Regulatory Compliance

Here we are in March, 2009, four months after the Red Flags Rules deadline OR two months until the Red Flags deadline…depending on your glass-half-full / glass-half-empty view of the world.  I can say with confidence that at this point in time, the Identity Theft Red Flags 'discussion' with our clients and the market at large continues in full earnest.  That said, however, the nature of our discussions has changed substantially.  A few months ago, the needs expressed by the market centered on education around the Red Flags Rule, Red Flag compliance and it's applicability to various markets and account types. I find that the majority of my daily conversations on the subject now regard efficiencies in process and cost combined with effectiveness and customer experience. Most of our clients 'get' what they need to be doing such as identifying, detecting and responding to Red Flag conditions.  Where we are still working closely with our clients is in how they can optimize their policies and procedures to ensure that the majority of Red Flag conditions are detected and reconciled in singular automated steps.  As I've said in previous blogs, detecting these conditions is the easy part. It's how you reconcile (a.k.a. respond to) those conditions that makes the difference in your bottom line. As May 1 approaches, now is a great time to be monitoring each step in your process in an effort to identify those areas that may still have room for efficiency gains and improved customer experience.

Address discrepancies aren't the end of the road, but they sure can be a bump in it. One of the handful of mandatory elements in the Red Flag guidelines, which focus on FACTA Sections 114 and 315, is the implementation of Section 315.  Section 315 provides guidance regarding reasonable policies and procedures that a user of consumer reports must employ when a consumer reporting agency sends the user a notice of address discrepancy.  A couple of common questions and answers to get us started: 1.  How do the credit reporting agencies display an address discrepancy? Each credit reporting agency displays an “address discrepancy indicator,” which typically is simply a code in a specified field. Each credit reporting agency uses a different indicator. Experian, for example, supplies an indicator for each displayable address that denotes a match or mismatch to the address supplied upon inquiry. 2.  How do I “form a reasonable belief” that a credit report relates to the consumer for whom it was requested? Following procedures that you have implemented as a part of your Customer Identification Program (CIP) under the USA PATRIOT Act can and should satisfy this requirement. You also may compare the credit report with information in your own records or information from a third-party source, or you may verify information in the credit report with the consumer directly. In my last posting, I discussed the value of a risk-based approach to Red Flag compliance.  Foundational to that value is the ability to efficiently and effectively reconcile Red Flag conditions…including addressing discrepancies on a consumer credit report. Arguably, the biggest Red Flag problem we solve for our clients these days is in responding to identified and detected Red Flag conditions as part of their Identity Theft Prevention Program.  There are many tools available that can detect Red Flag conditions.  The best-in-class solutions, however, are those that not only detect these conditions, but allow for cost-effective and accurate reconciliation of high risk conditions.  Remember, a Red Flag compliant program is one that identifies and detects high risk conditions, responds to the presence of those conditions, and is updated over time as risk and business processes change. A recent Experian analysis of records containing an address discrepancy on the credit profile showed that the vast majority of these could be positively reconciled (a.k.a. authenticated) via the use of alternate data sources and scores.  Layer on top of a solid decisioning strategy using these elements, the use of consumer-facing knowledge-based authentication questions, and nearly all of that potential referral volume can be passed through automated checks without ever landing in a manual referral queue or call center.  Now that address discrepancies can no longer be ignored, this approach can save your operations team from having to add headcount to respond to this initially detected condition.  

At which stage of the application process does the Red Flags Rule apply? The Red Flag Rule would apply whenever you detect a Red Flag in connection with an application. This could occur as soon as you receive an application, for example: if the application appears to have been altered or forged; or the consumer’s identification appears to be forged or is inconsistent with the information on the application. Is the social security number (SSN) check a requirement? No, but an invalid SSN may be a Red Flag – i.e., an indicator of possible identity theft – and obtaining and verifying a SSN may be a reasonable means of application risk management to detect this Red Flag when opening accounts. You may be able to utilize your existing procedures under your Customer Identification Program under the USA PATRIOT Act.  

What to do when you see a Red Flag. Your Identity Theft Prevention Program should include appropriate responses when you detect a Red Flag. You must assess whether the Red Flag evidences a risk of identity theft. If so, your response must be commensurate with the degree of risk posed. Depending on the level of risk, an appropriate response may include contacting your applicant, not opening a new account or even determining that no response is necessary.  

