Follow the Money: The Connection between Terrorism and Banking

Two developments on this topic:

1.  Yesterday the 2d Circuit handed down its decision in In re Arab Bank, PLC Alien Tort Statute Litigation,  The plaintiffs were non-US citizens who sought compensation for injuries caused by terrorist attacks in Israel between January 1995 and July 2005.   The plaintiffs brought their claims under the Alien Tort Statute (ATS), 28 U.S.C. sec. 1350 ("[t]he district courts shall have original jurisdiction of any civil action by an alien for a tort only, committed in violation of the law of nations or a treaty of the United States and federal common law").  Their claims were against Arab Bank, PLC, which has its headquarters in Jordan and branches around the world, for its alleged role in facilitating the banking activities of organizations who caused plaintiffs' injuries.  Arab Bank's branch in New York provides clearing and correspondent banking services to foreign financial institutions.   

The Second Circuit's opinion provides fascinating details about how Arab Bank allegedly and knowingly maintained accounts that customers used to raise funds for terrorist organizations, laundered funds for a purported charitable organization that was really a front for a terrorist organization, and maintained accounts for known  terrorists and supporters.  The plaintiffs also alleged that Arab Bank knowingly and actively organized banking services to transfer funds from terrorist groups to the families of suicide bombers, routing transfers through its New York branch to convert Saudi currency to Israeli currency.  Plaintiffs allege that after the accounts were funded, the Bank provided instructions to the public on how to qualify for and collect the money.

The district court dismissed the claim against Arab Bank on grounds that under Kiobel v. Royal Dutch Petroleum Co., 621 F. 3d 111 (2d Cir. 2010)(Kiobel I), the ATS does not permit claims against corporations.  On appeal, the plaintiffs argued that the 2d Circuit's decision in Kiobel I was overruled by the Supreme Court when it affirmed Kiobel I three years later on other grounds, 133 S.Ct. 1659 (2013)(Kiobel II).  The legal issue in Kiobel I was the scope of liability recognized by the "law of nations" referred to in the ATS.  The panel concluded that the ATS does not permit claims against corporations because corporations have never been subject to any form of liability under customary international law of human rights.  One of the three judges on the panel, however, filed a separate opinion concurring in the judgment but disagreeing with the panel's conception of the "law of nations" as invariably precluding action against a corporate actor.   In his view, the ATS does not prohibit corporate liability per se.  Rather, because the "law of nations" does not specifically address the issue of corporate liability, the scope of liability under the ATS should be considered a question of remedy governed by domestic law.  The Supreme Court in Kiobel II affirmed the 2d Circuit's dismissal but on extraterritoriality grounds-- the alleged banking conduct does not sufficiently "touch and concern" the territory of the United States to invoke the subject matter jurisdiction of the federal courts.

In In re Arab Bank, the 2d Circuit held that Kiobel II "casts a shadow" on Kiobel I.  On the question of extraterritoriality, the Court held that because corporations are "present" in many countries, corporate presence alone is not sufficient to displace the presumption against extraterritorial application of US law.  Because the Court in Kiobel II noted that mere corporate presence alone is insufficient to support subject matter jurisdiction, the obvious implications are that corporate presence plus something more may be sufficient and that the ATS does permit suits against corporations under some circumstances.  The Second Circuit noted that Kiobel I and II read together would limit application of the ATS to an extremely narrow set of circumstances-- suits against natural persons and perhaps non-corporate entities, based on conduct occurring at least in part within (or that "touches and concerns") US territory.  Because corporations are "among the more important actors on the world stage" this narrow reading of the application of the ATS may be inconsistent with the intent of Congress to provide access to US courts for injured aliens when more than two centuries ago it passed the ATS.  The Second Circuit noted that Kiobel II "may be viewed as casting doubt on Kiobel I, even though Kiobel II does not squarely address the issue of corporate liability under the ATS.  Nonetheless, it declined to conclude that Kiobel II overruled Kiobel I, setting up the question for an appeal to the court en banc and likely to the Supreme Court. 

The decision protects Arab Bank from claims under the ATS, but the protection is precarious.  Banks are intensely interested in the answers to two questions implicated in this litigation:  1) whether corporations can be liable under the ATS; and 2) whether "corporate presence" of a bank is sufficient for subject matter jurisdiction over it. The Institute of International Bankers filed an amicus brief in In re Arab Bank before the 2d Circuit in support of the defendant, arguing that bank clearing operations conducted in New York should not be enough to support jurisdiction over a foreign bank.  It noted that more than $1 trillion in foreign currency exchange transactions clear through New York City every day.  Recognizing this clearing function as "presence" in the US would subject foreign banks to suit in US courts whenever their provision of banking services to customers abroad included clearing operations in the US. 

2.  Closer to home, the gunman in the recent San Bernadino massacre had applied for and received a loan from online lender Prosper Marketplace, Inc. a few weeks before he and his wife opened fire at their office holiday party.  Criminal investigators are looking at a $28,000 deposit in the gunman's bank account likely to determine if he used it to buy weapons or ammunition.  Prosper is an online lending platform that matches up borrowers with lenders. The loans are actually provided by WebBank, a Utah-based bank.  Federal law requires both the gunman's bank and WebBank to "know their customers" and report suspicious transactions.

The online marketplace lending industry is in its infancy and federal regulators are considering how to regulate it.  It's clear that consumers who need cash fast like online lending as a faster, easier, and more anonymous alternative to traditional credit card debt or bank loans.  One capital market analyst told Bloomberg News that the connection between online marketplace lending and the San Bernadino shooter could be a "game changer" in the development of regulations.

Super Chapter 9: Treasury's Plan for Puerto Rico

Last week the Treasury Department provided its recommendation for a federal response to Puerto Rico's debt problem. It says that Congress should pass the chapter 9 extension bill for the benefit of Puerto Rico's municipal debtors who are responsible for about a third of the total debt. Congress should also authorize a "broader legal framework" that goes beyond relief for municipalities and that would cover all of Puerto Rico's debt. This process should be reserved exclusively for U.S. territories (states could not use it). The framework would provide the basic protections of a bankruptcy proceeding:  a stay on creditor collection action, priority for new, private short-term finance, and voting by creditor class on any proposed restructuring. Treasury does not mention cram down, but that would surely be included among the "basic protections" of bankruptcy.

Regarding a judicially supervised bankruptcy proceeding, Treasury notes that more than 20 creditor groups have already formed, making it "very difficult" for the Puerto Rican government to negotiate a voluntary restructuring in time to prevent a complete collapse. Without an orderly process, the alternative is default followed by "numerous creditor lawsuits and years of litigation" which would "depress the local economy, increase costs, and make long-term recovery harder to achieve."

The proposal has been dubbed a "super chapter 9."  One observer who is an economics professor and a Puerto Rican bondholder said that super chapter 9 legislation would be a de facto amendment of the Puerto Rican Constitution by Congressional fiat and an affront to the sovereignty of the Puerto Rican people.

At a Senate  Committe on Energy and Natural Resources hearing last Thursday, the reaction of senators was a mixed bag. Senator Warren used the occasion to urge Treasury to "step up and show more leadership," It's not clear what she had in mind for Treasury to do, but she did challenge the department to be "just as creative" in finding solutions as it was when several investment banks failed or were near failure during the 2008 financial crisis.  Senator Sanders said that Treasury should call a meeting with the unions and "all the players" in Puerto Rico including creditors (who he called "vulture funds") and just work something out.  Sanders and Warren both emphasized that any solution should not protect investors at the expense of  Puerto Rican workers.  Senator John Barasso (R.Wyo) asked about the impact of a haircut for bondholders on the people of his state-- whose pensions are invested in mutual funds that hold Puerto Rican bonds.  Short answer is if the bond investors take a hit, the pain will be felt by voters in Wyoming. The webcast of the hearing is available here.

Except for US Government Backed Debt

The Congressional budget deal includes a rider that would permit cellphone robocalls to collect debt owed to or guaranteed by the government, including federally guaranteed student loans, FHA mortgages and federal taxes.  The rider would amend the Telephone Consumer Protection Act (TCPA) that bans such calls except with the advance written consent of the borrower. The Obama administration supports the rider.  The Department of Education argues that with the ability to robocall borrowers, it will be in a better position to help borrowers avoid late payments. The FCC administers the TCPA.  It has declined to comment on the budget rider.

