action at the request of the Department, new section 506 of the DOBS Code provides that the Office of General Counsel ("OGC") may initiate an action on behalf of the Commonwealth. However, Dodd-Frank only authorizes an attorney general or the attorney general’s equivalent to initiate actions against national banks or federal savings associations. It is questionable whether the OGC, as the attorneys representing the governor and agencies under the governor’s jurisdiction, is the equivalent of the Office of Attorney General, which is an independent agency with the authority to represent the governor or administrative agencies in civil action in Pennsylvania pursuant to the Commonwealth Attorneys Act. 71 P.S. §§ 732-201, 732-301.
The DOBS Code has further been amended in light of Dodd-Frank to clarify that the Department can examine subsidiaries of national banks and their employees in order to enforce state consumer financial laws to the extent not otherwise preempted by federal law. Subsidiaries of national banks and federal savings associations doing business in Pennsylvania should anticipate examinations by the Department for compliance with state and local laws and regulations as if such laws and regulations apply to Pennsylvania state-chartered institutions and their subsidiaries. In addition, the DOBS Code has been amended to grant the Department the authority to share information with the CFPB, such as reports of examination.
New section 506.I of the DOBS Code provides that Pennsylvania’s consumer financial laws not otherwise preempted by federal law apply to national banks and federal savings associations and their subsidiaries as though they are state-chartered institutions. Dodd-Frank provides that state consumer financial laws are preempted only if: (1) the state consumer financial law would have a "discriminatory effect" on national banks; (2) the state consumer financial law "prevents or significantly interferes with the exercise by the national bank of its powers" in accordance with the Supreme Court decision in Barnett Bank of Marion County, N.A. v. Nelson, Florida Insurance Commissioner, et al. (517 U.S. 25 (1996)); or (3) the "State consumer financial law is preempted by a provision of Federal law other than [Title X of Dodd-Frank]." See section 1044 of Dodd-Frank. In addition, section 1044 of Dodd-Frank codified the Barnett holding by providing that a reviewing court shall assess the determinations of the OCC, the reasoning, the consistency with other determinations, and any other relevant factors for the court. Finally, the amendments clarify that state consumer financial laws also apply to foreign financial institutions, which include institutions regulated by other states and other countries.
Lastly, the provisions of new section 506 of the DOBS Code make it clear that no other Pennsylvania agency or political subdivision may exercise the Department’s powers and responsibilities without express authorization by the Department. Such agencies would be permitted to enforce any other permitted power so long as enforcement is not related to or incidental to the banking or financial activities, or operations or conditions of such entities. The restrictions on initiating enforcement actions in no way impact the Pennsylvania attorney general or municipal and law enforcement agencies’ ability to commence criminal proceedings against financial institutions.
As can be seen, this one bill significantly increased the Department’s enforcement power over financial institutions (both state and federal) and its ability to regulate all civil banking actions against institutions in the Commonwealth.
Amendments to the Banking Code of 1965 ("Banking Code"), 7 P.S. § 101 et seq.
H.B. 2368 was a major, 111-page bill that streamlined the Banking Code to eliminate provisions that are duplicative of federal law and incorporated certain provisions of Dodd-Frank.
1. Expansion of authority to conduct business in Pennsylvania
First, through the amendment of several sections of the Banking Code, limited liability companies will be permitted to conduct business in Pennsylvania as a bank, bank and trust company, trust company, or savings bank. Second, national banks and federal savings banks can act as fiduciaries in Pennsylvania. Finally, money transmitters, which are separately licensed and regulated by the Department, are now included on the list of entities not deemed to be engaged in the banking business.
2. New standard of care for directors and officers of a financial institution
The new standard of care set forth in the Banking Code for both officers and directors mimics the standard of care in the Pennsylvania Corporations Code, and provides that they will be permitted to perform their duties "in good faith in a manner he [or she] reasonably believes to be in the best interests of the corporation and with such care, including reasonable inquiry, skill and diligence, as a person of ordinary prudence would use under similar circumstances." By codifying this standard of care, the Department has a stronger basis for issuing orders for the removal of directors or officers, as well as to levy civil money penalties for violations of this enumerated standard of care. Officers and directors will not be held strictly liable for actions taken in good faith in performing their duties at the institution. Rather, directors of an institution may rely in good faith on the information, opinions and reports provided by officers, employees, attorneys, accountants, or committees of the board. In addition, an officer of an institution will not be held liable simply because that individual is an officer of the institution. These provisions should allow officers and directors to function in their capacity as officers and directors without fear of repercussions for decisions made in good faith on behalf of the institution and in compliance with the standard of care.