By: Tom Hannagan Part 1 Beyond the risk management considerations related to a bank’s capital position, which is directly impacted by Troubled Asset Relief Program (TARP) participation, it should be clear that TARP also involves business (or strategic) risk.  We have spoken in the past of several major categories of risk: credit risk, market risk, operational risk and business risk. Business risk includes: A variety of risks associated with the outcomes from strategic decision making; Governance considerations; Executive behavior (for lack of better terminology); Management succession events or other leadership occurrences that may affect the performance and financial viability of the business. Aside from the monetary impact on the bank’s capital position, TARP involves a new capital securities owner being in the mix. And, with a 20% infusion of added tier 1 capital, we are almost always talking about a very large, new owner relative to existing shareholders. The United States Department of the Treasury is the investor or holder of the newly issued preferred stock and warrants. The Treasury Department does not have voting rights like common shareholders, but the Treasury’s Securities Purchase Agreement – Standard Form includes at least 35 pages of terms, plus the required Letter Agreement, Schedules attached to the Letter Agreement and at least five significant Annex’s to the Purchase Agreement. It’s NOT an easy, quick or fun read. In the Recitals section, it states that the bank: “agrees to expand the flow of credit to U.S. consumers and businesses on competitive terms as appropriate to strengthen the health of the U.S. economy” and, later, “agrees to work diligently, under existing programs, to modify the terms of residential mortgages as appropriate to strengthen the health of the U.S. economy.” Fortunately, if you’re a banker, these topics are not (currently) revisited elsewhere in the document, period. However, these are examples of the new shareholder effecting business decision making without the need to be on the Board of Directors, or voting common shares. The Agreement covers a number of other requirements and limitations, such as executive compensation, dividend payments, other capital sourcing and retention of bank holding company status. None of these are particularly onerous, but they must be taken into account by management. Visit my next post to read about the very interesting Amendment clause that may represent an open-ended business portfolio risk management decision for the future.

How do I know which Red Flags apply to me? The Red Flag guidelines that will apply to you depend on a number of factors including: The types of covered accounts you offer and how those accounts may be opened and accessed Your previous experiences with identity theft In order to determine the applicable Red Flags, you must consider these factors as well as various sources and categories of Red Flags identified in the Guidelines. There are many resources available to help you gain the upper hand on Identity Theft Red Flags. I encourage you to visit this site for more information including a white paper, webinar, data sheet and more.  

It seems to me that there remains quite a bit of dispute and confusion around the inclusion of healthcare providers under the umbrella of "creditors." This would, in turn, imply that a physician's office would need to have a Red Flags Identity Theft Prevention Program in place.  Yikes!  My guess is that this will not be fully resolved by May 1, 2009.  I see too many disparate opinions out there to think otherwise.  I certainly see both sides.  On the one hand, the definition of "creditor" to include "deferred payment of debts" does make the case for most physicians’ offices to be covered under the rule.  On the other hand, to what extent will each and every physician's office be able to have a verification process in place by May 1, 2009?  Certainly, those offices integrated with third party processing will have an easier go of it, but the stand-alone practices are facing a tough challenge.    There is no doubt that the healthcare space is, and should be, covered under the Red Flags rule, I just have to wonder how comprehensive and enforceable compliance will be.  Let me know your thoughts!

During a recent real-time survey of 850 representatives of the financial services industry: only 36 percent said that they completely understood the new Identity Theft Red Flags Rule guidelines and were prepared to meet the deadline. 60 percent said that they had just started to determine their approach to Red Flag compliance.

I’m speculating a bit here, but I have a feeling that as the first wave of Red Flag rule examinations occurs, one of the potential perceived weak points in your program(s) may be your vendor relationships.  Of particular note are collections agencies.  Per the guidelines, “Section 114 applies to financial institutions and creditors.” Under the FCRA, the term “creditor” has the same meaning as in section 702 of the Equal Credit Opportunity Act (ECOA), 15 U.S.C. 1691a.15 ECOA defines “creditor” to include a person who arranges for the extension, renewal or continuation of credit, which in some cases could include third-party debt collectors.  Therefore, the Agencies are not excluding third-party debt collectors from the scope of the final rules and “a financial institution or creditor is ultimately responsible for complying with the final rules and guidelines even if it outsources an activity to a third-party service provider.” A general rule of thumb in any examination process is to look closely at activities that are the most difficult for the examinee to control.  Third-party relationship management certainly falls into this category.  So, make sure your written and operational programs have procedures in place to ensure and regularly monitor appropriate Red Flag compliance -- even when customer (or potential customer) activities occur outside your walls. Good luck!