Losing by Winning: Campbell-Ewald v. Gomez

The Supreme Court heard argument yesterday in Campbell-Ewald v. Gomez.  The question  is whether defendants in class action litigation can make the case moot by offering the plaintiff class representatives cash for all damages they could possibly win in court.  Defendants' argued that because they've made the offer for full compensation, plaintiffs have nothing at stake in the litigation (the case is "moot") even though they reject the offer.  The Constitution in Article III limits the power of the judicial branch to deciding "cases or controversies."  Issues where the litigants have no stake in the outcome of the proceeding are neither.

The class action litigation for which Gomez is the plaintiff class representative involved alleged violation of the Telephone Consumer Protection Act.  Gomez, claims that he and 100,000 other people received text messages from one of the defendants in violation of the Act.  The Act provides damages to consumers of $500 per violation. The defendants offered to pay Gomez triple the $500 for each text he received.  That's just not good enough for Gomez's lawyers who want a right to pursue damages plus attorneys fees on behalf of the plaintiff class.  The defendants raised the mootness issue all the way to the Ninth Circuit, which held that Gomez still had the requisite stake in the case.

Based on their questions, the justices understand the significance of this case to the plaintiffs-side class action bar. Justice Sotomayor made her view clear-- the plaintiffs are entitled to their day in court and their lawyers are entitled to class certification and fees.  She quipped to counsel for defendants:  "What's an Article III determination is whether [the plaintiff] is entitled to the relief that they asked for.  May well be they're not. But they are entitled to have the Court say it, not you." Justice Breyer asked counsel for the plaintiff class why the defendant couldn't just tender cash to the court and let the court distribute the cash to people who received the improper text messages.  Plaintiffs' counsel answered that even then the case would not be moot because the plaintiff would not have a judgment.  Breyer's response was not sympathetic-- "Give him a judgment-- who cares?"  Obviously, it's the lawyer who wants the  class certified who cares.  His chance for attorneys fees, typically calculated as a percentage of the settlement, is all that is at stake.  Justice Roberts nailed it:  "Oh well, that's the whole thing, right? This is all about class certification."

Here's Ronald Mann's fascinating roundup of the argument on this issue on Scotusblog.   Mann thinks that key voters Breyer and Kennedy might favor a middle ground position which would recognize a way for a defendant to moot a class action case (and save attorneys fees) by conceding liability and paying full damages in cash into the court.  But he's not predicting how the Court will rule.

A side note on the Telephone Consumer Protection Act:  In August 2014,Capital One and three collection agencies agreed to pay $75.5 million to settle and end a class action alleging that the companies used an automated dialer to call consumer's cell phones without their consent in violation of the Act.  The proposed agreement would pay about $20-40 per class member (about 21 million people).  The class consisted of all people who received an automatic dialer call to collect credit card debt between January 2008 and June 2014.  About 30% of the fund, $22.5 million, went to the attorneys for the class.  After the Capital One case settled, the FTC enacted new rules which now require an for-profit business to acquire "prior express written consent" before making any call or text using autodialers or prerecorded voices to cellphones.

Puerto Rico and US Treasury Consider a Treasury-Assisted Workout

WSJ reported  yesterday that Puerto Rican government representatives and US Treasury Department officials talked about a plan to workout Puerto Rico's $72 billion debt problem.   According to WSJ, the plan involves creation of a "lockbox" account set up and presumably controlled by Treasury into which some of Puerto Rico's tax revenue would be deposited.  Puerto Rico would issue a superbond which Treasury will administer.  I presume that the new bond would be secured by the funds on deposit in the account and backed by the issuer, but not the U.S. Treasury.  To make the deal work, most or all creditors would have to agree to exchange current debt on a "cents on the dollar" basis, reducing the total principal balance of Puerto Rico's debt.  The "haircut" in exchange for the superbond could be an attractive option relative to the alternative.

Yesterday, Treasury confirmed that it met with Puerto Rico's governor to talk about the federal government's possible role in providing assistance.  It denied that the federal government was talking about undertaking any of Puerto Rico's obligations, or in any way providing a "bailout."

The idea of a US-assisted workout for Puerto Rico's public debt is intriguing.  But, it faces long odds. An obvious issue is achieving consent among a diverse group of creditors with different investment strategies and payout priorities-- always a challenge in restructuring debt outside of bankruptcy. Another issue is the challenge of collecting tax from Puerto Ricans.  The territory has a large untaxed underground economy and local taxing authorities are not always transparent in the way they account for tax revenues.  If Puerto Ricans don't pay their own taxes now, compliance is not likely to improve when the tax collector is the IRS.

Plaintiffs' Lawyer Protection Bureau

Andy Pincus, partner at Mayer Brown called out the CFPB's proposed framework for arbitration terms for putting the interests of trial lawyers ahead of consumers.  His essay appears is on the U.S.Chamber of Commerce page.

He notes that based on the CFPB's own study, 251 settlements with 34 million class members yielded a total of $1.1 billion from defendants, for an average payment of about $32 per consumer.  Plaintiffs' lawyers in these cases yielded about $1 million per case in fees.  He notes with understatement:  "No wonder these lawyers are so eager to be able to bring class actions."  He also takes the CFPB to task for offloading to plaintiffs' lawyers their responsibility to protect consumers through rule making and enforcement actions.  

Almost the End for Class Action-Barring Arbitration Terms?

Yesterday, the CFPB published an outline of its proposed framework for regulation of arbitration agreements in contracts for consumer financial products like credit cards, auto leases and loans, residential mortgages and prepaid cards. Under the proposal, arbitration clauses in consumer financial contracts could be enforceable against an individual litigant, but must expressly state that they are not enforceable against a plaintiff class. CFPB Director Richard Cordray called arbitration terms a "free pass" for companies who use them to escape liability for profitable practices that harm consumers

The CFPB's March 2015 study  estimated that terms which expressly prohibit judicially supervised class action currently appear in tens of millions of contracts.  What about the economic impact of consumer protection regulation that opens consumer financial services providers to a barrage of class action lawsuits, including claims of disparate impact discrimination?  Apparently, that is someone else's problem:  "The Bureau understands that class lawsuits have been subject to significant criticism that regards them as an imperfect tool that can be expensive and cumbersome for all parties. However, the Bureau notes that Congress, state legislatures, and the courts have mechanisms for managing and improving class procedures over time."

Any final rule on consumer arbitration terms would apply to contracts made more than 180 days after the effective date of the regulation.  The CFPB's proposal is still subject to a review by a small business panel under the consultative process required by the Small Business Regulatory Enforcement Act.

EMV Liability Shift Deadline is Today

Today is the day.  Liability for "card present" fraud shifts to the party who is the least EMV compliant in the transaction.  I warned you this was coming last month.  I've got my chip card ready to go.  So far, the only place that takes it is Target.

1.2 billion credit and debit cards and 12 million terminals need to be upgraded to be EMV compliant, and that is going to take awhile.  About 40% of retail locations will be EMV compliant by the end of 2015.  About 60% of credit cards and 25% of debit cards will be compliant by the end of 2015.  It costs about $3.50 to issue a new EMV compliant card.  And, the average cost for an EMV compliant point of sale terminal is between $500-$1,000.  (Source is Creditcards.com).

33 Million Still Uninsured

According to Census Bureau reports issued in September, 33 million people, 10.4% of the U.S. population didn't have health insurance coverage during 2014.  4.5 million of these uninsured were children.  The reports show that most of these uninsured people could have had access to coverage under the Affordable Care Act or otherwise, but they chose not to sign up.  FiveThirtyEight.com has great graphics and story that offers an analysis.   The Census Bureau's Sept. 16 press release with links to its reports is here.  Excluding immigrants and people in the "medicaid gap" who are low income but don't qualify for a subsidy, about 22 million people are uninsured and more than a third of them are young adults between 19 and 34.

The Census Bureau reports that in 2014, there were 46.7 million people in poverty (14.8%).  The 2014 data shows no statistically significant difference in either number or rate from 2013 estimates, The percentage of people without health insurance coverage during 2014 was 10.4%, down from 13.3% in 2013.

