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Harvesting Tax Benefits in Global Supply Chain Management: How Apple Computer Does It

May 31, 2013 by Bierce & Kenerson, P.C.

Supply chain management normally addresses such risks as pricing of commodity components, disruptions in transportation, labor strikes, business continuity planning, disaster recovery, regulatory risks and, with Hon Hai / Foxconn, the risks of occasional suicidal workers.  Apple Computer, Inc. (“Apple Computer”) outsources production to contract manufacturers in China and elsewhere, but it insources its operations and centralizes its financial accounts through the use of Irish subsidiaries.

This article addresses some of the key issues for American technology companies, particularly those in pharmaceuticals, software, hardware, game developers and consumer electronics, who can learn from the clever use of complex U.S. tax rules governing controlled foreign corporations (“CFC’s”), transfer pricing and intercompany profit allocation to foreign subsidiaries through cost-sharing agreements, tax-transparency of entities consolidated in one jurisdiction, and, most astounding of all, a holding company that has no tax residency and thus pays no tax.

The road map to massive tax savings was revealed in the pending legislative initiatives that would tighten the U.S. income rules.  But there are still lessons for effective international tax planning after such loophole closing.  This article is based on published accounts of Apple Computer’s finances and operations, including a lengthy memorandum submitted in May 2013 to a U.S. Senate committee on offshore profit shifting by U.S. companies.

Apple Computer’s Basic Plan.  Apple Computer, like Microsoft and Hewlett-Packard, has used offshore entities to conduct foreign business.  It established Irish limited liability companies to act as funnels for all sales of products and services outside the United States.   Here are the essential details.

Top Irish Holding Company.  Apple’s primary holding company has no employees, only three directors, two of whom reside in the U.S. and one of whom resides in Ireland.  This company (“AOI”) has no U.S. offices.  Under U.S. law, it is not a U.S.-taxable company because it is incorporated in Ireland.  Under Irish law, it is not an Irish company because its place of management and control is not in Ireland.   So it appears to be obligated nowhere to pay income tax.

Sub Irish Holding Company.  A second holding company (“ASI”), likewise incorporated in Ireland, receives resale profits from buying Apple Computer® products made by a contract manufacturer in China and reselling to individual wholesale distributors (100% owned) outside the United States.   ASI effectively takes a manufacturer’s profit and the individual wholesale distributors only make a wholesaler’s profit.

Cost-Sharing Agreements for IP R&D.  Royalties for intellectual property rights can be avoided by a cost-sharing agreement (“CSA”) relating to R&D expenses.  Under a cost sharing agreement, two or more entities agree to share the cost of developing intangible assets (such as software, hardware designs, patents or copyrights) and each acquires a proportionate ownership share of such assets after development.   If ASI were unrelated to the owner of the intellectual property, it would normally pay a royalty fee for the right to make (or have made) Apple Computer® products.  However, through a cost-sharing arrangement, no royalties are owed since ownership of the intangible assets is proportionately split between an Irish company and the U.S. parent company.  Under such cost sharing, which is permitted by IRS regulations under Section 482 of the Internal Revenue Code, two companies can split the economic ownership benefits from new intellectual property developed under a commercially reasonable allocation of costs.

In Apple Computer’s case, the Irish and U.S. companies split R&D costs based on an allocation of gross sales between the U.S. and the “rest of the world.”  The Irish company thus does not need to pay any royalties for its use of the resulting technological innovations.

Furthermore, Apple takes advantage of loopholes in the U.S. tax structure which enables it to convert taxable offshore passive income into deferred income and to “disregard” income payments between its lower-tier subsidiaries by electing to treat them as part of a single upper-tier subsidiary.  This effectively treats this type of income as internal payments or transfers as opposed to taxable income.

Best Practices for Optimizing Tax Benefits in Global Supply Chain Management.  The brouhaha over Apple Computer’s tax strategies highlights the differences between “best practices” and aggressive optimization.   By not having any tax residency for two entities, Apple Computer is exposed to the tax collector’s claim (both in the U.S. and in Ireland) that it has abused the corporate formalities, unfairly reducing. income taxes through transfer pricing to artificial “shell” companies that have no business purpose other than tax avoidance.

Transfer Pricing Mechanisms.  Transfer pricing regulations under Section 482 have been changing for forty years.  The IRS vacillates between bright lines and vague “facts and circumstances” tests.  In a global economy, both businesses and tax collectors will have to navigate murky waters, and “reasonable” and “defensible” allocations of profits will continue to survive.  Of course, as anyone doing business in India will attest, a “reasonable” allocation in one country is not necessarily “reasonable” to the tax authorities of another.  So there are risks of “whipsaw” (double taxation due to differences in “reasonableness” metrics) in any international tax structure.

International Treaties: Limits on Extraterritorial Taxing Jurisdiction.  There may be international limits to anti-abuse tax rules.  Anti-abuse has been a hot topic for 30 or 40 years under the OECD Model Income Tax Convention formats.   The Senate subcommittee report fails to consider U.S. obligations under the WTO Uruguay Round trade agreements on intellectual property (“TRIP’s”), on trade-related investment measures (“TRIM’s”) and trade in services.  These agreements generally preclude discrimination in market access and regulation of foreign-owned companies.  Any new legislation will need to thread such “treaty needles.”

Bona Fide Business Purpose.  Adoption of “stateless” holding companies having no employees and no tax residency appears to fail the test of “business purpose” and may thus be ignored by tax collectors.  If you have a valid business non-tax purpose, the tax authorities should respect your choice of business structure.  Legitimate business purposes include establishment of legal protections that are based on a foreign country’s rights under international treaties, such as free trade agreements, investment protection treaties and tax treaties, as well as the protection of local law.  It also helps to employ local employees.

Controlled Foreign Corporations: Subpart F is still Friendly to U.S. Multinationals.  Current U.S. law on “controlled foreign corporations” and “foreign personal holding companies” still do not require repatriation and immediate taxation of foreign profits earned by legitimate foreign operations.   Of course, the interposition of a foreign company for no purpose other than to park profits will still fall into the definitions of CFC or FPHC.  However, there is no abuse where foreign profits are not actually repatriated and are used for foreign business investment and operations.  So, unless the law changes, the tax planning for offshore operations should not cause immediate U.S. taxation.

Tax Benefit Planning in Contract Manufacturing.  The use of contract manufacturing and “drop shipment” instructions are likely to continue without further challenge by tax authorities.  Under “drop shipment” procedures, a company like ASI might buy from China FOB China and resell to its wholesale buyer CIF at the foreign warehouse of the wholesale buyer, and ASI never takes physical delivery.  Such procedures are customary and commercially reasonable between unrelated buyers and sellers, so it bears no bad of any tax avoidance.

Tax Benefit Planning in BPO.  As American shared-service organizations and Indian BPO service providers have both learned, transfer pricing between affiliates for “back office” services can be complex and fraught with risks.  The U.S. IRS has an advance pricing agreement (“APA”) procedure allowing companies to “negotiate” (explain) a “fair” transfer pricing between affiliates, but this procedure is costly, time-consuming and inefficient in cases where any “material facts” change after the APA is agreed.

Impact of U.S. Tax Reform on Offshoring.   Legislation to impose taxes on foreign business operations may be counterproductive.   If a company without employees is seen as a sham, then it will hire foreign local employees to conduct real business.  If a company cannot arbitrage between the U.S. and the Irish methods of determining a company’s tax residency, then it will still look for the lowest tax rates and conduct business there, assuming the “quality” and quantity of employees is adequate.  In short, by taxing “shams” or “insubstantial” foreign operations, the U.S. might well promote foreign employment through legitimate entities with a large foreign employee pool.

This invites further discussion on integration of different teams in different countries in a company’s global workforce.   Strategic planning will thus focus on both opportunities for global teamwork as well as tax efficiency.

Outsourcing Law & Business Journal™ – April/May 2012

May 22, 2012 by Bierce & Kenerson, P.C.

