Thursday, April 18, 2024

December 2018 OBA Legal Briefs

  • IOLTA accounts
  • SCRA – What not to do
  • Privacy – Reg. P update
  • Notes on beneficial ownership

IOLTA accounts

By Pauli Loeffler

Since July 1, 2004, the Oklahoma Supreme Court has required all attorneys and law firms in Oklahoma to set up mandatory Interest on Lawyers’ Trust Accounts (IOLTAs) with interest payable to the Oklahoma Bar Foundation, with a few exceptions. In spite of the fact that these accounts have been around more than 14 years, the OBA Compliance Team still gets questions about documentation, how to set them up, etc. OBA’s former general counsel Charles Cheatham presented a seminar for both bankers and lawyers at the Oklahoma Bar Association in 2004, and but this is the first Legal Briefs article on the subject.

The Oklahoma Rules of Professional Conduct for Attorneys is found in Title 5, and the specific Rule covering IOLTAs is in Sec. 1.15 covering Safekeeping Property. It can be found at this link:

Are banks required to offer IOLTAs? No, banks are not required to offer these accounts. This is a business/marketing decision and/or a public relations decision.  It could be a charitably-motivated decision based on the charitable or non-profit activities supported by the interest on IOLTA accounts paid to the Oklahoma Bar Foundation (“OBF”). The OBF promotes “Prime Partner Banks” (banks that pay the highest interest rates and waive fees) to Oklahoma attorneys. It also has an “IOLTA Honor Roll.” You can find OBF’s IOLTA Guidelines here:

What funds go into an IOLTA? All unearned legal fees, unincurred expenses, and third‐party monies in connection with the representation should be deposited into an IOLTA. This typically means, for example, retainers (until the monies are earned), flat fees (until the monies are earned), filing fees, deposition and expert witness expenses.  Settlement proceeds to the lawyer and client or others may also go into the trust account for distribution.

An IOLTA is designed to operate as a pooled account for client balances that, if invested separately for each client, probably could not earn net income. Oklahoma lawyers and law firms are required to place client or third party funds that are nominal in amount or to be held for a short period in an interest-bearing pooled trust account when these client balances are large enough to earn some net interest for the OBF. The only funds of the attorney that may be commingled with those of the client or third party are those for the sole purpose of paying bank service charges such as a monthly maintenance fee or minimum balance required. NSF charges, stop payment charges, negative collected charges, wire transfer fees, fees for certified or cashier’s checks, electronic service fees, check and deposit slip printing costs and all other charges should be charged to the operating account rather than netted against interest earned on the IOLTA. Note: a garnishment or levy against a lawyer or law firm will NOT attach to an IOLTA.

Are IOLTAs mandatory for all lawyers/law firms? No, there are some exceptions:

  1. Only lawyers that hold client or third‐party funds regarding a representation must have trust accounts. If legal fees are received after the work is already done, i.e., the fees are already earned, the money would go into an operating account.
  2. If no financial institution offers IOLTA accounts in the community where the principal office of the lawyer or law firm is located, or the banks routinely charge more in fees than any interest generated, or it is otherwise not feasible, the lawyer is excused from establishing an IOLTA but is urged to consult with OBF first.
  3. If the funds are to be held for a long period of time or are non-nominal in amount so that the client would receive a positive net return , the lawyer or law firm should advise the client that the funds may be deposited in an account that pays interest to the client.

Note that the second and third exceptions will still require the attorney or law firm to establish some form of trust account. Under the second exception, it would not be styled as an IOLTA but rather under the SSN or EIN of the lawyer or law firm and styled like “John Doe & Associates Client Trust.”  Under the third exception, it would be titled under the client’s SSN or EIN, styled like “Jimmy Smith Settlement, Jim Bob Williams, agent” and the interest would be paid/reported to the client.

What account products can be used for an IOLTA? Originally, the only type of account available in 2004 that could be used for an IOLTA was a NOW account because an IOLTA must be an interest-bearing checking account allowing unlimited transactions. While For Profit entities aren’t eligible for NOW accounts, the Federal Reserve issued an opinion in 1984 that any IOLTA account can be set up as a NOW account provided the Attorney General of the state issue an opinion that all interest paid on an IOLTA account under that state’s program belongs to a charitable entity. The OBF meets this requirement. Since the Dodd-Frank Act in 2011 authorized interest-bearing checking accounts, these may be used as well, but ordinarily NOW accounts pay a higher rate and should still be the choice.

