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Are your vendor contracts putting you at risk?

05.31.19

Best practices for financial institution contracts with technology providers

As the financial services sector moves in an increasingly digital direction, you cannot overstate the need for robust and relevant information security programs. Financial institutions place more reliance than ever on third-party technology vendors to support core aspects of their business, and in turn place more reliance on those vendors to meet the industry’s high standards for information security. These include those in the Gramm-Leach-Bliley Act, Sarbanes Oxley 404, and regulations established by the Federal Financial Institutions Examination Council (FFIEC).

On April 2, 2019, the FDIC issued Financial Institution Letter (FIL) 19-2019, which outlines important requirements and considerations for financial institutions regarding their contracts with third-party technology service providers. In particular, FIL-19-2019 urges financial institutions to address how their business continuity and incident response processes integrate with those of their providers, and what that could mean for customers.

Common gaps in technology service provider contracts

As auditors of IT controls, we review lots of contracts between financial institutions and their technology service providers. When it comes to recommending areas for improvement, our top observations include:

  • No right-to-audit clause
    Including a right-to-audit clause encourages transparency and provides greater assurance that vendors are providing services, and charging for them, in accordance with their contract.
  • Unclear and/or inadequate rights and responsibilities around service disruptions
    In the event of a service incident, time and transparency are vital. Contracts that lack clear and comprehensive standards, both for the vendor and financial institution, regarding business continuity and incident response expose institutions to otherwise avoidable risk, including slow or substandard communications.
  • No defined recovery standards
    Explicitly defined recovery standards are essential to ensuring both parties know their role in responding and recovering from a disaster or other technology outage.

FIL-19-2019 also reminds financial institutions that they need to properly inform regulators when they undertake contracts or relationships with technology service providers. The Bank Service Company Act requires financial institutions to inform regulators in writing when receiving third-party services like sorting and posting of checks and deposits, computation and posting of interest, preparation and mailing of statements, and other functions involving data processing, Internet banking, and mobile banking services.

Writing clearer contracts that strengthen your institution

Financial institutions should review their contracts, especially those that are longstanding, and make necessary updates in accordance with FDIC guidelines. As operating environments continue to evolve, older contracts, often renewed automatically, are particularly easy to overlook. You also need to review business continuity and incident response procedures to ensure they address all services provided by third-parties.

Senior management and the Board of Directors hold ultimate responsibility for managing a financial institution’s relationship with its technology service providers. Management should inform board members of any and all services that the institution receives from third-parties to help them better understand your operating environment and information security needs.

Not sure what to look for when reviewing contracts? Some places to start include:

  • Establish your right-to-audit
    All contracts should include a right-to-audit clause, which preserves your ability to access and audit vendor records relating to their performance under contract. Most vendors will provide documentation of due diligence upon request, such as System and Organization Control (SOC) 1 or 2 reports detailing their financial and IT security controls.

    Many right-to-audit clauses also include a provision allowing your institution to conduct its own audit procedures. At a minimum, don’t hesitate to perform occasional walk-throughs of your vendor’s facilities to confirm that your contract’s provisions are being met.
  • Ensure connectivity with outsourced data centers
    If you outsource some or all of your core banking systems to a hosted data center, place added emphasis on your institution’s business continuity plan to ensure connectivity, such as through the use of multiple internet or dedicated telecommunications circuits. Data vendors should, by contract, be prepared to assist with alternative connectivity.
  • Set standards for incident response communications 
    Clear expectations for incident response are crucial  to helping you quickly and confidently manage the impact of a service incident on your customers and information systems. Vendor contracts should include explicit requirements for how and when vendors will communicate in the event of any issue or incident that affects your ability to serve your customers. You should also review and update contracts after each incident to address any areas of dissatisfaction with vendor communications.
  • Ensure regular testing of defined disaster recovery standards
    While vendor contracts don’t need to detail every aspect of a service provider’s recovery standards, they should ensure those standards will meet your institution’s needs. Contracts should guarantee that the vendor periodically tests, reviews, and updates their recovery standards, with input from your financial institution.

    Your data center may also offer regular disaster recovery and failover testing. If they do, your institution should participate in it. If they don’t, work with the vendor to conduct annual testing of your ability to access your hosted resources from an alternate site.

As financial institutions increasingly look to third-party vendors to meet their evolving technology needs, it is critical that management and the board understand which benefits—and related risks—those vendors present. By taking time today to align your vendor contracts with the latest FFIEC, FDIC, and NCUA standards, your institution will be better prepared to manage risk tomorrow.

For more help gaining control over risk and cybersecurity, see our blog on sustainable solutions for educating your Board of Directors and creating a culture of cybersecurity awareness.
 

Related Professionals

BerryDunn experts and consultants

Read this if you are at a financial institution.

Feeling stuck, or maybe even frozen, in your CECL readiness efforts? No matter where you are in the process, here are three things you can do right now to ensure your CECL implementation is on track:

  1. Create or re-visit your 2022 timeline
    With just under 12 months to the January 2023 CECL adoption date, it’s important to make every moment count. Consider CECL adoption your Olympic moment and, like every great Olympic athlete, you have interim events—a timeline of major milestones—to ensure you are ready for “Day 1” and beyond. One strategy to ensure you do not “run out of time” is to start at the end of your timeline and work backward.

    Tip: Whether it be 1/1/2023 (“Day 1” adoption), or the first date by which you want to start parallel runs, fix the date of that final must-hit milestone, and work backward. For example, in order to adopt CECL on 1/1/2023, what major milestone has to be achieved before then and how much time will you need for that? Setting milestones from the final date backward will help you fit the remaining major activities into the time you have left—you can’t “run out of time” this way!



     
  2. Assess where you are, tactically, and fill in the gaps
    What would an Olympic athlete be without a training schedule, and coaches, trainers, and other professionals to guide and push them? In order to make the most of each event (or milestone) in the countdown to CECL adoption, let’s fill in our training schedule. What key decisions still need to be made or documented? Who has the authority to approve them? What’s the right time and venue to obtain that approval? Will these be one-to-one, small group, or committee/board meetings? Will meetings be set up as-needed, or is the meeting schedule (e.g. quarterly executive/board) already set? Who are you engaging for model validation and key control review? What is the date of that review work? 