OUTSOURCING LAW & BUSINESS JOURNAL™ : Strategies and rules for adding value and improving legal and regulation compliance through business process management techniques in strategic alliances, joint ventures, shared services and cost-effective, durable and flexible sourcing of services. www.outsourcing-law.com. Visit our blog at http://blog.outsourcing-law.com.

Insights by Bierce & Kenerson, P.C. Editor. www.biercekenerson.com.

Vol. 12,  No. 4,  April/May 2012

_____________________________________

Announcement:

Four “Hot” Deal Structures and Pricing Models in Sourcing of BPO and KPO Services

May 21, 2012 by Bierce & Kenerson, P.C.

CIO Magazine observes that outsourcing service providers are offering innovative pricing models to escape commodity-based pricing pressures: joint ventures, “business outcomes”-based pricing, revenue sharing and dedicated centers of excellence.  Here’s an outsourcing lawyer’s analysis of these pricing models. I have only two questions: is it valid, legal, binding and enforceable?  Does it cover the most significant risk-reward scenarios?

Classic Pricing Model: Inputs and Outputs. The traditional pricing model has been either an agreed fee per resource used (such as “dollars per full-time equivalent”) or, if demand and scope are stable, per-user per month.  These resource-based pricing models start with a “base case” of the customer’s current utilization rates for resources and projects future changes in volume.  The provider wants to ensure that demand will exceed a baseline, or that it can exit due to unrealized expectations.

In a resource-based pricing model, the customer wants scalability and predictability based on demand levels.  This traditional pricing model has resulted in mismatches of supply and demand, cost overruns due to the vendor’s adding resources to accommodate changed demand or scope, and a focus on input costs, not outputs or business results.   Further, this pricing model leaves the customer with little control over management of operations, which achieves the basic goals of delegation of operations but leaves the customer with only the contract to exercise governance and change management.

Innovative Alternatives:

1.         Joint Ventures. Any joint venture involves an ongoing relationship for a substantial time.  It can take the form of a contract or a new legal entity between the customer and service provider.

Contract Model: Scope, SLA’s, Pricing, Governance. The contract-based model is reflected in the classic outsourcing agreement.  The scope of service is defined, and related tasks and responsibilities are allocated, in an exhibit.  In early outsourcing contracts, the scope was defined by taking existing processes and re-defining them for sharing between the users and the provider.   Currently, it is a well-established best practice to take industry-standard definitions of process workflows (such as by using ITIL or ISO standards for operating a data center, or security management) as the baseline for defining scope.   By using industry standards, the parties improve transparency of interactions and workflows, as well as better governance, regulatory compliance and risk management.  The classic sourcing agreement also includes service level agreements (SLA’s) as key performance indicators, and pricing discounts for missing the targets.  Finally, governance by contract involves establishment of governance bodies, meeting schedules, informal dispute resolution, escalation of issues to “senior” executives and eventual arbitration.

Entity-Type Joint Ventures. The entity-type joint venture offer some advantages over classic sourcing contracts.  This assumes the entity’s structure contemplates the predictable relationship life cycle starting with transition and steady-state, then progressing to one of three future outcomes: renegotiation (such as restructuring of scope, SLA’s or pricing), rebid/or and post-termination insourcing.  Such advantages arise from the ownership structure: the entity, not the provider, is delivering the services to the corporate customer.

An entity-type joint venture can be structured to look just like a captive shared services “center of excellence.”   The JV entity, not the service provider, receives the customer’s proprietary process and the service provider’s personnel.  The resulting intellectual property, knowledge management procedures, workforce administration and deliverables are allocated under the entity’s internal corporate documents, such as an LLC operating agreement, and any licenses, services agreements and other transactional documents to define the roles of the parties.  This structure fits industry-specific BPO and KPO services, where knowledge management generates the most value to the customer.

Customers may like entity-type joint ventures for two reasons.  First, it can control operations by its ownership of equity interests.  Ownership can be shared during the term and transferred to either the service provider or the customer upon termination.  Second, the JV model has built-in governance models and requires the provider to disclose all cost and process information as co-managers.

• Call Option. Under a “call option,” the customer would have the right to require the service provider to transfer equity ownership to the customer.  The customer could convert the entity into a captive by merely taking ownership of all equity.  A transfer to the customer might occur if the customer wanted to take control of the people, process rights and internal knowledge base of the joint venture.

• Put Option. Under a “put option,” the customer would have the right to transfer equity ownership to the service provider.  This scenario might occur if the customer felt that the entity provided no value to the customer or a new supplier would provide better services, value or “seemless integration.”

• Impact of any Transfer of Ownership. Upon either transfer of ownership rights, there would be a transfer of shares, and no termination of employment or assignment of intellectual property, real estate (or leases) or equipment.  The entity has the full bundle of operating rights.  However, there could be tax consequences for each party.  The lesson of the 2012 Vodaphone decision (of India’s Supreme Court) and the Indian government’s General Anti-Abuse Rules suggests that third-country holding companies would be appropriate.  However, intercompany pricing between related parties would invite double taxation in the absence of a double-income tax treaty, and such treaties may limit benefits to local nationals.

Service providers may like this model for other reasons.  It can simplify governance management.  It is an alternative to insourcing.

In the end, though, joint-venture based arrangements require careful negotiation on:

• allocation of human resources and knowledge management,
• competitive offerings, and
• opportunity costs for the service provider and the economic incentives for the service provider to hire, train and then lose skilled personnel who could be lost not by attrition, but by a call option.

Also, joint ventures run the same legal gauntlet as any business.  Bankruptcy is possible.   See http://www.outsourcing-law.com/2009/10/case-study-farmland-industries-inc/

2.         “Business Outcomes”-Based Pricing. The resource-based pricing model fails to identify opportunities or opportunity cost of the enterprise customer.  An “outcomes-based” pricing structure will align the customer’s bottom-line goals with the service provider’s compensation.   In employment law, this kind of incentive compensation represents a bonus for achieving benefits for the employer.  As such, “incentive-based compensation” can work effectively.   However, just as senior executives get paid a base salary, so too would the service provider receive a base compensation relating to the customary “financial base case” starting point for resource-based pricing.

Sophisticated customers familiar with SLA management understand the negative impact of choosing unwisely.  If you target one outcome, you will optimize that outcome, potentially at the expense of all others.  But if you then add multiple SLA’s and multiple optimized metrics, you create conflicts of priorities, and each priority will have a “pecking order” based on the financial reward structure.

Thus, for the customer a broad business outcome could be used: shareholder value, cash flow, cost of goods sold, return on equity, return on investment, etc.

For the service provider, an outcome-based pricing exposes a raw nerve.  The service provider controls its service delivery environment, but not the customer’s core business operations.  The outcome-based pricing method forces the provider to become intimately familiar with the customer’s business and commercial environment and provide consulting services (in addition to IT-enabled BPO or KPO) without additional compensation.  And the customer might not accept any provider recommendations for achieving the relevant business outcome.   Hence, the service provider will adopt such an approach only if it understands the customer’s business gaps (to the extent disclosed or discovered in due diligence) up front, and it sees how its efficiencies can improve upon such gaps.  But after the provider “fixes” the customer’s “train wreck” processes, future “outcomes-based” pricing might not be able to achieve such goals.

This approach is just another way to address the problem of “continuous process improvement” vs. “specific short-term improvement projects.”

3.         Revenue Sharing. Revenue sharing focuses on defining revenue sources and increasing gross and/or net revenue.  This pricing method assumes the parties will be able to increase revenues by contributing to a quasi-joint venture that measures only revenue, not expenses.

Revenue-sharing models resemble traditional “build-own-operate-transfer” models of project finance.  An independent private company builds an infrastructure (such as a toll road, port, airport, bridge or other facility), operates it (and collects revenues), then transfers ownership to the local community (e.g., a government).  This model encourages BPO and KPO service providers to invest, collect a share of revenue for a while and then, if mutually agreeable, let go of the investment upon expiration.

