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Appeals of Material Supervisory Determinations: Guidelines and Determinations

SARC- 2007-02 (March 10, 2008) 

I. Background
This appeal arises from disputed material supervisory determinations set forth in an August **, 2006 Compliance Report of Examination (“examination report” or “examination”) for Bank X (“X” or “the Bank”) issued on January 11, 2007, by the FDIC’s Chicago Regional Office (“Regional Office”). The Bank’s portfolio of consumer loans is relatively small (27 loans valued at $6 million); the examination focused on limited scope transactional testing (rather than full scope reviews) for the lending-related regulations. X challenges Truth in Lending Act (“TILA”), Home Mortgage Disclosure Act (“HMDA”), Real Estate Settlement Procedures Act (“RESPA”), Equal Credit Opportunity Act (“ECOA”), and Truth in Savings Act (“TISA”) violations cited in the examination report. In contesting these violations, X makes a number of interpretive arguments based on the relevant regulations as well as factual assertions related to specific transactions that were subject to the findings of violations. The Bank seeks reversal of reimbursement requirements related to the TILA violations, elimination of notice regarding future possible civil money penalties related to the HMDA violations, and restoration of a “2” Consumer Compliance Rating in place of the assigned “3.”

After careful consideration of all of the written and oral submissions and the facts of this case, the Bank’s appeal is granted in part and denied in part. For the reasons set forth in this decision, we find the TILA restitution orders are not supportable and they are reversed as X has requested; we uphold the remaining violations found in X’s examination report for the reasons set forth herein; and we uphold X’s Consumer Compliance Rating of “3” because of overarching weaknesses in its compliance management system that are supported by the facts of this case.

X filed its request for review with the Director of the Division of Supervision and Consumer Protection (“DSC”) on March 9, 2007. On April 19, 2007, DSC issued its determination, concluding that the examination report accurately reflected the violations discovered during the examination and accurately interpreted the various regulations involved. DSC found the overall assessment of X’s compliance management system to be indicative of a “3” rated institution and determined that all of the disputed violations would remain in the examination report. X timely filed this appeal to the Supervision Appeals Review Committee (“Committee”) on May 18, 2007.

In its appeal, X broadly challenges DSC’s examination report, but focuses on the TILA violations and HMDA violations. X contends that certain construction escrow fees in question are not finance charges as that term is defined in TILA’s Regulation Z, and that three incorrect entries on its Loan Application Register are not repeat violations, but rather unintentional bona fide errors entitled to the safe harbor protections of HMDA’s Regulation C. Asserting reputational harm from the Regulation Z restitution order and objecting to “notice” that future HMDA violations will likely result in civil money penalties, X asks that these be stricken from the examination report.

In an appendix to its appeal, X also challenges RESPA Regulation X violations regarding two residential mortgage loans with insufficient disclosures, namely, failure to check a box to note a “required provider” and omitted property tax and hazard insurance estimates. The Bank asserts that the provider was not required and that the tax omission was prior in time to relevant guidance, but admits to one insurance oversight arguing new procedures will prevent recurrence. X dismisses an ECOA Regulation B violation (government monitoring information collected) as inadvertent and (now) prevented by improved compliance procedures, and a TISA violation (disclosure omissions on a rate sheet) as insignificant and not subject to Regulation DD.

Most of the examination report violations, according to X, are wrong as a matter of fact and law, are “artificially magnified” in significance, or result from past compliance practices that have already been altered; accordingly, it seeks restoration of its former “2” Consumer Compliance Rating.

DSC urges the Committee to uphold all of the examination report findings and X’s Consumer Compliance Rating of “3.” According to DSC, X’s appeal does not address systemic weaknesses identified in the examination report concerning the Bank’s compliance management system. Nor, in DSC’s view, does X discuss its failure to appropriately address criticisms and recommendations in the 2004 Report of Examination regarding its compliance program, including policies and procedures, training, internal monitoring, and audits. These operational weaknesses, DSC asserts, resulted in numerous violations, a majority of them repeat violations despite previous commitments from the Bank to address them.