Banks Are Still Holding Lots of Bad Loans

Seven years after the start of the financial crisis, banks are still holding big distressed loan portfolios. FDIC reports that as of June 30, 2015, non-current loans and other bank owned real estate totaled $162 billion.  That's a 63% decrease from mid 2010.  But it's nearly three times the $56 billion banks reported just before the crisis in mid 2006.

Why banks have held onto so many bad loans is not entirely clear.  One explanation might be that low interest make alternative investments relatively unattractive.  Non-current loans that are paying something may be more attractive than a sale to a distressed debt buyer and reinvestment of cash into low yielding alternative investments.  Many banks are holding non current loans because they are required to do so as part of loss sharing agreements with the FDIC. 

Inspector General's Report on the FDIC's Role in "Operation Choke Point"

The Office of the Inspector General's just released report is here.

Excerpt:  "We determined that the FDIC’s supervisory approach to financial institutions that conducted business with merchants on the [DOJ's] high-risk list was within the Corporation’s broad authorities granted under the FDI Act and other relevant statutes and regulations. However, the manner in which the supervisory approach was carried-out was not always consistent with the FDIC’s written policy and guidance."

Consumer Debt Negotiation: Is it Practice of Law?

Earlier this week the Connecticut Supreme Court held that Connecticut bank regulators must  keep their hands off lawyers who offer consumer debt negotiation services because the Connecticut constitution gives the judicial branch exclusive authority to regulate attorneys engaged in the practice of law.  The case is Persels & Assoc. LLC v. Banking Comm'r, 2015 BL 289966 (September 15, 2015).

Persels & Associates is a Maryland-based consumer advocacy law firm that offers assistance to consumers nationwide who are behind on their debts.  The case was about the effect of a Connecticut debt negotiation statute that authorized the Banking Commissioner to require attorneys who provide "debt negotiation services" to comply with licensing and registration requirements.  The statute was passed after the housing bubble burst in 2009 in response to the large number of consumer complaints about debt negotiation firms that tricked debtors in to paying up-front fees but not performing any debt negotiation work and sometimes making a debtor's circumstances worse.  The statute provided that before providing debt negotiation services a person must first obtain a license from the Banking Department and be subject to approval of financial responsibility, character reputation, integrity and general fitness.  The statute gave the banking commissioner power to investigate any debt negotiation transaction and discipline anyone who violated the law, including revocation of a debt negotiation license, disgorgement of fees, and a civil penalty up to $100K.  In deference to the judicial branch's power to regulate attorneys, the statute originally exempted from the licensing requirement attorneys who are admitted to practice in Connecticut and who engage in debt negotiation.  Around the time the Connecticut legislature passed its debt negotiation law, other states enacted similar laws, and the FTC passed rules governing debt negotiation businesses as amendments to its Telemarketing Sales Rule.

In 2011, the Connecticut legislature amended the attorney exception so it applied only to a subset of attorneys "who engage in or offer debt negotiation services as an ancillary matter to such attorney's representation of a client."   The 2011 amendment was passed to respond to a shift in the debt negotiation industry toward a model that used attorneys superficially to exempt the debt negotiation business from regulation that otherwise applied.  The commissioner observed:  "In many cases, newly admitted attorneys are employed by national debt negotiation firms and consumers are charged excessive fees for legal services that consist only of debt negotiation services."

In 2012, Persels & Associates asked the banking commissioner for a declaratory ruling to the effect that its method of offering debt negotiation services using Connecticut attorneys and persons supervised by them was within the exception from the license requirement.  The commissioner opened the matter to public comment which did not go well for Persels & Associates. Many of the comments accused Persels & Associates of misrepresenting its business model.  They said that the the firm does not engage in the practice of law, but rather is a debt negotiation company masquerading as a law firm solely to avoid consumer protection regulation.  Others pointed to the pile up of complaints, lawsuits and administrative enforcement actions against the firm in other states and to the FTC.  The commissioner declined to issue a declaratory ruling.  Instead, he determined that the attorney exception applies only to s a member of the Connecticut bar who "is not retained to perform, and does not perform, debt negotiation services. . . as the primary purpose of the representation.... "  The commissioner determined that because Persels & Associates uses non-lawyers (along with lawyers) to render debt negotiation services, it would need a license and would be subject to all the other provisions of Connecticut debt negotiation law.

Persels & Associates appealed and the Superior Court affirmed, finding that as a matter of law it was proper for the commissioner to construe the attorney exception to adopt a "primary purpose test" so that an attorney would not be entitled to the exception whenever debt negotiation is the primary purpose of the relationship with the client.  The Superior Court held that because debt negotiation does not constitute the practice of law, the attorney exception as construed by the commissioner, does not unconstitutionally delegate to the Banking Department the authority to license and regulate the practice of law.

The Connecticut Supreme Court reversed with respect to Persels & Associates' constitutional claim and the trial court's conclusion that debt negotiation services are not the practice of law.  It argued that the way the commissioner construed and applied the statute in its case, Connecticut's debt negotiation statute impermissibly intruded on the judicial branch's exclusive authority to regulate attorney conduct.  In particular, the debt negotiation statute as the commissioner interpreted it would give the commissioner authority to determine which Connecticut attorneys have the "character, reputation, integrity and general fitness" to provide debt negotiation services to a client in the course of representation, would require them to pay license fees to a legislative agency as a condition to offering legal services, and would encroach on the power of the judicial branch to suspend or disbar attorneys who engage in professional misconduct.  "No statute can control the judicial department in the performance of its duty to decide who shall enjoy the privilege of practicing law" and any attempt by the legislature to direct the rules that govern attorneys crosses the constitutional line between the judicial and legislative branches.

The court also agreed with Persels & Associates that debt negotiation services can be the practice of law.   The fact that a non-attorney may provide basic debt negotiation services in Connecticut without violating Connecticut's debt collection statute does not mean those services are not the practice of law when an attorney performs them in the course of an attorney client relationship. The  court concluded with a warning for debt negotiators and lawyers.  If the commissioner can establish in a particular case that a debt negotiation company was using Connecticut attorneys as a facade to circumvent the debt negotiation statute, "there would be no separation of powers problem" and the commissioner would be entitled to exercise his full statutory authority.  Attorneys who are engaged in debt negotiation and are not acting as attorneys fall outside the scope of the Rules of Professional Conduct and the exclusive regulatory authority of the judicial branch.  Moreover, attorneys engaged in debt negotiation who are acting as attorneys are subject to the Rules of Professional Conduct that preclude attorneys from charging an unreasonable fee for their services.  "We likewise trust that Connecticut attorneys, both newly admitted and experienced, will remain mindful of the potential ethical pitfalls they may encounter in this area of practice."

Another Banker Sentenced

United Commercial Bank was the first bank to fail after receiving TARP bailout funding from the federal government.  Last week, one of its top executives was sentenced to eight years in prison. Ebrahim Shabudin was convicted for falsifying bank records to hide bank losses from regulators. The failure of United Commercial Bank in 2009 cost the FDIC and US taxpayers more than $675 million. Here's the Washington Post story.   Here's a list of investigations undertaken by SIGTARP, a federal investigative task force set up to go after banks and bankers who misused TARP bailout finds.  

No Bankruptcy Relief for Marijuana Business

Marijuana sales for medical and recreational use is legal in several states.  But, it's a crime under federal law.  What happens when a marijuana business fails?

Frank and Sara Arenas owned a building in Denver with two units.  In one, Frank grew and sold marijuana wholesale.  He leased the other unit to tenants to dispense marijuana for medical use. The tenant sued Arenas over an issue with the lease and obtained a judgment against him.  Arenas filed for bankruptcy and the United States Trustee asked the bankruptcy court to dismiss Arenas's case.  (A US Trustee is an agent of the US Department of Justice responsible for monitoring bankruptcy cases for fraud and protect the integrity of the system). Although Arenas's medical marijuana business was legal under Colorado law, it violated the federal Controlled Substances Act (CSA).