Revenue sharing models are familiar in other industries, such as the distribution of Hollywood films in the after-market.   Success depends on the ability of the service provider to streamline the customer interface, build brand equity and manage collections in a transparent, audited manner.

Customers may like revenue sharing since it requires no payment without an increase in revenue.   The customer might be a non-profit membership organization that wishes to license its membership list and organizational meeting archives for a service provider to manage as a service for promotion and member loyalty.  What customers must balance, however, is whether the revenue gains are attributable to the service provider or to the customer’s own initiatives.

Service providers may like this model if they understand the customer’s business, the needs of its users and how to sell an improved service.

Pitfalls for both parties abound.  The enterprise customer cannot reasonably expect its service provider to depend on revenue growth if the enterprise customer does not perform its own, mutually agreed efforts for revenue growth.  This may involve new product development, patenting, branding, marketing, sales support and customer after-sales support.  And, most important, the customer needs to announce upfront that it wants a creative pricing model.

4.  Dedicated “Center of Excellence.”

A “center of excellence,” “shared service center,” “offshore development center” and “virtual outsourcing” all enable a global enterprise to develop, manage, update and retain knowledge processes.   A “dedicated” “center of excellence” offers outsourcing benefits of managed services, minimal startup capital investment and a managed workforce, without ownership.  It may just be an outsourcing with a call option (in the “build-own-operate-transfer” model).

Customer organizations might rely on this approach to build a center that would be transferred to a shared services captive over time.  The big questions for both parties in such arrangements relate to return on investment by each, as well as key assumptions on supply, demand, opportunity cost and exit costs.

HR Management: Having Practical Control without Legal Control. Pricing models rarely address the costs of human capital investment and workforce management.  The advent of these innovative pricing models invites a discussion beyond merely whether the “key employees” can be hired by the customer organization upon expiration or termination.  Key topics for agreement include:

• Workforce Planning as a Team Sport. The customer having its own project management office anticipate the expiration of particular project phases where key employees might be transitioned away from the customer to another account of the service provider.  By anticipating such transitions, and developing additional projects for such key employees to continue for the customer, both parties benefit through continuity, additional revenue and reduced training of replacement workers.  Of course, this strains the provider’s own workforce management and the key employee’s career path.  Unless the key employee is retained for increasingly challenging and complex work, he or she might leave the provider, to the detriment of both provider and customer.

• Planning for the Insourcing after the Outsourcing. In the 1990’s, outsourcing providers hired the customer’s production team, extracted and automated business processes, and then tranferrred work to lower cost venues.  To the amazement of experienced employment lawyers at the time, enterprise customers were too naïve, generous or stupid to demand a headhunter’s price: one third of the person’s first year gross compensation.  But when, now, enterprise customers want to re-hire persons who had been working on their business for years, service providers are reluctant to permit it, or seek to obtain a similar headhunter’s compensation.   The topic of investment in human capital now merits a frank exchange on planning, scenarios, costs and benefits.

Conclusion. Sourcing relationship have become more modular.  Every element of the relationship has an impact on pricing.  Pricing structure, capital investment, ROI, end-game scenarios, tectonic shifts in the service delivery model and human capital management are now part of the process of getting to viable, enforceable agreements.

Regulatory Settlement of Fraudulent Robo-Signing by Mortgage Servicing Companies

September 30, 2011 by Bierce & Kenerson, P.C.

Like a well-designed software package, BPO services offer the advantages of process uniformity and standardization, scalability, speed to completion, predictability and transparency.  When BPO is abused, the advantages can quickly turn into disadvantages of equally grand scale.  Such is the tale of “robo-signing” of affidavits of compliance with banking regulations that were based on common practice of non-compliance.  This article addresses the settlement by Goldman Sachs with the New York State Department of Financial Services and New York Banking Department in early September 2011.  For more click here.

The Business Services of Mortgage Loan Origination Management. The origination of mortgage loans is the first step in the syndication of bundles of mortgage loans for sales to investors, or for retention in a bank’s own loan portfolio of assets.  Whether a loan is bundled into a package of collateralized debt obligations (“CDO’s”) or retained as a portfolio asset, the origination process must comply with applicable laws governing Truth in Lending and eligibility for loan guarantees.  Such laws include full disclosure of applicable financing terms, consumer protection, due diligence and verification of due execution of the borrower’s promissory note, the mortgage securing the loan, title documents confirming the underlying assets are owned of record in the name of the borrower.

Robo-Signing. The phrase “robo-signing” arose in 2008-2009 when regulators discovered that many BPO service providers in loan origination services falsely provided affidavits of compliance with statutory requirements for bank lending.

The Sub-Prime Debt Crisis. Affidavits of compliance with loan origination requirements are an essential element of any loan origination program for a bank.  In the 2000’s, many U.S. banks outsourced the compliance function to service companies.  In the U.S. sub-prime mortgage crisis that began in 2008 and continues through at least 2011, the failure of the outsourcing companies to meet a service level of 100% compliance has triggered a tsunami of legal woes:

• Borrowers have alleged in court that they were defrauded (and therefore cannot be foreclosed).
• Investors have sued to rescind their investments in CDO’s because the underlying collateral was fraudulently obtained.
• The CDO market has become unsettled, impairing the free trade and circulation of CDO’s as a source of liquidity in the housing market (and thus a source of sustainability of higher prices).
• Housing prices have collapsed by 30% in many locations.
• Banks are not only prudent to ensure 100% compliance with loan origination laws, but they have been reluctant to lend to qualifying buyers, thereby depressing     the housing market and increasing the immobility of homeowners seeking jobs elsewhere.
• Delinquent borrowers have been subjected to loan servicing fees that make it more difficult to repay the loan.
• Non-delinquent borrowers might have an escape from repayment obligations under principles of fraud and rescission, but they cannot escape due to the collapse of “normal” lending markets for residential real estate since 2007.
• Regulators have conducted investigations and sought penalties against banks using robo-signing practices.

Litton Loan Servicing: Goldman Sachs’ Alleged Robo-Signers. In September 2011, the New York State Department of Financial Services and New York Banking Department reached a settlement with Goldman Sachs, as owner of Litton Loan Servicing, as a condition of allowing Goldman to sell Litton to another mortgage servicing company, Ocwen Financial Corp.   On September 2, 2011, Ocwen described the deal in its SEC filing:

On September 1, 2011, Ocwen Financial Corporation (“Ocwen”) completed its acquisition of (i) all the outstanding partnership interests of Litton Loan Servicing LP (“Litton”), a subsidiary of The Goldman Sachs Group, Inc. (“Seller”) and provider of servicing and subservicing of primarily non-prime residential mortgage loans (the “Business”), and (ii) certain interest-only servicing strips previously owned by Goldman Sachs & Co., also a subsidiary of Seller. These transactions and related transactions (herein referred to as the “Transaction”) were contemplated by a Purchase Agreement (the “Agreement”) between Ocwen and Seller dated June 5, 2011 which was described in, and filed with, Ocwen’s Current Report on Form 8-K dated June 6, 2011. The Transaction resulted in the acquisition by Ocwen of a servicing portfolio of approximately $38.6 billion in unpaid principal balance of primarily non-prime residential mortgage loans (“UPB”) as of August 23, 2011 and the servicing platform of the Business.

The purchase price for the Transaction was $247.2 million, which was paid in cash by Ocwen at closing. In addition, Ocwen paid $296.4 million to retire a portion of the outstanding debt on an advance facility previously provided by an affiliate of Seller to Litton. To finance the Transaction, Ocwen received a senior secured term loan facility of $575 million with Barclays Capital as lead arranger and also entered into a new facility with the Seller to borrow approximately $2.1 billion against the servicing advances associated with the Business.

The actual purchase price differed from the estimated base purchase price of $263.7 million disclosed in the current report on Form 8-K filed by Ocwen on June 6, 2011 as a result of certain adjustments specified in the Agreement for changes in Litton’s estimated closing date net worth, servicing portfolio UPB and advance balances, among others. The purchase price may be further adjusted as these estimated closing-date measurements are finalized after the closing date.

