Monthly Archives:' April 2014

Patrick J. Kennedy Jr. Quoted in American Banker Basel III Article

Kennedy Sutherland attorney, Patrick J. Kennedy Jr., was quoted in the April 25th American Banker article entitled, “S Corp Consolidation Could Be Side Effect of Basel III.” In the article Mr. Kennedy, who is the managing partner of Kennedy Sutherland and President of the Subchapter S Bank Association which are headquartered in San Antonio, Texas, joins others in expressing concern that Basel III could be the last straw for countless S corporation banks as they mull their futures.

Currently, banks would be required by Basel III to hold a certain level of capital; failure to do so could result in a prohibition against paying dividends to shareholders. Dividends are critical to those investors, who rely on the payments to cover tax obligations if the bank is profitable. For that reason, S Corp banks believe they face a greater burden under Basel III than C corporations, where the company is taxed for its profit. Concerns also exist that the proposed rules could force more S Corps to delay growth plans or opt to sell themselves.

Basel III will require banks to have a common equity Tier 1 capital ratio of 4.5% plus a 2.5% capital conservation buffer. Banks that fall below 7% can have their ability to deploy capital, like paying dividends or bonuses, limited. S Corp shareholders are responsible for paying their share of the company’s profits on their personal tax returns. Shareholders would have to pay those taxes out of pocket if a profitable S Corp is barred from paying dividends to cover their costs. That burden could discourage some people from investing in S Corps, industry experts say.

In the article, Mr. Kennedy states, “If the rule is implemented, more S Corps could choose to switch to a C Corp structure. But this could also cause more banks to consider selling. The C Corp structure isn’t an effective structure for a closely held bank since you are basically double taxed and you’re competing against credit unions that aren’t taxed at all.”

Read More of the Article

CFPB Works to Improve Mortgage Closing Experience

“Buying a home is one of the biggest financial decisions most people will make in their lifetimes, but navigating the closing process can be a challenge, ” said Director Corday of the Consumer Finance Protection Bureau (CFPB). The package of closing documents is large, and the process is overly complex and stressful for consumers. Therefor, the  CFPB has been committed to work on improving the mortgage closing experience and last year’s “Know Before You Owe” rule that integrated the Truth in Lending Act (TILA) and Real Estate Settlement Procedures Act (RESPA) disclosures, which will take effect in August 2015. The goal of the new rule was to help improve consumer empowerment and avoid surprises at the closing table by requiring that the new closing disclosure be provided at least three business days prior to closing.  .

This month, The CFPB published a report summarizing the results of its Request for Information about the challenges consumers face when closing on a home.  The Bureau identified several “pain points” consumers regularly experience during the closing process.  Consumers reported being frustrated by:

  • The lack of time they have to review a large number of closing documents, even when they did not understand the terms;
  • The lack of resources capable of providing explanations about closing documents, which are often full of legalese and technical jargon; and
  • Minor errors in paperwork resulting in long delays affecting multiple parties.

In addition, the Bureau released guidelines for an upcoming eClosing pilot project to study how eClosings can benefit consumers and address some of the challenges borrowers face at closing. The Bureau hypothesizes that technology-enabled electronic closing (eClosing) solutions may have the potential to improve consumer understanding and empowerment and efficiency for all involved. The intention of this pilot is for the CFPB to conduct targeted research on eClosing solutions and to release the findings publically. To achieve both of these goals, the CFPB will dictate certain terms of the research environment, including specific tests, defined test groups, and a minimum number of loans to close during the pilot. The loan-level data relevant to this study may include data on cost, time, and/or process (e.g., errors, consumer interaction) that will help the CFPB to evaluate the use or impact of eClosing features.


SEC's OCIE Cybersecurity Initiative

On March 26, 2014, the Securities and Exchange Commission (SEC) hosted a roundtable to discuss cybersecurity issues facing public companies, broker-dealers, investment advisers and other market participants. While cybersecurity has been a hot topic for the last couple of years, the SEC has provided only informal guidance to registrants and other market participants. At the roundtable, Chair Mary Jo White  emphasized the “compelling need for stronger partnerships between the government and private sector” to address cyber threats.