The 10th Circuit BAP considered Arenas's case late last month.  Arenas v. United States Trustee (In re Arenas), 2015 Bankr. LEXIS 2821 (B.A.P. 10th Cir. Aug. 21, 2015):

The pivotal issue here is whether engaging in the marijuana trade, which is legal under Colorado law but a crime under federal law, amounts to "cause" including a "lack of good faith" that effectively disqualifies these otherwise eligible debtors from bankruptcy relief. We agree with the bankruptcy court that while the debtors have not engaged in intrinsically evil conduct, the debtors cannot obtain bankruptcy relief because their marijuana business activities are federal crimes.

 Arenas had argued unsuccessfully in his brief  before the BAP the hypocrisy of the federal government in tolerating Colorado's legalization of marijuana businesses. Twenty three states and the District of  Columbia have legalized medical marijuana use, while such use remains a federal crime.

Debtor Can't Explain Millions in Missing Protein Powder

Ultimate Nutrition, maker of Pro Star Ultimate Whey Powder, filed for chapter 11 bankruptcy last December in Hartford, Connecticut.  The debtor is in a headlock with TD Bank NA over a  $13 million loan.  Millions of dollars worth of powdered protein shake supplement ingredients are missing from Ultimate's warehouse and TD Bank is trying to find out what happened.  

TD has asked the bankruptcy court for an investigation into the whereabouts of the missing inventory.  Brian Rubino, Ultimate's CEO, says he destroyed the missing powder, about 40% of the company's inventory worth about $3.8, because it was "unsaleable."   Perhaps the powder was never really in stock, but Ultimate reported it to pump up its inventory.  Or, the powder is out there somewhere still subject to TD's lien.  The possibility that really scares me is that Rubino dumped the mountain of "unsaleable" powder into the Hog River that runs underneath the City of Hartford.

Not Too Big to Jail

Presidential hopeful Hillary Clinton said in a recent speech on economic policy that individual bankers should go to jail for their role in the 2008 financial crisis.  In May 2015, JP Morgan  and Citibank, along with several foreign banks, plead guilty to conspiracy to manipulate the foreign currency exchange spot market.  The banks agreed to pay criminal fines of $2.5 billion.   That's not enough justice for Ms. Clinton. Individuals must go to jail and she promised that they will on her watch.  

A Morning Consult poll in April 2015 showed that about 58% of Americans surveyed think individual bank employees should be prosecuted, convicted and imprisoned for financial crimes and 44 % said that criminal sentences and fines for financial institutions is not sufficient to deter "Wall Street" from engaging in financial misdeeds.  So far, although banks have taken a beating, no individuals have been jailed for unlawful conduct contributing to the 2008 crisis.  The reasons why we haven't seen video of Wall Street bankers in orange jumpsuits remain the subject of speculation and debate.

Last week, the U.S. Attorneys' Office for the Southern District of New York announced a guilty plea and jail time for a banker.  Charles Antonucci, Sr., former president of The Park Avenue Bank, was sentenced to 30 months for his role in a massive fraud involving self-dealing, bribery, embezzlement of bank funds, and a scheme to steal about $11 million from the Troubled Assets Relief Program (TARP), a federal program established in the aftermath of the 2008 crisis to help banks stabilize and address liquidity problems.  (The press release is a fascinating read for those interested in how to rob a bank without a gun).  It's not the widespread humiliation of individual bankers that so many Americans seem to want, but it proves that if the evidence is there, bankers are not too big to jail.

The Chips Are in the Mail: EMV Liability Shift in October 2015

A few weeks ago I got a new credit card with a microchip.  Last weekend, when I swiped it at Target, I got a lesson on how to use the microchip reader in the checkout line.  The new technology is called "EMV" which refers to a technical standard developed in the 1990's for payment instruments that store data on integrated circuits (chips) rather than magnetic stripes. The term comes from the names of the three companies that created the technical standards: Europay, Mastercard and Visa.  These three companies, along with JCB, American Express, China UnionPay and Discover formed a consortium managed by EMVCo.  The six member organizations work together with banks, merchants, payment processors and other stakeholders.

Use of chip technology reduces fraud relative to use of magnetic stripe technology because the chip permits "dynamic authentication" of the payment.  Put very simply, a magnetic stripe embeds a unique identifier, but all it does when swiped through a reader is show the identifier, which is always the same.  A dynamic authentication protocol authenticates the payment by computing a unique response to a challenge which uses both the data presented in the challenge (from the authentication server) and the secret data contained in the chip.   A thief can steal the credit card number, but without the chip-enabled dynamic authentication, the number is useless.

In August 2011, Visa announced its plans to implement the "Global POS (point of sale) Liability Shift Policy" for the US. For most counterfeit card fraud at a retailer's in-store locations ("card present" transactions), liability for an unauthorized transaction has always fallen on the card issuing bank and not the merchant. Effective October 1, 2015, the new policy shifts liability to the party in the payment process that has not made the investment in EMV chip cards or readers.  Each payment network (e.g., Visa, MasterCard, Discover) has its own rules, but they all implement the same cheaper loss avoider principle.  According to a paper by EMV Migration Forum that summarizes information collected from payment networks, the party supporting the most secure technology for each fraud type will prevail, and in the case of a technology tie, the fraud liability will remain with the card issuing bank. So, if the issuing bank hasn't switched to chip enabled cards, the issuer will bear the loss even if the merchant hasn't switched to a chip reader.  However, the merchant will bear the loss from use of data copied from a chip-enabled card if the data is used on a counterfeit card at the merchant's swipe card reader.  The merchant could have prevented that loss by switching to a chip reader that would have blocked approval of the counterfeit magnetic swipe transaction.

Chip technology will reduce counterfeit loss in "card present" transactions. But, it won't affect counterfeit fraud in "card-not-present" (CNP) transactions, e.g., via internet, mail (snail and e) and telephone.  So far, there is no single, simple solution to eliminate CNP fraud.  According to the EMV Migration Forum Card-Not-Present Working Committee, the best practice is multi-layered. The key is to authenticate the identity of the person who initiates the CNP transaction. The best practice is to adopt an authentication protocol that requires at least two of these three authentication factors:  1) ownership --something the authorized user has, such as a credit card; 2) knowledge -- something the authorized user knows (such as a PIN); or 3) inherence --something the authorized user is or does (such as a fingerprint).

Banks Beat Back New York City Regulation

The New York Bankers Association (NYBA) scored a win over the City of New York in federal court last week.  In NYBA v. City of New York,  the court granted NYBA's motion for summary judgment.  The District Court for the Southern District of New York found that City Local Law 38 (the Responsible Banking Act) was preempted by both federal and state law.   The RBA would have required New York banks to submit information to a community advisory board, which would in turn submit a report to the City Banking Commission for its consideration in deciding whether to permit the banks to accept any part of New York City's $6 billion in deposits.  The opinion sets out the long and fascinating history of the legislation through two mayoral administrations (Bloomberg who thought it was both misguided and preempted, and De Blasio who supported it).

Treasury Speaks to Puerto Rico's Debt Problem But Doesn't Say Much

Treasury Secretary Jack Lew sent a letter yesterday responding to questions posed by Sen. Orrin Hatch (R. Utah) about Puerto Rico.   Lew notes that the Obama administration is not considering a federal bailout for Puerto Rico. He said that returning Puerto Rico to a sustainable economic path requires "development of a long-term comprehensive fiscal plan" that addresses Puerto Rico's financial challenges (high unemployment, "labor market challenges" and high energy and transportation costs, "exacerbated by a history of less than adequate fiscal policy choices").  The plan must include input from stakeholders, be based on credible projections for revenue, expenses and growth, and include a "realistic and robust economic growth strategy that encourages new private investment, increases Puerto Rico's competitiveness, and strengthens its economic structure."  Lew said that Puerto Rico's situation requires "a collective action" and "the immediate attention of Congress."  Puerto Rico has about 18 different debt issuing entities that together owe about $72 billion.  Each entity's liability is unique based on the terms of individually negotiated and issued debt.