In connection with the Transactions, Ocwen, Goldman Sachs Bank USA, Litton and the New York State Banking Department have entered into an agreement (the “NY Agreement”) that sets forth certain loan servicing practices and operational requirements. No fines, penalties or other payments were assessed against Ocwen or Litton under the terms of the NY Agreement. We believe the NY Agreement will not have a material impact on our financial statements.

Settlement Terms. The “Agreement on Mortgage Servicing Practices” was consented to by Goldman, Ocwen and Litton.  Goldman, which is exiting the mortgage servicing business with the sale of Litton, agreed to adopt these servicing practices if it should ever reenter the servicing industry.

According to the Banking Department, the settlement makes “important changes in the mortgage servicing industry which, as a whole, has been plagued by troublesome and unlawful practices. Those practices include: ‘Robo-signing,’ referring to affidavits in foreclosure proceedings that were falsely executed by servicer staff without personal review of the borrower’s loan documents and were not notarized in accordance with state law; weak internal controls and oversight that compromised the accuracy of foreclosure documents; unfair and improper practices in connection with eligible borrowers’ attempts to obtain modifications of their mortgages or other loss mitigation, including improper denials of loan modifications; and imposition of improper fees by servicers.”

“The Agreement makes the following changes:

1. Ends Robo-signing and imposes staffing and training requirements that will prevent Robo-signing.
2. Requires servicers to withdraw any pending foreclosure actions in which filed affidavits were Robo-signed or otherwise not accurate.
3. Requires servicers to provide a dedicated Single Point of Contact representative for all borrowers seeking loss mitigation or in foreclosure, preventing borrowers from getting the runaround by being passed from one person to another. It also restricts referral of borrowers to foreclosure when they are engaged in pursuing loan modifications or loss mitigation.
4. Requires servicers to ensure that any force-placed insurance be reasonably priced in relation to claims incurred, and prohibits force-placing insurance with an affiliated insurer.
5. Imposes more rigorous pleading requirements in foreclosure actions to ensure that only parties and entities possessing the legal right to foreclose can sue borrowers.
6. For borrowers found to have been wrongfully foreclosed, requires servicers to ensure that their equity in the property is returned, or, if the property was sold, compensate the borrower.
7. Imposes new standards on servicers for application of borrowers’ mortgage payments to prevent layering of late fees and other servicer fees and use of suspense accounts in ways that compounded borrower delinquencies and defaults.
8. Requires servicers to strengthen oversight of foreclosure counsel and other third party vendors, and imposes new obligations on servicers to conduct regular reviews of foreclosure documents prepared by counsel and to terminate foreclosure attorneys whose document practices are problematic or who are sanctioned by a court.

Notably, the adoption of new “best practices” does not release Litton from future claims or from being investigated in the future.

Lessons Learned. While Goldman might have been negligent in supervising its mortgage loan origination subsidiary, it learned the lesson by divesting the BPO service provider to a larger, more stable BPO service provider.   The services provided by Litton had helped feed Goldman’s role as an originator and underwriter of CDO securities that it then packaged and sold into financial markets.  The sale of Litton represents an unwinding of this financial chain and should improved the credibility, marketability and liquidity of the CDO markets.

On a broader level, the New York banking settlement underscores the importance of a BPO service provider’s “getting it right the first time.”   This means that service supporting regulated businesses should anticipate that their functions will be supervised by regulators even if their function is only a slice of a regulated function.  As a result, the risk profile for service providers can be expected to increase where the enterprise customer or the service provider fails to ensure 100% compliance with regulations.   Master Services Agreements should be structured to ensure appropriate allocation of liability, together with risk management practices to limit the enterprise customer’s exposure to regulatory investigation and penalties.

Surprisingly, there were no regulatory penalties for Goldman.  This may be attributable to good lawyering as well as the fact the “settlement” arose solely in the context of a divestiture, where the purchaser willing purchased a troubled asset.

To learn more about robo-signing click here.

Outsourcing Law & Business Journal™: July 2010

July 30, 2010 by Bierce & Kenerson, P.C.

OUTSOURCING LAW & BUSINESS JOURNAL (™) : Strategies and rules for adding value and improving legal and regulation compliance through business process management techniques in strategic alliances, joint ventures, shared services and cost-effective, durable and flexible sourcing of services.  www.outsourcing-law.com. Visit our blog at http://blog.outsourcing-law.com for commentary on current events.

Insights by Bierce & Kenerson, P.C., Editors.  www.biercekenerson.com

Vol. 10, No. 7 (July 2010)
_______________________________

1.   Dodd-Frank Financial Reform: New “Systemic Risks” for the BPO Industry.

2.  Humor.

3.  Conferences.

____________________________

1. Dodd-Frank Financial Reform: New “Systemic Risks” for the BPO Industry. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, H.R. 4173, signed by President Obama on July 21, 2010, invites a rethinking of the traditional outsourcing model in the financial services sector.   The new law adopts new requirements to limit systemic financial risks.  It calls for new regulations to delineate prohibited transactions and to implement new certain reporting and operational restrictions.   The regulations apply to broker-dealers, banks dealing with hedge funds, commodity brokers, swap dealers and participants and credit rating agencies.  It establishes a Bureau of Consumer Financial Protection to ensure compliance.

The traditional outsourcing model does not involve legal liability of service providers for legal wrongdoing by their enterprise customers.  The Dodd-Frank law shifts the risk profile of service providers in the financial services sector.  This could have a chilling effect on outsourcing for financial services companies and their external service providers.  For more, click here.

2.  Humor.

Whistleblower, n. (1) in sports, the umpire; (2) in law enforcement, the policeman; (3) in business process management, the employee who sees the emperor is wearing no clothes; (4) in false advertising in the tobacco industry, a retired researcher; (5) under Sarbanes-Oxley, a self-appointed member of a spy network; (6) under Dodd-Frank, a bounty-hunter.

Aiding and abetting, n.  In LPO, a “regulatory process” transformation that automatically converts the back office transaction provider into a  front-office crook.

3.  Conferences.

September 13-15, 2010.  5th eDiscovery for Pharma, Biotech and Medical Device Industries, Philadelphia, Pennsylvania.  Presented by IQPC, this event will bring together industry leaders from in-house eDiscovery teams, expert judges and outside counsel as they discuss:

• How the new Pension Committee decision will effect eDiscovery professionals in the life science industries
• The unique challenges biopharmaceutical and medical device companies face with respect to social media content
• Preparing and responding to FDA inquiries, patent issues, and other types of pharmaceutical litigation
• A progress report on the 7th circuit eDiscovery pilot program and its implications for Pharma and Biotech
• Reducing patient privacy risks and unnecessary disclosures due to indiscriminate document retention
• Discovering new technologies to reach your goal of gaining proactive control over all your data

To register and view the whole program, click here.

September 26-28, 2010.  IQPC Shared Services Exchange™ Event, 2nd Annual, to be held in The Hague, Netherlands. Shared Service Centres have long been seen as the cost saving centre of HR, Finance & Accounting and IT processes, but with changing employment trends and global challenges facing organisations, how can SSC’s continually offer service value?

Unlike typical conferences, the Shared Services Exchange™, which will be co-located with the Corporate Finance Exchange™, focuses on networking, strategic conference sessions and one-on-one meetings with solution providers. The Exchange invites strategic decision makers to take a step back from their current operations, see what strategies and solutions others are adopting, develop new partnerships and make investment choices that deliver innovative solutions and benefits to their businesses.

To request your complimentary delegate invitation or for information on solution provider packages, please contact: exchangeinfo@iqpc.com, call +44 (0) 207 368 9709, or visit their website at http://www.sharedservicesexchange.co.uk/Event.aspx?id=263014

September 28-30, 2010, SSON presents Finance Transformation 2010, Chicago, Illinois. If you are facing challenges to meet your finance end-to-end and top quartile requirements, consider Finance Transformation 2010 – the most comprehensive event for anyone managing finance back office operations looking for end-to-end capability.