As far as the account styling, the OBF requires the use of its EIN: 73-0710244. This number is used because the OBF is the recipient of any interest paid on the account. This can raise another issue since the name of the attorney or law firm will be used on the account which results in a TIN/Name mismatch.  In this case, there is a special exception to the general rule:  Under Treasury Reg. Section 1.6049-4(c) (1), no Form1099-INT is required to be filed with respect to interest paid to an organization exempt from taxation such as the OBF. Therefore, if the bank has an easy way to do so, it should suppress the filing of 1099s on all IOLTA accounts, which will totally eliminate the bank’s problem with potential name/TIN mismatches on 1099s.  The styling of the account can be anything that is descriptive, such as Smith & Wesson, PLLC — IOLTA Account or Smith & Wesson, PLLC — IOLTA Client Trust Fund.

On the other hand, if the bank cannot easily suppress the 1099 reporting on such an account, it should be careful to style the account in such a manner that  the EIN reported to the I.R.S. will match the name on the first line of the account’s styling, something like Oklahoma Bar Foundation IOLTA Account (Smith & Wesson, PLLC)

Regardless of how a bank styles the accounts, it is important to get “IOLTA” or Client Trust if the second exception noted above applies and an IOLTA is not required. The reason for the special styling is for deposit insurance purposes.  If the account style indicates that funds are held in a special capacity rather than as funds of the business itself, the customer will be allowed to prove who the underlying owners of the money are, and each will be insured separately for $250,000.

What forms are involved? In order to be an “approved” bank for attorney trust accounts, whether the account is an IOLTA or not, the bank must execute the Trust Account Overdraft Reporting Agreement (“TAORA”). This agreement was mandated in 2009, and it will come from the Oklahoma Bar Association’s General Counsel. The TAORA covers both IOLTAs and lawyer/law firm escrow, trust, or client trust fund accounts that aren’t IOLTAs. Only one agreement needs to be executed by the bank and will cover for all branches.

The TAORA requires the bank to notify the attorney or law firm promptly any time there is an overdraft or dishonor for insufficient funds. It also requires the bank to notify the Oklahoma Bar Association’s General Counsel in these situations and has provisions on how this should be done.

For IOLTAs, the bank will also see the IOLTA Notice to Financial Institution & Oklahoma Bar Foundation “Compliance Statement,” which will be filled out by the attorney and/or the bank but is only signed by the attorneys or authorized signers on the account. Yes, a non-attorney may be a signer on an IOLTA. It’s a very old joke that goes back pre-IOLTA: “Can anyone be a signatory on the trust account?” “Yes, anyone you want to trust your license to.”

Beneficial ownership. IOLTAs are not statutory trusts. Start by understanding who your customer is. The attorney’s clients do not own the account even though they may beneficially own (some of) the funds in the account. And the bar association doesn’t own the account, either. The account is owned by the attorney (in the case of a sole practitioner) or law firm. If your customer is a sole practitioner, there is no legal entity involved and the rule can’t apply. But if the customer is a law firm, a partnership, limited liability partnership (LLP), limited liability company (LLC), professional corporation (PC), etc., it is a legal entity, and you will apply the Beneficial Ownership regulation just as you would for any other legal entity customer.

CTRs. Let’s say an attorney brings in funds from one or more clients and is depositing cash over $10,000 into the IOLTA, so a CTR is required. Would we be required to ask for the client name(s) in this case? Yes, you need to request the names of the client name(s). See FIN-1989-R005. If you get any push back, we suggest that the bank cite the regulatory requirement for the CTR and the provision for penalties for anyone causing the filing of a CTR with incomplete information, along with a suggestion that the information requested does not fall under attorney-client privilege in the first place.

SCRA – What not to do

By Andy Zavoina

Here is what the headline in said, “Credit Union to Pay for Seizing Vehicles of Service Members” and many newpapers near the credit union carried similar headlines after the Department of Justice (DOJ) took the CU to task in United States v. Hudson Valley Federal Credit Union. The decision in the case was filed November 2, 2018. The headlines were dated November 3, but you know they had been working on what happened and why for some time. The lawsuit was filed in the U.S. District Court for the Southern District of New York in December 2016. It started when two servicemembers filed private lawsuits over the repossession of their vehicles. When it comes to drawn-out court actions such as this, time is money. Researching files is money. Writing new policies and procedures and training is money. These headlines mean reputation risk and potentially lost customers. There is no “win-win” as the institution seems to lose on all accounts.