On April 15, 2014, SEC’s Office of Compliance Inspections and Examinations (OCIE) issued a Risk Alert describing an initiative it is currently undertaking to assess cybersecurity preparedness in the securities industry. The nine-page documen contains several examples of the questions Securities and Exchange Commission examiners might ask brokerages and asset managers during inspections. According to OCIE, the examinations will focus on “cybersecurity governance, identification and assessment of cybersecurity risks, protection of networks and information, risks associated with remote customer access and funds transfer requests, risks associated with vendors and other third parties, detection of unauthorized activity, and experiences with certain cybersecurity threats.”

The SEC hopes these examinations will help identify areas where the Commission and the industry can work together to protect investors and our capital markets from cybersecurity threats. The sample document request is intended to empower compliance professionals in the industry with questions and tools they can use to assess their firms’ level of preparedness, regardless of whether they are included in OCIE’s examinations.

Who Can Buy a Failed Bank?

The Federal Deposit Insurance Corporation (FDIC) adopted a final rule on April 14, 2014 to implement section 210(r) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Under the final rule individuals or entities that have, or may have, contributed to the failure of a “covered financial company” cannot buy a covered financial company’s assets from the FDIC. The final rule establishes a self-certification process that is a prerequisite to the purchase of assets of a covered financial company from the FDIC.

With one exception, the final rule is unchanged from the proposed rule. Language is added to require that a prospective purchaser certify that a sale of assets of a covered financial company by the FDIC is not structured to circumvent section 210(r) or the final rule. The final rule is distinct because it would apply to sales of covered financial company assets by the FDIC and not to sales of failed insured depository institution assets. The final rule addresses the statutory prohibitions contained in section 210(r). It does not address other restrictions on sales of assets. For instance, the final rule does not address purchaser restrictions imposed by 12 CFR part 366 (“Minimum Standards of Integrity and Fitness for an FDIC Contractor”) and 5 CFR part 3201 (“Supplemental Standards of Ethical Conduct for Employees of the Federal Deposit Insurance Corporation”). Further, the final rule is separate and apart from any policy that the FDIC has, or may adopt or amend, regarding collection of amounts owed by obligors to a failed insured depository institution or a covered financial company. The focus of a collection policy is to encourage delinquent obligors to promptly repay or settle obligations, which is outside the scope of section 210(r) and the final rule.

Higher Expectations for Community Banks In Extraordinary Circumstances

On April 10, 2014, Comptroller of the Currency Thomas J. Curry presented remarks concerning risk management and related corporate governance issues before the American Bankers Association Risk Management Forum.  Comptroller Curry focused his presentation on the OCC’s “heightened expectations” for risk management and corporate governance.  He stated that the OCC’s “heightened expectations” program applies exclusively to large, complex banks, i.e., those with consolidated total assets of $50 billion or more (“Large Banks”).”

In his remarks, Comptroller Curry responded to community banks’ concerns that the heightened expectation program would only apply to a bank with less than $50 billion in consolidated assets “in extraordinary circumstances,” i.e., if the OCC determined that the bank’s operations were highly complex or present a heightened risk.  News outlets have recently reported that the OCC is reviewing the public comments on its proposed heightened expectation program and is expected to tweak it by clarifying that the guidelines are not intended to apply to smaller banks and on providing some assurance to bank directors that, although they are expected to oversee their bank’s compliance performance, they are not required by the OCC to “ensure” their bank’s compliance with applicable regulations.

Rehabilitation & Preservation Tax Incentives

The federal government and 35 states have enacted historic rehabilitation tax credits. Until 2013, Texas did not have one. These incentives greatly help developers as depending on the eligibility of a project, one or both of these tax credits can be utilized as important sources of financing for projects involving rehabilitation and revitalization of historic buildings and buildings within historic districts in Texas.

