Free Market Dogma

QUESTION 

I am a former employee of a lender whose president is a hard-core hater of the CFPB. He believes that our government is out of control and the CFPB has been overreaching for years. He is glad that the CFPB is being shut down. I was a paralegal in the legal department. After having to put up with his railing and cursing about the government in general and the CFPB in particular, I decided to resign. Since then, I have been with a law firm and continue to attend law school. 

It's not as if his mortgage company has been in trouble with the CFPB. It complies with all the rules and regulations, and every audit by states and the CFPB itself has shown that the company complies adequately. There have been no administrative actions or fines. 

From what I can tell, the CFPB is a kind of anti-scam police. They are also involved in protecting consumers' financial interests with respect to financial products and services. I can't figure out why this is such a bad thing that it should be destroyed. I thought regulating on behalf of consumers is what good government is supposed to do. We can debate what overreach and unnecessary regulations are, but destroying the agency that actually helps consumers seems really dangerous. 

My former boss takes the position that any government involvement in the free market is an attack on free enterprise, which to him means running his business the way he wants to run it. And, any agency, like the CFPB, that regulates his company is an attack on its survival. I think that's really very extreme. I got tired of trying to convince him otherwise. 

I know this is controversial. I want to widen the lens a bit. You have always been willing to discuss controversial subjects. My former president reads every post you've written for years. I'm sure he will recognize me as the questioner, though I didn't tell you his name or company name. It may bother him that I am writing to you. Fortunately, I am no longer an employee. 

He often discusses your views and interpretations of the law. I have subscribed for years. I think you are a reliable resource for regulatory guidance. I want to know your view. It would really help! 

Is government involvement in free markets justifiable? 

COMPLIANCE SOLUTION 

Management Tune-up 

RESPONSE 

I respond to controversial subjects as they may relate to many aspects of regulatory compliance. I make no apologies. I know they are controversial because we predictably get a small tranche of unsubscribes whenever I discuss a topic that bugs the unsubscribers. Sometimes, the unsubscribers write to me, and we have enjoyable correspondence. 

We offer this newsletter as a labor of love. It's free! All are welcome. However, I discuss the regulatory landscape with all its ups and downs, controversies, and wrangling, and always try to ensure that compliance with the law is clarified. My goal is to educate and offer some helpful guidance. 

Anyone who does not recognize that the government partners with markets, be it mortgage or any other economic market, exhibits a view that borders on willful ignorance. I have taught graduate classes on market action relating to mortgage origination, and one obvious factor we discuss is the "free market" concept, which is the thesis that markets should not allow government involvement (often framed as "government interference"). 

"Free market" lingo wears several masks, such as "free trade" and "free enterprise," but the notion that any economic market is free of government involvement is belied by the fact that the government must be involved in ensuring and monitoring its legal and regulatory framework. 

Now, for a dose of reality: 

There has never been a free market in the history of the world.

Never. Nowhere. Not now. Not ever. 

The concept indirectly stems from an economic theory called "laissez-faire" – which, in French, means "allow to do" – which is a financial concept that purports to inform free markets and capitalism. In that scenario, the government does not regulate business, taxes, or tariffs. Instead, it proposes that a market self-regulates through the economic mechanism of supply and demand of products and services. And, it asserts that individuals drive markets through self-interest, which, somehow, leads to social and economic benefits.  

There are economists of certain schools who reframe laissez-faire as a "hands-off" approach to market activity. The motto: Let the chips fall where they may, irrespective of the outcome, because, magically, it will all work out for the better! 

The attempt at minimal government intervention historically and economically leads, among other things, to income inequality and the lack of protection for workers (i.e., the middle class). In that sense, the free market theory is, by extension, a tool of class warfare. Sure, laissez-faire can promote economic growth, but it can also exacerbate social problems. 

