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Can a financial institution take a security interest in a consumer’s existing account through the use of a cross-collateralization clause when the consumer takes out a loan as a covered borrower under the Military Lending Act (MLA)? The answer to this question may depend on who you ask. Some will say “yes,” and others “no.”
The MLA was enacted in 2007, and expanded in 2015 (2015 MLA), to protect servicemembers and their dependents from lending-related abuses related to tax anticipation loans, vehicle title loans, payday loans, and consumer loans covered under Regulation Z. Both iterations of the MLA permit creditors to take a security interests in funds deposited after the extension of credit in an account established in connection with the consumer credit transaction [See Section 232.8(e)(3) of the 2015 MLA]. The attorneys who say “yes” are relying on guidance provided by the Department of Defense (DoD) Interpretive Rule issued on August 26, 2016. These DoD interpretations, presented in a question and answer format, provide as follows: 18. Does the limitation in §232.8(e) on a creditor using a check or other method of access to a deposit, savings, or other financial account maintained by the covered borrower prohibit a creditor from exercising a statutory right to take a security interest in funds deposited within a covered borrower’s account? Answer: No. Under certain circumstances federal or state statutes may grant creditors statutory liens on funds deposited within covered borrowers’ asset accounts. For example, under 12 U.S.C. 1757(11) federal credit unions may “enforce a lien upon the shares and dividends of any member, to the extent of any loan made to him and any dues or charges payable by him.” … Therefore, §232.8(e) does not impede a creditor from exercising a statutory right to take a security interest in funds deposited in an account at any time, provided that the security interest is not otherwise prohibited by applicable law and the creditor complies with the MLA regulation, including the limitation on the MAPR to 36 percent. In a legal action with a covered borrower, it is certainly helpful to have the DoD on your side with regard to a claim the financial institution took an illegal security interest in accounts opened before an MLA was issued. However, it must be noted that in the opening paragraphs of the Interpretive Rule, the DoD makes clear “this interpretive rule does not substantively change the regulation implementing the MLA, but rather merely states the Department’s preexisting interpretations of an existing regulation.” If the regulation is unchanged, does this Interpretive Rule really permit a security interest in an existing account? If you believe it does, here is where the proverbial wheels begin to fall off the argument. Section 232.7(a) of the 2015 MLA includes a preemption provision related to existing state of Federal laws. Specifically, Section 232.7(a) states the 2015 MLA will preempt a state or Federal law, rule or regulation to the extent any such law, rule or regulation provides protection to a covered borrower greater than those provided by the MLA. The DoD’s preexisting interpretation - not included in the MLA or the DoD’s implementing regulation – regarding a federal credit union’s statutory lien under the Federal Credit Union Act actually benefits the creditor, not the covered borrower. Therefore, the MLA provisions will override any state or federal law, rule or regulation to the contrary. Still not convinced taking a statutory lien in an existing account involving a covered borrower with an MLA loan is okay based on the DoD guidance? Ask yourself this question: Would the law or a contrary interpretation that does not have the force of law win the day in court when a servicemember sues your financial institution for taking a security interest in an account opened before an MLA loan was approved? So what does your financial institution do with this if you haven’t changed the language of your loan agreements. The following options can be taken:
Until the statutory language of the MLA that specifically exempts statutory liens from the security interest and preemption provisions is enacted, it may take a lawsuit to answer this question. It appears, in my opinion, that the DoD guidance does not provide sufficient comfort to support the argument that a security interest in existing accounts would survive a legal challenge. Have a regulatory question? Email me at vmadsen@esteecompliance.com. Veronica Madsen PLEASE NOTE: The information and opinions provided on this blog are not intended to be legal advice. No attorney-client relationship is formed, nor should any such relationship be implied. Nothing on this blog is intended to substitute for the advice of an attorney that is licensed in your jurisdiction. No article may be republished without the express written permission of ESTEE Compliance, LLC. © 2018
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Because internal fraud losses are not slowing down, credit unions will need to demonstrate to examiners that they have an adequate prevention program in place.