X violated TILA Regulation Z, DSC contends, because the construction escrow services in question were “ordered” by X and resulted in understated finance charges subject to TILA reimbursement (approximately $800). Despite improvement, DSC views X’s current HMDA violations - transcription errors and a mistaken co-borrower’s ethnicity - as resulting from failure to implement effective monitoring procedures since the previous compliance examination. This failure, DSC asserts, deprives X of the Regulation C safe harbor and merits the examination report reference to possible future civil money penalties should HMDA violations continue.

Regarding the RESPA violations, DSC contends that insufficient evidence was submitted to indicate that customers were routinely given a choice of service providers (a repeat violation), that at least one new violation occurred after the issuance of appropriate FDIC guidance, and that the hazard insurance omissions were repeat violations from the 2004 compliance examination. DSC maintains that the ECOA violation regarding government monitoring information was also a repeat violation previously communicated to X, although not included in the prior examination report. DSC views X’s rate sheet as a covered advertisement under Regulation DD, making omission of appropriate disclosures a TISA violation.

In accordance with the Guidelines for Appeals of Material Supervisory Determinations,1 the Committee reviews the Bank’s appeal for consistency with the policies, practices, and mission of the FDIC, as well as the reasonableness of, and support for, the respective positions of the parties. At the September 4, 2007 meeting, the Committee allowed X, pursuant to the Guidelines, to make an oral presentation. Appearing on behalf of X were A, outside counsel for X, B, President of X, and C, Director of X. DSC’s position was also presented orally to the Committee. The Committee has carefully considered all of the written submissions made by X2 and by DSC, as well as the oral presentations made at the meeting. Under the Guidelines, the scope of the Committee’s review is limited to facts and circumstances as they existed prior to or at the time of the examination (August **, 2006). No consideration has been given to facts or circumstances that developed after the examination.

II. Analysis.

A. The Truth in Lending Act Violations.
In the August **, 2006 examination report, DSC cited three residential construction loans originated by X that failed to include construction escrow (staged disbursement) fees as a prepaid finance charge, a repeat violation from the March 10, 2004 compliance examination. For two of those loans, DSC contends the Annual Percentage Rate (“APR”) and finance charge were understated by amounts exceeding the restitution tolerance levels of the Truth in Lending Act and Regulation Z3 (12 C.F.R. Part 226). On the third loan, according to DSC, the APR and finance charge were also understated due to the exclusion of the staged disbursement fee, but the amounts were not reimbursable because they fell within Regulation Z’s tolerance levels.

DSC informed X that an analysis of six residential construction loans reviewed through the 2004 and 2006 examination cycles revealed that a third-party service provider (D) was used for the construction escrow services. DSC concluded that in the three loans reviewed during the 2006 examination the escrow services were “ordered” by X, the fees were paid by the borrowers at closing, and the Bank acted as settlement agent. In DSC’s view, this made the fees for the construction escrow services includable in the finance charges for the extension of credit, under Regulation Z, 12 C.F.R. § 226.4(a). DSC also relied upon the Staff Commentary to Regulation Z, which provides guidance for interpreting section 226.4(a), and lists as a finance charge “[i]nspection and handling fees for the staged disbursement of construction loan proceeds.” 12 C.F.R. Part 226 Supp. I, § 226.4 – Finance Charges.

Concluding that the construction escrow fees were includable in the final finance charge and APR calculations, DSC cited the three loans for TILA violations and ordered reimbursement (totaling approximately $800) for two of the loans.