    Tip: Add those key approval, review, and validation dates to your timeline, and make sure the meeting time you need with decision-makers is booked in their calendars now. Scheduling this time in advance is a transparent and tangible sign that you’ve charted the course, helps ensure decision-makers are available to you when needed most, and incremental progress is being consistently made toward your ultimate goal. 
  3. Identify the top three tasks to complete this week, reserve the time in your calendar, and complete them!
    Like any athlete, you are now “in training”, and daily and weekly actions you take will ensure you reach your goal in as strong a position possible. Whether it’s scheduling those meetings, identifying subject matter experts you can rely upon for coaching, or putting the finishing touches on model documentation and internal control mapping, booking that time with yourself to complete these tasks is key to feeling prepared and ready for CECL adoption. 

    Tip: Set aside a few minutes at the end or start of each week to review your timeline/milestones and identify the next key actions to complete.

Would you like assistance with certain aspects of your CECL readiness efforts? Are you ready for some validation/review work, or need guidance on policy, governance, or internal/financial reporting controls?

Contact our Financial Institutions team. We'll help you get your CECL implementation over the finish line. 


 

Article
CECL implementation: Three steps for a medal-winning adoption 

Read this if your State Medicaid Agency is planning Medicaid Enterprise System enhancements.

Are you a system integrator (SI) or a State Medicaid Agency (SMA) implementing or enhancing a Medicaid system or specific module? Have you considered how decisions made during design and implementation could impact the federal Payment Error Rate Measurement (PERM) reviews for SMAs?

The goal of PERM is to measure and report an unbiased estimate of the true improper payment rate for Medicaid and Children’s Health Insurance Program (CHIP). Every state is reviewed once every three years using a sample that includes both fee for service (FFS) and managed care (MC) payments. A state assigned error rate is not the only consequence resulting from the PERM review; there are also financial implications.

Risk reduction from PERM review

Maintaining a focus on PERM review factors when making decisions during design and implementation can protect states by reducing the risk of:

  • Submitting change requests (CR) during implementation, which can result in additional cost and time
  • Implementing changes to existing Medicaid systems during maintenance and operations
  • Findings reported during certification efforts
  • Refunding federal dollars due to improperly paid claims
  • A reduction in federal match on all claims paid

It is also important to understand the benefits of a dedicated PERM team within the state organization that includes members from the system vendor and outside PERM experts. These benefits include providing states an additional level of security to help ensure a positive outcome to the federal PERM review, helping to protect federal funding.

Having a dedicated team will help ensure all decisions made during system updates and/or implementations are made while keeping focus on PERM requirements and the further impacts of PERM reviews, saving time and remaining compliant.

Plan ahead for best results

When planning for a new module or Medicaid system request for proposal (RFPs), consider PERM-related requirements to help ensure all PERM needs are met to prevent errors and repayment of federal funds. Including PERM requirements can also help your agency ensure federal compliance and successful PERM audits. Doing so will likely reduce the amount of time system integrators spend re-working earlier development decisions and help ensure claim payments are processed, and eligibility determinations are made in accordance with federal and state regulations.

If you have questions about PERM or your specific situation, please contact our Medicaid Consulting team. We’re here to help.

Article
PERM success for Medicaid agencies through system implementations

Read this if you are a behavioral health agency leader looking for solutions to manage mental health, substance misuse, and overdose crises.

As state health departments across the country continue to grapple with rising COVID-19 cases, stalling vaccination rates, and public heath workforce burnout, other crises in behavioral health may be looming. Diverted resources, disruption in treatment, and the mental stress of the COVID-19 pandemic have exacerbated mental health disorders, substance use, and drug overdoses.

State agencies need behavioral health solutions perhaps now more than ever. BerryDunn works with state agencies to mitigate the challenges of managing behavioral health and implement innovative strategies and solutions to better serve beneficiaries. Read on to understand how conducting a needs assessment, redesigning processes, and/or establishing a strategic plan can amplify the impact of your programs. 

Behavioral health in crisis

The prevalence of mental illness and substance use disorders has steadily increased over the past decade, and the pandemic has exacerbated these trends. A number of recently released studies show increases in symptoms of anxiety, depression, and suicidal ideation. One CDC study indicates that in June 2020 over 40% of adults reported an adverse mental or behavioral health condition, which includes about 13% who have started or increased substance use to cope with stress or emotions related to COVID-19.1 

The toll on behavioral health outcomes is compounded by the pandemic’s disruption to behavioral health services. According to the National Council for Behavioral Health, 65% of behavioral health organizations have had to cancel, reschedule, or turn away patients, even as organizations see a dramatic increase in the demand for services.2,3 Moreover, treatment facilities and harm reduction programs across the country have scaled back services or closed entirely due to social distancing requirements, insufficient personal protective equipment, budget shortfalls, and other challenges.4 These disruptions in access to care and service delivery are having a severe impact.

Several studies indicate that patients report new barriers to care or changes in treatment and support services after the onset of the pandemic.5, 6 Barriers to care are particularly disruptive for people with substance use disorders. Social isolation and mental illness, coupled with limited treatment options and harm reduction services, creates a higher risk of suicide ideation, substance misuse, and overdose deaths.

For example, the opioid epidemic was still surging when the pandemic began, and rates of overdose have since spiked or elevated in every state across the country.7 After a decline of overdose deaths in 2018 for the first time in two decades, the CDC reported 81,230 overdose deaths from June 2019 to May 2020, the highest number of overdose deaths ever recorded in a 12-month period.8 

These trends do not appear to be improving. On October 3, the CDC reported that from March 2020 to March 2021, overdose deaths have increased 29.6% compared to the previous year, and that number will only continue to climb as more data comes in.9  

As the country continues to experience an increase in mental illness, suicide, and substance use disorders, states are in need of capacity and support to identify and/or implement strategies to mitigate these challenges. 

Solutions for state agencies

Behavioral health has been recognized as a priority issue and service area that will require significant resources and innovation. In May, the US Department of Health and Human Services' (HHS) Secretary Xavier Becerra reestablished the Behavioral Health Coordinating Council to facilitate collaborative, innovative, transparent, equitable, and action-oriented approaches to address the HHS behavioral health agenda. The 2022 budget allocates $1.6 billion to the Community Mental Health Services Block Grant, which is more than double the Fiscal Year (FY) 2021 funding and $3.9 billion more than in FY 2020, to address the opioid epidemic in addition to other substance use disorders.10 

As COVID-19 continues to exacerbate behavioral health issues, states need innovative solutions to take on these challenges and leverage additional federal funding. COVID-19 is still consuming the time of many state leaders and staff, so states have a limited capacity to plan, implement, and manage the new initiatives to adequately address these issues. Here are three ways health departments can capitalize on the additional funding.

