Maryland Legal Alert for Financial Services

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Fourth Circuit Ruling on Navigating ACH Fraud: Implications for Financial Institutions   

RESPA Enforcement Action Involving Affiliated Business Arrangements

Fourth Circuit Ruling on Navigating ACH Fraud: Implications for Financial Institutions   

The Fourth Circuit’s decision in Studco Building Systems, U.S. v. 1st Advantage Federal Credit Union has significant implications for financial institutions handling  Automated Clearing House (ACH) transfers. In this case, a company received a fraudulent email appearing to be from a supplier, instructing it to redirect ACH payments to a new account held by the financial institution. Unaware of the scam, the company initiated ACH transfers to the new account. The funds were deposited into the new account, which was not held by the actual supplier but by another customer of the financial institution. The financial institution was alerted by its system to a mismatch in the names associated with the account number, but it did not take further action to inquire into the discrepancy.  

The Fourth Circuit held that a beneficiary institution (i.e., the financial institution receiving the funds) is not liable for fraudulently misdirected funds unless it has actual knowledge of a name-account mismatch, reaffirming the protections offered by UCC § 4A-207. This means financial institutions are not required to manually verify every ACH transfer for discrepancies between the beneficiary’s name and account number, alleviating a potential operational burden. However, the case also underscores the importance of internal monitoring systems and risk management practices, as financial institutions that do not have clear policies for addressing fraud indicators may still face reputational risks and legal scrutiny in certain instances. 

Additionally, the ruling highlights the growing prevalence of business email compromise (BEC) scams and the challenges they pose for both financial institutions and their customers. While the decision relieves financial institutions from an impractical account monitoring obligation, it also signals to businesses and consumers the need for enhanced customer education, stronger internal fraud detection mechanisms, and collaboration between financial institutions and businesses to mitigate cybercrime risks, as the risk would largely fall on them.  

Practice Pointer: Financial institutions should take proactive steps to enhance internal fraud detection and ensure compliance with UCC § 4A-207. This includes refining automated monitoring systems to prioritize high-risk alerts, training staff to recognize patterns of fraud, and educating members on the risks of email scams. Financial institutions should also ensure they have clear fraud response protocols to address potential legal and reputational concerns in similar cases.  

For more information, contact Christopher R. Rahl or Tamia J. Morris.

Contact Christopher R. Rahl | 410-576-4222

Contact Tamia J. Morris | 410-576-4021

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RESPA Enforcement Action Involving Affiliated Business Arrangements

The Pennsylvania Attorney General (AG) recently took action against a mortgage lending enterprise and its principals concerning alleged violations of Section 8(a) of the Real Estate Settlement Procedure Act (RESPA) and its implementing regulation, Regulation X.  RESPA prohibits giving things of value or “illegal kickbacks” in exchange for business referrals for a settlement service involving federally related mortgage loans. In this case, a licensed mortgage broker/lender set up affiliated mortgage brokerage entities that were part-owned by real estate brokers who referred loan business to the affiliated entity.  While RESPA contemplates (and permits) certain affiliated business arrangements, compliance requirements include: (a) provision of specific consumer disclosures; (b) the affiliated entities must be legitimate providers of actual settlement services; and (c) owners of the affiliated entities must buy into the entities on fair market value terms and only receive ownership distributions in relation to their ownership interests in the affiliated entities.   

The AG’s action contends that the price that real estate brokers paid to buy into the affiliated mortgage brokerage entities were too low in relation to the ownership distributions that were then paid to the real estate broker owners.  The AG also faulted the mortgage lending enterprise for providing other incentives to real estate brokers related to the referral of settlement service business, including tickets to expensive sporting events.

Practice Pointer: The recent enforcement action serves as a reminder of the requirements of RESPA concerning affiliated business arrangements. Regulated institutions should review company policies and practices regarding affiliated entities to ensure that the affiliated entities perform compensable services, that owners purchase interests in the entities on a fair market value basis, and that owners receive nothing other than actual ownership distributions in proportion to their ownership interests.  

For more information, contact Christopher R. Rahl.

Contact Christopher R. Rahl | 410-576-4222

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