Puerto Rico's representative (non voting) in Congress has proposed legislation that would permit Puerto Rico's public bond-issuing entities to file for protection under Chapter 9 (H.R. 870). Chapter 9 of the Bankruptcy Code is titled "Adjustment of Debts of a Municipality."  Chapter 9 does not provide a way for a state government to adjust its debts.  Instead, only "a political subdivision or public agency or instrumentality of a State" (a "municipality") may be a debtor under Chapter 9, and only if the municipality is "specifically authorized... to be a debtor under such chapter by State law" or by a State officer empowered by State law to authorize it.  11 U.S.C. sec. 108(c) (requiring also that the debtor be insolvent, wants a plan to adjust its debts in Chapter 9, and has made an effort to work out the debt problem outside of bankruptcy).  The term "State" includes both D.C. and Puerto Rico "except for the purpose of defining who may be a debtor under chapter 9..."  11 U.S.C. sec. 101(52).  So, the proposed legislation amends current law to make Puerto Rico a State for purposes of access to Chapter 9 by Puerto Rican "municipalities". 

Even if Congress acts to amend 11 U.S.C. sec. 101(52) to open chapter 9 to Puerto Rico's municipalities, it's hard to imagine a bankruptcy court-supervised process that might yield economically and politically feasible plans of reorganization for Puerto Rico's municipalities.   Secretary Lew noted in his letter to Senator Hatch the mainland political issue ticking like a bomb within the Puerto Rican debt crisis.  Lew stressed that special bankruptcy legislation is not a "federal bailout."  And, he noted that a court supervised restructuring in a "tested legal bankruptcy regime" could mitigate "further harm [to] retiree investment portfolios across the country" that hold Puerto Rican debt.   More than 20% of mutual bond funds own Puerto Rican bonds according to Morningstar (377 funds out of 1, 884),  In 2012, Puerto Rican government agencies were the second busiest borrowers in the municipal bond market.  Only municipal bond issuers in California were busier.  (California's population is 10 times bigger than Puerto Rico's). Puerto Rican public agency bonds have long been popular because of high yields and triple tax exempt status (federal, state and local).  

How would municipal bond funds fare as creditors in chapter 9 relative to their chances outside of Chapter 9?  In Detroit's bankruptcy, bondholders were happy that the bankruptcy court ruled that union pension claims were not entitled to priority in payment, notwithstanding Michigan law which protected them.  (Contrast the preferred treatment United Auto Workers got in the GM restructuring in its June 2009 bankruptcy, which was achieved with significant Obama Administration intervention outside of bankruptcy.)   On the other hand, bondholders under Detroit's bankruptcy plan did take less than the full amount of their claims  and ultimately settled their objections to the confirmation of the plan on grounds it favored city pensioners over bondholders.  Even in a "tested legal bankruptcy regime" like Chapter 9, politically powerful groups can press their advantage and unlovable "Wall Street" creditors will absorb disproportionate pain.  

Several groups have considered Puerto Rico's financial situation and proposed in very general terms,  pathways out of the current financial disaster:  The New York Federal Reserve, Update on the Competitiveness of Puerto Rico's Economy (2014, updating 2012 report); Anne Kreuger, Rajut Teja, and Andrew Wolfe, Puerto Rico- A Way Forward (June 29, 2015); Centennial Group International, For Puerto Rico, There is A Better Way (July 2015).  The Centennial Group prepared its report for a group of hedge funds that hold Puerto Rican bonds.  Not surprisingly, the report recommended fiscal austerity and structural reform rather than write down of bond debt.

Senate Judiciary Committee Considers Dodd-Frank Act Constitutionality

The hearing on July 23, 2015 was entitled:  The Administrative State v. The Constitution:  Dodd-Frank at Five Years."  The Committee website has the testimony.

Student Loan "Abuses?"

The CFPB got Discover Financial Services to enter into a $18.5 million settlement to resolve CFPB's claims that its subsidiaries engaged in illegal student loan servicing practices.  Discover did not admit or deny the conduct alleged.  It just agreed to pay $16 million in compensation and $2.5 million in penalties to end the CFPB action against it.

News reports yesterday described Discover's conduct as  "harassment" and "lying" to student loan borrowers.  I thought it would be interesting to see exactly what CFPB alleged that Discover's subsidiaries did.  So I dug up the Consent Order.

In late 2010, Discover's subsidiaries acquired substantially all of Citibank's private student-loan portfolio (about 800,000 loan accounts) and took over as servicer on those loans.  Here is the misconduct CFPB alleged:

• With respect to the Citibank loans, Discover failed to notify borrowers properly of the amount of interest they paid on their loans for purposes of claiming a federal tax deduction.  CFPB conceded that Discover notified borrowers on their loan statements that they would not get a form 1098-E (reporting interest paid) unless those borrowers first submitted a form W-9S (certifying that the loan proceeds were used solely to pay for qualified higher ed expenses).  That wasn't enough, according to the CFPB, and was "likely to mislead borrowers into believing that they had not paid interest qualifying for the tax deduction...." 
• For some of the Citibank loans, Discover misstated the minimum amount due by improperly including in the minimum payment calculation interest accrued on loans still in deferment.  Apparently Discover credited all payments properly.  (The agreed redress for borrowers is an account credit equal to $100 or 10% of the overpayment up to $500 per borrower.)
• Between late 2010 and February 2013, Discover made about 150,000 collection calls at improper times (too early or too late) because, it appears, Discover timed its calls using only the time zone associated with the borrower's cell phone number area code rather than both the area code and the borrower's mailing address.  CFPB alleged "[o]ver 1000 consumers received dozens of calls at inconvenient hours."
• Discover engaged in collection activity with respect to 252 of the Citibank loans that were in default, and failed to comply with the consumer information requirements imposed on "debt collectors" under the Fair Debt Collection Practices Act.

Discover may have made some mistakes probably because it plunged into a politically sensitive and highly regulated line of business before it had acquired the back office capability to handle it.  Harrassment and lying?   "Abuse" of student loan borrowers?  I don't think so. 

Discover Financial Service stock held steady yesterday and it reported second quarter net income of  $599 million or $1.33 per share. 

California Supreme Court Decides "Separate and Apart" Requires Separate Residences

In Davis v. Davis, decided Monday, the California Supreme Court held that spouses must live separately in different residences to claim that property they accumulate is not community property.  California Family Code section 760 makes all property acquired by spouses during a marriage community property "[e]xcept as otherwise provided by statute," including section 771(a): "earnings and accumulations of a spouse...while living separate and apart from the other spouse, are the separate property of the spouse."  The court held that spouses are not "living separate and apart" when they live together.

Mr. and Mrs. Davis married in 1993 and had two children. Mrs. Davis testified that by 2004, they were "living entirely separate lives" but in the same house.  When Mrs. Davis petitioned for divorce in December 2008, she listed their date of separation as June 1. 2006.  Mr. Davis listed the date of separation as July 1, 2011.

The California Supreme Court considered the history of the 1870 Act in which section 771(a) originated entitled "An Act to protect the rights of married women in certain cases."  The first section of the 1870 Act provided that "[t]he earnings and accumulations of the wife...., while the wife is living separate and apart from her husband, shall be the separate property of the wife."  And, it provided that a wife who was living "separate and apart from her husband" had "sole and exclusive control [over] her separate property," and could sue and be sued without joinder of the husband. Section 4 of the Act provided a means for a wife "living separate and apart" to convey her separate real property without her husband's consent by recording a declaration containing a description of her real estate, the name of her husband, and stating "her own place of residence" and that she is "living separate and apart from her husband." 1870 Act sec. 4.

Before the 1870 Act was adopted, married women had no control over separate or marital property. The husband had absolute right of "management and control" of community property, including the power to sell assets.  Under the predecessor 1850 statute, "rents and profits of separate property" were deemed community property subject to the husband's sole control, and the husband had the exclusive right to manage the wife's separate property "during the continuance of the marriage" subject only to the requirement that to sell or encumber the wife's separate property, the transaction must be documented in an instrument signed by both spouses.  The court concluded that the 1870 Act provided married women some protection from the oppressive effect of the prior law.  As a result of the 1870 Act, a married women who was not physically living with her husband could control her own earnings and control and dispose of her separate property.  Early cases interpreting the scope of the exception in section 771(a) considered not whether separate residences were required, but whether the wife had to show something more, e.g., whether one spouse had "abandoned" the other as part of a "separation which [they] intended to be final."  Tobin v. Galvin, 49 Cal. 34, 36-37.  A married couple was not "living separate and apart" if they were residing in separate places for economic or social reasons, but only when they were living in separate locations and have "no present intention of resuming marital relations and taking up life together under the same roof."  Makeig v. United Security Bank &Trust Co., 112 Cal. App. 138 (1931).