Conduct a needs assessment to identify opportunities to improve use of data and program outcomes

Despite meeting baseline reporting requirements, state agencies often lack sufficient quality data to assess program outcomes, identify underserved populations, and obtain a holistic view of the comprehensive system of care for behavioral health services. Although state agencies may be able to recognize challenges in the delivery or administration of behavioral health services, it can be difficult to identify solutions that result in sustained improvements.

By performing a structured needs assessment, health departments can evaluate their processes, systems, and resources to better understand how they are using data, and how to optimize programs to tailor behavioral health services and promote better health outcomes and a more equitable distribution of care. This analysis provides the insight for agencies to understand not only the strengths and challenges of the current environment, but also the desires and opportunities for a future solution that takes into account stakeholder needs, best practice, and emerging technologies. 

Some of the benefits we have seen our clients enjoy as a result of performing a needs assessment include: 

  • Discovering and validating strengths and challenges of current state operations through independent evaluation
  • Establishing a clear roadmap for future business and technological improvements
  • Determining costs and benefits of new, alternative, or enhanced systems and/or processes
  • Identifying the specific business and technical requirements to achieve and improve performance outcomes 

Timely, accurate, and comprehensive data is critical to improving behavioral health outcomes, and the information gathered during a needs assessment can inform further activities that support programmatic improvements. Further activities might include conducting a fit-gap analysis, performing business process redesign, establishing a prioritization matrix, and more. By identifying the greatest needs and implementing plans to address them, state agencies can better handle the impact on behavioral health services resulting from the COVID-19 pandemic and serve individuals with mental health or substance use disorders more efficiently and effectively.

Redesign processes to improve how individuals access treatment and services

Despite the availability of behavioral health services, inefficient business and technical processes can delay and frustrate individuals seeking care and in some cases, make them stop seeking care altogether. With limited resources and increasing demands, behavioral health agencies should analyze and redesign work flows to maximize efficiency, security, and efficacy. Here are a few examples of process improvements states can achieve through process redesign:

  • Streamlined data processes to reduce duplicative data entry 
  • Automated and aligned manual data collection processes 
  • Integrated siloed health information systems
  • Focused activities to maximize staff strengths
  • Increased process transparency to improve communication and collaboration 

By placing the consumer experience at the core of all services, state health departments can redesign business and technical processes to optimize the continuum of care. A comprehensive approach takes into account all aspects that contribute to the delivery of behavioral health services, including both administrative and financial processes. This helps ensure interconnected activities continue to be performed efficiently and effectively. Such improvements help consumers with co-occurring disorders (mental illness and substance use disorder) and/or developmental disorders find “no wrong door” when seeking care. 

Establish a strategic plan of action to address the impact of the COVID-19 pandemic

With the influx of available dollars resulting from the American Recovery Plan Act and other state and federal investments, health departments have a unique opportunity to fund specific initiatives to enhance the delivery and administration of behavioral health services. Understanding how to allocate the millions of newly awarded dollars in an impactful and sustainable way can be challenging. Furthermore, the additional reporting and compliance requirements linked to the funding can be difficult to navigate in addition to current monitoring obligations. 

The best way to begin using the available funding is to develop and implement strategic plans that optimize funds for behavioral health programs and services. You can establish priorities and identify sustainable solutions that build capacity, streamline operations, and promote the equitable distribution of care across populations. A few of the activities state health departments have undertaken resulting from the strategic planning initiatives include: 

  • Modernizing IT systems, including data management solutions and Electronic Health Records systems to support inpatient, outpatient, and community mental health and substance use programs 
  • Promoting organizational change management 
  • Establishing grant programs for community-driven solutions to promote health equity for the underserved population
  • Organizing, managing, and/or supporting stakeholder engagement efforts to effectively collaborate with internal and external stakeholders for a strong and comprehensive approach

The prevalence of mental illness and substance use disorder were areas of concern prior to COVID-19, and the pandemic has only made these issues worse, while adding more administrative challenges. State health departments have had to redirect their existing staff to work to address COVID-19, leaving a limited capacity to manage existing state-level programs and little to no capacity to plan and implement new initiatives. 

The federal administration and HHS are working to provide financial support to states to work to address these exacerbated health concerns; however, with the limited state capacity, states need additional support to plan, implement, and/or manage new initiatives. BerryDunn has a wide breadth of knowledge and experience in conducting needs assessments, redesigning processes, and establishing strategic plans that are aimed at amplifying the impact of state programs. Contact our behavioral health consulting team to learn more about how we can help. 

Sources:
Mental Health, Substance Use, and Suicidal Ideation During the COVID-19 Pandemic, CDC.gov
COVID-19 Pandemic Impact on Harm Reduction Services: An Environmental Scan, thenationalcouncil.org
National Council for Behavioral Health Polling Presentation, thenationalcouncil.org
The Impact of COVID-19 on Syringe Services Programs in the United States, nih.gov
COVID-19 Pandemic Impact on Harm Reduction Services: An Environmental Scan, thenationalcouncil.org
COVID-19-Related Treatment Service Disruptions Among People with Single- and Polysubstance Use Concerns, Journal of Substance Abuse Treatment
Issue Brief: Nation’s Drug-Related Overdose and Death Epidemic Continues to Worsen, American Medical Association
Increase in Fatal Drug Overdoses Across the United States Driven by Synthetic Opioids Before and During the COVID-19 Pandemic, CDC.gov
Provisional Drug Overdose Death Counts, CDC.gov
10 Fiscal Year 2022 Budget in Brief: Strengthening Health and Opportunity for All Americans, HHS.gov

Article
COVID's impact on behavioral health: Solutions for state agencies

Read this if you are a community bank.