X contends that it never required the construction escrows in question. X reads Regulation Z to mean that a construction escrow fee levied by a third party is never a finance charge unless the creditor “requires the use of a third party as a condition of or incident to the extension of credit” or “retains a portion of the third-party charge ….” Section 226.4(a)(emphasis added). Since the parties agree that X retained no portion of the third-party charge, X argues that the construction escrow fees are includable in the finance charges only if X required the third-party construction escrow “as a condition of or an incident to the extension of credit.” Further, the language of the Staff Commentary also applies, in X’s view, only if the services in question are required by the lender.

X contends that it did not require the borrowers to pay a construction escrow fee to anyone, either as an incident to or a condition of the extension of credit. At the September 4 meeting, the Bank asserted (and maintained that it has contended from the outset of this matter) that the construction escrows in question were voluntary. According to X, the borrowers opted for the service of a construction escrow after being verbally informed by the Bank of the option to do so, and paid the attendant fees at settlement. DSC acknowledged at the September 4 meeting that if the borrowers requested the escrows, the fees should be excluded from the finance charges.

To resolve the TILA restitution issue, the Committee must make a factual determination whether the escrow fees in question are part of the finance charge because they were ordered by the Bank – as DSC contends – or are not part of the finance charge because the construction escrow services were requested by the borrowers, as the Bank contends.

The Committee is willing to accept the Bank's statements in its appeal and at the September 4 meeting that the Bank did not require the construction escrow fees and that the borrowers opted for such arrangements after being verbally notified by the Bank of their option to do so. Given DSC's prior criticism of the Bank's handling of construction escrow fees, however, it is notable to this Committee that no documentation of the borrowers' request for a construction loan escrow was included in the loan jackets reviewed at the time of examination. This omission raises issues related to the adequacy of the Bank’s compliance management system, as well as X’s compliance rating, which are addressed in Section F of this decision.

Accordingly, for the reasons discussed above, we find - as to the two loans for which reimbursement was ordered - that X did not require the use of a third-party construction loan escrow. Restitution is therefore not applicable.

B. The Home Mortgage Disclosure Act Violations.
The August **, 2006 examination report identified three violations of HMDA Regulation C4 (12 C.F.R. Part 203), which governs the compilation of certain loan data. Specifically, subject institutions must record on a prescribed register (loan application register) a number of items of data related to applications for, and originations, purchases and refinancings of, home purchase and home improvement loans for each calendar year. 12 C.F.R. § 203.4(a). The data must include, among other things, the date the application was received and the ethnicity and race of the applicant or borrower. Section 203.4(a)(1), (10). The examination report identified three errors on X’s 2005 loan application register, two of which related to loan application dates, while one related to a co-borrower’s ethnicity. DSC and X agree that the loan application dates were correctly listed on X’s worksheet, but were mistranscribed onto the loan application register.

DSC considers these three violations to be repeat violations from the prior examination, which it attributes to weakness in monitoring procedures. DSC noted in the examination report that management had made an effort to improve the accuracy of its HMDA recordkeeping since the prior examination, but this was the second consecutive compliance examination in which significant HMDA violations were cited and that civil money penalties were considered but not pursued.

X considers two of the violations in question to be clerical mistakes and the third the result of confusion as to a co-borrower’s ethnicity, none of which is a repeat violation from the 2004 examination. According to X, six HMDA errors occurred in the prior compliance examination – all involving key fields as those fields are defined by the Federal Reserve Board.5 The three errors in the 2006 examination, by contrast, involved one key field and reflect the Bank’s aggressive and successful campaign to reduce compliance errors, X asserts. Moreover, according to the Bank, the errors noted in 2004 stemmed from a misapplication of the regulation, while the current errors involved transcription mistakes and confusion as to ethnicity. X claims that the errors in question are “bona fide errors” for purposes of the safe harbor provision in Regulation C. A bona fide error is “unintentional” and “occurred despite the maintenance of procedures reasonably adapted to avoid such error.” 12 C.F.R. § 203.6(b). No HMDA violation is found for “bona fide errors.”