Mrs. Davis cited the dissent  in In re Marriage of Norviel, 102 Cal. App. 4th 1152 (2002) as support for her contention that spouses can be "living separate and apart" while living together.  In that case, the majority recognized that under California law, spouses may live apart (in separate residences) and not be separated.  But, the Norviel majority held, the reverse is not true.   However, the dissent in Norviel found that the evidence introduced at trial supported the trial court's finding that the date of separation predated the husband's physical departure from the marital home, because the husband had communicated his intent to end the marriage before he moved out, and the parties' conduct thereafter was consistent with that expressed intent.  The dissent thought that the majority rule requiring that the couple live in separate residences would not permit the couple "a transition period to take the necessary steps to untangle the financial, legal and social ties incident  to their decision."  Id. at 1166.

The California Supreme Court considered the policy implications of a bright line rule requiring physical separation to establish "living separate and apart."  Mrs. Davis argued as a matter of public policy that spouses may need to reside together in the same residence as "roommates" after they mutually intend an end to their marriage for pressing financial reasons, and one spouse who wants to separate and stay in the marital home may find it difficult to compel the other spouse to move out. The court held that although the rule may impose hardships, it does what a bright line rule does-- it provides predictability of outcome and clear guidance to judges. And, it reduces strategic behavior invited by a more flexible standard.  The bright line rule requiring physical separation "retains the presumption of community property for earnings and accumulations acquired during marriage during a period of time likely to be prior to the institution of court proceedings and any court order of support, thereby protecting the lower earning spouse."

The bright line may not be all that bright.  In a concurring opinion, Justice Liu agreed that "living separate and apart" refers to separate residences, but noted that the majority did not foreclose the possibility of circumstances where a couple could live "separate and apart" with the requisite separate residences "even though they continued to literally share one roof."  Justice Liu added to the history of California's community property laws amendments in the 1970's through which the Legislature afforded both spouses equal control rights in community property, and adopted no-fault divorce, with the effect that by the end of the 1970's the "living separate and apart" exception was not necessary to protect married women.  Rather, the exception now serves to recognize that separation before divorce ends the community "in situations where the spouses have effectively though not formally ended their marriage."  Justice Liu noted that "countervailing considerations of family economics and parenting suggest that the physical separation need not assume the precise form that the Legislature in 1870 envisioned, namely, separate addresses."  Citing the dissent in In re Marriage of Norviel, Justice Liu wrote that the test for whether the parties are "living separate and apart" is whether they can demonstrate not only intention to separate, but also unambiguous, objectively ascertainable conduct amounting to physical separation under the same roof."

New Rule Expands Military Lending Act

Today, the Department of Defense issued a final rule expanding the scope of the Military Lending Act (MLA).  The MLA was enacted in 2006 and was implemented by DOD rules in 2007.  It prohibited contracting with service members for three types of consumer credit products:  1) closed end payday loans for $2000 or less with a term of 91 or fewer days; 2) closed end auto title loans for a term of 181 days or less; and 3) closed-end tax refund anticipation loans.

The new rule, which will become effective in October 2015, expands the scope of the MLA:

• Imposes a 36% interest rate cap (calculated as the Military Annual Percentage Rate or MAPR) including all interest and fees associated with a loan;
• Prohibits creditors from imposing mandatory arbitration terms on service member borrowers, and prohibits terms that require service members to waive certain other rights;
• Prohibits loans to service members that provide a payroll allotment as a condition for obtaining credit, permit rollover of a payday loan, or use of a security in the form of a post-dated check  or a car title (with some exceptions);
• Expands the definition of "credit" covered by the MLA to include any closed or open-end loan, including car loans but excluding loans secured by real estate;
• Modifies the provisions relating to the optional mechanism a creditor can use to assess whether a consumer is a "covered borrower" under the MLA;
• Modifies disclosures a creditor must provide to a covered borrower;
• Implements the MLA's enforcement provisions.

The DOD consulted (as the MLA required) with a host of federal agencies including the CFPB.  CFPB Director Richard Cordray said "The CFPB strongly supports the Department's efforts to strengthen consumer protections for our nation's military families."  In December 2014, the CFPB issued a report asserting that lenders were exploiting "loopholes" in the MLA.  The CFPB report took aim at "deposit advance products" (see April 2013 CFPB whitepaper,  OCC's supervisory guidance and Federal Reserve Board on these products).  A "deposit advance product" is a loan that a lender makes to a borrower whose deposit account reflects recurring direct deposits.  The borrower promises to repay the principal plus a fee from the next direct deposit. The underwriting basis for the loan is cash flow (the recurring direct deposit) and not an "affordability" analysis of the borrower's ability to repay the loan and also meet other recurring financial obligations.  

In November 2013, the OCC and FDIC issued guidance governing deposit advance products that applied to banks subject to their regulation.  By early 2014,  banks abandoned the business citing the regulations.  The guidance warned banks that they must to take into account the borrower's ability to pay, and that bank examiners would ensure that bank's deposit advance programs comply.

As part of the comment process on the  DOD's rule, the American Banker's Association (ABA)  urged the DOD not to rely on the CFPB's December 2014 study (the Study) and accompanying comment letter.   1) the CFPB did not apply to the Study the "evidence-based" standards it must apply to its own rule making process under the Dodd-Frank Act; and 2) the Study did not support the conclusion that service members are more vulnerable to deposit advance products than the general public.  (Footnote 11 of the Study makes clear that the differential impact identified in the Study was not evaluated against other explanatory variables that might eliminate statistical significance, and that the differential "does not mean that being a servicemember makes a person more likely to use deposit advance products.").  The ABA further noted that the CFPB has not yet issued its own final rules on deposit advance products. (In March 2015, the CFPB released an outline for potential regulation of the payday lending industry).  

It is clear that Americans have a love/hate relationship with payday loans.  According to a study by Pew, 12 million American's spend about $17 billion on payday loans each year.  The DOD rule is a victory for consumer groups who consider deposit advance products to be "predatory" and oppressive.  It's not clear whether the rule is a victory for service members, who will be excluded from credit products that are available to all other Americans.

 

Treasury Requests Information About Online Marketplace Lending

American Banker called 2014 a "Gold Rush" year for online marketplace lending, and named it the innovation of the year.  Online lenders provide a host of different credit products from merchant cash advance services, cash flow-based loans, and term loans.  Other online companies provide loan matching services for potential borrowers, e.g., Biz2Credit, and Fundera.

Yesterday the Treasury Department published a request for information about online marketplace lending.  Fed. Reg. Vol. 80, No. 138, July 20, 2015, 42866.  Treasury describes "online marketplace lending" as "the segment of the financial services industry that uses investment capital and data-driven online platforms to lend directly or indirectly to small businesses and consumers." Treasury wants information about the business models and products offered by online marketplace lenders, the potential for this type of lending to "expand access to credit to historically underserved market segments," and "how the financial regulatory framework should evolve to support the safe growth of this industry." It recognizes three categories of lenders within this industry segment:  1) balance sheet lenders that hold credit risk and are funded by hedge fund or family office investments; 2) online platforms (peer to peer) that sell securities to raise capital to enable third parties to fund borrowers, but do not retain credit risk; and 3) bank affiliated online lenders funded by a commercial bank, and that directly originate loans and assume credit risk.

How this market will be regulated remains up in the air.  Treasury noted that the CFPB has "broad authority governing standards that may apply to a variety of consumer loans issued through this segment."  In March 2015, the CFPB announced it was considering proposing rules governing payday, vehicle title, deposit advance and certain other high cost installment and open-end loans (specifically loans with a term of 45 days or less and an APR greater than 36%, or lower than 36% if the loan provides for repayment from the borrower's deposit account or paycheck or creates a PMSI in a vehicle).  Treasury noted that potential CFPB rules are "outside the scope" of its request for information and that Treasury is interested in information on online marketplace lenders not covered in the CFPB's proposed rules.  Treasury's RFI notes that the "framework" by which CFPB will regulate consumer loans issued through an online marketplace lender "is currently under discussion" and "the CFPB may ultimately change the scope of any proposed or final CFPB regulation."