Financial loss due to internal fraud continues to be a problem despite increased examiner focus on the issue in 2017. According to the National Credit Union Administration’s NCUA Report, from 2012 to September 2016, fraud-related losses cost the National Credit Union Share Insurance Fund $146.8 million. It is no surprise that internal controls and fraud prevention are among NCUA’s supervisory priorities for 2018. NCUA Prohibition Orders were issued in 11 of the 12 months of 2017, prohibiting 46 individuals across 24 states from participating in the affairs of any federally insured financial institution. These individuals pleaded guilty to such crimes as mail fraud, grand theft, misappropriation of funds, bank fraud, money laundering, racketeering and embezzlement. The total restitution amount published in the prohibition orders for 2017 totaled $39,494,437.60. This amount is larger than the asset size of 2,344 of the 5,757 credit unions in the United States as of the third quarter of 2017, which represents just over 40 percent of the total number of credit unions, according to the Credit Union National Association’s “U.S. Credit Union Profile, Third Quarter 2017.” Internal fraud loss is not showing any signs of slowing down. In January 2018 alone, four individuals in four states received prohibition orders with a total restitution amount published totaling $1,067,595.82. Why is internal fraud continuing to occur, despite well-publicized cases of prosecutions and lengthy prison sentences? The short answer? Opportunity due to weak internal controls. In its published supervisory priorities for 2018, NCUA states its examiners expect federal and federally insured credit unions to establish “a strong system of internal controls and a comprehensive approach to managing fraud risk. Examiners will continue to evaluate the adequacy of credit union internal controls, as well as overall efforts to prevent and detect fraud.” In practical terms, what does a strong system of internal controls look like? As the NCUA Report provides, some of the measures that should be taken to deter insider fraud include the following:
Understanding how fraudsters operate provides additional insight into the prevention and detection of internal fraud. For example, employees may engage in fraudulent transactions through dormant accounts changed to an “active” status unbeknownst to the real account holder. Fraudulent memberships are sometimes established in the names of family members, with loan proceeds deposited into the fictitious accounts later taken by the thief when the fraudulent loans for these “members” are approved. An effective internal control structure would also include a review of membership cards, loan files (including interest rates and terms that may be much more favorable than the rest of loans in the portfolio, exceptions, refinancings and extensions), dormant accounts, as well as other areas in which operational weaknesses have been exploited by actual fraudsters. It is a very positive sign that the regulator is taking notice and addressing this issue. However, due to the lengthy exam cycle by the time an examiner uncovers the abuse, it is often too late. NCUA advises credit union employees who suspect potential fraud or abuse to notify a supervisor, audit department and/or the examiner. Unfortunately, some credit unions do not have the appropriate staffing that engages in regular auditing, and often the best internal control structure on paper is ineffective when the fraud is being committed by the very leaders who are in charge of ensuring its success. Credit union staff are required to file mandatory Suspicious Activity Reports under the Bank Secrecy Act as appropriate. Whenever insider fraud is suspected (regardless of the amount), credit union staff also can report suspected fraud to NCUA’s toll-free fraud hotline at 800.827.9650. This hotline is available to report suspected fraudulent or illegal activity by credit union employees, officials and members in federally insured credit unions. All reports to the line are confidential. Many resources for learning more about internal fraud are available, including NCUA’s Office of Small Credit Union Initiatives’ (now the Office of Credit Union Resources and Expansion) eight-part YouTube video series on fraud prevention and “Internal Controls and Accounting Tips for Small Credit Unions” webinars and other training for boards of directors and supervisory committees. Veronica Madsen ESTEE Compliance LLC PLEASE NOTE: The information and opinions provided on this blog are not intended to be legal advice. No attorney-client relationship is formed, nor should any such relationship be implied. Nothing on this blog is intended to substitute for the advice of an attorney that is licensed in your jurisdiction. No article may be republished without the express written permission of ESTEE Compliance, LLC. © 2015 |
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