Federal Historic Rehabilitation Tax Credit:

The Federal Historic Rehabilitation Credit provides a 20% tax credit to owners of buildings listed in or eligible for listing in the National Register of Historic Places. The program is administered by the National Park Service (“NPS”). Owners apply for the credit through the NPS. The credit, provided for in Internal Revenue Code Section 47, is equal to 20% of qualified rehabilitation expenses for a certified historic structure. Buildings that do not qualify as certified historic structures may, nevertheless, be eligible for a 10% tax credit on qualified rehabilitation expenses provided the building was placed in service prior to 1936 and other requirements are satisfied. The tax credit has a compliance period of 5 years, during which the owner must hold the property, with the recapture amount reduced by 20% during each year of the compliance period. Additionally, there are special rules regarding use and ownership of historic buildings by tax-exempt entities for purposes of allowing the credit. Generally, these credits are used to provide financing for a project through investments in the project by banks and other investors in exchange for the tax credits. These credits can also be used in conjunction with New Markets Tax Credits or other investment tax credits to provide financing for a given project.

Texas Historic Preservation Tax Credit

In 2013, Texas enacted a state historic preservation credit. Generally, the legislation provides a 25% credit against Texas franchise tax for qualified expenses incurred with respect to certified historic structures placed in service on or after September 1, 2013. The Texas credit tracks many of the requirements of the Federal tax credit and building-owners must follow a similar application process. The state credits may be taken beginning January 1, 2015 and are freely transferrable and assignable. On March 3, 2014, the Texas Attorney General’s office released an opinion clarifying section of the legislation, but rules from the Texas Historical Commission regarding implementation of the tax credit program have yet to be drafted. The Texas credit, however, should add significant value to qualifying taxpayers who choose to proceed with the process for obtaining the federal tax credit.

Certified Historic Structures

The 20% federal tax credit only applies to Certified Historic Structures. Historic buildings qualify as Certified Historic Structures if they are listed in the National Register of Historic Places. If they are not individually listed in the Register, they can still qualify if they are located in a registered historic district and are certified by the NPS as contributing to the historic significance of that district. Buildings not currently registered can apply to be listed in the National Register through the NPS application process.

As mentioned, buildings that are not eligible for certification may still qualify for the 10% tax credit provided they were placed in service prior to 1936. The 10% tax credit has no application or review process and is claimed on Form 3468. A rehabilitation project on a pre-1936 buildings will qualify provided the applicable existing external wall/internal structure test is met. For most projects, 50% or more of existing external walls must be retained as external walls, 75% or more of existing external walls must be retained as internal or external walls, and 75% or more of internal structural framework must be retained in place. Further, expenditures that increase the total volume of the building will not qualify for the credit.

Tax Credit Application Process

For the 20% federal credit, the applications are administered by the NPS through a three-step process. Part 1 allows currently unlisted buildings to apply for and obtain certification to be listed in the National Register of Historic Places, and therefore, become eligible for the credit. Part 2 provides a detailed plan of rehabilitation for the Certified Historic Structure and Part 3 is a request for Certification of Completed Work, which makes the tax credit available to the owner.

Part 1 consists of an application for Certified Historic Structure status. Buildings already listed in the National Register of Historic Places are already certified and do not have to complete this step of the application process. Upon completion of Part 1, the application is submitted to the applicable State Historic Preservation Office (“SHPO”) in the state the building is located. The SHPO reviews the application for compliance with the standards for registered historic structures and forwards the application to the NPS with a preliminary recommendation. The NPS then evaluates the application based on the Standards for Evaluating Significance within Registered Historic Districts, promulgated by the Secretary of the Interior. Among the relevant factors evaluated are the location, design, setting, materials, workmanship, feeling and association that add to the district’s sense of time and place and historical development. The NPS will also determine whether alterations to or deterioration of the building have been so extensive as to diminish its overall integrity. Generally, buildings constructed within the past fifty years will not be certified.

Part 2 of the application consists of certification of the plan of rehabilitation for the Certified Historic Structure. In determining whether the plan constitutes a Certified Rehabilitation, the NPS will look to its consistency with the historic character of the property and the historic character of the district in which it is located. Additionally, the plan of rehabilitation must not damage, destroy or cover materials or features that help define the building’s historic character or significance. Part 2 of the application is also initially overseen by the SHPO, which is available to provide technical assistance and literature on appropriate rehabilitation and advise owners on their applications. The SHPO will also make site visits to the structure as part of this review process. Finally, the SHPO will forward the application with a recommendation to the NPS. The NPS will review the application for conformity with the Standards for Rehabilitation issued by the Secretary of the interior and will issue a certification decision after reviewing the project. Once this certification has been obtained, construction on the project can commence.

