Wednesday, July 24, 2013

Steering Consumers to Expensive Mortgage Loans

The CFPB announced that it had filed a complaint yesterday in a federal district court against Utah-based Castle & Cooke Mortgage, LLC (“C & C”) and two of its officers for illegally giving bonuses to loan officers who steered consumers into mortgages with higher interest rates.

C & C is not some mom and pop mortgage company: in 2012 it originated in the range of $1.3 billion, and it does business in at least 22 states, and maintains approximately 45 branches across the country.

At the core of the complaint is the allegation that C & C violated the Loan Originator Compensation Rule (“LOC Rule”) which bans compensation based on loan terms, such as the interest rate of the loan. Specifically, the CFPB alleges that C & C violated the LOC Rule by establishing a quarterly bonus program, which paid certain C & C loan officers greater bonus compensation when they persuaded consumers to take on more expensive loans. The average quarterly bonus ranged from $6,100 to $8,700.

The CFPB further alleges, that, by contrast, those loan officers who did not charge consumers higher interest rates did not receive quarterly bonuses. (The CFPB also alleges that C & C did not record what portion of each loan officer’s quarterly bonus was attributable to a particular loan and did not reference its quarterly bonus program in each loan originator’s compensation agreement, in violation of federal consumer financial law.)

The idiomatic expression for this is called "selling up" or "upselling the consumer" or "up-charging the borrower." So, briefly put, the CFPB alleges that more than 1,100 illegal quarterly bonuses were paid - where the loan officers had been given the forgoing incentive - and that tens of thousands of customers may have been upsold by C & C since April 6, 2011, the compliance effective date of the LOC Rule.

The time frame is important. It is alleged that from July 8, 2011 through April 27, 2012 the company paid to its loan officers more than 500 quarterly bonuses, in amounts that varied based on loan terms or conditions, totaling more than $4 million. And is it further alleged that since May 2012, C & C had actually continued paying quarterly bonuses to loan officers in amounts that varied based on loan terms or conditions, and, thus by doing so from the compliance effective date, according to the CFPB, the company “recklessly or knowingly paid quarterly bonuses based on loan terms or conditions, in violation of the Compensation Rule.” The “recklessly and knowingly” allegation is made in order to set the bar for civil monetary penalties at the highest levels.

Bottom Line: The CFPB's position is that, by tying bonuses to the interest rate of the loans in this manner, C & C was in direct violation of the LOC Rule.

Another interesting facet of this complaint is that the case was referred to the CFPB by investigators with the Utah Department of Commerce, Division of Real Estate (jointly, “CFPB”). This should further reinforce the fact and make exceedingly clear that states and the CFPB are more and more working together seamlessly to enforce the applicable regulations. The complaint was filed in the United States District Court for the District of Utah, where the company is located and where the individual defendants reside.

Both the state regulator and the CFPB are claiming that C & C violated the LOC Rule by paying its loan officers quarterly bonuses in amounts based on terms or conditions of the loans they closed, thus "incentivizing loan officers to steer consumers into mortgages with less favorable terms," which, of course, is the very practice the LOC Rule seeks to prevent.

The remedies being sought would require C & C to desist from providing an incentive to loan officers to up-charge consumers by distributing quarterly bonuses based on the interest rates of loans sold. In addition to the restitution to consumers, the CFPB seeks civil monetary penalties, which is three tiered: up to $5,000 for any violation; up to $25,000 for reckless violations; and up to $1,000,000 for knowing violations.

I have read the full complaint. Permit me to outline the "before and after" process that the CFPB alleges C & C used, which forms the basis of the CFPB's complaint:

Before the LOC Rule compliance effective date, it is alleged:

1) Each branch of C & C employed loan officers who interacted directly with borrowers. C & C paid its loan officers to assist borrowers with obtaining credit to be secured by a dwelling.

2) A loan officer took an initial loan application, assessed the borrower’s creditworthiness, and determined the interest rates available to the borrower for a given loan product.

3) Borrowers did not directly compensate C & C's loan officers for the loan origination services they provided.

4) C & C paid its loan officers commissions based on the interest rates of the loans they offered to consumers, that is, the higher the interest rates, the higher the loan officers’ commissions.

Monday, July 22, 2013

CFPB: Spying to Protect the Consumer

It all began with a Bloomberg article. Although the CFPB spying on the financial habits of at least 10 million consumers seems to be a far cry from NSA's spying on the telephone calls, emails, snail mails, website usage, and many other communication media used by hundreds of millions of US citizens, the timing of the Bloomberg article comes at, shall we say, a rather sensitive time - given its publication just shortly prior to the recent revelations regarding the NSA's rather unique way of interpreting the Fourth Amendment of the US Constitution regarding search and seizure.