X also questions language changes that occurred between a preliminary draft of the Report of Examination provided to the Bank on September 12, 2006 and the final Report of Examination provided on January 11, 2007. X complains that the early draft characterized the Bank as having an “extremely low error rate of less than 3 percent” in its HMDA recording and showed a “notable effort” to improve, while this language did not appear in the final examination report. X seeks to have the examination report references to civil money penalties and repeat violations stricken, and to have the preliminary report language restored.

The 2006 examination report language fairly characterizes the Bank’s HMDA violations as the result of failure by the Bank to implement effective monitoring systems. X concedes that six errors in HMDA recording occurred in the prior compliance examination. While it is true that just three HMDA recording errors were identified in the examination at issue, that reduction by itself does not establish that the Bank’s compliance management needs no further improvement. Nor does the finding of three violations at the 2006 examination mean that no improvement has occurred. Indeed, the final examination report “noted that management has made an effort to improve the accuracy of HMDA recordkeeping since the prior examination.”

The fact remains, however, that the violations are repeat violations - incorrect entries on the Loan Application Register - despite X’s assertion that they arise from different causes. The examination report statement that “this is the second consecutive compliance examination in which significant violations have been cited in this area and … civil money penalties for repeat violations of HMDA have been considered but are not being pursued at this examination” is an accurate and supported description of what occurred during this compliance examination.

The primary cause for the Bank’s deficiencies in HMDA recordkeeping has been identified as weakness in monitoring procedures and as to that, the examination report correctly “recommended that management expand its monitoring and auditing procedures to fully address the issue.” For this reason, the Committee determines that the Bank did not maintain procedures reasonably adapted to avoid the violations in question and, therefore, the safe harbor provision of Regulation C for bona fide errors does not apply. The Committee finds that the facts support the violations found in the examination report.

C. The Real Estate Settlement Procedures Act Violations
1. Provider required by lender disclosures. The August **, 2006 examination report identified three violations of RESPA Regulation X6 (24 C.F.R. Part 3500), which governs disclosures regarding the nature and costs of the real estate settlement process. Section 3500.7(e)(1)(iii) of Regulation X mandates that, if the lender requires the use of a particular provider of a settlement service and requires the borrower to pay for the service, the lender must disclose that the provider is required and describe the relationship between the service provider and the financial institution.

X was cited in the examination report for failing to disclose required information about a settlement service provider (E) on the Good Faith Estimate (“GFE”). In the examination report, it is noted that the Bank charges customers for the cost of credit reports run by the Bank, and the Bank determines which provider to use. The violation was cited as a repeat violation from the 2004 examination. In addition, the examination report indicated that the Bank agreed to correct this error, and management had, since the prior examination, included the name, address, and phone number for all service providers that it regularly used, even if their use was not required by the Bank. DSC asserts that the Bank failed to check the box on the GFE indicating that the use of the credit reporting service was required and to disclose that the Bank repeatedly used this provider in the past 12 months.

X asserts that it does not require the use of E or any other credit report provider, and that customers are free to use any provider they choose. In its appeal, however, the Bank states: “While the Bank does generally choose the credit bureau, it does so in the absence of an alternative choice by the customer.” (X Appeal, Appendix 1, at ii.) The distinction between a provider chosen by the Bank and one required by the Bank is, on this point and on these facts, not clear. Moreover, little conflict is seen with DSC’s position that it is the Bank that determines which provider to use. In that sense, the Bank’s choice is “required.” The Committee finds that the facts support the violation found in the examination report.

2. Property taxes and hazard insurance disclosures. The August **, 2006 examination report identified three additional violations of RESPA Regulation X (24 C.F.R. Part 3500). Section 3500.7(c) of Regulation X requires disclosure of certain charges that the borrower will normally pay in the locality while section 3500.8(b) requires that the settlement agent complete the HUD-1 in accord with appropriate instructions.