3. Increased penalties for certain violations
The penalties provided for in section 2104 for willful violations of sections 105 and 106 by natural persons engaging in the business of a bank or as a fiduciary are changed from a misdemeanor punishable with imprisonment for up to one year, a fine of not more than $1,000, or both, to a felony punishable by up to two years imprisonment, a fine of not more than $10,000 per violation, or both. For non-natural persons, the penalty for willful violation of the Banking Code has been increased from a fine of up to $5,000 to a fine of up to $500,000. The increased penalties reflect the seriousness with which the Department views such activities, and the Department’s desire to ensure that no person or entity engages in such unauthorized activity.
4. Increased powers of financial institutions to acquire certain real property
Revised section 202 of the Banking Code significantly increases the threshold limit required for Department approval for an institution and other entities to acquire and hold real property for the purpose of conducting business, or providing parking facilities or data processing centers. The threshold will now be 100 percent (rather than the previous threshold of 25 percent) of the aggregate of surplus, unallocated reserves, undivided profits and subordinated securities for mutual savings banks, or 100 percent of the aggregate of capital, surplus, undivided profits and capital securities for any other institution. As a result, institutions do not need the approval of the Department to purchase or otherwise acquire such real property unless in doing so, the institution would be caused to incur obligations that exceed 100 percent of its aggregate capital, surplus or undivided profits.
5. Consolidated consumer lending provisions into one comprehensive section
The Banking Code had previously been comprised of different consumer lending empowerments enacted over many years that were distributed throughout the Banking Code. New section 303 of the Banking Code appears to be the new "one stop shop" for consumer lending law applicable to banks in Pennsylvania.
First, new section 303 consolidated, repealed, and moved many of the sometimes competing credit and other lending sections of the Banking Code into one section. For instance, new section 303 includes the old section 319 "parity provision," and empowers state banks to make loans at "such interest, finance charge, rate or terms" authorized to any other lender "regulated by any Federal or State supervisory authority on the specified class of loan." The legislature’s retention of the substance of section 319 may be helpful as a basis for state banks to obtain permissive legal authority for making consumer loans that other lenders enjoy.
New section 303 retains almost in its entirety repealed section 322, which contained the 1994 "Simplification and Availability of Bank Credit Act" (the "Simplification Act"). New section 303 retains the favorable and permissive environment created by the Simplification Act for banks making consumer loans, but it also contains some requirements and limitations such as requiring a written agreement with specified contents, and prohibiting prepayment charges that readers should review in full.
Second, new section 303 expands lending authority as well. The Banking Code now includes, for the first time: (i) first lien, purchase money residential loans; (ii) student loans guaranteed by Pennsylvania’s Higher Education Assistance Agency; and (iii) a series of loans previously excluded because they were not subject to state usury law. For example, business loans are exempt from civil usury laws and were thus not covered by the Simplification Act. Now, arguably, certain business loans are subject to section 303 and can benefit from its favorable legal authority. Another example involves unsecured consumer loans of more than $35,000, which are exempt from civil usury law and previously were not covered by the Simplification Act. New section 303 may apply to them. Therefore, almost all closed and open-end consumer loans by banks are authorized under the Simplification Act in new section 303, and that is generally good news for lenders.
As mentioned above, loans covered by section 303 must be the subject of a written agreement. Such loans are arguably free of a maximum rate limitation (subject to criminal usury laws), although the law does not expressly say that the rates may be established as agreed. Interestingly, a prior Simplification Act provision limiting variable rate loans to a maximum rate has been deleted, again suggesting that no maximum rate limitation exists. The maximum limitation on a delinquency charge (previously the higher of $20 or 10 percent) has also been deleted. Otherwise, the relatively permissive consumer lending provisions of the Simplification Act are retained.
Third, former section 310 covered "real estate loans" and was deemed to be restrictive in its payment and loan-to-value ratio ("LTV") limitations. Section 310, however, has been repealed, its content has been moved to new section 303, and its restrictions have been substantially liberalized. Banks now are generally authorized to make real estate loans for a term of up to 40 years and at an LTV of up to 90 percent. That section is shorn of its prior limitations, such as requiring loans to have "substantially equal payments." Even a 100 percent LTV ratio is permitted for loans of less than $100,000, or for those with private mortgage insurance, subject to federal law LTV requirements. Section 310’s coverage is expanded beyond first lien loans.
6. New derivatives authorization
New section 306 implements section 611 of Dodd-Frank, which provides that state banks may engage in derivative transactions only if the lending limit laws of their chartering states take credit exposure on derivate transactions into consideration. By virtue of section 306 including derivative transactions in the calculation under Pennsylvania law of the lending limit to one borrower, Pennsylvania-chartered banks will be able to continue to enter into interest rate swaps, options, and other derivative transactions. Absent section 306’s language, Pennsylvania banks would have been competitively disadvantaged as they could not have offered derivative transactions to their customers, while national banks had no such restrictions.
7. Agents of banks
The Banking Code Amendments made to section 902 now allow affiliated banks that are subsidiary institutions of the same bank or financial holding company, to engage in certain banking activities (such as accepting deposits and servicing loans) as an agent for the institution’s affiliated entity. Thus, it permits inter-affiliate transactions as non-branching activities. This permits an out-of-state bank to engage in limited activity in Pennsylvania without Department approval.