Upon completion of the project, the owner submits Part 3 of the application, requesting Certification of Completed Work. Again the SHPO will review and make an initial recommendation to the NPS. The NPS will evaluate the completed project for conformity with the plan of rehabilitation that was certified in Part 2 of the application. Upon Certification of the Completed Work, the building is automatically eligible for the tax credit.

Technical Requirements of the Credit

In addition to the standards for Certified Historic Structure and Certified Rehabilitation status imposed by the NPS, Code Section 47 imposes technical requirements on the uses of the building and the amount, substance, and timing of the rehabilitation that will be eligible for the tax credit. The building must be depreciable, that is it must be used in a trade or business or otherwise held for the production of income. Additionally, the approved plan of rehabilitation must meet a “substantial rehabilitation test.” A rehabilitation plan will be considered substantial if expenditures exceed the greater of $5,000 or the adjusted basis of the building and structural components over a 24-month measuring period. Once these threshold requirements are met, the tax credit may be claimed for all qualified expenditures incurred before the measuring period, during the measuring period, or after the measuring period through the end of the taxable year in which the building is placed in service. Additional requirements are imposed of the plan of rehabilitation is to be completed in multiple phases.

The tax credit applies only to qualified expenses incurred during the rehabilitation. Generally, qualified expenses are those costs that are added to the property basis. Common examples include the cost of work on the building structure, architectural and engineering fees, site survey fees, legal fees, development fees and other construction-related costs. Qualified expenses, however, will not include acquisition or furnishing costs, the cost of any new additions or expansions, new building construction, parking lots, sidewalks, landscaping or other related facilities. An exhaustive list of qualifying and non-qualifying expenses can be found in Code Section 47 and the accompanying Treasury Regulations. 

Claiming the Credit and Limitations

Once the rehabilitation is completed, the credit can be claimed for the tax year in which the building is placed in service. Unused tax credit can be carried back one year or carried forward 20 years. The credit is claimed on Form 3468 and the approved application is required to be filed with the tax return. The credit cannot be used to offset the Alternative Minimum Tax and is also subject to the passive and at-risk loss rules. To satisfy the five-year compliance period, the owner must hold the building for five years after completing the rehabilitation. If the owner transfers the building within the compliance period, recapture of the credit is 100% during year 1 and is phased out by 20% during each successive year. Finally, there are certain limitations on buildings that are leased to tax exempt entities. Subject to specific requirements, such leases may be disqualified and prevent the owner from taking the credit. Generally, a safe harbor will protect the owner’s use of the credit if less than 35% of a building is leased to a tax exempt entity.

Texas Historic Preservation Tax Credit

As mentioned above, the Texas credit follows many of the requirements of the Federal credit including the Certified Historic Structure and Qualified Rehabilitation Expenses requirements. Generally, historic rehabilitation projects located in Texas that qualify for the Federal credit will also qualify for the state credit. Unlike the Federal credit, however, qualified expenses need only exceed $5,000 and there is not adjusted basis test for the minimum expenditure threshold. Eligibility for the credit requires application for certification with the Texas Historical Commission after completion of the project. Once the project has been certified, owners of buildings placed in service after September 1, 2013 are eligible for a 25% franchise tax credit against all qualified expenses, regardless of when those expenses were incurred. While the review process may begin prior to the effective date of the credit (January 1, 2015), no certificates of eligibility will be issued and no tax credits may be claimed prior to that date.

In order to claim the credit, an owner must submit to the Comptroller the certification issued by the Texas Historical Commission, an audited cost report itemized eligible costs and expenses incurred in the rehabilitation, evidence of the date the building was placed in service after the rehabilitation, and an attestation as to the qualifying expenses incurred. The credit may be carried forward for five years. The credit may also be freely transferred or assigned to other entities, provided that notice of the sale or assignment is submitted to the Comptroller. There is no limit as to the number of sales or assignments allowed, but the credit may only be claimed on an annual report by one entity. This free transferability allows more flexibility than the federal credit as entities not subject to the franchise tax may claim the tax credits and sell or assign such credits to taxable entities. This feature could potentially allow non-profits and other entities not subject to Texas franchise tax to benefit from the credit by claiming the credit for a qualifying project and selling or assigning to a taxable entity.