In the examination report, violations were cited for failure to include an estimate for hazard insurance on the GFE for one loan and on the HUD-1 for two loans. In addition, for all three loans, an estimate for property taxes was not provided on either the GFE or the HUD-1. According to DSC, the hazard insurance omissions were repeat violations during the last three compliance examinations. X acted as settlement agent in two of the transactions in which the omissions occurred.

DSC contends that one of the real estate disclosure violations noted above occurred during May of 2006, after issuance of the Region’s Supervisory Compliance Advisory Notification System (“SCANS”) newsletter (an e-mail issued on September 26, 2005). The loan containing that violation, according to DSC, was booked as a new loan after September 26, 2005, so the disclosures set forth in the SCANS guidance were required. DSC further contends that it determined during the 2006 examination that the Bank’s automated loan preparation software still was not properly configured to include property tax estimates.

Moreover, DSC contends that, consistent with its practice, it is appropriate to consolidate the discussion of all violations of a single statute or regulatory section. In that way, DSC determined the hazard insurance and property tax omissions to be appropriately characterized as repeat violations. DSC maintains that the examination report appropriately clarified that the hazard insurance omissions were the deficiencies cited at prior examinations.

X argues that no property tax violations occurred because two of the loans in question originated prior to issuance of the necessary FDIC guidance (the SCANS newsletter), one loan originating on June 27, 2005, and the other on August 15, 2005. The third loan, according to the Bank, originated prior to issuance of the guidance, but was renewed subsequent to that guidance. Since that renewal did not require the borrower to pay property taxes, the Bank argues, disclosure of property taxes was not required on the GFE or the HUD-1.

As to the hazard insurance issues, X concedes that it did not disclose an estimate for hazard insurance on the GFE and HUD-1 for one of the loans (the “F” loan). In its defense, X maintains that it was not the settlement agent for that loan and therefore should not be cited for a significant repeat violation where an unaffiliated third party prepared the HUD-1. Even so, the Bank states it will enhance its closing instructions to settlement agents. The Bank also “separately acknowledges” that it did not disclose hazard insurance on the GFE or the HUD-1 for another loan (the “G” loan), and states that it has implemented procedures to prevent recurrence.

Finally, X challenges DSC for “bundling” the hazard insurance and property tax claims – to make them both appear to be repeat violations – when only the hazard insurance violations were repeated from the prior examinations.

As to the “bundling” of the hazard insurance and property tax disclosure deficiencies, X would prefer that the FDIC break out the discussion of omissions of hazard insurance and property tax separately, to eliminate any appearance that the institution’s mishandling of property tax was a repeat violation. It is clear that the violations in the 2004 examination report regarding sections 3500.7(c) and 3500.8(b) are solely attributable to the Bank’s mishandling of hazard insurance premiums. The property tax omissions are the subject of the 2006 examination only. Nevertheless, the FDIC’s practice is to discuss all circumstances surrounding violations of a particular regulatory section in the same area of the examination report. Both the hazard insurance and the property tax omissions relate to similar sections of Regulation X and we find it was appropriate to consolidate the discussion of both issues in the same area of the Significant Violations pages. Further, the examination report expressly and accurately stated: “The omission of the hazard insurance is a repeat violation cited during the last three compliance examinations.” (Emphasis in original.)

Moreover, at least one loan was booked as a new loan after the issuance of the FDIC guidance in question, and as a result it was revealed that the Bank’s automated preparation software was not configured to include property tax estimates. This deficiency is sufficient supporting evidence for the violation cited by DSC.

Although a limited number of transactions was reviewed (X originates a small volume of RESPA-applicable loans), a pattern of violations is revealed from this and the prior compliance examination. The deficiency in the bank’s oversight and management of RESPA requirements appears evident, despite past assurances that it would be corrected. The Committee finds that the facts support the violation found in the examination report.