The complaint alleged the Hudson Valley Credit Union violated the Servicemembers Civil Relief Act (50 U.S.C. 3901 et seq.) by repossessing vehicles of servicemembers without first obtaining a court order. Sections 3931 and 3932 of the SCRA impose certain requirements.

Section 3931 applies when you have a civil proceeding against a servicemember and that person cannot appear in the court.

Default judgments you may obtain require a certification/affidavit from you that the customer is or is not in the military service. Facts to support your position should be provided. The requirement for an affidavit may be satisfied by a statement, declaration, verification, or certificate, in writing, subscribed and certified or declared to be true under penalty of perjury.

If your customer is in the service, the court will appoint an attorney to represent them. They will attempt to locate the customer and cannot waive any defense they have if they cannot locate them.

If the court is not able to determine if your customer is in the service, it can specify the amount of a bond that you will need to obtain before a judgment will be entered.  If the customer is later found to be in the service, the bond will be available to indemnify the customer against any loss or damage suffered by reason of the judgment in the event it is set aside in whole or in part.

Upon a motion of the customer’s attorney, or upon the court’s own motion, a stay of proceedings of 90 days will be granted if there may be a defense and it can’t be presented without the defendant, or the customer’s attorney can’t reach them to determine if there is a good defense.

Under Section 3932, when your customer is in the military or is within 90 days after discharge/release, but you are able to serve notice upon them and have done so, the court may stay the proceedings for not less than 90 days when a letter or other communication from the customer outlines how their military duty materially affects their ability to appear before the court and states a date when they will be available. Alternatively, the customer’s commanding officer may indicate that their military duty prevents their appearance and leave is not currently authorized.

An additional stay may be granted when the customer cannot appear. No time limit is specified for this. If the court refuses to grant the stay, an attorney will be appointed by the court to represent the customer.

Past actions indicate that when the 90-day stay expires the court will evaluate the servicemember’s needs and responsibilities and could allow the repossession or could require reimbursement of some or all of the payments already made. It could renew the stay (a distinct probability if the servicemember is currently unable to attend court), or may order an equity payment. This means the bank would be required to compensate the servicemember for the difference between the value of the car and the balance of the debt before repossessing the car. Paying back a past due borrower can be a hard pill to swallow but the SCRA is intended to protect the servicemember and will typically not favor the bank.

Staying out of SCRA problems is the easiest way to avoid swallowing that pill. Having a sound policy and procedures is the start, along with effective training. It was noted that Hudson Valley Credit Union did not have a policy prior to 2014. Not having a policy is a common thread in the DOJ enforcement actions. If your bank does not have one, it should. Customers indicating they are potentially covered by the SCRA should be reviewed. In the Hudson Valley case, the DOJ noted that two requests for SCRA protections were denied. One servicemember was serving in South Korea but his girlfriend contacted Hudson Valley “multiple times” and while the bank, or credit union in this case, can require a copy of the orders, being aware of SCRA protections should have caused precautions. Another servicemember claimed to have contacted the CU to request relief from his monthly payments before starting a six-month deployment. He claimed his car was then repossessed without any court order and sold at auction. He was billed $16,700 for the repossession costs.

Does your bank required orders from the servicemember to categorize them as “covered?” Alternatively, many banks verify the status of a customer by comparing that customer’s information (individually or by batching the Central Information File) to the database maintained by the Department of Defense. The banking agencies expect banks to use the Defense Manpower Data Center (DMDC) database. The DMDC database has improved and recent changes to the SCRA provide a safe harbor when using this, so keep your records of the search.

In the Hudson Valley case the DOJ initially found nine accounts from July 2008 until February 2014 that violated the SCRA prohibitions on repossession without court order, but proceeded on only seven cases. Six of the seven servicemembers will receive $10,000 and compensation with interest. The remaining servicemember had the car returned within a day of the repossession and will receive $5,000. Hudson Valley Credit Union is also paying a $30,000 civil money penalty as a part of the DOJ settlement agreement and will provide SCRA training to its employees. Additionally, it will report to the DOJ any SCRA complaints received, which you can imagine will be scrutinized extensively.