The Federal Deposit Insurance Corporation (FDIC) recently issued its third quarter 2021 Quarterly Banking Profile. The report provides financial information based on Call Reports filed by 4,914 FDIC-insured commercial banks and savings institutions. The report also contains a section specific to community bank performance. In third quarter 2021, this section included the financial information of 4,450 FDIC-insured community banks. Community banks are identified based on criteria defined in the FDIC’s 2020 Community Banking Study. Here are BerryDunn’s key takeaways from the community bank section of the report:

  • There was a $1.4 billion increase in quarterly net income from a year prior despite continued net interest margin (NIM) compression. This increase was mainly due to higher net interest income and lower provision expenses. Net interest income had increased $2.2 billion due to lower interest expense and higher commercial and industrial (C&I) loan interest income, mainly due to fees earned through the payoff and forgiveness of Paycheck Protection Program (PPP) loans. Provision expense decreased $1.4 billion from third quarter 2020. However, it remained positive at $270.4 million, which was an increase of $219.2 million from second quarter 2021. For noncommunity banks, provision expense was negative $5.2 billion for third quarter 2021

    *See Exhibit B at the end of this article for more information on the third-quarter year-over-year change in income.
     
  • Quarterly NIM increased 3 basis points from third quarter 2020 to 3.31%. The average yield on earning assets fell 20 basis points to 3.60% while the average funding cost fell 23 basis points to 0.29%. This was the first annual expansion of NIM since first quarter 2019. The annual decline in both yield and cost of funds were the smallest reported since first quarter 2020.
  • Net gains on loan sales revenue declined $1.2 billion (41.5%) from third quarter 2020. However, other noninterest income increased $343.3 million or 15.2% while revenue from service charges on deposit accounts increased $100.3 million or 14.5%. In total, noninterest income decreased $616.3 million from third quarter 2020.
  • Noninterest expense increased 5.7% from third quarter 2020. This increase was mainly attributable to salary and benefit expenses, which saw an increase of $402.2 million (4.3%). That being said, average assets per employee increased 10.4% from third quarter 2020. Noninterest expense as a percentage of average assets declined 12 basis points from third quarter 2020 to 2.45%, despite 74.1% of community banks reporting higher noninterest expense.
  • Noncurrent loan balances (loans 90 days or more past due or in nonaccrual status) declined by $847 million, or 7.1%, from second quarter 2021. The noncurrent rate dropped 4 basis points to 0.65% from second quarter 2021.
  • The coverage ratio (allowance for loan and lease losses as a percentage of loans that are 90 days or more past due or in nonaccrual status) increased 44.1 percentage points year-over-year to 203.5%. This ratio is well above the financial crisis average of 147.9% and is a record high. The coverage ratio for community banks is 26.2 percentage points above the coverage ratio for noncommunity banks.
  • Net charge-offs declined 4 basis points from third quarter 2020 to 0.06%.
  • Loans and leases declined from second quarter 2021 by 0.2%. This decrease was mainly seen in the C&I loan category, which was driven by a $45.6 billion decrease in PPP loan balances due to their payoff and forgiveness. Total loans and leases declined by $19.2 billion (1.1%) from third quarter 2020. The largest decline was shown in C&I loans ($87.3 billion or 24.9%). Growth in other loan categories, such as nonfarm nonresidential commercial real estate, construction & development, and multifamily loans of $69.9 million offset a portion of this decline. 

    *See Exhibit C at the end of this article for more information on the change in loan balances.
     
  • Nearly seven out of ten community banks reported an increase in deposit balances during the third quarter. Growth in deposits above the insurance limit increased by $57.8 billion, or 5.5%, while growth in deposits below the insurance limit showed an increase of $1.7 billion, or 0.1%, from second quarter 2021. In total, deposit growth was 2.6% during third quarter 2021.
  • The average community bank leverage ratio (CBLR) for the 1,737 banks that elected to use the CBLR framework was 11.3%. The average leverage capital ratio was 10.25%.
  • The number of community banks declined by 40 to 4,450 from second quarter 2021. This change includes one new community bank, 10 banks transitioning from community to noncommunity bank, five banks transitioning from noncommunity to community bank, 35 community bank mergers or consolidations, and one community bank having ceased operations.

Third quarter 2021 was another strong quarter for community banks, as evidenced by the increase in year-over-year quarterly net income of 19.6% ($1.4 billion). However, NIMs remain low despite seeing growth in the most recent quarter (for the first time since first quarter 2019), as shown in Exhibit A. The consensus remains that community banks will likely need to find creative ways to increase their NIM, grow their earning asset bases, or continue to increase noninterest income to maintain current net income levels. In regards to the latter, many pressures to noninterest income streams exist. Financial technology (fintech) companies are changing the way we bank by automating processes that have traditionally been manual (for instance, loan approval). Decentralized financing (DeFi) also poses a threat to the banking industry. Building off of fintech’s automation, DeFi looks to cut out the middle-man (banks) altogether by building financial services on a blockchain. Ongoing investment in technology should continue to be a focus, as banks look to compete with nontraditional players in the financial services industry. The larger, noncommunity banks are also putting pressure on community banks and their ability to generate noninterest income, as recently seen by Capital One Bank eliminating all overdraft fees.

According to the Consumer Financial Protection Bureau, the financial services industry brought in $15.5 billion in overdraft fees in 2019. Seen as a move to enhance Capital One Bank’s relationships with its customers, community banks will also need to find innovative ways to enhance relationships with current and potential customers. As fintech companies and DeFi become more mainstream and accepted in the marketplace, the value propositions of community banks will likely need to change.

The importance of the efficiency ratio (noninterest expense as a percentage of total revenue) is also magnified as community banks attempt to manage their noninterest expenses in light of low NIMs. Banks appear to be strongly focusing on noninterest expense management, as seen by the 12 basis point decline from third quarter 2020 in noninterest expense as a percentage of average assets, although inflated balance sheets may have something to do with the decrease in the percentage.

Furthermore, much uncertainty still exists. For instance, although significant charge-offs have not yet materialized, the financial picture for many borrowers remains uncertain. And, payment deferrals have made some credit quality indicators, such as past due status, less reliable. Payment deferrals for many borrowers are coming to a halt. So, the true financial picture of these borrowers may start to come into focus. The ability of community banks to maintain relationships with their borrowers and remain apprised of the results of their borrowers’ operations has never been more important. This monitoring will become increasingly important as we transition into a post-pandemic economy.