Probable Cause Conundrum

I call it the "probable cause conundrum," because (1) the Fourth Amendment expressly states that "the right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated, and no Warrants shall issue, but upon probable cause, supported by Oath or affirmation, and particularly describing the place to be searched, and the persons or things to be seized," yet (2) a warrant to spy on Americans these days, at least with respect to probable cause and the requirement that a warrant to spy must be limited in scope according to specific information, has been hugely expanded. At least one of the Supremes has interpreted "probable cause" to mean "reasonable." For some reason, I really don't think that point of view was ever the way the Framers considered it, based on the law extant at the time the Constitution was actually drafted. But I digress.

As a result of Tennessee v. Garner [471 U.S. 1 (1985)], inter alia, we all learned that the "reasonableness requirement" applies not just to a search in combination with a seizure, but also to a search without a seizure, as well as to a seizure without a search. But, again, I digress. So not to go too far afield, let us return to that Bloomberg article which, by the way, was published back in April of this year.

To quote the very first paragraph of the article, its author, Carter Dougherty, writes that "the new U.S. consumer finance watchdog is gearing up to monitor how millions of Americans use credit cards, take out mortgages and overdraw their checking accounts. Their bankers aren’t happy about it." And Mr. Dougherty later on states that "Director Richard Cordray has said that the consumer bureau needs raw material to make 'data-driven' decisions based on how financial products and services are used or abused. Research will improve regulation as well as the marketplace."

We don't like to think that our federal agencies are spying on us, watching our communications, perhaps especially our financial habits, determining therefrom how best to "serve" the public interest. Sure, we know that Google and other web giants are constantly monitoring our financial habits - presumably with our permission to do so. Somehow, it's acceptable if private corporations do it, but when the government does it - not so much!

It all becomes rather weird when the NSA (backed by, say, the DOJ) orders private corporations to spy on us, but the latter are not permitted to admit that the former ordered them to do so - with or without our permission - on the basis of what appears to be a new meaning of "probable cause."

What I find interesting is the similarity between the NSA's and the CFPB's reasons for the need to collect, respectively, virtually all communication data on American citizens and also the financial data on millions of American consumers. It seems that spying has an underlying positive cause, one that apparently we citizens simply don't fully appreciate. For if we did appreciate the workings of these agencies that are just trying to protect us, watch over us to make sure we are safe, and do what they can to mitigate our worst fears, we would overwhelmingly and clearly express our gratitude to the NSA and CFPB for their commitment to our protection - and some Americans certainly seem very grateful.

The Fourth Amendment - how quaint it has become!

Justifying Spying
NSA and CFPB – Two Peas in a Pod

But let's look at some of these justifications that both the NSA and the CFPB have in common for spying on us. Or, if you find that phrase to be nettlesome, perhaps the phrase ‘conducting surveillance on us’ is easier to accept.

First Justification: We need a bogeyman, whom we shall call El Coco, its Spanish version, as when a Spanish-speaking parent tells a child 'si no te portas bien vendrá el coco' ("if you're not good the bogeyman will come and get you"). Almost every civilization has had some version of the bogeyman, that amorphous, unpredictable, malevolent being whose primary role is to scare the living daylights out of us and make us willingly compliant and malleable victims.

So, in the case of the NSA, El Coco comes in the form of terrorists and other malcontents; and, in the case of the CFPB, El Coco seems to be residential mortgage lenders and originators (RMLOs) and other members of the financial markets and sometimes even consumers themselves. In both instances, we can thank the government for protecting us from the mischievous schemes of El Coco.

Tuesday, July 16, 2013

Policy, Procedures, and Examinations - Part II: Mortgage Bankers

The most common question my colleagues and I are asked by prospective clients is whether we provide the “full set” of policies and procedures for all of the mortgage acts and practices. Of course we do! But policies and procedures are only one aspect of the many risk management services my firm offers.*

Nevertheless, policy statements seem to be ‘first and foremost’ when it comes to a client’s compliance needs.

Yet we do not often get questions such as the following:

  • How can we effectuate policies and procedures?
  • What policies are the most important for us to adopt?
  • Although we have policy statements, how often should we update them?
  • Who would be in charge of maintaining and enforcing policies?
  • How do we build policy statements into a Compliance Management System (CMS)?
  • Which policy statements are important to our warehouse lenders?
  • Which policy statements are important to investors and Regulators?
  • Which policy statements are important to our servicing affiliate and subservicers?
  • How can we prove that our policies are being adequately implemented?
  • What are the key components of policies and procedures?
  • What vendor offers the most professionally safe policy statements?
  • How do we go about building our own policies and procedures?
  • How often should we train our employees on our policies?
  • Is there a self-assessment checklist that we can put into our policy statements?
  • What is the best way to document our implementation of procedures?
  • Is there a core set of policies that we absolutely must have at all times?
  • Which policies require testing and auditing, either internally or externally?
  • How do we stay up to date on regulatory changes that affect our policies?
  • What method is preferred to review, adopt, and update policy statements?
  • Do we have a sufficient budget for maintaining policies and procedures?
  • What resources should we use to draft comprehensive policy statements?
  • What is the best method to retire a policy that is no longer a regulatory requisite?
  • Where should we go for guidance in those areas that are not yet fully regulated?
These are but a few of the many questions that a lender should be resolving.