Reconsider the above and focus on the fact that the case was filed in 2016, and the DOJ went back through files to at least 2008. The SCRA policy did not exist at that time and that was a consideration in the enforcement action. Being proactive helps mitigate risks. All banks should implement consistent procedures for determining when someone is eligible for benefits under the SCRA. Some benefits apply to pre-service obligations, some to pre- and post-service.  Remember that commercial accounts are included in SCRA protections, but not under the Military Lending Act so separate the two or draw a distinction when needed. Be aware of rules applicable to reservists getting orders who do have some protections, but not all.

Design your foreclosure and repossession procedures to ensure counsel and bank employees are following all requirements, to include completion of all background research and proper notice as required.

If your SCRA policy, procedures or training are weak, you can only change the present and future.

Privacy – Reg. P update

By Andy Zavoina

The Bureau of Consumer Financial Protection issued its final rule to adopt changes to Regulation P. This was issued in August 2018 and was finalized in September (link is below). Reg P has the requirements under which banks issue privacy notices to its customers. This final rule implements new timing requirements for sending annual privacy notices regarding banks who no longer qualify for the exception and eliminates the “alternative delivery” option for annual privacy notices.

The new rule creates an exception permitting banks to not send an annual privacy notice under limited circumstances. Banks sharing only non-public personal information with nonaffiliated third parties and have no obligation to provide an opt-out will benefit from the final rule.

The changes are intended to align Reg P with the 2015 changes to the Gramm Leach Bliley Act (GLBA). Under this Act, banks were required to send a privacy notice to all customers every 12 months without exception. The law changed, and many banks changed at that time, but now Reg P has been updated as well. The final rule created an exception so that banks meeting two conditions will be exempted.

(1) The bank only shares nonpublic personal information with nonaffiliated third parties where there is no obligation to offer an opt-out.

(2) The bank must not have changed its “policies and procedures with regard to disclosing nonpublic personal information” from the policies and procedures outlined in the most recent privacy notice sent to the consumer.

Under the GLBA, there is no requirement to provide an opt-out notice to customers where personal information is shared with:

  • service providers performing functions on the company’s behalf,
  • non-affiliated third parties who perform joint marketing on the bank’s behalf; or
  • if the disclosure is necessary to “effect, administer, or enforce a transaction.”

This exception only applies to annual privacy notices and does not impact the requirements for providing the initial privacy notices or amended notices when a change is made.

The final rule also adopted new timing requirements for issuing annual privacy notices. If your bank has made changes to its privacy policies and procedures and no longer qualifies for the exception, the timing requirements are to issue an annual privacy notice either before implementing those changes or within 100 days after adopting a policy or practice that eliminates the notice, when the changes did not trigger a required delivery of a revised privacy notice.

Lastly, the Bureau eliminated the “alternative delivery” method for annual privacy notices. Under the “alternative delivery” method, banks were permitted to meet the annual privacy notice requirement in certain circumstances by posting a copy of the annual notice on their websites. The Bureau recognized that many of the requirements permitting the “alternative delivery” method were the same as the requirements to qualify for the new annual privacy notice exception and, therefore, the method was now considered moot.

We have recommended following the revised GLBA since it was enacted, and we have not heard of regulators conflicting with that. But the Reg P final rule now makes it official and clear.

Notes on beneficial ownership

By John S. Burnett

When we last visited this topic in August, FinCEN’s second temporary exceptive relief was about to be issued. Then, on September 7, 2018, just as a 30-day temporary administrative ruling was ending, FinCEN issued Ruling FIN-2018-R004, “Exceptive Relief from Beneficial Ownership Requirements for Legal Entity Customers of Rollovers, Renewals, Modifications, and Extensions of Certain Accounts” indicating it is permanent (at least until it changes).

BSA and compliance officers jumped all over the newest ruling, hoping it answered their concerns about renewals and rollovers. And they quickly realized that FinCEN’s “exceptive relief” wasn’t the panacea they had hoped for. And, as is always the case, the definitions are where the keys to FinCEN’s ruling are found.

In the opening paragraph of the ruling, FinCEN gave us fair warning that there is a “catch” involved. In fact, it would be fair to say that FinCEN carved out exceptions from its exceptive relief.

