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Vendor Management Risks and Controls

​What are the Risks?

In an effort to heighten efficiency and cost effectiveness, many financial institutions choose to outsource certain services to third party vendors. While these providers often play a beneficial role, financial institutions should be aware of the possible risks involved in such relationships. These risks include: reputational risk, operational risk, transactional risk, financial risk, and legal risk, just to name a few. Vendor relationships gone wrong could result in dissatisfied customers, compromised network security, or a multitude of other damaging outcomes. It is vital to note that reliance on outside vendors to provide services to a regulated financial institution does not relieve this financial institution from potential liability or from its responsibility to ensure that outsourced activities are conducted in a safe and sound manner and in compliance with applicable laws. Due to the substantial risks involved, financial institutions should enter these relationships with caution.

Vendor Risk Management Programs

The Office of the Comptroller of the Currency (the “OCC”) has issued its guidance regarding vendor management, which is available at: http://occ.gov/news-issuances/bulletins/2013/bulletin-2013-29.html This guidance requires regulated financial institutions to implement vendor risk management programs prior to entering into third-party relationships. Each program should address:

  1. Planning and Risk Assessment: Financial institutions should assess risk and set out options for controlling risk through vendor agreements. 

  2. Due Diligence and Selection:  Financial institutions should conduct due diligence on potential vendors and select only qualified entities to implement the activity or program.   If a vendor is considered a “critical vendor,” the due diligence should be more extensive.

  3. Contract Negotiation and Review:  Management should carefully negotiate contracts so that the rights and responsibilities are clearly laid out. Contracts should be reviewed by management periodically to ensure pertinent risks are addressed.

  4. Ongoing Monitoring and Oversight: Financial institutions should continuously monitor the relationship and the operations of the third party vendor.

  5. Termination of third-party relationships:  Management should ensure there is a procedure in place in the event of termination of the third-party relationship. This is imperative to a seamless transition to another vendor or in-house operation.

The CFPB is Watching

In order to mitigate the risks described above, regulators require financial institutions to implement vendor management controls. Vendor management has been examined for many years and is therefore not a novel area of concern for financial institutions. Enhanced awareness has arisen in recent years due to the delegation of oversight to the Consumer Financial Protection Bureau (the “CFPB”). The Dodd Frank Act vests the CFPB with supervisory and enforcement authority to monitor “service providers,” defined as “any person that provides a material service to a covered person in connection with the offering or provision by such covered person of a consumer financial product or service.” The Director of the CFPB, Richard Cordray, expressed that “[c]onsumers must not be hurt by unfair, deceptive, or abusive practices of service providers. Banks and nonbanks must manage these relationships carefully and can be held accountable if they break the law.” Due to this increased scrutiny, we recommend financial institutions heed the warning and comply with the guidelines provided by the CFPB in Bulletin 2012-03. These guidelines include: conducting extensive due diligence on the potential service provider, reviewing the service provider’s policies and procedures to ensure proper training of employees, making compliance expectations clear, continuously monitoring for compliance with the law, and taking prompt action on any identified problems.

Settlement Agents = Service Providers

The new CFPB rules also affect the residential real estate arena. Under new CFPB rules, the term “service provider” is generally considered to be broad enough to include settlement agents and law firms which close residential real estate transactions. Therefore, regulated financial institutions must treat their settlement agents just as they would any other third-party vendor. The American Land Title Association (“ALTA”) developed Best Practices for settlement agents in hopes that adherence thereto would lift some of the supervisory burden off the shoulders of lenders. To review these Best Practices, please visit:http://www.attorneystitle.com/best-practices  Regulated financial institutions should ensure that their vendor management policies address their relationships with settlement agents. A requirement that settlement agents conducting closings for the regulated financial institution comply with the ALTA Best Practices could be incorporated into such policies. 

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About this Author

Amanda L Sherin, Transactional Attorney, Poyner Spruill Law Firm

​Amanda assists in representing clients in a broad range of transactional matters. She is a member of the firm's Business Law and Financial Services practice groups.

Prior Legal Experience

Prior to joining Poyner Spruill, Amanda held various accounting positions with International Business Machines (IBM) from 2007-2011.   Amanda was a summer intern for Disability Rights North Carolina and also served as a Research Assistant to a University of North Carolina Law Professor.   Amanda was a summer clerk for Tuggle Duggins P.A. and Poyner...

Christopher H. Roede, Commercial Real Estate Attorney, Poyner Spruill Law Firm

Chris Roede works primarily in the financial services industry, working with banks, FinTech companies, and others on regulatory and lending matters.

Chris’s practice includes regulatory and compliance review of new bank products and processes, acting as transaction counsel in closing both real estate secured and personal property secured loans, and working with lenders to resolve distressed credit assets. His focus for bank regulatory and compliance products is on new and emerging technologies, including advice regarding payment and credit card processing laws, multi-state licensing advice regarding money transmission licensing laws, BSA/AML compliance advice, and mobile technologies.

Chris joined Poyner Spruill after clerking with the firm in the summer of 2006. The same year, he completed internships for the Virginia State Corporation Commission in Richmond, and for the Honorable Edward Thomas Brady of the Supreme Court of North Carolina.