8. Expanded ability to establish and close branches
Section 904(b) rescinds the prior requirement that, in order for a foreign bank to establish a branch in Pennsylvania, the state in which the foreign bank was chartered had to provide reciprocal rights for a Pennsylvania bank. Such reciprocity provisions are no longer necessary because section 613 of Dodd-Frank did away with the reciprocity requirement by amending the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. In addition, section 613 provides that a national bank or a state-insured bank can establish a branch wherever a state bank can have a branch. Thus, institutions that want to establish branches in other states no longer need to worry about whether the foreign state has reciprocal banking laws.
In addition, institutions no longer need to obtain Department approval to close branch locations. Institutions that want to cease operations at a branch location must simply provide notice to the Department of such branch closure.
9. Conversion to a state-chartered institution
In order for a financial institution incorporated under the laws of another state or the United States to convert to a Pennsylvania state-chartered institution, the institution must meet certain minimum capital requirements. Section 1102(b) has been amended to repeal a table that established the minimum capital requirements for an institution based on the population where the institution’s principal place of business will be located. Now, the minimum capital requirements for an institution to convert shall be set by, and will be at the discretion of, the Department. This means that the minimum capital amount could be significantly higher than the previous requirements established by the population table. Also, this means that a certificate of authorization to do business will not be issued by the Department until the converting institution meets those specified minimum capital requirements.
10. Clarifications on mergers The Banking Code Amendments clarify institution merger procedures by: (i) eliminating any ambiguity as to an institution’s ability to pay dividend earnings "acquired as a result of a merger and transferred to surplus" so long as such earnings are used within seven years of the date of the merger; (ii) closing loopholes as to the types of entities that could merge in Pennsylvania and whose net earnings prior to a merger were not transferred to capital or surplus of the resulting institution; and (iii) expanding the list of entities that may merge or consolidate into state-chartered institutions. These amendments combine to expand the scope of merger opportunities available in Pennsylvania.
The Banking Code Amendments made a number of technical amendments as part of the goal of streamlining the regulatory requirements for financial institutions conducting business in Pennsylvania. Such amendments include (i) expanding the powers of savings banks regarding the pledge of deposits and limits on indebtedness to one customer to mirror changes to the general powers of banks; (ii) providing for the ability to name an unlimited number of beneficiaries on trust deposit accounts; (iii) requiring that an institution’s principal place of business be located within the Commonwealth of Pennsylvania; (iv) requiring that audits of savings banks be conducted by certified public accountants pursuant to standards set forth by the Department in the same manner the Department requires for other regulated institutions; (v) removing all references to "national banks" in the Banking Code consistent with federal preemption and Dodd-Frank, and to eliminate confusion for national banks and consumers; (vi) eliminating all requirements that banks use a corporate seal; and (vii) streamlining the definition of savings bank lending powers.
The changes appear to make Pennsylvania a more competitive place for banks to do business, while granting the Department the authority to ensure that entities and individuals involved in the banking industry conduct themselves with the highest degree of responsibility and integrity.
Amendments to the Loan Interest and Protection Law ("LIPL"), 41 P.S. § 101 et seq.
The shortest of the three bills, H.B. 2370, amended Pennsylvania’s civil usury statute to remove provisions deemed to be duplicative of federal law. Section 301 of the LIPL, relating to residential mortgage interest rates, provided that variable interest rate transactions are permissible so long as the documents evidencing the debt comply with sets of variable rate limitations and disclosures. The LIPL Amendments delete several of these variable rate restrictions, including the notice of rate change, a variable rate disclosure for the note and mortgage, and an application disclosure.
Many lenders had deemed all of these LIPL variable rate provisions to be of little relevance as other federal or Pennsylvania variable rate laws applied. The LIPL Amendments repealed provisions of section 301(e) that were deemed duplicative of Federal Regulation Z (the implementing regulation for the Truth-in-Lending Act), which has similar variable rate requirements. Also, until 2008, the LIPL’s coverage was limited to loans of up to $50,000. Now the LIPL covers mortgage loans of up to $230,110.
In addition, the LIPL had previously empowered most state institutions (and now savings banks) to charge the rate of interest available to a national bank under 12 U.S.C. § 85. Now, state institutions can charge rates as authorized by "other applicable Federal or State law." It will be interesting to see how the Department or a court views this new language.
The stated intent of the three bill legislative package was to modernize and streamline the bank regulatory scheme in Pennsylvania, improve Pennsylvania’s competiveness in the banking industry, and comply with applicable provisions of Dodd-Frank. In many ways the legislative package achieves these goals by repealing outdated provisions, increasing the Department’s ability to levy civil money penalties, and expanding the scope of powers and entities that may conduct business in Pennsylvania. Pennsylvania may become a more desirable location to conduct banking business while ensuring that its laws and regulations are enforced.