Texas lawmakers are considering a bill that would protect banks from losses when their customers fall prey to scams.
The legislation was introduced after six Texas banks were ordered to compensate dozens of senior citizens fleeced by a financial planner who had used their bank certificates of deposit as collateral for his personal loans. The bill, which has passed a Senate committee, would let a financial institution keep funds derived from criminal activities if it could prove that it had no knowledge of the crime and did not ignore obvious improprieties.
Texas bankers say the proposal is a major improvement over the existing forfeiture law. As it stands, financial institutions must give up any ill-gotten gain, whether they knew of the funds origin or not.
I think the legislation is a good compromise between law enforcement and financial institutions, said Karen Neeley, general counsel of the Independent Bankers Association of Texas. A bank that knows or just refuses to see the facts is still going to lose in a forfeiture hearing, and thats the way it should be.
The bill would also let a bank hold funds in a separate account until a court decides whether it had knowledge of any criminal activity. Currently, district attorneys may seize funds immediately, even before a court decides whether the prosecutor has a right to them. Bankers have argued that such sudden withdrawals could cause liquidity or capital problems.
The separate-account provision would give them time to make up for the capital or liquidity loss so that it doesnt jeopardize the safety and soundness of the bank, said John Heasley, executive vice president of the Texas Bankers Association.
Cliff Herberg, chief of the Bexar County district attorneys white-collar crime division in San Antonio, agreed that the law should be changed to let institutions hold the money until a forfeiture hearing. Mr. Herberg was the prosecutor in last years case who collected funds from six area banks to reimburse victims of a Ponzi scheme.
In the San Antonio case, the only way we could have conducted proper seizure was to take the money immediately under the current state law, Mr. Herberg said.
The Bexar County district attorney seized about $9.2 million of cash and CDs from the banks in February 2000.
The funds were mainly certificates of deposit owned by about 90 elderly investors who had allowed San Antonio financial planner Bradley Farley to buy the certificates on their behalf. The investors, according to the district attorney, also unwittingly gave Mr. Farley authority to use their CDs as collateral for $9.1 million of personal loans he took out at the six banks.
Mr. Farley defaulted not only on the loans but also on the CD interest payments to his investors, who complained to state authorities in late 1999. The state directed the Bexar County district attorney to investigate Mr. Farley. He was arrested in February 2000, made a plea agreement to a criminal count a year later, and is now awaiting sentencing. His properties also were seized.
Because Mr. Farley had defaulted on his loans, the banks maintained that they had the right to foreclose on the CDs. Their argument: Investors had each signed a document labeled application for insured deposit that gave Mr. Farley permission to use the CDs as collateral for his loans.
All six banks have since settled or are in the process of settling with the district attorney, which plans to distribute $7 million to the CD owners. The balance will go back to the banks.
The state Senate is expected to take up the bill within a few weeks. If enacted, the measure would take effect in September.
Whatever the outcome, Mr. Herberg said, he hopes that bankers have learned from the San Antonio case and will take extra precautions to ensure their funds have not been derived from criminal activities.
In Mr. Farleys case, if the banks would have called his victims, they would have realized the victims had no idea what was really going on, Mr. Herberg said.
However, the independent bankers Ms. Neeley said she believes most customers would not be comfortable if their banks began investigating all activity that could be viewed as suspect. In fact, a public clamor broke out several years ago, she added, when federal regulators called on banks to contact the original sources of funds in questionable transactions.
When federal regulators proposed that banks go beyond the transaction to identify the source of funds, the public sent in hundreds of thousands of comments saying this was an invasion of privacy, and regulators dropped the proposal, Ms. Neeley said.
Bankers must walk a fine line in transactions between proper due diligence and protecting the privacy of their customers and third-party sources of funds. But Ms. Neeley admitted that the distinction is far from easy to make.
You cant always predict a situation in which you have somebody engaging in an alleged scam, she said, but the case in San Antonio was definitely a wake-up call for banks to realize the importance of knowing who they are dealing with.