In my view, we ought to get away from the thinking that considers policies and procedures to be a panacea for the effects of improper management, regulatory deficiencies, and trending defects. Policies are a continually changing, dynamic means to an end, but not the end itself. And they are only as good as the accuracy of their content and the efficacy of their implementation.

Just one employee who does not know, or contravenes, the requirements of a policy statement becomes the weakest link in an otherwise strong chain of compliance enforcement. When it comes to acting in compliance with, and according to, a policy and procedure, the financial institution is only and always as strong as its weakest link!

Most mortgage bankers want to be proactive, not reactive, though, often, that is not always achievable, especially when new policies, guidelines, rules, procedures, and actionable implementations seem to arise all the time. This reminds me of Say’s Law in economics, which, when referring to aggregate expenditure in an economy, states that spending rises to the level of income. In the case of policy statements, it seems that policies and procedures rise to the level of demands for them by the spate of regulations requiring them. If this seems like a circular kind of way to get things done, it is!

Still, we must make our way through the thicket of policy statements, hopefully coming oneday to a clearing where, if even for a brief moment, there is some equilibrium between the policies needed and the regulatory demand for them.

Some proactive lenders make it their business to always be ready for a regulatory examination; others drag out the process interminably, waiting to receive an examination letter before they get ready – which, by the way, is usually too late. And, yes, in mortgage compliance, it is certainly possible to be too late to do anything about a violation of law. Compliance leaves traces; it is impossible to obliterate its trail. I have said many times, preparation is protection! Indeed, I have written extensively on this theme.[i]

The US Coast Guard has a famous Latin motto: Semper Paratus, which means “Always Ready”. Let’s use an admonishment, also in Latin! I offer this cautionary advice to mortgage bankers: always stay vigilant; always make sure your policy statements meet regulatory scrutiny; and, to now use my own Latin phrase, never be put in the position of being Ex Abrupto, which means “Without Preparation”.

Wednesday, July 10, 2013

CFPB’s Mortgage Rules for Readiness

The just released 2013 CFPB Dodd-Frank Mortgage Rules Readiness Guide (Guide) from the Consumer Financial Protection Bureau (CFPB) provides, finally, a set of criteria and preparation procedures for residential mortgage lenders and originators. It is Version 1.0 and, like previously issued guides and manuals, the CFPB will update the Guide periodically, using the results from its field examinations to further enhance the audit methodologies.

Note that it is called a “Readiness Guide.” Such documents are not meant to be, and are not, conclusive. Such guides are expected to be sign posts leading the way, a means by which a company may learn of the priorities and exigencies of a regulator’s oversight functions. In other words, as the Guide itself declaims: “The Guide summarizes the mortgage rules finalized by the CFPB in January 2013, but it is not a substitute for the rules.”

To put a finer point on the use of the Guide, please always remember that only the rules and their official interpretations can provide complete and definitive information regarding their requirements.*

These rules can be found at

Each rule in the Guide also includes a hyperlink with additional information, which includes Small Entity Compliance Guides that may make the rule easier to digest. There are links to videos outlining the main elements of the rule. Furthermore, a convenient hyperlink compendium structure is embedded in the Guide, so that the rule headings are themselves hyperlinks directing the reader to the rule-specific CFPB website page.
Sections of the Guide
Summary of the Rules

The Guide consists of the following sections:

Part I: Summary of the Rules
Part II: Readiness Questionnaire
Part III: Frequently Asked Questions
Part IV: Tools

Part I (Summary of the Rules) contains an outline of the eight final rules issued in January 2013 concerning mortgage markets in the United States pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) Public Law 111-203, 124 Stat. 1376 (2010) (2013 Title XIV Final Rules).

The rules amend several existing regulations, including Regulation Z, X, and B. Throughout the year, CFPB expects to provide updates to the rules where necessary. Updates will be posted, along with summaries of the changes, on the regulatory implementation CFPB webpage.

The questionnaire in Part II (Readiness Questionnaire) is '”not intended” to encompass all details of a comprehensive compliance program. This should not be interpreted to mean that the questionnaire is a replacement for the examination procedures or regulations. It is intended to serve as a guide in preparing for implementation of the mortgage rules and in performing a self-assessment. Thus, the questionnaire should be used as a self-assessment in determining a company’s progress towards compliance with the new mortgage rules. The questionnaire contains twenty-nine self-assessment questions and numerous subsections. Do not confuse the questionnaire with a proxy examination tool: it will not be added to the Examination Manual. The CFPB views the questionnaire as a “voluntary guide” for preparation. I have no doubt that it will be used by management in their discussions with examiners. The extent of those discussions may be determined by the institution’s size, products offered, risk mitigation, risk profiles, and other factors, such as the overall strength of the compliance management system.