I have heard this question posed and you may be asking yourselves: Why are referral volumes (the potential that the account origination or maintenance process will get bogged down due to a significant number of red flags detected) such a significant operations concern? These concerns are not without merit.  Because of the new Red Flag Rules, financial institutions are likely to be more cautious.  As a result, many transactions may be subject to greater customer identification scrutiny than is necessary. Organizations may be able to control referral volumes through the use of automated tools that evaluate the level of identity theft risk in a given transaction.  For example, customers with a low-risk authentication score can be moved quickly through the account origination process absent any additional red flags detected in the ordinary course of the application or transaction.  In fact, using such tools may allow organizations to quicken the origination process for customers. They can then identify and focus resources on transactions that pose the greatest potential for identity theft. A risk-based approach to Red Flags compliance affords an institution the ability to reconcile the majority of detected Red Flag conditions efficiently, consistently and with minimal consumer impact.  Detection of Red Flag conditions is only half the battle.  Responding to those conditions is a substantial problem to solve for most institutions.  A response policy that incorporates scoring, alternate data sources and flexible decisioning can reduce the majority of referrals to real-time approvals without staff intervention or customer hardship.   

What is your greatest concern as the May 1, 2009 enforcement date approaches for all guidelines in the Identity Theft Red Flags Rule?

Hello Red Flaggers!  I’m still getting some questions from our clients these days around the FTC enforcement extension.  My concern is that there seems to be a perception that May 1, 2009 is the enforcement date for all of the guidelines in the Red Flags Rule.  In reading through the recently released FTC Enforcement Policy (Identity Theft Red Flags Rule, 16 CFR, 681.2), it clearly states the following: This delay in enforcement is limited to the Identity Theft Red Flags Rule (16 CFR 681.2), and does not extend to the rule regarding address discrepancies applicable to users of consumer reports (16 CFR 681.1), or to the rule regarding changes of address applicable to card issuers (16 CFR 681.3). So, while you may be breathing a sigh of relief as far as the implementation of your overall Identity Theft Prevention Program is concerned, be advised that the May 1, 2009 extension does not cover the need to detect and/or respond to address discrepancies on consumer reports or during address changes on card accounts. As previously mentioned in an earlier blog of mine (see Nov. 13 blog), responding to address discrepancies on consumer reports may be the biggest challenge for many of our clients, as (depending on market served) the percentage of consumer reports with an address discrepancy can number over 20 percent.  This can create an operational burden from the perspective of cost, customer experience, and the ability to quickly book legitimate and profitable customers.  Have a look at my previous blog on a risk based approach to address discrepancies for a refresher on this subject.  Good luck!!

We continue to receive inquiries from our clients, and the market in general, around whether they are required to comply with the Red Flag Rule or not. That final decision can be found with the legal and compliance teams within your organization. I am finding, however, that there generally seems to be too literal and narrow an interpretation of the terms ‘creditor’ or ‘financial institution’ as described in the guidelines.  I often hear an organization state that they don’t believe they’re covered because they are not one of those types of entities. Ultimately, as I said, that’s up to your internal team(s) to establish. I would recommend, however, that you ensure that opinion and ultimate determination is well researched. It may sound simple, but reach out to your examining agencies or the Federal Trade Commission (FTC) and discuss any ambiguities you feel exist related to covered accounts.  There is some great clarifying language out there beyond the initial Red Flag Rule. For example, the FTC provided a very useful article (www.ftc.gov/bcp/edu/pubs/articles/art11.shtm) that described how even health care providers can be covered under the Red Flag Rule.  At first glance, they may not seem to fall under the umbrella of a ‘creditor or financial institution.’ As stated in the article, the extension of credit “means an arrangement by which you defer payment of debts or accept deferred payments for the purchase of property or services. In other words, payment is made after the product was sold or the service was rendered. Even if you’re a non-profit or government agency, you still may be a creditor if you accept deferred payments for goods or services.” Maybe it’s just me, but that description is arguably much broader-reaching than one might initially think. Long story short: do your research, and don’t assume you or your accounts are not covered under the guidelines. Better to find out now instead of after your first examination….for obvious reasons.