The main themes explore the strategic views of true transformation across the entire finance supply chain and highlight the roadmaps which will help you to achieve top quartile business outcomes you aspire to. Sessions will cover the key tenets that all of you in the industry – large and small, beginner and established, vendor and buyer, private and public – are required to confront. For more information and to register, visit Finance Transformation.

October 21-22, 2010, American Conference Institute’s 5th National Forum on Reducing Legal Costs, Philadelphia, Pennsylvania.

The essential cross-industry forum for corporate and outside counsel who are truly motivated to create value and reduce legal costs through innovative fee arrangements, enhanced relationships, and streamlined operations

Come join senior corporate counsel responsible for cost-reduction success stories, as well as leaders from law firms that have pioneered the use of alternative fee arrangements and other innovative cost-reduction initiatives, as they provide a roadmap for navigating the complexities of keeping legal department costs in check. Now in its fifth installment, this event offers unique networking opportunities with senior practitioners from around the nation, including in-house counsel from a wide range of companies and industries.

Reference discount code “outlaw” for the discounted rate of $1695!  To get more information, visit www.americanconference.com/legalcosts

October 25-27, 2010, The 8th Annual HR Shared Services and Outsourcing Summit, Orlando, Florida. This will be a gathering for corporate HR & shared services executives from companies across North America to exchange ideas, develop new partnerships and discuss the latest tools, technologies and strategies being employed in the profession to enhance departmental efficiencies and propel corporate growth. The event will focus on the most current topics in the HR shared services industry including metrics, automation, outsourcing, globalization, compensation & rewards, benefits and an overall focus on the new strategic role of HR shared services.  We will review how to tackle change management, analyze current and future projects and further develop the instrumental key areas within HR shared services. Outsourcing Law contacts can receive 20% off the standard all access price when they register with the code HRSS5. Register by calling 212-885-2738. View the program brochure for more details by clicking here.

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FEEDBACK: This newsletter addresses legal issues in sourcing of IT, HR, finance and accounting, procurement, logistics, manufacturing, customer relationship management including outsourcing, shared services, BOT and strategic acquisitions for sourcing. Send us your suggestions for article topics, or report a broken link at: wbierce@biercekenerson.com. The information provided herein does not necessarily constitute the opinion of Bierce & Kenerson, P.C. or any author or its clients. This newsletter is not legal advice and does not create an attorney-client relationship. Reproductions must include our copyright notice. For reprint permission, please contact: wbierce@biercekenerson.com . Edited by Bierce & Kenerson, P.C. Copyright (c) 2010, Outsourcing Law Global LLC. All rights reserved.  Editor in Chief: William Bierce of Bierce & Kenerson, P.C. located at 420 Lexington Avenue, Suite 2920, New York, NY 10170, 212-840-0080.

Dodd-Frank Financial Reform: New “Systemic Risks” for the BPO Industry

July 30, 2010 by Bierce & Kenerson, P.C.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, H.R. 4173, signed by President Obama on July 21, 2010, invites a rethinking of the traditional outsourcing model in the financial services sector.   The new law adopts new requirements to limit systemic financial risks.  It calls for new regulations to delineate prohibited transactions and to implement new certain reporting and operational restrictions.   The regulations apply to broker-dealers, banks dealing with hedge funds, commodity brokers, swap dealers and participants and credit rating agencies.  It establishes a Bureau of Consumer Financial Protection to ensure compliance.

The traditional outsourcing model does not involve legal liability of service providers for legal wrongdoing by their enterprise customers.  The Dodd-Frank law shifts the risk profile of service providers in the financial services sector.  This could have a chilling effect on outsourcing for financial services companies and their external service providers.

Vicarious Liability for Service Providers. The Dodd-Frank law raises the standards for external service providers who support any regulated financial services.

o    It imposes vicarious liability on any service provider processing consumer financial transactions as “aiders and abettors” for operational support in some cases.
o    It encourages employees of shared service centers and outsourcers to file claims of violation so that they can reap a bounty in an enforcement case.
o    It makes mere “recklessness” the equivalent of a “knowing” violation of:

o    the Securities and Exchange Act of 1934, Dodd-Frank, Sec. 929O, amending 15 USc 78t(e);
o    the Investment Company Act, Dodd-Frank, Sec. 929M, amending 15 USC 77o; and
o    the Investment Advisers Act of 1940, Dodd-Frank, Sec. 929N, amending 15 USC 80b-9.

o    It extends the extraterritorial jurisdiction of U.S. courts in enforcement of U.S. securities laws.

Whistleblowers Beyond Sarbanes-Oxley. The Sarbanes-Oxley Act of 2002 protects the employment of “whistleblowers” who report to governmental authorities the employer’s violations of the SOX law.   Section 922 of the Dodd-Frank law extends protection of “whistleblowers” by appointing them as bounty hunters against securities law violations by banks, financial services companies, insurance companies (BFSI) and by others including credit rating agencies, investment advisers, investment companies (mutual funds), commodities future dealers and others.

The bounty would be manditorily paid, where the Securities and Exchange Commission (SEC) brings any administrative or judicial proceeding that results in monetary sanctions exceeding $1.0 million.  15 USC 78a, Sec. 21F, per Dodd-Frank, Sec. 922.   Under future SEC regulations to be adopted, bounties will be awarded to individuals for “original information” not known to the SEC from any other source in an aggregate amount of between 10% and 30% of the total amount collected from SEC-imposed monetary sanctions on the wrongdoer.   In deciding how much to award, the SEC must consider the significance of the information to the success of the SEC, the degree of assistance by the whistleblower and his or her “legal representative” and the “programmatic interest” of the SEC in deterring future violations of the securities laws.

The new statute explicitly promotes anonymous whistleblowing by contemplating a scenario where the whistleblower is represented by legal counsel.   However, identification of the whistleblower is required, but only “prior to payment of the award.”

The statute extends the usual prohibitions against retaliation for initiating, testifying in or assisting in any judicial or administrative proceeding.   Specifically, “no employer may discharge, demote, suspend, threaten, harass, directly or indirectly, or in any other manner, discriminate against a whistleblower” in terms of employment, by reason of the whistleblowing.  The protection applies to any employer, even if the employer is not the violator of the Dodd-Frank law.  This protection expires with a new statute of limitations of six years, but not more than ten years if the “materials facts” were not immediately discovered till later.  The whistleblower is entitled to reinstatement of employment, 200% of back pay lost plus litigation costs including attorneys’ fees.

The bounty-hunting whistleblower is a new phenomenon.   It invites anyone having insider knowledge, including those who process financial transactions under a confidentiality (non-disclosure) agreement, to breach the duty of confidentiality and pursue a bounty by reason of wrongdoing by the client enterprise.

This new law raises the risks for both outsourcers and captives that an employee might become embroiled in whistleblowing.  It is not difficult to imagine that an outsourcer’s employee (or captive financial service center’s employee) might identify patterns of trading, and might indeed hear conversations in the course of transactions processing, that might provide evidence of breaches of the new Dodd-Frank restrictions and future SEC implementing regulations.

The bounty-hunting awards were payable for securities violations before the Dodd-Frank act became law.  Dodd-Frank, Sec. 924(c).

Aiders and Abettors. The Dodd-Frank law also imposes penalties under the Investment Advisers Act of 1940 (IAA) for anyone who assists a securities violation by a registered investment adviser.  Thus, anyone who “knowingly or recklessly has aided, abetted, counseled, commanded, induced or procured a violation of any provision” of the IAA shall be deemed in violation to the same extent as the direct violator.   Dodd-Frank, Sec. 929N, amending 15 USC 80b-9, new Sect. 209.