D. The Equal Credit Opportunity Act Violations
The August **, 2006 examination report identified three violations of ECOA Regulation B7 (12 C.F.R. Part 202), which promotes the availability of credit to all creditworthy applicants without regard to race, color, religion, national origin, sex, marital status, or age. Section 202.5(d)(3) of Regulation B prohibits a creditor from requesting the sex of an applicant, except as required for monitoring purposes. Section 202.5(d)(5) prohibits a creditor from requesting the race, color, religion or national origin of an applicant, except as required for monitoring purposes.

In the examination report, repeat violations were cited stemming from X’s collection of government monitoring information on three out of three non-HMDA applicable construction loans reviewed. Such monitoring information is not required for these loans. According to DSC, its policy is to provide details about isolated exceptions or violations to banks during the examination but to omit these issues from the written examination report. Moreover, DSC states that its records for the 2004 examination indicate that details and information regarding the ECOA violation (prohibited collection of government monitoring information on non-applicable loans) were provided to the Bank in 2004. Specifically, DSC policy is to leave copies of “Other Violations” pages with bank management; these pages are considered part of the examination, even though not included in examination report itself.

X concedes the violations, but contests whether the violations are repeated from the prior examination. First, the Bank contends they should not be labeled “repeat” because they were not included in the 2004 examination report. Second, the Bank avers that it “has no record of receiving such details from the Division in 2004.”

Violations may be considered repeat even though not memorialized in the prior examination report, so long as the violations are communicated to the institution. DSC acknowledges that the 2004 Regulation B violations were isolated and not significant, but maintains that its records indicate that the violations were communicated to the Bank. Under the Guidelines, ¶ J, the burden of proof rests with the institution. X’s statement merely that it “has no record” that it received the details of the 2004 examination ECOA violations is not entitled to sufficient evidentiary weight to dispose of this issue. The Committee finds that the facts support the violation found in the examination report.

E. The Truth in Savings Act Violation
The August **, 2006 examination report identified three violations of TISA Regulation DD8 (12 C.F.R. Part 230), which requires depository institutions to provide disclosures so that consumers can make meaningful comparisons among depository institutions. Section 230.8(b) of Regulation DD requires that if an advertisement states a rate of return, the rate must be stated as an “annual percentage rate” using this term. Section 230.8(c) requires that, among other things, if the annual percentage yield is stated, the advertisement shall also include a statement regarding the effect of fees (section 230.8(c)(5)) and the features of time accounts (section 230.8(c)(6)).

The examination report found violations of sections 230.8(c)(5) and (6) on X’s deposit rate sheet (X Appeal, Attachment K), which was deemed to be an advertisement under section 230.2(b). The rate sheet failed to include, at the least, the effects of fees and the features of time accounts. The rate sheet is made available to the Bank’s customers in its lobby. DSC viewed the rate sheet as covered advertising for purposes of Regulation DD.

X argues that its rate sheet is not an advertisement because it lacks a “message” to customers inviting, offering, or announcing the availability of accounts, but rather is a “simple reference document” providing data to anyone who might consult it. Even if the rate sheet is considered an advertisement, X contends that a separate brochure available in the same display with the rate sheet provides the requisite regulatory disclosures. Finally, the Bank alleges that it was told during the examination that it could avoid a cited violation if immediate changes were made to the rate sheet so that it complied with Regulation DD.

The rate sheet is a “photocopied paper page,” as the Bank describes it. It bears the Bank’s name and logo at the top, a heading that reads “Selected Personal Deposit Rates,” and lists available Certificates of Deposit, Savings Accounts, Money Market Accounts, and Checking Accounts, providing the interest rate, annual percentage yield (“APY”), minimum deposit to open, and minimum balance to earn the APY for each.

