Maryland Legal Alert for Financial Services

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Maryland Legal Alert - December 2023

In This Issue

Syndicated Loans Not Treated as Securities

CFPB Consent Order Involves RESPA Violations

New Regulations Concerning Canceled Treasury Checks


Syndicated Loans Not Treated As Securities

A recent decision from the U.S. Court of Appeals for the Second Circuit held that loan notes representing parts of a syndicated loan are not “securities” under the federal and state securities laws. 

In Kirschner v. JP Morgan Chase Bank, N.A., the borrower’s bankruptcy trustee sued the lenders alleging violations of the federal and state securities laws in the syndication of the loan made to the borrower.  The Court dismissed the suit, holding that the syndicated notes were not a “security.” The Court relied upon the holding of the U.S. Supreme Court in Reves v. Ernst & Young that a promissory note is not a security if it bears a strong resemblance to one of the categories described in the Securities Act of 1933, as amended, as not being securities.  This is referred to as the “family resemblance test.” 

In the Reves case, the Supreme Court held that a presumption exists that notes are securities.  However, a court must determine whether the note was issued as an “investment” and therefore would be a security, or if the notes were issued in a “consumer or commercial context” and therefore not a security. The analysis must focus on four factors: (1) the motivations that would prompt a reasonable seller and buyer to enter into the transaction; (2) the plan of distribution of the notes; (3) the reasonable expectations of the investing public; and (4) the existence of another regulatory scheme that would reduce the risk of the instrument, thereby rendering application of the Securities Act unnecessary.” 

  • As to the first factor, the court found that the motivation actually supported the claims that the notes were securities because they were investment-oriented, although the borrower’s motivation was commercial because it planned to use the note proceeds for corporate working capital purposes;
  • Nevertheless, the remaining factors militated against finding that the notes were securities.  The plan of distribution was directed only to sophisticated institutional entities and the notes were unavailable to the general public;
  • Regarding the third Reves factor, the reasonable expectations of the investing public, the entities that bought the notes were given ample noticed that the notes were loans and not investments in a business enterprise.  In fact, the note purchase documents had the lenders certify that they were sophisticated and experienced in extending credit, and that they had made an independent appraisal of the loans;
  • In assessing the fourth factor, the presence of another regulatory scheme that reduced the investment risk, the court noted that the notes were secured by collateral, thereby ameliorating the risk, and that federal regulators had issued specific policy guidance regarding syndicated loans.

If the court had found that loan syndications are securities, this would have significantly disrupted the commercial loan markets. The Second Circuit’s decision should assuage these immediate concerns and provide further guidance to lenders and borrowers seeking to minimize the risk of having loans classified as securities in the future. 
For questions concerning this topic, please contact Abba D. Poliakoff.  

Contact Abba D. Poliakoff | 410-576-4067  

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On August 17, 2023, the Consumer Federal Protection Bureau (CFPB) issued a consent order finding that a mortgage originator violated Section 8(a) of the Real Estate Settlement Procedure Act (RESPA) and its implementing regulation, Regulation X.  RESPA prohibits giving things of value or “illegal kickbacks” in exchange for business referrals for a settlement service involving federally related mortgage loans. In this case, the CFPB found that for five years the mortgage originator provided free subscription services to real estate brokers and agents for a particular real estate brokerage firm. These services provided access to information about property reports, sales comparables, and foreclosure data. Over 2,000 real estate agents were provided access to this subscription service. Additionally, the mortgage originator subsidized admissions to social events (e.g., sporting events and galas) and paid monthly marketing services agreement payments in exchange for referrals. The consent order also noted that in some cases, real estate agents made more than 1,000 mortgage referrals. The CFPB explained that the actions of the mortgage originator demonstrated a pattern of giving items of value with the intent to “create, maintain, and strengthen mortgage referral relationships.”   As a consequence, the mortgage originator was required to cease its unlawful practices and pay a $1.75 million civil penalty. The real estate brokerage involved was also penalized for accepting the valuable items and ordered to pay a $200,000 civil penalty.

Practice Pointer: Following the issuance of the consent order, the CFPB released RESPA compliance guidance, further outlining which activities the CFPB considers illegal kickbacks that are prohibited under RESPA. Regulated institutions should review company policies and practices regarding gifts and promotional activities to ensure compliance with RESPA in accordance with these guidelines.

For more information concerning this topic, please contact Christopher R. Rahl or Tamia J. Morris.

Contact Christopher R. Rahl | 410-576-4222

Contact Tamia J. Morris | 410-576-4021

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New Regulations Concerning Canceled Treasury Checks

The United States Treasury Department (Treasury) recently updated federal regulatory requirements concerning how financial institutions process U.S. Treasury checks.  The changes were effective on December 1, 2023, and impact what financial institutions must do when negotiating Treasury checks and what promises they make to the Treasury when obtaining payment.  The new regulatory provisions require financial institutions to check information from a Treasury-specified database maintained by the Federal Reserve (FRB) concerning canceled or fraudulent Treasury checks. The regulatory release indicates that Treasury’s Fiscal Service arm is working to get this “cancelled check” information to the applicable FRB database faster so financial institutions will have the information before paying Treasury checks.  The new regulations will give Treasury more leeway to pull funds back from a financial institution if it does not make “all reasonable efforts” to ensure that a Treasury check is valid (has not been previously negotiated or cancelled).  Treasury will have the right to pull back funds on Treasury checks where a financial institution failed to check the applicable FRB database information and where Treasury has notified the FRB that a check is not valid.

For questions about this topic, please contact Christopher R. Rahl or Natalie C. Gibson.

Contact Christopher R. Rahl | 410-576-4222

Contact Natalie C. Gibson | 410-576-4029

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