For seasonal borrowers, current indications, such as the most recent results from the Federal Reserve’s Beige Book, show that economic activity was modest in August and September 2021. Supply chain pressures, labor shortages, and concerns over COVID-19 variants (delta and now omicron) have slowed economic growth and continue to provide uncertainty as to (1) the trajectory of the economy, (2) whether inflation is transitory, and (3) the need for the Federal Reserve to increase the federal funds target rate. If an increase in the federal funds target rate is used to combat inflation, community banks could see their NIMs in another transitory stage.

Also, as offices start to open, employers will start to reassess their office needs. Many employers have either created or revised remote working policies due to changing employee behavior. If remote working schedules persist, whether it be full-time or hybrid, the demand for office space may decline, causing instability for commercial real estate borrowers. Banks should closely monitor these borrowers, as identifying early signs of credit deterioration could be essential to preserving the relationship.

The financial services industry is full of excitement right now. While the industry faces many challenges, these challenges also bring opportunity for banks to experiment and differentiate themselves. The forces at play right now indicate the industry will likely look much different ten years from now. However, as the pandemic has exhibited, you may be full steam ahead in one direction and then an unforeseen force may totally up-end your plans. As always, please don’t hesitate to reach out to BerryDunn’s Financial Services team if you have any questions.

Article
FDIC Issues its Third Quarter 2021 Quarterly Banking Profile

Read this if you are a division of motor vehicles, or interested in mDLs.

It can be challenging to learn about the technical specifications that must be met to safely acquire, implement, and use emerging technologies. And why wouldn’t it be? Technical specifications are full of jargon only a technical expert can understand, and seem to appear out of thin air. Well, BerryDunn is here to help. When it comes to mobile driver’s licenses (mDLs), we’ve got the scoop.

Technical standards are developed by a few large international organizations. The International Organization for Standardization (ISO) is a Swiss-based organization responsible for the development of international standards for technical, industrial, and commercial industries in 165 countries. The International Electrotechnical Commission (IEC) is an international standards organization that develops and publishes standards for electronic technologies. The ISO and IEC have been collaborating on international technical standards for mDL technology. Recently, the ISO/IEC finalized and published these standards, which can be purchased on ISO’s website for $198 Swiss francs (about $213 US).

These technical standards cover three key components: 

  • Data exchanged during an mDL transaction
  • Security during online and offline mDL transaction scenarios
  • mDL data model to ensure mDL interoperability 

Data exchange/transaction

Data exchange is the process by which an mDL device is used to provide credentials (e.g., verify age or identity) to an mDL reader. Broadly speaking, data exchange consists of three phases: initialization (activating your device at a store to confirm your identity), device engagement (the mDL device creates a connection with the mDL reader), and data retrieval (the mDL reader requests the appropriate data to continue a transaction). The process can occur when the mDL has an internet connection (online retrieval) or when it does not have an internet connection (offline retrieval). Offline data retrieval can be conducted using a combination of Bluetooth Low Energy (BLE), Near-Field Communication (NFC), or Wi-Fi Aware technologies. These are all methods by which an mDL can connect to mDL readers at short ranges, functionally similar to Apple Pay. Online Data retrieval can be conducted using a web-based application programming interface (WebAPI) or OpenID Connect (OIDC). These are methods by which mDLs connect with the mDL issuer, confirm the mDL holder’s identity, and allow the mDL issuer to transfer data to the mDL reader. In short, an mDL transaction might look something like this:

  1. Initialization: An mDL holder attempts to purchase alcohol from a local store. The mDL holder opens their device, enters their mDL application using a PIN or biometric security feature, and uses NFC or a QR code to initiate a connection between the mDL and mDL reader.
  2. Device engagement: The mDL and mDL reader connect using NFC or a QR code.
  3. Data retrieval: The mDL reader either asks the mDL for data to confirm the holder’s age, or asks the mDL issuer to confirm the mDL holder’s age. Either the mDL or mDL issuer sends appropriate data to the mDL reader to confirm the holder’s age. Once validated, the mDL-reading establishment and mDL holder are free to complete the transaction. 

Security for mobile driver’s licenses 

mDL security aims to protect against four primary threats.

  1. mDL forgery/forgery of data elements
  2. mDL cloning/cloning of data elements
  3. mDL communication eavesdropping
  4. Unauthorized mDL access 

mDL security needs to cover online scenarios, in which an mDL-holder’s device is connected to the internet, as well as offline scenarios, when an mDL holder’s device does not have internet connectivity. Potential mDL security options include: 

  • Authentication of mDL data to protect against data cloning
  • Authentication of the legitimacy of the mDL reader to prevent alteration of communications between the mDL and mDL reader 
  • Session encryption to preserve mDL data confidentiality and prevent mDL data alteration or unauthorized data access
  • Issuer data authentication to ensure the mDL data originates at a legitimate issuing authority

During online retrieval scenarios, mDLs can employ transport layer security (TLS) to preserve the confidentiality of mDL data, or use a JavaScript Object Notation (JSON) Web Token (JWT) to authenticate mDL data origin.  

mDL technical specifications: Key terms and definitions

Technical specifications are an important, yet confusing aspect of IT system implementations, particularly for emerging technologies where expertise has not yet been established within the market. The same holds true for mDLs. Understanding mDL technical specifications requires understanding the specific terms used to describe the technical specifications along with general mDL terminology. Here’s a list of mDL-related and technical specification terms and definitions.