Puerto Rico's Problem: How the Politics Breaks

The Wall Street Journal reported yesterday that the "Puerto Rico problem" has U.S. politicians, particularly GOP presidential hopefuls, stumped.  Hillary Clinton, Bernie Sanders and Martin O'Malley have all issued statements backing the pending federal legislation that would open chapter 9 bankruptcy to Puerto Rico's utilities and other public debt issuers.  The legislation is stuck in the House.  Democrats Charles Schumer of New York and Richard Blumenthal of Connecticut may introduce similar legislation in the Senate.

For Republicans, the next step is tricky.  Mutual and hedge fund creditors hold Puerto Rican debt and they want to avoid any write down of their debt-- a likely outcome if Puerto Rican debt issuers can use chapter 9.  On the other hand, about 1 million Puerto Ricans who reside in Florida and many want some federal action.  29 electoral votes are on the table.  Republicans running for president need to be seen as pro Puerto Rico, with compassion for Puerto Rican people and their economic future.  But that is hard to do without appearing to support a "bailout" for Puerto Rico.

Republican Congressman Tom Marino (R. PA) is head of the judiciary panel considering the chapter 9 relief bill in the House.  WSJ reports that he said the fate of the bill depends on whether Puerto Rico first puts together an "austerity plan" for the future.

Reading on Screen vs. Book

According to a report published in December 2009 by the Global Information Industry Center, Americans consumed information outside of work for about 1.3 trillion person/hours in 2008, for an average of almost 12 hours, 100,500 words and 34 gigabytes for an average person on an average day.  The report analyzed consumption of more than 20 sources of information from old fashioned (paper newspapers and books) to new (computer games, satellite radio, and internet video).

The study defined "information" as flows of data delivered to people.  So "information" includes video, with 1.3 zettabytes (a million million gigabytes) from television and about 2 zettabytes from computer games.   Radio and TV dominate  as sources of information, for about 60 percent of the hours expended in consuming information.  But computers have had a huge effect on information consumption.   Before widespread use of computers, information was usually consumed passively (with the exception of telephone).  Reading as a means of consuming information was hit hard by TV.  But reading as a source of information tripled from 1980 to 2008 because reading is how we consume information on the internet.

A 2005 study about reading behavior in the digital environment by Ziming Liu (available online in the Journal of Documentation) concludes that screen-based reading is different than reading text on paper.  People reading on screen tend to spend more time browsing and scanning, and reading more selectively.  They spend less time on in-depth, concentrated reading.

I've noticed a difference for myself between reading the screen and reading text on paper.  The screen is the best for fast access to a wide range of related information.  But, when I need to break down complicated information and really learn it for long term use, the screen is no match for paper.  I had thought my longing for paper and a squeaky yellow highlighter to go with it was nothing more than habit-- an old-fashioned vestige of the way I learned to consume information.  But scientists who research how we consume information by reading are beginning to learn about intrinsic differences in the two modes.  The trick seems to be matching the mode to the text.  The screen is great for Facebook, but not so much for Ulysses.

Puerto Rico's Debt - Update

WSJ today reported that Puerto Rico Electric Power Authority (PREPA) and its bondholders are close to a deal that would cover the $400 million plus due to bondholders and avoid default.

Yesterday, Dealbook ran "The Bonds that Broke Puerto Rico" offering an explanation of how Puerto Rico could issue "enough debt to crush it."  The answer:  "a confluence of factors, including American investors' desire to avoid taxes; the mutual fund industry's practice of competing on the basis of yield; complacency about the practice of long-term borrowing to plug holes in budgets; and laws [Puerto Rican] that supposedly give bond buyers ironclad guarantees."  

MoneyBeat ran  Puerto Rico's Crisis Deals a Blow to Municipal-Bond Funds providing more detail on the impact of Puerto Rico's debt problems on the municipal bond market.   Puerto Rico's $3.5 billion in general-obligation bonds issued in 2014 had a yield of 8.7%, compared to the yield on 10-year U.S. treasury notes which was around 2-3% over the same period.   Interest on Puerto Rican bonds is federal and state tax free for investors in every state.  Interest on other municipal bonds is exempt from federal tax, but exempt from state tax only if the investor lives in the state that issued the bonds.  Single-state municipal bond funds have used Puerto Rican bonds to diversify and boost yield.

Why Don't We Care About Puerto Rico?

Late Sunday, Puerto Rico's governor announced that the U.S. territory would likely default on $72 billion in debt. Yesterday, the White House said that the Treasury Department will offer advice, but there will be no "bailout." Rather, the White House urged Congress to pass legislation that would amend the Bankruptcy Code so Puerto Rico could reorganize its debts under chapter 9. Chapter 9 is available only to municipalities (defined as a "political subdivision or public agency or instrumentality of a state," 11 USC 101(40)), and only when state law specifically permits the municipality to use it. Puerto Rico is a U.S. Territory, not a municipality or a State, and thus is not eligible to seek relief in chapter 9.

Detroit filed for relief under chapter 9 in July 2013.  Puerto Rico's $72 billion is about 4 times bigger than Detroit's $18 billion debt problem.  Detroit confirmed a plan of debt adjustment in November 2014.  Retired Bankruptcy Judge Steven Rhodes presided over Detroit's bankruptcy and is now working to assist Puerto Rico.  "It's exactly like Detroit," he said.

There is some support in Congress for a bill offered by Puerto Rico's non-voting Congressman to open chapter 9 to Puerto Rico.  Supporters of the bill say that extending chapter 9 would be consistent with federal bankruptcy policy and would offer Puerto Rico an orderly way to extend debt maturities, reduce the principal or interest rates, or refinance with new loans.  A chapter 9 bankruptcy proceeding is not a federal taxpayer-funded bailout.  It would provide a judicial forum to consider which creditor groups and other stakeholders feel which part of the pain of Puerto Rico's debt problem. The legislation met opposition from Republicans who say they are worried that offering Puerto Rico a chance to restructure its debts in a federal bankruptcy case would relieve the Puerto Rican government from responsibility for decades of fiscal mismanagement, and disrupt the expectations of creditors who incurred debt in reliance on the current law.  Of course that's exactly what happened in Detroit.

About a third of the population of Puerto Rico relies on government support to survive.  Government workers make up about a quarter of the work force.  Just 41% of Puerto Ricans are working or looking for work (compare to 63% on the mainland). To raise revenue, in 2014, the government raised taxes, $1.3 billion in new taxes.  Public debt as a percentage of GDP is 64.9%; for Haiti it is 21.3%.  With an economic situation as grim as this, it's hard to imagine that even a chapter 9 proceeding could result in a plan to put Puerto Rico's economy back on track.  

Puerto Rico is an economic disaster area. So why the lack of  federal interest in the Puerto Rican debt problem?  Perhaps Puerto Ricans don't matter because Americans don't think of Puerto Ricans as "Americans."  But they are as American as the citizens of Detroit.  The term "United States" includes the 50 states. DC and Puerto Rico, Guam and the Virgin Islands.  8 USC 1101 (a)(38).  Puerto Ricans are US citizens and can move and work anywhere in the US without passports or green cards.   And move they did.  An August 2014 Pew report showed that from mid 2010 to 2013, more Puerto Ricans left the island than during the entire decades of the 1970's, 80's and 90's. The recent migrants are less educated than those who stayed, and are more likely to hold less skilled jobs.  640,000 Puerto Rican voters make up about 10% of the population of central Florida.  Although residents of Puerto Rico do not have voting representation in the U.S. Congress and are not entitled to electoral votes in a Presidential election, the votes of Puerto Ricans who live on the mainland count in local and national politics.  In Florida, Puerto Ricans are 28 percent of Hispanic registered voters with real political clout in that state and in the 2016 Presidential race.  (When Obama won Florida over Romney in the 2012 presidential election, he did so by a margin of 74,000 votes.)  So, Puerto Ricans in Florida matter.  But, nobody seems too concerned about the Puerto Ricans in Puerto Rico.