We expect further clarification and guidance regarding the application of the Texas historic credit throughout the year. The Texas Historical Commission and the Comptroller will be issuing further rules regarding the application and certification process and claiming of the tax credit. In the meantime, we recommend that entities interested in claiming the state tax credit in addition to federal credits, proceed with the certification and approval process for the federal tax credit. This should streamline the approval process for obtaining a certificate of eligibility for the state credit.

For further information regarding the either the Federal or Texas Historic Tax Credits, please contact us at (210) 228-9500 or email William “Dub” Sutherland.

A Shareholder Agreement as a Sword and Shield

A shareholder agreement is a contract between and among the shareholders of a corporation and potentially the company as well. Shareholder agreements can do all of the following:

  • create limitations on the number and type of shareholders that may own a company’s stock;
  • create the mechanisms to allow existing shareholders or the company the option to acquire any shares prior to their being sold or transferred to a new shareholder;
  • ensure that certain administrative functions and securities laws are complied with throughout future transfers of the stock;
  • create unilateral or mutual obligations and duties on the part of shareholders or the company;
  • outline the methods and process for determining fair market value of the company’s stock and any related disputes; and
  • establish programs for shareholder liquidity.

All of these considerations and related provisions may impact the value of a company’s stock and the ability to ever realize that value. Taking the time to understand the shareholder agreement is of critical importance for all shareholders. Taking the time to periodically review the shareholder agreement and ensure its ability to achieve its intended purpose and provide the greatest benefit to the company and shareholders is even more important.

For more information on a shareholder agreement related to your company or institution contact William D. Sutherland VI.

Payday Loan Alternatives

On April 1st at the 2014 National Interagency Community Reinvestment Conference, Comptroller Thomas Curry delivered remarks to all attendees. He began his remarks by identifying key objectives in the interagency’s effort to update and modernize the CRA process by aligning the agencies’ approaches to CRA evaluations, improving evaluation procedures, and providing effective training that prepares examiners to develop well-supported CRA evaluations.

Next, he discussed an issue that has received a lot of focus and concerns with the OCC, high cost payday loans. In 2000, the OCC issued an advisory letter to banks warning about the compliance, legal, and reputation risk associated with payday lending. While the Comptroller applauded banks for providing loan products to consumers with strong credit histories; he defended his agency’s guidance on deposit advance products and stated that “properly managed small-dollar loan programs do not exhibit the same level of risks we identified with deposit advance products, and that such loans can be made available to consumers.” He added that they understand the challenges presented by small-dollar consumer lending. Specifically, banks have told the OCC that the underwriting processes need to be streamlined to make such products viable. However, the OCC determined that many of the risks identified with regard to deposit advance guidance, including the product’s short-term balloon payment feature, were specific to that product. He encouraged banks to offer small-dollar loan products with reasonable loan terms that can put consumers on a path toward a brighter credit future. In addition, he believes such programs can :

  • be offered at a low cost to banks;
  • help build a banks’ reputation;
  • expand existing customer relationships; and
  • potentially be elegible for positive CRA consideration.

In closing the Comptroller reiterated the OCC’s commitment to helping consumers by encouraging banks to offer reasonable loan products in a safe, sound, and responsible manner. “Properly structured small-dollar loans can offer borrowers a safe and affordable path, as opposed to high-cost loans that can lead to a cycle of debt. When consumers are able to reduce their dependence on short-term financial expedients, they benefit, banks benefit, and the economy benefits.”

Virtual Currencies Under Texas Money Services Act

On April 3, 2014, The Texas Department of Banking issued a supervisory memorandum interpreting how virtual currencies, including cryptocurrencies, will be regulated under the Texas Money Services Act. Virtual currencies have increased rapidly in recent years and, particularly with the advent of cryptocurrencies like Bitcoin, have raised novel questions in relation to money transmission and currency exchange. Due to this advent and rapid growth, the policy expresses the Department’s interpretation of the Texas Money Services Act, the application of its interpretation to various activities involving virtual currencies, and the regulatory treatment of virtual currencies under existing statutory definitions.