Key terms and definitions
 

Terms Definitions
Bluetooth Low Energy (BLE) A form of Bluetooth that provides a wireless connectivity of similar range to traditional Bluetooth at reduced device power consumption.
IEC International Electrotechnical Commission
ISO International Organization for Standardization
JavaScript Object Notation (JSON)  An open standard file format and data interchange format that uses human-readable text to store and transmit data objects.
JSON Web Token (JWT) An object used to transfer information between two parties over the web.
mDL issuer  The department of motor vehicles or bureau of motor vehicles responsible for administering rights to, and overseeing distribution of, mDL data to mDL holders.
mDL holder The person whose data is contained in, and represented by, the mDL.
mDL reader The hardware technology used to consume mDL data from an mDL holder’s device.
mDL-reading establishment The institution consuming mDL data via an mDL reader (e.g., law enforcement, liquor store, Transportation Safety Administration).  
Near-Field Communication (NFC) Communication protocols that allow electronic devices to communicate over distances of 1.5 inches or less (e.g., Apple Pay).
Offline retrieval The mDL holder’s device is not directly connected to an internet network via Wi-Fi or cellular data, requiring the mDL device to hold some mDL data—behind security features (e.g., PIN, or biometric lock)—and, at a minimum, confirm holder identity, driving privileges, age, and residence.
Online retrieval  The mDL holder’s device is connected to an internet network via Wi-Fi or cellular data. Upon request, the mDL holder can initiate a transfer of mDL data using a QR code or web token to approve the sharing of mDL data between the mDL issuer and mDL reader. 
OpenID Connect (OIDC) OpenID Connect is an authentication protocol that allows for the verification of end user identity.
Transport Layer Security (TLS) A cryptographic protocol that provides communication security over a computer network (e.g., between an mDL reader and mDL issuer).
Web Application Programming Interface (API)   An interface for a web server or web browser.
Wi-Fi Aware A Wi-Fi capability that allows devices to discover potential Wi-Fi connections nearby without connecting to them. Wi-Fi Aware runs in the background, and does not require users to have current Wi-Fi or cellular connections.


If you have any questions regarding mDLs and technical requirements, please contact us. We’re here to help. 

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mDL technical specifications: Background, terms, and topics

Read this if you are an employee benefit plan fiduciary.

Fiduciary risk management

This is the final article in a series to help employee benefit plan fiduciaries better understand their responsibilities and manage the risks of non-compliance with ERISA requirements. You can find the full series here.

If, as part of your involvement with an employee benefit plan, you have decision-making ability; you advise those with decision-making ability; or someone tasks you with decision-making related to the plan, you are more likely than not, a fiduciary. As discussed in the first article of the series, this status comes with responsibilities and, therefore, risks and consequences.

The general approach to handling risk is a cycle of identifying, assessing, controlling, and reviewing controls over risks. Based on the assessment of a given risk, there are four ways to manage it: you can avoid, reduce, transfer, or accept the risk. 

Identifying and assessing fiduciary risk1 

The risks facing a plan fiduciary include, but are not limited to, the following:

Removal of fiduciary

In appropriate cases, a fiduciary may be removed and permanently prohibited from acting as a fiduciary or from providing services to ERISA plans.

Civil penalties

Among other penalties, the DOL may assess a civil penalty equal to 20% of the amounts recovered for the plan through litigation or settlement.

Criminal prosecution

Upon a conviction for a willful violation of ERISA’s reporting and disclosure requirements, a fiduciary may be subject to fines and/or imprisonment for not more than ten years. There is also a provision in ERISA that applies to any person, not just ERISA fiduciaries, that makes coercive interference with ERISA rights a criminal offense punishable by fines and/or imprisonment for up to ten years. In addition, outside of ERISA, there are a number of criminal statutes that apply to any person, not just ERISA fiduciaries, including criminal statutes for embezzling from an ERISA plan, making false statements in ERISA documents, and taking illegal kickbacks in connection with an ERISA plan.

Participant lawsuits

Additionally, plan participants may file a lawsuit against the fiduciary for breach of their fiduciary duty. Over the past few years, this has become more common and has generally been related to the fiduciary’s failure to adequately negotiate and monitor plan fees. 

Co-fiduciary liability

ERISA's unique co-fiduciary liability provisions make each fiduciary responsible for the actions of the other plan fiduciaries but only under certain circumstances. As a general rule, fiduciaries aren’t responsible for the breach of another fiduciary unless:

  • They participate knowingly in, or knowingly undertake to conceal, an act or omission of such other fiduciary, knowing such act or omission is a breach;
  • Their failure to be prudent in the administration of their own fiduciary responsibilities enables the other fiduciary to commit a breach; or
  • They have knowledge of a breach by such other fiduciary and don’t make reasonable efforts under the circumstances to remedy the breach.

Controlling fiduciary risk

There are several ways to effectively manage fiduciary risk. When used together, they give you solid controls to greatly reduce your level of risk.

Plan documentation

A fiduciary and/or plan sponsor should reduce their exposure to the risks identified above and their first line of defense is through plan documentation (discussed in depth here). Broadly speaking, the organizers and fiduciaries of the plan should ensure that policies and procedures are laid out to ensure proper oversight and internal controls are in place to prevent any voluntary or involuntary noncompliance with ERISA and the DOL.

Oversight

Fiduciaries should meet formally on a regular basis to review the plan’s offerings, service providers, fees, and other issues that may affect the plan. A single individual who is the sole fiduciary for a plan may not have the knowledge or bandwidth to appropriately fulfill the responsibilities of the plan. Additionally, having an auditor come in and audit the plan can help identify some of the risks identified above, although an audit of the plan does not reduce your responsibility to monitor and review the plan’s activity on an ongoing basis.

Third Party Administrators (TPA) & recordkeepers

Fiduciaries may also be able to mitigate some of the risks identified above through use of a TPA and/or recordkeeper. While TPAs and recordkeepers are not generally considered fiduciaries or co-fiduciaries, TPAs have varying service offerings, including recordkeeping, that are powerful tools to plan administrators to review and operate the plan. For example, depending on the plan sponsor’s existing payroll and HR structure, inclusive of TPAs and recordkeepers, fiduciaries may be able to automate the transfer of contributions to ensure timeliness of deposits. The plan may also be able to add another layer of internal controls by incorporating the TPA’s or recordkeeper’s internal controls into the plan’s control environment assuming the fiduciary has gained an understanding and comfort around the controls present at the TPA and/or recordkeeper.

Professional investment advisors and co-fiduciaries

Employee benefit plans must meet certain requirements with regard to their investment offerings. For instance, the plan must allow participants to invest in a diversified portfolio. The plan may try to transfer some of these risks and employ the help of a professional investment advisor to help ensure the plan’s investment offerings meet such criteria. This could involve hiring either an ERISA 3(21) fiduciary or an ERISA 3(38) fiduciary. The former serves as an advisor and a co-fiduciary, but does not have any authority by themselves, while the latter is an investment manager and therefore authorized to select investments for the plan. Doing so may help demonstrate to regulators that a fiduciary has fulfilled their duty in this regard. Alternatively, a plan may hire a 3(16) Fiduciary. 3(16) Fiduciaries are individuals or organizations that are charged with running plans as the plan administrator. A company may be able to shift most of their fiduciary risk to such a fiduciary. 