What's in Your Wallet?

Consider these findings by Scott Fulford, Claire Greene and William Murdock III, Federal Reserve Bank of Boston as part of their study of U.S. consumers' holdings of $1 bills based on data from the 2012 Diary of Consumer Payment Choice, a national online survey tracking payments made by participants over a three day period during October 2012.  2,467 people ages 18-94 participated in the survey and reported 12,647 transactions for combined spending of $453,655.

• About 64% of adults 18 years or older start the day with at least one dollar bill on their person.  The median holding is two dollar bills; the mean is slightly below three dollar bills.  Hardly anyone had more than ten dollar bills in his or her pocket.   To compare, the median holding in cash (all bill denominations) is $27.  The mean is larger at $62 dollars.  Some people carry a large amount of cash.
• For consumers who hold some cash on their persons, 71% of the consumers who started the day with no dollar bills ended the day with none.
• Around 50% of consumers make at least one transaction with cash on any given day.
• Consumers appear to be managing their dollar bills actively.  Consumers who start the day with few dollar bills tend to acquire some during the day.  Consumers with many dollar bills at the start of the day tend to end the day with fewer dollars.
• People who make a transaction during a day tend to gain one dollar bills in larger numbers than they lose dollar bills.  The median gain of dollar bills over the course of a day is three bills; the median loss is two bills.

Fight over Arbitration in Consumer Financial Contracts

Dodd-Frank required the CFPB to conduct a study on the use of pre-dispute arbitration clauses (PDAA's) in consumer financial markets.  Sec. 1028(a).  It also gave the CFPB authority to issue regulations on the use of arbitration clauses in other consumer finance markets "if the Bureau finds that such a prohibition or imposition of conditions or limitations is in the public interest and for the protection of consumers."  Sec. 1028.

The CFPB posted a public inquiry on arbitration terms in Aprils 2012 and released preliminary research results in December 2013.   It issued its final report in March 2015.  In a press release accompanying the report, the CFPB noted that "very few consumers individually seek relief through arbitration or the federal courts, while millions of consumers are eligible for relief each year through class action settlements."  Also, "more than 75 percent of consumers surveyed did not know whether they were subject to an arbitration clause in their agreements with their financial service providers, and fewer than 7 percent of those covered by arbitration clauses realized that the clauses restricted their ability to sue in court." 

In May 2015, 58 Democratic Congressmen signed a letter to CFPB Director Richard Cordray urging the CFPB to promulgate rules prohibiting PDAA's.  Last week, the House Appropriations Committee adopted an amendment offered by Reps. Steven Womak (R-Ark,) and Tom Graves (R-Ga.) to a 2016 appropriations bill for funding for agencies that regulate financial services.  The amendment conditions CFPB appropriations on completion of a new study on PDAA's.  The American Banker's Association wrote to support the amendment, calling the CFPB's study "a deeply flawed piece of research that excludes critical information, misinterprets key data...."

The fight over PDAA's is hot, but based on the data, it's not clear what stake consumers have in the outcome.  The CFPB"s study concluded that arbitration was important in only 8% of the 562 class action cases it studied.  The defendants moved to compel arbitration in 94 of the 562 class actions.  The CFPB study does not support the conclusion that PDAA's are a tool to crush consumer redress, or have been particularly effective in eliminating consumer class action litigation.

Reg A+ is Effective Today; Still Waiting for Crowdfunding Rules

The SEC's rules to facilitate Regulation A+ become effective today.  The rules implement Title IV of the Jumpstart Our Business Startups Act of 2012 (the JOBS Act).  Title IV Small Company Capital Formation  raised the cap on the amount of securities that can be sold in a 12 month period from $5 million (under Reg A) to $50 million (under new Reg A+), subject to disclosure requirements (e.g., a certified audit) not required for ordinary Reg A offerings.

Market watchers are not expecting that the newly effective Reg A+ rules will have much of an impact on start ups and small businesses that don't already have the cash necessary to comply with its  requirements.  The big development yet to occur is SEC adoption of final rules for Title III of the JOBS Act titled Crowdfunding.  In Title III, Congress directed the SEC to write rules implementing an exemption from securities laws for crowdfunding via the internet, and rules for a funding portal by which internet-based platforms could facilitate a market for securities without registering with the SEC as brokers.  The SEC published proposed rules for comment in October 2013 and the public comment period closed in February 2014.  The SEC announced that the final rules will be released in October 2015.

Crowdfunding sites are already operating to offer securities for accredited investors only under Regulation D.  Some commentators see a bleak future for crowdfunding for non-accredited investors under the rules the SEC has proposed.   The SEC estimates that to raise $100K via non-accredited investor crowdfunding, an issuer would have to incur around $39K in fees for accountants, lawyers and the funding portal.  To raise $1 million the estimated costs tops $150K.  An offering under Reg D, although restricted to accredited investors, is relatively light on required disclosure and much cheaper.  So, if/when the SEC promulgates the final crowdfunding rules, it may be that only the most desperate issuers will use it.

No Fees to Defend Fees

In Baker Botts LLP v. ASARCO LLC, the Supreme Court held that law firms that represented the debtor in possession (DIP) cannot recover from the estate for fees incurred defending their fee petition.  Two firms representing the DIP had successfully litigated a fraudulent transfer claim against ASARCO's parent corporation and obtained a judgment in favor of the estate worth around $7-10 billion.  The  parent objected to the fees and after a six day trial, the court awarded the firms about $120 million for legal services, a $4.1 million enhancement for exceptional performance, and over $5 million for time spent defending their fee petition.  The parent corporation appealed and the Fifth Circuit reversed on the award of fees for defending fees.  It held that absent express statutory authority, each party pays his own attorney's fees (the "American Rule"), and although the Bankruptcy Code provides for payment of fees for legal services rendered to the estate, it does not provide a statutory basis to shift to the estate the fees incurred defending a fee petition. 

Justice Thomas wrote the opinion for the majority (Thomas, Roberts, Scalia, Kennedy, Alito).  Justice Sotomayor concurred in part and concurred in the judgment.  Justices Breyer, joined by Ginsburg and Kagan, dissented.  Justice Thomas invoked the Court's general jurisprudence regarding attorneys' fee awards under the American Rule.  Under the Bankruptcy Code, the bankruptcy court may "award...reasonable compensation for actual, necessary services rendered by" such lawyers but only after "notice to the parties in interest and the United States Trustee, and a hearing....."  11 U.S.C. sec.330(a)(1).  The U.S. Trustee regulates and monitors the fee petition process and requires compliance with its guidelines for compensation which impose timekeeping and reporting standards for professionals who submit fee petitions.  The Court held that the phrase "reasonable compensation for actual, necessary services rendered" in section 330(a)(1) limits recovery of fees to those rendered for services to the DIP.  In contrast, the law firms' claim for attorneys' fees were incurred in representing themselves in the fee petition process. 

The law firms, of course, saw it differently.  They argued that the litigation over the propriety of their fees was part of "services rendered" to the estate.  The Court called that argument "untenable" and noted that the dissent rejected it too.  The balance of the opinion addressed the arguments made by the United States as amicus curiae.  The government conceded that defense of a fee application is not "service to the estate."  But, it argued that such fees should be borne by the estate because costs incurred in defending fees affect the net compensation an attorney receives.  This is the effect of the American Rule in every context in which it applies. 

The United States argued that the unique nature of bankruptcy litigation justified a "judicial exception" to the American Rule.  Outside of bankruptcy, a dispute about attorneys' fees is a private matter between the lawyers and the client.  In a bankruptcy proceeding, the court supervises attorneys' fees (and other professional fees), with notice to and an opportunity to be heard from "parties in interest" who may raise their own objections to the fees on the merits or for strategic reasons.  Justice Thomas concluded that whether bankruptcy litigators are especially vulnerable to fee dilution due to abusive litigation over their fees, "Congress has not granted us 'roving authority... to allow counsel fees...whenever [we] might deem them warranted. (citation omitted).  Our job is to follow the text even if doing so will supposedly undercut a basic objective of the statute.'"