Extraterritorial Jurisdiction of U.S. Courts. The Dodd-Frank law focused on international transactions that could result in violations of U.S. securities laws, even though the “bad acts” are conducted offshore.  The new law clarifies and, some would say, extends, the statutory jurisdiction of U.S. federal District Courts to adjudicate any SEC enforcement proceeding alleging a violation of fraud to two international contexts that were somewhat controversial under existing judicial precedents:

o    Conduct within the USA that constitutes significant steps in furtherance of the violation, even if the securities transactions occurs outside the USA and involves only foreign investors (i.e., domestic activities); and
o    Conduct occurring outside the USA that has a foreseeable substantial effect within the USA (i.e., foreign activities).

In this case, the foreign activities of business intelligence, research, analytics, transaction processing and reporting, customer relationship management, and other tasks could have such a “foreseeable substantial effect.”   Thus, foreign activities are thus subject to US judicial jurisdiction, and the foreign service providers engaged in supporting violations by US persons could be governed by US enforcement jurisdiction for direct wrongdoing, recklessness or “aiding and abetting.”

Shared Services Center or Outsourcer’s Risks under Consumer Financial Protection Laws. Outsourcing contracts allocate the risks and responsibilities for compliance with applicable laws.   The Dodd-Frank law puts financial services outsourcing on the radar for possible direct enforcement action against the shared services center or outsourcer.

The Dodd-Frank law enumerates the consumer laws that are covered:  These consist of:

(A) the Alternative Mortgage Transaction Parity Act of 1982 (12 U.S.C. 3801 et seq.);
(B) the Consumer Leasing Act of 1976 (15 U.S.C. 1667 et seq.);
(C) the Electronic Fund Transfer Act (15 U.S.C. 1693 et seq.), except with respect to section 920 of that Act;
(D) the Equal Credit Opportunity Act (15 U.S.C. 1691 et seq.);
(E) the Fair Credit Billing Act (15 U.S.C. 1666 et seq.);
(F) the Fair Credit Reporting Act (15 U.S.C. 1681 et seq.), except with respect to sections 615(e) and 628 of that Act (15 U.S.C. 1681m(e), 1681w);
(G) the Home Owners Protection Act of 1998 (12 U.S.C. 4901 et seq.);
(H) the Fair Debt Collection Practices Act (15 U.S.C. 1692 et seq.);
(I) subsections (b) through (f) of section 43 of the Federal Deposit Insurance Act (12 U.S.C. 1831t(c)-(f));
(J) sections 502 through 509 of the Gramm-Leach-Bliley Act (15 U.S.C. 6802-6809) except for section 505 as it applies to section 501(b);
(K) the Home Mortgage Disclosure Act of 1975 (12 U.S.C. 2801 et seq.);
(L) the Home Ownership and Equity Protection Act of 1994 (15 U.S.C. 1601 note);
(M) the Real Estate Settlement Procedures Act of 1974 (12 U.S.C. 2601 et seq.);
(N) the S.A.F.E. Mortgage Licensing Act of 2008 (12 U.S.C. 5101 et seq.);
(O) the Truth in Lending Act (15 U.S.C. 1601 et seq.);
(P) the Truth in Savings Act (12 U.S.C. 4301 et seq.);
(Q) section 626 of the Omnibus Appropriations Act, 2009 (Public Law 111-8); and
(R) the Interstate Land Sales Full Disclosure Act (15 U.S.C. 1701).

BFSI outsourcers and shared services centers will be deemed to be providing regulated “financial products or services” if they provide any one or more of the following functions.   (There are some exceptions, but for general discussion, the key elements can be summarized here.)

(i) extending credit and servicing loans, including acquiring, purchasing, selling, brokering, or other extensions of credit;
(ii) extending or brokering leases of personal or real property that are the functional equivalent of purchase finance arrangements
(iii) providing real estate settlement services (other than appraisals);
(iv) engaging in deposit-taking activities, transmitting or exchanging funds, or otherwise acting as a custodian of funds or any financial instrument for use by or on behalf of a consumer;
(v) selling, providing, or issuing stored value or payment instruments
(vi) providing check cashing, check collection, or check guaranty services;
(vii) providing payments or other financial data processing products or services to a consumer by any technological means, including processing or storing financial or banking data for any payment instrument, or through any payments systems or network used for processing payments data;
(viii) providing financial advisory to consumers on individual financial matters or relating to proprietary financial products, including–

(I) providing credit counseling to any consumer; and
(II) providing services to assist a consumer with debt management or debt settlement, modifying the terms of any extension of credit, or avoiding foreclosure;

(ix) for others, collecting, analyzing, maintaining, or providing consumer report information or other account information, including information relating to the credit history of consumers, used or expected to be used in connection with any decision regarding the offering or provision of a consumer financial product or service.

Conclusion. The Dodd-Frank law requires further regulations, which could be retroactive.

1.    Expanding Scope of Vicarious Liability.   Service providers and shared service centers face new risks of direct and vicarious liability for performing certain covered financial service activities.  As a matter of policy, the Dodd-Frank act raises the policy question whether, in future laws and regulations, service providers be exposed to more scenarios of vicarious liability.

2.    Living in a Climate Protecting Whistleblowers.  Whistleblower laws already protect persons who report violations of tax laws and securities laws.  The Dodd-Frank act expands the concept of whistleblowers as tools for law enforcement.

o    Employment Law.  The Dodd-Frank law pushes the boundaries in the field of employer-employee relations.   Every employer now has a duty to avoid discrimination against its employees who become whistleblowers as private spies for governmental enforcement of violations of law.  Service providers cannot simply adopt a policy of prohibiting whistleblowing.  Rather, they now have to define their policies, procedures and contractual risk management in cases where their customers are potentially violating the laws.

o    Contractual Design and Risk Allocation.  What should a service provider do if an employee poses questions about a financial service company’s operational compliance with Dodd-Frank? Should the service provider encourage the employee to be a whistleblower?

o    Relationship Governance.  Can the provider deal with the problem through the existing “relationship governance” framework?  What are the possible outcomes and costs of dealing with a “whistleblowing” situation in business process management?

o    Termination Management.  Does the provider have any contractual rights or remedies to terminate the relationship?  What process should be initiated before any such right becomes enforceable?  Who pays for transition costs in case of termination for alleged breach by the customer of laws that could inveigle the service provider as an “aider and abettor”?

3.    The Service Provider’s Price for Moving up the Value Chain.  Today, service providers are moving up the value chain by providing end-to-end transaction processing across business functions that are increasingly regulated.   Service providers’ business intelligence (BI), deductive and predictive analytics, knowledge-process outsourcing (KPO), legal process outsourcing (LPO) and core finance and accounting functions.   In this context, service providers need to put  “aiding and abetting” and whistleblower management on their radar for risk assessment, policy development and actions to mitigate risks.  This will require investment in compliance analytics, workflow definition and contractual reallocation of risk.

4.    Insurance.   The increased risk profile for servicing the back-office needs of the BFSI market exposes service providers (and their directors and officers) to significant financial liability.  Typically, insurance products are developed to spread risks to cover losses from the rare occasion of catastrophic liability.  It is time for risk managers to discuss this issue with their legal counsel, insurance brokers and insurance carriers.

Accordingly, in the consumer financial services sector (and other consumer sectors), it is time for reassessment of the business models for outsourcing and shared services.  Redesign of the business models will reflect these pinpoint areas of primary legal risks, identify possible avenues for eliminating or mitigating those risks, and redesign the services and contractual risk allocations.

For further discussion of this article, contact  William Bierce in New York.

Outsourcing Law & Business Journal™: June 2010

June 30, 2010 by Bierce & Kenerson, P.C.

OUTSOURCING LAW & BUSINESS JOURNAL (™) : Strategies and rules for adding value and improving legal and regulation compliance through business process management techniques in strategic alliances, joint ventures, shared services and cost-effective, durable and flexible sourcing of services.  www.outsourcing-law.com. Visit our blog at http://blog.outsourcing-law.com for commentary on current events.

Insights by Bierce & Kenerson, P.C., Editors.  www.biercekenerson.com

Vol. 10, No. 6 (June 2010)
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1.  U.S. Discrimination against Foreign Call Centers: Sen. Schumer’s Personal Trade War.

