Top Federal Reserve System Violations in 2022: Regulation E Error Resolution Requirements and Regulation X Escrow Account Requirements
As discussed in the cover article in this issue, CCO is regularly publishing articles that leverage Federal Reserve supervisory data. The 2022 data (see Table 1 in the cover article) reveal that violations of the Electronic Fund Transfer Act (Regulation E) and the Real Estate Settlement Procedures Act (Regulation X) were among the most cited consumer compliance violations in examinations of state member banks in 2022. This article discusses violations of Regulations E and X, examiner observations, and sound practices to mitigate associated compliance risks.
REGULATORY REQUIREMENTS
Regulation E — Electronic Fund Transfer Act
12 C.F.R. §1005.11(c) Time Frames for Investigating Errors
Ten business days: A financial institution shall promptly investigate and determine whether an error occurred within 10 business days of receiving a notice of error (20 business days if the notice of error involved an electronic fund transfer (EFT) to or from a new account within 30 days after the first deposit to the account was made).1 The bank is not required to provide provisional credit.
Forty-five days: If the institution cannot complete an investigation within 10 business days (20 business days for a new account), it may take up to 45 days from receipt of a notice of error to investigate and determine if an error occurred, provided the institution:2
- provisionally credits the consumer’s account for the amount of the alleged error within 10 business days of receiving the error notice;3 and
- informs the consumer within two business days after provisional crediting and provides full use of the funds during the investigation.4
Ninety days: An institution may take up to 90 days in place of 45 days to complete an investigation if a notice of error involves an EFT that was not initiated within the state, resulted from a point of sale debit card transaction, or occurred within 30 days after the first deposit to the account was made.5 The bank is required to provide provisional credit.
The Electronic Fund Transfer Act (EFTA), as implemented by Regulation E, provides the legal framework for the rights, liabilities, and responsibilities of participants in EFTs involving a consumer’s checking, savings, or other asset account held by a financial institution.6
If a consumer notifies a financial institution that an error occurred with an EFT, the institution must investigate and notify the consumer of its findings and the action taken to resolve the error. The regulation defines an error as follows:
- an unauthorized EFT;
- an incorrect EFT to or from the consumer’s account;
- the omission of an EFT from a periodic statement;
- a computational or bookkeeping error made by the financial institution relating to an EFT;
- the consumer’s receipt of an incorrect amount of money from an electronic terminal;
- an EFT not identified in accordance with §1005.9 or §1005.10(a); or
- the consumer’s request for documentation required by the regulation or for additional information or clarification concerning an EFT, including a request the consumer makes to determine whether an error exists under the regulation.7
The regulation further clarifies this definition by providing these examples of inquiries that are not errors:
- a routine inquiry about the consumer’s account balance;
- a request for information for tax or other recordkeeping purposes; or
- a request for duplicate copies of documentation.
Section 1005.11(c) requires institutions to investigate errors within certain time frames as applicable. Examiners commonly observed these violations and the underlying causes:
- Not promptly investigating. Examination reports indicate some financial institutions were not promptly initiating error resolution investigations after the consumer notified them of an error, in violation of §1005.11(c). These errors typically occurred because bank staff did not recognize when consumers were making error resolution claims, did not know how to initiate investigations, or did not correctly identify all of the disputed transactions.
- Not providing provisional credit. Examiners cited institutions for violating §1005.11(c)(2)(i) by not providing provisional credit for the amount of the alleged error within 10 business days of receiving an error notice when the institutions could not complete their investigation within 10 business days and took up to 45 days to investigate under §1005.11(c)(2). Examiners also cited institutions that provisionally credited accounts but failed to provide full access to and use of the funds during the investigation. These errors occurred because the institutions lacked effective procedures, controls, monitoring, and/or training to ensure compliance with the regulation.
- Not conducting an adequate investigation. Examiner data also showed some institutions conducting inadequate investigations of error claims. As stated in a prior CCO article: “A financial institution cannot deny a consumer’s claim of an error without conducting a reasonable investigation, unless it corrects the error as alleged by the consumer. A reasonable investigation includes reviewing relevant information within the institution’s records. If this review confirms the error, the claim cannot be denied. When the alleged error is an unauthorized EFT, the EFTA places the burden of proof on the financial institution to establish the transaction was authorized.8 Therefore, if the institution cannot establish the disputed EFT transaction was authorized, the institution must credit the consumer’s account.”9
These errors occurred because staff either did not review or research all the transactions the consumer disputed or denied claims because of prior disputed transactions with the same merchant. Examiners identified root causes as not providing effective policies and procedures and not conducting adequate training and monitoring.