Certificates of deposit

The first item to receive exceptive relief is listed as a “rollover of a certificate of deposit (as defined below).” That sent readers of the ruling to the page 3, where FinCEN tucked away its definition (I’ve included in brackets a footnote that’s part of the definition):

“For purposes of this Ruling, a certificate of deposit (CD) is a deposit account that has a specified maturity date, but cannot be withdrawn before that date without incurring a penalty. [The definition of “CD” for the purposes of this Ruling differs from the definition of “time deposit” in Regulation D of the Board of Governors of the Federal Reserve System (Reserve Requirements of Depository Institutions, 12 CFR Part 204); see 12 CFR 204.2(c)(i).] During the term of the CD, a customer cannot add additional funds to the CD. The term of a CD may vary from a week to several years. At the end of the term, when the CD matures, the customer is entitled to the amount deposited and any interest that has accrued; the customer may also have the ability to elect to either renew or close the account. Typically, the account will automatically renew absent affirmative action by the customer to close the account.”

The sentence in bold italics excludes any CD account that a bank allows the depositor to add to during its term. That’s probably not a crippling exception, but it does mean that banks need to be careful they aren’t applying the FinCEN exceptive relief to a CD that doesn’t qualify for it.

Loans and lines of credit

The next two types of accounts receiving exceptive relief are renewals, modifications or extensions of a loan or commercial line of credit or credit card account. For starters, most bankers had felt that loan modifications or extensions weren’t new accounts at all, so it was a bit of a surprise seeing them itemized as something getting exceptive relief. But it’s the limitations placed on the exceptions that warrant careful attention. In these cases, the description of these credit accounts on the very first page of the ruling create some very broad exclusions from the types of “renewals, modifications and extensions” that get exceptive relief:

  • “A renewal, modification, or extension of a loan (e.g., setting a later payoff date) that does not require underwriting review and approval;
  • A renewal, modification, or extension of a commercial line of credit or credit card account (e.g., a later payoff date is set) that does not require underwriting review and approval

How many business loans does your bank make that can be renewed without additional underwriting or approval? They would have to be loans written with an understanding up front that they would be renewed, perhaps as seasonal inventory is liquidated. But an extension or modification? Either would almost always require underwriting, approval or both.

Safe deposit box rentals

I was in the camp that never thought that safe deposit rental renewals were new accounts. But apparently FinCEN felt they were, but they gave exceptive relief on them anyhow. No strings on this item (not that it comes up often).

So, the industry got exceptive relief, but not everything it hoped for. There is apparently some discussion at FinCEN about taking another look at the subject to see if there is anything else it can include in the exceptions, but we’ll just have to keep our eyes peeled and hope for the best. In the meantime, banks need to make sure they don’t overstep in their adoption of the exceptive relief in their policies and procedures.

Estate accounts

The question of whether decedent estates are legal entity customers subject to the Beneficial Ownership rules has come up a few times in the last several months. Apparently, there is a belief that estates register with the state and obtain EINs, so they must therefore be legal entity customers. That’s simply not the case.

While it is true that an estate is a different legal “person” from the individual who died, an estate is not an entity like a corporation or LLC. Estates don’t register with the Secretary of State (or similar public state office) to be created; they are “created,” if you will, by the death of an individual. If they are to be probated, they file with the Probate Court. The Probate Court is part of a state’s court system, but it is not part of, or related to, the Secretary of State’s office. So, no, a decedent’s estate is not a legal entity customer under the Beneficial Ownership rules.

Single-member LLCs

The IRS, on its website, says that it treats a single-member LLC as a sole proprietor if it elects “disregarded entity” status for taxation purposes. So, if the IRS says it’s a sole proprietorship and sole proprietors are excluded from the Beneficial Ownership rule, then banks can exclude single-member LLCs, right?

WRONG! First, because not all single-member LLCs elect “disregarded entity” status. Next, the IRS treating an LLC as a sole proprietor for tax purposes doesn’t make it a sole proprietor under the law, and certainly not under FinCEN’s Beneficial Ownership rules. This is like the old flawed suggestion that a single-member LLC can have a NOW account because the IRS lets it use the single member’s SSN.

Depending on IRS rules to determine whether a customer is a legal entity customer under the Beneficial Ownership rules is like consulting a physics professor about brain surgery. You could live to regret it!