In any case, the plan fiduciary must continue to monitor a 3(16), 3(21) or 3(38) advisor to make sure it is still prudent to use that advisor.

Bonding and fiduciary liability insurance

Bonding is required for most EB plans and does not protect the fiduciary from any risk. It does however protect the plan from fraud or dishonesty. On the other hand, fiduciary liability insurance can protect the fiduciary in the case of breach of fiduciary duty. This type of insurance is not required but is another option to transfer fiduciary risk.

As mentioned in our second article, much like owning a car, regular preventative maintenance can help you avoid the need for costly repairs. Plan fiduciaries should periodically refresh their understanding of ERISA requirements and re-evaluate their current and future business activities on an ongoing basis. Doing so will help mitigate any risks associated with non-compliance with the DOL and IRS and keep the plan running smoothly. 

Need help navigating the fiduciary road? Reach out to the BerryDunn employee benefit consulting team today.

1From Fidelity’s Plan Sponsor Webstation: Consequences of breach of fiduciary duties 

Article
Fiduciary risk: Five ways to control and reduce it

Read this if you are an employer that gives employee gifts.

The holiday season is officially in full swing! Unlike Ebenezer Scrooge, many employers are looking for ways to recognize the dedication and hard work of their employees. This gratitude often comes in the form of a holiday gift of some fashion. While this generosity is well-intended, gifts to employees can be fraught with potential tax consequences organizations should be aware of. This article will attempt to demystify the rules surrounding employee gifts to ensure organizations and their employees have a joyous holiday season.

Holiday gifts: Taxable or not?

So, are holiday gifts to employees taxable? The answer, as is so often the case with tax questions, is it depends. The IRS is very clear that cash and cash equivalents (specifically including gift cards) are always included as taxable income when they are provided by the employer, regardless of amount, with no exceptions. This means that if you plan to give your employees cash or a gift card this year, the value must be included in the employees’ wages and is subject to all payroll taxes. Bah humbug indeed!

Nontaxable gift options

There are however, a few ways to make nontaxable gifts to employees. In each instance the gift must be noncash (nor convertible to cash). IRS Publication 15 offers a variety of examples of de minimis (minimal) benefits, defined as any property or service you provide to an employee that has a minimal value, making the accounting for it unreasonable and administratively impracticable. Examples include holiday or birthday gifts with a low market value (a card and flowers, fruit baskets, a box of chocolates, etc.), or occasional tickets for theater or sporting events, among others. Again, cash and cash equivalents never qualify. The key is that the gift must be occasional or unusual in its frequency and must not be a form of disguised compensation. While de minimis benefits can be a gray area, the IRS has generally deemed items with a value exceeding $100 as too large to qualify as de minimis.

Holiday gifts can also be nontaxable if they are in the form of a gift coupon, if given for a specific item (with no redeemable cash value). A common example would be issuing a coupon to your employee for a free ham or turkey redeemable at the local grocery store. Nontaxable employee gifts can also come in the form of achievement awards, either for length of service or for safety achievements. The proverbial gold watch upon retirement is a classic example of such a gift. Here too, the award must always be tangible personal property—never cash or a cash equivalent. There are additional rules and value thresholds on any such gift. Please contact a member of your tax team to discuss these specific details further.

Whether employers are considering supplying gift cards, turkeys, or something in between, we hope all find this guidance helpful and still in the giving spirit! Coincidentally, at the end of A Christmas Carol, Ebenezer himself gives Bob Cratchit a turkey on Christmas day. Of course Mr. Scrooge would be aware of the potential tax consequences! We wish you all a very happy and healthy holiday season!

Not-for-profit resources

If you are a not-for-profit organization receiving charitable gifts, read Donor Acknowledgements: We have to file what?

Article
What employers need to know before making gifts to employees

Read this if you are responsible for cybersecurity at your organization. 

During the financial audit process auditors are required to develop and confirm their understanding of Information Technology (IT) and cybersecurity practices as it relates to financial reporting to better understand risks and because of auditors’ heavy reliance on data pulled from accounting information systems. As auditors, we have seen a significant increase in the amount of impactful incidents affecting not-for-profit organizations and our IT security experts often share valuable advisory comments in annual audit communications with our clients. With recent incidents and a very rapidly changing business environment, here are the three most important from the last six months that impact all not-for-profits. 

Board oversight of cybersecurity 

Cybersecurity gaps within an organization’s systems may lead to risk exposure and have material impacts on all aspects of operations. Responsibility for cybersecurity controls and for establishing a culture of awareness and security should come from the Board and senior leadership. Board members and senior leaders should stay apprised of cybersecurity efforts on a regular basis and incidents should be summarized and reported on a quarterly basis. 

The Board should also consider adding a member who is a professional with IT and cybersecurity experience to help manage and understand the specific risks to the organization and help drive and support cybersecurity efforts.

Ransomware threats and preventive controls

The use of ransomware as a profitable attack on organizations by hackers continues to rapidly increase. Within the last year there have been multiple high-profile incidents that illustrate the impact of a successful attack. These impacts fall into two main areas. One impact may be financial, as millions of dollars are paid to the bad actors as ransom in hopes of being able to regain control of systems. The second impact is operational, resulting in a loss of control of systems and data during the event. Potentially, an unsuccessful data restoration could result in the total loss of information and data maintained on your networks. 

Though no organization may be able to prevent a ransomware attack from occurring entirely, there are basic cybersecurity controls that help reduce the likelihood and impact of an attack. Preventive controls may include: 

  • Security awareness training on phishing emails and overall IT security practices for all organization users
  • Multi-factor authentication 
  • Access controls that prevent users from installing unapproved software onto organization-owned workstations and networks
  • Anti-malware software installed on devices that connect to organization systems 
  • Use of Zero Trust data management tools for backups
  • Disabling macros in emails (prevents back-end processes from automatically running) 

In addition to including these preventive controls to your cybersecurity program, your organization should assess current corrective controls already in place to react to a ransomware event if one is detected or reported. Corrective controls may include:

  • Disaster recovery plans/business continuity plans 
  • Incident response plans
  • Backup controls and restoration tests 

As the risk of ransomware continues to increase and the types of attacks continue to increase in sophistication, your organization should consider regular assessments of IT controls and cybersecurity practices on a regular basis. Such assessments may be performed in conjunction with annual financial statement audits as an expanded scope and/or as a separate annual IT assessment. 