REGULATORY REQUIREMENTS
Regulation E — Electronic Fund Transfer Act
12 C.F.R. §1005.11(d) Procedure When an Error Did Not Occur or Did Not Occur as Alleged
After an institution completes its investigation, if it determines an error did not occur, or one occurred that differs in the manner or amount the consumer alleged, the institution must notify the consumer in writing of the results of its investigation and the consumer’s right to request the documents the institution relied on in making its determination.10 If the institution debits a provisional credit, it must also notify the consumer of the date and amount of debiting and that the institution will honor checks, drafts, or similar instruments payable to third parties and preauthorized transfers from the consumer’s account for five business days after the notification (without charge to the consumer as a result of an overdraft).11
Examiners cited institutions for not explaining the results of an investigation and not providing a notice to the consumer of the right to request the documents the institution relied on in making its determination. These errors occurred primarily because staff did not adhere to the institution’s policies and procedures.
Sound Practices to Mitigate Regulation E Risks
Sound practices can help limit these types of violations, including:
- Providing enhanced procedures. Adopting sufficiently detailed error resolution procedures can help ensure staff comply with regulatory requirements. Procedures may include, but are not limited to, instructions for gathering sufficient and accurate information upon notice of an error by a consumer, what constitutes a thorough investigation, how consumer engagement should occur, and how to document the process throughout.
- Conducting training. Training is an important tool for helping to proactively prevent or minimize violations. The requirements of §1005.11 are technical and nuanced. Periodic training can help to reinforce compliance staff’s understanding of the requirements and clarify any ambiguities.
- Monitoring Regulation E compliance. Bank management can regularly monitor the effectiveness of its controls, including Regulation E processes and procedures. To do this, bank management may consider conducting periodic reviews of notices of error, and completed investigations, to ensure that staff are adhering to established procedures and deadlines. Reviewing data points can also help identify violations. If a high percentage of error investigations are resolved in the bank’s favor, the bank may want to review a sample to ensure they complied with the regulation.
- Enhancing consumer complaint response. Several of the Regulation E errors discussed here were identified through consumer complaints. Institutions can regularly review complaint activity to identify and address Regulation E errors that may not have been identified through monitoring reviews to help ensure compliance.
REGULATORY REQUIREMENTS
Regulation X — Real Estate Settlement Procedures Act
12 C.F.R. §1024.17(c) Escrow Requirements
Section 17(c) specifies the procedures for administering an escrow account, including the following requirements:
- Payments generally cannot not exceed the “target balance,” which is defined as “the estimated month end balance in an escrow account that is just sufficient to cover the remaining disbursements from the escrow account in the escrow account computation year, taking into account the remaining scheduled periodic payments, and a cushion, if any,” which cannot exceed one-sixth of the estimated total payments from the escrow account, with certain exceptions in the case of a shortage or deficiency.
- “Before establishing an escrow account, the servicer must conduct an escrow account analysis to determine the amount the borrower must deposit into the escrow account…, and the amount of the borrower’s periodic payments into the escrow account,” subject to the limitations discussed above.12
- Thereafter, the servicer must conduct an escrow account analysis at the end of the escrow account computation year to determine the borrower’s monthly escrow account payments for the next computation year and use that analysis to determine whether a surplus, shortage, or deficiency exists and make required adjustments as appropriate.13
- A servicer may issue a short-year annual escrow account statement to change one escrow account computation year to another. The short-year statement must end the escrow account computation year and establish the beginning date of the new escrow account computation year. The servicer shall deliver the short-year statement to the borrower within 60 days from the end of the short year.14
- If a surplus exists, which is defined as a balance in excess of the target balance for the account, it must be refunded within 30 days from the date of the analysis if it is $50 or greater. If the surplus is less than $50, the servicer can either refund it within 30 days or credit it to the escrow account for the next year.15
- The aggregate accounting method must be used to conduct the escrow account analyses.16
- Where the borrower is required to make payments to an escrow account, the servicer must also ensure it makes timely disbursements “on or before the deadline to avoid a penalty, as long as the borrower’s payment is not more than 30 days overdue.”17
- If an escrow disbursement is billed for periods longer than one year (for example, a flood insurance premium payable every three years), the servicer must estimate the borrower’s payments for a full cycle of disbursements (using the flood premium example, by dividing the three-year period into 36 monthly payments).18
The Real Estate Settlement Procedures Act (RESPA),19 as implemented by Regulation X, provides the legal framework of consumer protections for the servicing of federally related mortgage loans, as defined in 12 C.F.R. §1024.2(b).20 These protections include the procedures in §17(c) servicers must follow for a federally related mortgage loan with an escrow account, which lenders may require to pay real estate taxes, insurance premiums, and other mortgage-related disbursements.