Section 230.2(b) defines an advertisement as “a commercial message, appearing in any medium that promotes directly or indirectly … the availability or terms of, or a deposit in, a new account; and … the terms of, or a deposit in, a new or existing account.” At the very least, the rate sheet promotes the availability and terms of new and existing accounts. The Staff Commentary to Regulation DD describes covered messages as “visual, oral, or print media that invite, offer, or otherwise announce generally to prospective customers the availability of consumer accounts ….” 12 C.F.R. Part 230, Appendix D, § 230.2(b). The regulatory language is sufficiently broad to encompass the rate sheet in question within the defined term “advertisement.”

The proximity of a brochure that meets the disclosure requirements of Regulation DD does not remedy the defects in X’s rate sheet. Nor does the allegation that X was told it could avoid a violation by immediately correcting the rate sheet. The Committee finds that the facts support the violation found in the examination report.

F. The Compliance Rating
The FDIC’s Consumer Compliance Handbook contains the FDIC's compliance examination policies and procedures in effect as of June 2006. The Handbook describes a “2” rated institution as follows:

An institution in this category is in a generally strong compliance position. Management is capable of administering an effective compliance program. Although a system of internal operating procedures and controls has been established to ensure compliance, violations have nonetheless occurred. These violations, however, involve technical aspects of the law or result from oversight on the part of operating personnel. Modification in the bank’s compliance program and/or the establishment of additional review/audit procedures may eliminate many of the violations. Compliance training is satisfactory. There is no evidence of discriminatory acts or practices, reimbursable violations, or practices resulting in repeat violations.

By contrast, a 3-rated institution is in a less than satisfactory compliance position and is described as follows:

Generally, an institution in this category is in a less than satisfactory compliance position. It is a cause for supervisory concern and requires more than normal supervision to remedy deficiencies. Violations may be numerous. In addition, previously identified practices resulting in violations may remain uncorrected. Overcharges, if present, involve a few consumers and are minimal in amount. There is no evidence of discriminatory acts or practices. Although management may have the ability to effectuate compliance, increased efforts are necessary. The numerous violations discovered are an indication that management has not devoted sufficient time and attention to consumer compliance. Operating procedures and controls have not proven effective and require strengthening. This may be accomplished by, among other things, designating a compliance officer and developing and implementing a comprehensive and effective compliance program. By identifying an institution with marginal compliance early, additional supervisory measures may be employed to eliminate violations and prevent further deterioration in the institution’s less-than-satisfactory compliance position.

The examination report concluded that X’s overall compliance management system was weak and in need of improvement. In its Appeal, the Bank maintains that it is in a strong compliance position. The Bank argues that, when the erroneous material supervisory determinations are corrected, management is revealed as capable of administering an effective compliance program. According to the Bank, while some violations have occurred, they generally involve technical aspects of the law. Considering the nature and extent of present compliance with consumer protection and civil rights statutes and regulations, the commitment of management to compliance, ability and willingness to take the necessary steps to assure compliance, and the adequacy of operating systems, including internal procedures, controls, and audit activities on a routine and consistent basis, the Bank contends that overall it is a strong compliance performer and merits restoration of its prior “2” rating.

The Bank’s appeal focuses on the accuracy of the significant violations and their role in the overall rating. However, the Appeal does not meaningfully address any of the system weaknesses identified in the Examination Report with regard to the Bank’s compliance management system. Nor does the appeal address the Bank’s failure to appropriately amend policies to address previous criticisms. In particular, had X adequately addressed the weaknesses in its compliance management system identified at the 2004 compliance examination so that the borrowers’ determination to request a construction loan escrow was indicated in the documents contained in the loan jacket, FDIC examiners would not have been induced by that omission into citing the Bank for the two TILA violations requiring restitution, which the Committee has stricken.

The previous Report of Examination (2004) included recommendations to formalize monitoring procedures, establish a formal compliance audit function, and implement follow-up training to correct misinterpretations of the regulations. The present examination demonstrates that improvement is still needed in the following areas:

Policies and Procedures. Components of the Bank’s written policies and procedures do not reflect the Bank’s actual practices. The Bank maintains few policies and procedures embedded into existing operational and procedural guidance that would direct employees performing routine business transactions to ensure compliance with consumer protection laws and regulations.