After discussing types of virtual currencies, the Department of Banking determines that for purposes of currency exchange under the Texas Finance Code, cryptocurrencies are not considered currencies under statute as they are not “coin and paper money issued by the government of a country.” Therefore absent a legislative change to the statute, no currency exchange license is required in Texas to conduct any type of transaction exchanging virtual with sovereign currencies.

In regards to money transmission, the Department of Banking declines to offer generalized guidance on centralized virtual currency under the Texas Money Service Act because such schemes require individual analysis. As to whether transactions in cryptocurrency should be considered money transmission, the Department of Banking indicates that the determination turns on the single question of whether they are “money or monetary value.” The Texas Finance Code defines the terms for “money” and “monetary value” to mean “currency or a claim that can be converted into currency through a financial institution, electronic payments network, or other formal or informal payment system.” As noted in the currency exchange analysis, cryptocurrencies are not issued by a government as legal tender and thus are not “currency”. The Department of Banking reasons that because owners of cryptocurrency do not have a guaranteed right to convert their cryptocurrency into sovereign currency, cryptocurrencies are also not a “claim” within the meaning of the statute. Cryptocurrency is therefore not considered “money or monetary value” under the Money Service Act.

Because cryptocurrency is not money under the Money Services Act, receiving it in exchange for a promise to make it available at a later time or different location is not money transmission. Consequently, absent the involvement of sovereign currency in a transaction, no money transmission can occur. However, when a cryptocurrency transaction does include sovereign currency, it may be money transmission depending on how the sovereign currency is handled. To provide further guidance, the regulatory treatment of some common types of transactions involving cryptocurrency can be determined as follows. 

  • Exchange of cryptocurrency for sovereign currency between two parties is not money transmission. This is essentially a sale of goods between two parties. The seller gives units of cryptocurrency to the buyer, who pays the seller directly with sovereign currency. The seller does not receive the sovereign currency in exchange for a promise tomake it available at a later time or different location.
  • Exchange of one cryptocurrency for another cryptocurrency is not money transmission (regardless of how many parties are involved).
  • Transfer of cryptocurrency by itself is not money transmission.
  • Exchange of cryptocurrency for sovereign currency through a third party exchanger is generally money transmission.
  • Exchange of cryptocurrency for sovereign currency through an automated machine is usually but not always money transmission.

Lastly, the Department of Banking highlights three considerations that cryptocurrency businesses that conduct money transmission must comply with for licenses in Texas: (1) because a money transmitter conducting virtual currency transactions conducts business through the Internet, the minimum net worth requirement is $500,000 (and possibly up to $1,000,000), (2) a license holder may not include virtual currency assets in calculations for its permissible investments, and (3) applicants must provide a third party security audit of their computer systems in order to ensure the virtual currency is safeguarded for consumers.

Read more of Supervisory Memorandum – 1037.

Cyber-Attacks on ATM & Card Authorization Systems and DDoS

The Federal Financial Institutions Examination Council (FFIEC) issued a statements for financial institutions of the risks associated with cyber-attacks on Automated Teller Machine (ATM) and card authorization systems and the continued distributed denial of service (DDoS) attacks on public-facing websites. The statements describes steps institutions need to take to address these attacks and highlight resources institutions can use to help mitigate the risks posed by such attacks.

Cyber-attacks on small- to medium-sized financial institutions are on the rise. The FFIEC expects financial institutions to take steps to address this threat by reviewing the adequacy of their controls over information technology networks, card issuer authorization systems, ATM usage parameters, and fraud detection processes. In addition, the members expect financial institutions to have effective response programs to manage cyber attacks.

The members also expect financial institutions to address DDoS readiness as part of their ongoing information security and incident plans. More specifically, each institution is expected to monitor incoming traffic to its public website, activate incident response plans if it suspects that a DDoS attack is occurring, and ensure sufficient staffing for the duration of the attack, including the use of pre-contracted third-party servicers, if appropriate.

Cyber-attacks on Financial Institutions’ ATM and Card Authorization Systems (PDF)
Distributed Denial-of-Service (DDoS) Cyber-Attacks, Risk Mitigation, and Additional Resources