The Federal Trade Commission (FTC) suspended enforcement of the new Red Flag Rule until May 1, 2009.  According to the FTC’s Enforcement Policy, “…during the course of the Commission’s education and outreach efforts following publication of the rule, the Commission has learned that some industries and entities within the FTC’s jurisdiction have expressed confusion and uncertainty about their coverage under the rule.  These entities indicated that they were not aware that they were undertaking activities that would cause them to fall within FACTA Sections 114 and 315 definitions of ‘creditor’ or ’financial institution’.” So, depending upon which enforcement entity (or entities) will be knocking on your door in the coming months, you may (and I emphasize “may”) have some extra time to get your house in order.   While many of you are likely confident that you have a compliant written and operational Identity Theft Prevention Program, this break in the action can be a great time to take care of setting up some ongoing procedures for keeping your program up to date.  Here are some ideas to keep in mind along the way: 1. Make sure you have clear responsibilities and accountabilities identified and assigned to appropriate persons.  Lack thereof may lead to everyone thinking someone else is keeping tabs. 2. Start setting the stage for a process to update your program based on: a. Your new experiences with identity theft; b. Changes in methods of identity theft; c. Changes in methods to detect, prevent, and mitigate identity theft; d. Changes in the types of accounts you offer or maintain; and e. Changes in your business arrangements, including mergers, acquisitions, alliances, joint ventures and service provider arrangements. 3. Set up a process for program review at the board level.  Remember that your program does not have to be approved by your board of directors annually, but the board (or a committee of the board) or senior management must review reports regarding your program each year.  They must approve any material changes to your program should they occur. 4. Prepare now for follow up actions associated with your first Red Flag Rule examination(s).  There will surely be suggestions or mandates stemming from that exercise, and now is a good time to start securing appropriate resources and time. My key message here is that, while there may be lull in the world of Red Flags activity, this is a great time to keep momentum in your program development and upkeep by planning for the next wave of updates and your impending examinations.  Best of luck.

I’m working with many of our clients in reviewing their existing or evolving Red Flags Identity Theft Prevention Programs.  While the majority of them appear to be buttoned up from the perspective of identifying covered accounts and applicable Red Flag conditions, as well as establishing detection methodologies, I often still see too much subjectivity in their response and reconciliation procedures. Here are a few reasons why the “response” portion of a strong Red Flags Identity Theft Prevention program needs to employ consistent and objective process, decisioning, and actions: 1. Inconsistent or subjectively varied responses and actions greatly reduce the ability to measure process effectiveness over time.  It becomes increasingly difficult for retro-analysis to identify which processes and specific steps in those processes were successful in either positively or negatively reconciling potential fraudulent activity.  Subsequently, it clouds any ability to make effective or necessary changes to specific activities that may not be working well. 2. Examiners may focus heavily on the response portion of your program.  During operational side by sides, or even written program reviews, the less ambiguity and inconsistency identified or perceived, the better.  A quick rule of thumb for any examination: preempt any questions with exhaustive information and clarity.  Examiners that don’t need to ask many, or any, questions are happy examiners. 3. Objective and consistent process allows for more manageable staff training.  It is much easier to educate your staff around a justified and effective uniform process than around intuitive and haphazard procedures and consumer interactions.  It is tough to set expectations with your staff if there are gaping holes in the activities they are expected to execute. 4. Customer experience will certainly be more positive, and less of a worry for managers, as inequity of treatment is removed from the equation.  It is better to have each customer progress through similar steps toward authentication than varied ones from the perspective of time, perception, effectiveness, and convenience.   Now, certainly, a risk-based approach allows for varied treatment based on that risk.  The point here is more toward the need to apply those varied techniques consistently. 5. Social engineering.  Fraudsters are pretty good at figuring out if an operational process is open to interpretation and manipulation.  They’ll continue to engage in a process with the goal of landing with the right associate who may be following a more easily penetrable fraud detection method.  Bottom line: keep the walls around your business the same height throughout. Until next time, best of luck as you continue to develop and improve your Red Flags programs.