COVID-19 IT considerations 

The global COVID-19 pandemic significantly impacted nearly every aspect of modern life, including the way we work. As personnel were sent home and literally became a remote workforce overnight, changes to IT systems and controls rapidly adjusted to accommodate this new way of business. 

Where controls and procedures were adjusted, if not suspended, your organization should review those changes and determine if controls should revert back to the pre-pandemic process—or be formally changed and documented as policy. 

Guidance from the American Institute of Certified Public Accountants (AICPA) dictates that a gap in controls associated with the pandemic is not a legitimate reason for not completing a control and that any changes must be documented and properly managed.  

Well over a year into the pandemic, the concept of a hybrid workforce has emerged as the predominant way employees and businesses want to work. Your organization should review current policies and procedures that may pre-date the pandemic to ensure that the updates both document and consider the current business environment. 

Additionally, with personnel working remotely or in a hybrid model, or a combination of both, you should assess practices for managing remote access and a hybrid workforce and, where needed, implement industry best-practice tools and procedures to accommodate a remote workforce while maintaining security controls. If you have questions regarding you cybersecurity procedures or want to learn more, please contact our team. We’re here to help. 
 

Article
Cybersecurity update for organizations: Considerations for boards and senior management

Read this if you are a Chief Financial Officer, Chief Compliance Officer, FINOP, or charged with governance of a broker-dealer.

The results of the Public Company Accounting Oversight Board’s (PCAOB) 2020 inspections are included in its 2020 Annual Report on the Interim Inspection Program Related to Audits of Brokers and Dealers. There were 65 audit firms inspected in 2020 by the PCAOB and, although deficiencies declined 11% from 2019, 51 firms still had deficiencies. This high level of deficiencies, as well as the nature of the deficiencies, provides insight into audit quality for broker-dealer stakeholders. Those charged with governance should be having conversations with their auditor to see how they are addressing these commonly found deficiencies and asking if the PCAOB identified any deficiencies in the auditor’s most recent examination. 

If there were deficiencies identified, what actions have been taken to eliminate these deficiencies going forward? Although the annual report on the Interim Inspection Program acts as an auditor report card, the results may have implications for the broker-dealer, as gaps in audit quality may mean internal control weaknesses or misstatements go undetected.

Attestation Standard (AT) No. 1 examination engagements test compliance with the financial responsibility rules and the internal controls surrounding compliance with the financial responsibility rules. The PCAOB examined 21 of these engagements and found 14 of them to have deficiencies. The PCAOB continued to find high deficiency rates in testing internal control over compliance (ICOC). They specifically found that many audit firms did not obtain sufficient, appropriate evidence about the operating effectiveness of controls important to the auditor’s conclusions regarding the effectiveness of ICOC. This insufficiency was widespread in all four areas of the financial responsibility rules: the Reserve Requirement rule, possession or control requirements of the Customer Protection Rule, Account Statement Rule, and the Quarterly Security Counts Rule.

The PCAOB also identified a firm that included a statement in its examination report that referred to an assertion by the broker-dealer that its ICOC was effective as of its fiscal year-end; however, the broker-dealer did not include that required assertion in its compliance report.

AT No. 2 review engagements test compliance with the broker-dealer’s exemption provisions. The PCAOB examined 83 AT No. 2 engagements and found 19 of them to have deficiencies. The most significant deficiencies were that audit firms:

  • Did not make required inquiries, including inquiries about controls in place to maintain compliance with the exemption provisions, and those involving the nature, frequency, and results of related monitoring activities.
  • Similar to AT No. 1 engagements, included a statement in their review reports that referred to an assertion by the broker-dealer that it met the identified exemption provisions throughout the most recent fiscal year without exception; however, the broker-dealers did not include that required assertion in their exemption reports.

The majority of the deficiencies found were in the audits of the financial statements. The PCAOB did not examine every aspect of the financial statement audit, but focused on key areas. These areas were: revenue, evaluating audit results, identifying and assessing risks of material misstatement, related party relationships and transactions, receivables and payables, consideration of an entity’s ability to continue as a going concern, consideration of materiality in planning and performing an audit, leases, and fair value measurements. Of these areas, revenue and evaluating audit results had the most deficiencies, with 45 and 27 deficiencies, or 47% and 26% of engagements examined, respectively.

Auditing standards indicate there is a rebuttable presumption that improper revenue recognition is a fraud risk. In the PCAOB’s examinations, most audit firms either identified a fraud risk related to revenue or did not rebut the presumption of revenue recognition as a fraud risk. These firms should have addressed the risk of material misstatement through appropriate substantive procedures that included tests of details. The PCAOB noted there were instances of firms that did not perform any procedures for one or more significant revenue accounts, or did not perform procedures to address the assessed risks of material misstatement for one or more relevant assertions for revenue. The PCAOB also identified deficiencies related to revenue in audit firms’ sampling methodologies and substantive analytical procedures. Other deficiencies of note, that were not revenue related, included:

  • Incomplete qualitative and quantitative disclosure information, specifically in regards to revenue from contracts with customers and leases.
  • Missing required elements from the auditor’s report.
  • Missing auditor communications:
    • Not inquiring of the audit committee (or equivalent body) about whether it was aware of matters relevant to the audit.
    • Not communicating the audit strategy and results of the audit to the audit committee (or equivalent body).
  • Engagement quality reviews were not performed for some audit and attestation engagements.
  • Audit firms assisted in the preparation of broker-dealer financial statements and supplemental information.

Although there have been improvements in the amounts of deficiencies found in the PCAOB’s examinations, the 2020 annual report shows that there is still work to be done by audit firms. Just like auditors should be inquiring of broker-dealer clients about the results of their most recent FINRA examination, broker-dealers should be inquiring of auditors about the results of their most recent PCAOB examination. Doing so will help broker-dealers identify where their auditor may reside on the audit quality spectrum. If you have any questions, please don’t hesitate to reach out to our broker-dealer services team.

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2020 Annual Report on the Interim Inspection Program Related to Audits of Brokers and Dealers