2.  Business Method Patents for Business Process Sourcing : Strategies for Hedging Your Bets when Strategies for Hedging Weather Futures are Unpatentable under U.S. Supreme Court’s Bilski Decision.

3.  Humor.

4.  Conferences.

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1.  U.S. Discrimination against Foreign Call Centers: Sen. Schumer’s Personal Trade War. Call center operations can be conducted anywhere in the world without U.S. regulation, unless the activities involve regulated business services such as mortgage banking, consumer credit and lending, broker-dealer securities brokerage, life insurance sales and the regulated professions such as public accounting, the practice of law, engineering and architecture.  The Democrats and the Obama Administration appear to want to control call center operations more than the mere directive in the TARP program, which forbids the use of any federal funds by TARP stimulus recipients for foreign call centers.  Now comes Sen. Charles Schumer (D., N.Y.) with a proposal to tax all foreign call center calls at $0.25 per call, but exempt all U.S. call center calls from this tax.  For the complete article, click here:  http://www.outsourcing-law.com/2010/06/u-s-discrimination-against-foreign-call-centers/

2.  Business Method Patents for Business Process Sourcing : Strategies for Hedging Your Bets when Strategies for Hedging Weather Futures are Unpatentable under U.S. Supreme Court’s Bilski Decision. Business process outsourcing (BPO) has led many entrepreneurs and their investor cousins (sometimes called “patent trolls”) to seek patent protection for their business methods.   The long-awaited decision of the U.S. Supreme Court in Bilski v. Kappas, 561 U.S. ___ (June 28, 2010) was anticipated to lay down the groundwork for defining the parameters of patentable business methods.  Its decision disappoints the more than 60 parties that filed briefs on both sides of the debate over what is patentable.  Read more by clicking here:  http://www.outsourcing-law.com/2010/06/business-method-patents-for-business-process-sourcing/

3.  Humor.

Patent, n. (1) a legal monopoly until it is declared illegal, invalid, obvious or not useful; (2) bargaining chip for a standard agreement; (3) public declaration of what you do in private.

Patent troll, n. (1) non-operating owner of a business method that everyone uses; (2) sheriff deputized for highway robber.

4.  Conferences.

July 14-16, 2010.  IQPC Presents Shared Services for Finance and Accounting, Chicago, Illinois. The SSFA 2010 Summit brings together leading financial shared services experts to network, benchmark and learn through keynote presentations, interactive roundtables, case studies and discussion panels. This program will help you improve internal accounting processes, maximize your efficiency with less resources, make smarter sourcing decisions, and drive continuous value through your financial services.  For more information, visit http://www.sharedservicesfa.com/Event.aspx?id=314126

September 13-15, 2010.  5th eDiscovery for Pharma, Biotech and Medical Device Industries, Philadelphia, Pennsylvania.  Presented by IQPC, this event will bring together industry leaders from in-house eDiscovery teams, expert judges and outside counsel as they discuss:

• How the new Pension Committee decision will effect eDiscovery professionals in the life science industries
• The unique challenges biopharmaceutical and medical device companies face with respect to social media content
• Preparing and responding to FDA inquiries, patent issues, and other types of pharmaceutical litigation
• A progress report on the 7th circuit eDiscovery pilot program and its implications for Pharma and Biotech
• Reducing patient privacy risks and unnecessary disclosures due to indiscriminate document retention
• Discovering new technologies to reach your goal of gaining proactive control over all your data

To register and view the whole program, click here.

September 26-28, 2010.  IQPC Shared Services Exchange™ Event, 2nd Annual, to be held in The Hague, Netherlands. Shared Service Centres have long been seen as the cost saving centre of HR, Finance & Accounting and IT processes, but with changing employment trends and global challenges facing organisations, how can SSC’s continually offer service value?

Unlike typical conferences, the Shared Services Exchange™, which will be co-located with the Corporate Finance Exchange™, focuses on networking, strategic conference sessions and one-on-one meetings with solution providers. The Exchange invites strategic decision makers to take a step back from their current operations, see what strategies and solutions others are adopting, develop new partnerships and make investment choices that deliver innovative solutions and benefits to their businesses.

To request your complimentary delegate invitation or for information on solution provider packages, please contact: exchangeinfo@iqpc.com, call +44 (0) 207 368 9709, or visit their website at http://www.sharedservicesexchange.co.uk/Event.aspx?id=263014

October 21-22, 2010, American Conference Institute’s 5th National Forum on Reducing Legal Costs, Philadelphia, Pennsylvania.

The essential cross-industry forum for corporate and outside counsel who are truly motivated to create value and reduce legal costs through innovative fee arrangements, enhanced relationships, and streamlined operations

Come join senior corporate counsel responsible for cost-reduction success stories, as well as leaders from law firms that have pioneered the use of alternative fee arrangements and other innovative cost-reduction initiatives, as they provide a roadmap for navigating the complexities of keeping legal department costs in check. Now in its fifth installment, this event offers unique networking opportunities with senior practitioners from around the nation, including in-house counsel from a wide range of companies and industries.

Reference discount code “outlaw” for the discounted rate of $1695!  To get more information, visit www.americanconference.com/legalcosts

October 25-27, 2010, The 8th Annual HR Shared Services and Outsourcing Summit, Orlando, Florida. This will be a gathering for corporate HR & shared services executives from companies across North America to exchange ideas, develop new partnerships and discuss the latest tools, technologies and strategies being employed in the profession to enhance departmental efficiencies and propel corporate growth. The event will focus on the most current topics in the HR shared services industry including metrics, automation, outsourcing, globalization, compensation & rewards, benefits and an overall focus on the new strategic role of HR shared services.  We will review how to tackle change management, analyze current and future projects and further develop the instrumental key areas within HR shared services. Outsourcing Law contacts can receive 20% off the standard all access price when they register with the code HRSS5. Register by calling 212-885-2738. View the program brochure for more details by clicking here.

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FEEDBACK: This newsletter addresses legal issues in sourcing of IT, HR, finance and accounting, procurement, logistics, manufacturing, customer relationship management including outsourcing, shared services, BOT and strategic acquisitions for sourcing. Send us your suggestions for article topics, or report a broken link at: wbierce@biercekenerson.com. The information provided herein does not necessarily constitute the opinion of Bierce & Kenerson, P.C. or any author or its clients. This newsletter is not legal advice and does not create an attorney-client relationship. Reproductions must include our copyright notice. For reprint permission, please contact: wbierce@biercekenerson.com . Edited by Bierce & Kenerson, P.C. Copyright (c) 2010, Outsourcing Law Global LLC. All rights reserved.  Editor in Chief: William Bierce of Bierce & Kenerson, P.C. located at 420 Lexington Avenue, Suite 2920, New York, NY 10170, 212-840-0080.

Financial Services Outsourcing: New Roles and Risks under a Consumer Financial Protection Agency

May 18, 2010 by Bierce & Kenerson, P.C.

The financial services industry is facing major regulatory changes following the global sub-prime credit crisis and ensuing recovery plans.  These changes will have a major impact on outsourcers that deal with consumer financial information or in back-office support for financial investment transactions that are deemed unfair, deceptive or abusive.  The adoption of a new Consumer Financial Protection Agency Act would have a significant negative impact on the risks and costs of outsourcing of IT and business process functions by companies that deal with consumers.  It would invite a new view of risk allocation between enterprise customers and independent contractors as outsourcers, increasing the costs of doing business by putting the service provider into a new role of whistleblower.  It remains to be seen whether the analysis of public policy in this arena will spill over into other industries and other types of outsourcing.

Draft Consumer Financial Protection Agency Act

As of mid-May 2010, the U.S. Congress was considering possible enactment of financial regulatory reform.   Among the proposals is the draft “Consumer Financial Protection Agency Act,” as inserted into another draft law, H.R. 4173, “Wall Street Reform and Consumer Protection Act of 2009,” referred to Senate committee after being enacted by the House.  This consumer protection bill was originally H.R. 3126, 111th Cong., 1s Sess.; H. Rept. No. 111-367 (Dec. 9, 2009) (“Draft CFPAA”).  As the dissenting Republicans observed in that December 2009 House report:

Rather than address the failure of banking regulations related to consumer protection and the failure of the States to police activities under their purview (e.g., mortgage brokers and real estate agents), the proposed legislation to create the CFPA seeks to consolidate the consumer protection jurisdiction of all banking regulators into one new agency and regulate many new activities and persons that largely are unrelated to the financial markets or the crisis of 2008. (Dissenting views).