Training. The Bank’s training program is ineffective and considered weak. Training is conducted almost exclusively through in-house sessions with materials and publications that have not been updated since 2003. The training materials focus on the specific regulatory requirements, but lack any link to the Bank’s actual products and operations. There are no standards of measurement for the effectiveness of training efforts themselves and there are no monitoring functions to determine if employees are effectively implementing measures to ensure compliance.

Internal Monitoring. As noted throughout the current Examination Report, monitoring and audit functions are weak, as shown by the existence of numerous violations, including repeat violations. Examiners determined that the Bank has other monitoring and auditing processes for back-office operations, but they do not include consumer compliance.

Audits. The Examination Report notes that the Bank has not implemented effective compliance audit programs, despite the recommendation in the 2004 examination. The Bank has a program that contains an annual schedule for compliance-related audits; however, the review of the actual audits conducted between the 2004 examination and the current examination revealed that the audits focused on deposit and privacy regulations. Lending compliance was reviewed strictly through a series of checklists in actual transaction files, which was ineffective given the number of violations cited in the Examination Report. Examiners concluded that the audits of lending functions were not comprehensive enough to avoid future errors.

X is primarily focused on commercial transactions. When consumer transactions are a small portion of a bank’s business, strong policies and procedures for consumer protection issues are highly important because Bank staff does not have as much day to day experience and must rely more heavily on procedures to guide them to ensure compliance. In this case, the lack of effective procedures and monitoring activities poses a high risk for non-compliance.

The Bank has provided little evidence to support its contention that its compliance management system has improved sufficiently during the period covered by the 2006 examination or to contradict the criticisms of that system noted by the FDIC’s examiners and included in the examination report. Mindful of the experience and expertise brought to bear in the examination process, we find the noted deficiencies in the compliance management system supported. Moreover, the suggestion that the overall number of significant violations has been reduced by forty percent relative to the March 2004 examination, as the Bank maintains, overlooks the fact that the number of violations is largely a product of examination scope and sample size. For the Bank, we think it is more to the point that multiple violations of regulatory sections were cited at the current and previous examinations, the majority being repeat violations. This reflects an overarching weakness when it comes to the compliance management system. It is this weakness that prompts our concerns and informs our determination to affirm the Bank’s compliance rating of “3.”

III. Conclusion
For the reasons set forth above, X’s appeal is granted in part and denied in part. This is a final supervisory decision by the FDIC.

By direction of the Supervision Appeals Review Committee, dated March 10, 2008.


Valerie J. Best
Assistant Executive Secretary


1 The Guidelines are set out in FDIC Financial Institution Letter (“FIL”) 113-2004 (Oct.  13, 2004) and at 69 Fed. Reg. 41,479 (July 9, 2004).

2 Including X’s post-meeting submission dated September 11, 2007.

3 The Truth in Lending act is implemented by the Federal Reserve Board’s Regulation Z.

4 The Home Mortgage Disclosure Act is implemented by the Federal Reserve Board’s Regulation C.

5 The following are key fields: loan type; loan purpose; property type; owner occupancy; loan amount; action taken type; request for pre-approval; application date and action date; Metropolitan Statistical Area; state; county; census tract; ethnicity, race, and sex of the applicant and co-­applicant; income; type of purchaser; rate spread; Home Ownership and Equity Protection Act status; and lien status.  Federal Reserve Board, Consumer Compliance Handbook, Appendix A, at 8 (January 2006).

6 The Real Estate Settlement Procedures Act is implemented by the Department of Housing and Urban Development’s Regulation X.

7 The Equal Credit Opportunity Act is implemented by the Federal Reserve Board’s Regulation B.

8 The Truth in Savings Act is implemented by the Federal Reserve Board’s Regulation DD.

 


Last Updated 04/15/2008 Legal@fdic.gov