Examiners frequently found bank staff inaccurately computed and disclosed the initial and annual escrow analyses. Incorrect system settings and payment amount issues typically caused these errors. For the system settings, bank staff erroneously used the payment due date rather than the anticipated disbursement date as the disbursement date for escrow items on the initial and annual escrow analyses. Using the payment due date rather than the anticipated disbursement date resulted in computation and disclosure errors on the initial and annual escrow account analyses. For the payment amount issue, bank staff itemized the incorrect number of payments from the escrow account on the initial and annual escrow account analyses, resulting in inaccurate initial and annual escrow computations and projections.
Examiners also observed errors related to bank staff conducting annual escrow account analyses beyond the 12-month computation year, without issuing short-year statements as required under the regulation. In these cases, staff conducted annual escrow analyses for all loans during the same month. If a loan was originated outside of this month, an annual escrow account analysis was not prepared until the loan aligned with the bank’s escrow analysis schedule. This resulted in staff not conducting timely annual escrow account analyses, as §1024.17(c)(3) requires.
SOUND PRACTICES TO MITIGATE RESPA RISKS
Several sound risk management practices can facilitate compliance with escrow account requirements:
- Increasing oversight. Implementing approval processes and/or secondary levels of review for changes to system settings, for example, is one way to help ensure compliance with the regulation.
- Enhancing escrow procedures. Given the technical nature of escrow-related rules, adopting sufficiently detailed escrow procedures is important to help ensure bank staff set up and manage escrow accounts appropriately and provide accurate and timely disclosures to borrowers.
- Conducting regular training. Providing regular and detailed training on escrow-related rules, particularly for mortgage origination and servicing staff, can help to ensure that staff understand how to manage the escrow accounts appropriately and comply with regulatory requirements. Additionally, institutions may want to consider establishing a training schedule with appropriate training frequency, as well as a tracking mechanism to ensure required trainings are satisfactorily completed.
CONCLUSION
This article discussed the most common Regulation E and X violations from 2022 and sound risk management practices institutions can consider to help mitigate compliance risk. Specific issues and questions related to these regulations should be raised with your primary regulator.
RESOURCES
- Richele S. Brady, “Escrow Accounting Rules: Are You in Compliance?,” CCO (Second Issue 2018)
- Kenneth Benton and Robert Sheerr, “Error Resolution Procedures and Consumer Liability Limits for Unauthorized Electronic Fund Transfers,” CCO (Fourth Quarter 2012)
- Scott Sonbuchner, “Error Resolution and Liability Limitations Under Regulations E and Z: Regulatory Requirements, Common Violations, and Sound Practices,” CCO (Second Issue 2021)
- Kathleen Benson, “Enhancing Your Compliance Training Program,” CCO (First Issue 2019)
ENDNOTES
1 12 C.F.R. §1005.11(c)(1) and (c)(3)(i).
2 12 C.F.R. §1005.11(c)(2).
3 12 C.F.R. §1005.11(c)(2)(i).
4 12 C.F.R. §1005.11(c)(2)(ii).
5 12 C.F.R. §1005.11(c)(3)(ii).
6 12 C.F.R. §1005.2(b)(1).
7 12 C.F.R. §1005.11(a).
8 15 U.S.C. §1693g(b).
9 Scott Sonbuchner, “Error Resolution and Liability Limitations Under Regulations E and Z: Regulatory Requirements, Common Violations, and Sound Practices,” CCO (Second Issue 2021).
10 12 C.F.R. §1005.11(d)(1).
11 12 C.F.R. §1005.11(d)(2).
12 12 C.F.R. §1024.17(c)(2).
13 12 C.F.R. §1024.17(f) and (c)(3). An exception applies if a servicer is issuing a short-year statement to change one escrow account computation year to another. See 12 C.F.R. §1024.17(i)(4).
14 12 C.F.R. §1024.17(i)(4)(i)
15 12 C.F.R. §1024.17(f)(2)(i).
16 12 C.F.R. §1024.17(c)(4).
17 12 C.F.R. §1024.17(k)(1).
18 12 C.F.R. §1024.17(c)(9).
19 12 U.S.C. §2601 et seq.
20 12 C.F.R. §1024.5(a), (b), and (d).