General Scope. If enacted, this proposed reform would transfer enforcement of consumer financial protection laws from various existing agencies (including the SEC). The new commission would regulate:

(1) brokers and dealers registered under the Securities Exchange Act of 1934;
(2) investment advisers under the Investment Advisers Act of 1940;
(3) investment companies (mutual funds) under the Investment Company Act of 1940;
(4) national securities exchanges under the ‘34 Act;
(5) a transfer agent under the ’34 Act;
(6) clearing corporations under the ’34 Act;
(7) municipal securities dealers and self-regulatory organizations registered with the SEC;
(8) national securities exchanges and the Municipal Securities Rulemaking Board.

Regulation of “Financial Activity.” Under H.R. 4173, Sec. 4002 (19) (A), the term `financial activity’ means any of  many activities.  (The list is long, so we have put it in a separate document.) ¹

Liability of “Covered Persons” and “Related Persons.” Under the proposed law, a “covered person” subject to regulation would include “any person who engages directly or indirectly in a financial activity, in connection with the provision of a consumer financial product or service.” This definition is so broad, and governmental involvement in financial operations so extensive, the draft specifically excludes the Secretary, the Department of the Treasury, any agency or bureau under the jurisdiction of the Secretary (H.R. 4173, Sec. 4002 (9)(A)(B)), or any federal tax collector.

Vicarious Liability on Certain “Consultants” and “Independent Contractors.” The proposed law would treat “related persons” in the same manner, and impose the same punishments, as for “covered persons.” By adopting a sweeping definition of “covered person” and an equally sweeping definition of “related person,” the proposed law puts outsourcers at risk of direct liability and for merely doing the tasks assigned under a Master Services Agreement in the ordinary course of business. There would be a distinction between consultants and service providers. A “related person” would include either:

• a “consultant” that, in the view of the new Consumer Financial Protection Commission determines (whether by regulation or on a case-by-case basis), “materially participates in the conduct of the affairs of such covered person” (H.R. 4173, Sec. 4002 (33)(A)(ii)); or
• “any independent contractor (including any attorney, appraiser, or accountant), with respect to such covered person, who knowingly or recklessly participates in any–(I) violation of any law or regulation; or (II) breach of fiduciary duty.” ( H.R. 4173, Sec. 4002 (33)(A)(iii)).

Liability of Outsourcers for “Unfair, Deceptive or Abusive Acts or Practices.” The proposed Consumer Financial Protection Agency Act would not require “related persons” to register with the commission. However, they would be liable for “unfair, deceptive or abusive act or practice in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service.” (H.R. 4173, Sec. 4301(a)).  The proposed law would impose federal criminal liability on anyone (including outsourcers as “related persons”) if they are shown to “knowingly or recklessly provide substantial assistance to another person in violation” of the new statute and regulations on “unfair, deceptive or abusive acts or practices.” “Related persons” would be “deemed to be in violation of that section to the same extent as the person to whom such assistance is provided.” (H.R. 4173, Sec. 4308(3)).

Outsourced Business Functions that Would be Exempt. The draft law would exclude certain functions that are typically outsourced from the scope of “financial activity “ that would be regulated.

• “Financial data processing” would be excluded from the definition of “financial activity.” H.R. 4371, Sec. 4002(19)(A)(xi). However, even assuming that the mechanical conditions of processing were satisfied under this exclusion, there remains a subjective standard that could ensnare the outsourcer in an ITO or BPO context:  Does the outsourcer provide “a material service to any covered person in connection with the provision of a consumer financial product or service.”  (H.R. 4173, Sec. 4002 (19)(A)(xi)(II)(cc))
• Providing certain “information products or services” that are “incidental and complementary” to any activity that the new commission defines as a “financial activity” would be excluded.  (H.R. 4173, Sec. 4002 (19)(A)(xvi)(I)(bb))  Specifically, there would be no regulation of such ITO or BPO services that are for identity authentication, fraud or identify theft detection, prevention, or investigation; document retrieval or delivery services; public records information retrieval; or for anti-money laundering activities. That exposes BPO providers of other business functions, such as mortgage and credit card origination, credit verification, and virtually everything else that is not clearly excluded by the draft law.

Neither of these exclusions addresses the growing use by the financial services industry of third party ITO, BPO and LPO services for labor-intensive or labor-value services. This draft law could bring vicarious liability for providers of such services as due diligence for investment banking and finance usually has some consumer financial impact, either in the design of analytics, the design and structuring of financial products or services, document review in an acquisition, divestiture or financing (where “consumers” might be investors in one of the deal participants).

Outsourcers as Auditors and Whistleblowers: The “Knowing or Reckless” Standard of Care for Outsourcers. The draft law would cover independent contractors providing services in support of “financial activity,” but only if their conduct were “knowing” or “reckless.” This standard could establish vicarious liability when the outsourcer “knew” that its actions would be unfair, deceptive or abusive, or because the outsourcer failed to become informed on the legality of its support for its financial institution customer’s unfair, deceptive or abusive practices. In effect, the consultants and outsourcers (other than data transmitters) are enlisted as surrogate auditors and whistleblowers with a duty to cease rendering their services if they “knowingly” or “reckless” participate in their customer’s unfair, deceptive or abusive practices.

Additional Costs of Outsourcing. This role would be a new one.  It would entail additional costs of legal reviews and audits by the service provider’s own independent regulatory experts (more lawyers and accountants) and additional premiums for new “directors and officers” liability insurance (if indeed such insurance would cover such vicarious liability). It would add hidden costs on the outsourcer that would have be added to the service charges in order to segregate service costs from legal compliance costs.

Additional Risks of Termination. Under these circumstances, regulated financial institutions and financial service enterprises would face the risk that a whisteblowing outsourcer could unilaterally terminate an ITO or BPO services agreement. Lawyers would argue about the conditions and consequences of when an outsourcer could do so.  Relationship governance would involve a new discussion about illegality.

• Service providers would want the right to terminate if, in their good faith opinion, the enterprise customer was engaged in any violation of this draft law or its regulations.
• Financial services enterprises would want a slower trigger.  One can imagine a series of steps that delay termination, with notices, opportunity to cure, maybe an independent legal opinion as a letter of comfort (thus escaping “recklessness” as a risk but not necessarily escaping “knowingly” risk).

Due Diligence Process. If this draft law is enacted, it would force service providers to clients engaged in any “financial activity” to conduct due diligence into the legality of the proposed customer’s business practices for the protection of consumers’ financial rights. Such an investigation would normally include questions about existing and future practices as well as information on the actions or recommendations of incumbent service providers who might have sought termination to avoid vicarious liability.

Adverse Impact on Business Process Transformation, Process Change and Operational Innovation. The draft law would impose direct liability on “consultants” who “materially participate” in a financial business.  The concepts of “materiality” and “participation” are so broad that any outsourcer who administers any of the “affairs” of its enterprise customer will be treated as such a “consultant” if the outsourcer proposes changes in the “covered person’s” business. This would stifle any proposals by outsourcers for business process transformation, even simple process changes, since the outsourcer might no longer be treated under the “independent contractor” standard of knowing or reckless violation or breach of fiduciary duty.

Spill Over to Other Industries and Outsourcing Services. For perhaps the first time, the draft CFPAA raises the specter of service providers worrying about the risk of vicarious liability because they support a criminal enterprise. “Aider and abettor” liability exists already in relation to the sale or distribution of “securities.” The question now is whether service providers should change their current practices and contract risk allocation in light of such a specter. Informed executives will get more information as this political process unfolds.

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