Can you guess when laissez-faire was most prominent in the United States? The answer is it was most notable as a policy during the Gilded Age, the age of the Robber Barons, in the late 19^th and early 20^th centuries. These days, three individuals collectively are worth more than the bottom half of the population of our country.[i] This inequality is obviously not sustainable. Clearly, free market thinking is utopian thinking but does not pertain to human action. 

In terms of economic theory, a hypothetical free market leads to monopolies. For instance, a successful supplier tends to get bigger and more powerful. It then buys up smaller competitors or puts them out of business. This tendency is an evolution toward monopoly. Therefore, what might seem to be a theory that can favor small businesses is actually one that destroys them. This is the case in many markets, and governments have had to put in place regulations to avoid monopolistic and predatory practices.

Guilty Until Proven Innocent?

QUESTION 

I am the Chief Executive Officer of a lender and servicer. Last week, the CFPB hit us with a Civil Investigative Demand. Our in-house lawyer has put a team together from various departments to respond to it. And you kindly referred us to an attorney who specializes in this process. We are retaining the attorney you recommended. 

At this point, many people in the company are aware that we received the Civil Investigative Demand, and I am very concerned about reputation risk. We have built a fantastic company, yet rumors have already started that we did something to violate laws and regulations. I need a way to calm everyone down and not worry. 

Because of the rumors, some employees now think we are guilty of wrongdoing. We intend to fight any such charges! I need to issue a statement that explains the process in plain and simple language. I need your help in providing information that helps them to understand the process. 

What is the CFPB’s Civil Investigative Demand? 

Are we guilty until proven innocent? 

COMPLIANCE SOLUTION 

CMS Tune-up®  

RESPONSE 

Rumour doth double, like the voice and echo,

The numbers of the feared.

Henry IV, Part 2, Shakespeare 

Allow me to put the above lines into our modern idiom: An unconfirmed report expands like an echo growing louder and louder, magnifying the perceived size and threat. 

DO NOT IGNORE THE RUMORS! 

Perhaps you think that the truth will reduce the rumors. Sometimes, it does; sometimes, it does not. One of my favorite literary figures, Jonathan Swift, once said that “falsehood flies, and the truth comes limping after it.” He cautioned that by the time people become “undeceived,” the “jest” is over, and the “tale” has already had its effect.  

Reputation risk is real, and adverse issues can hobble a company financially, even when there’s nothing to the allegations of wrongdoing. Some rumors don’t have a scintilla of truth, but they thrive nonetheless. Like a garden of weeds, pull out one, and another takes its place. Your aim should be to control the message. However, do not ignore rumors! 

PEEKING BENEATH THE CFPB HOOD 

I am going to give you a peek into the CFPB’s Civil Investigative Demand process. The acronym is “CID,” and for brevity, I will use this acronym. If you’re wondering if the CFPB has coopted the authority to conduct CIDs, you might be interested in knowing that it certainly does have the authority pursuant to the Dodd-Frank Act.[i] A primary access point to the authority is Unfair, Deceptive, or Abusive Acts or Practices (UDAAP),[ii] which

 “…take any action . . . to prevent a covered person or service provider from committing or engaging in an unfair, deceptive, or abusive act or practice under Federal law in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service…”[iii] 

Most CIDs are triggered by CFPB examination. However, the examination is not the only source of the CID. I’ll get back to examinations momentarily. 

NON-EXAMINATION SOURCES OF CIDs 

Other sources can trigger a CID, many of them being external to the company itself. For instance, the Office of Enforcement monitors the CFPB’s Consumer Complaint Database for potential violations.[iv]

The CFPB also sources allegations of violations from its Whistleblower and Tips portal. 

In addition, states and federal agencies may send referrals relating to possible breaches of regulations. 

News reports and even Better Business Bureau complaints can lead to activating a CID. 

Unfortunately, a company may have no idea that it has come to the attention of the CFPB’s enforcement investigation team until the CID is actually issued. Often, the company is surprised by the CID. Indeed, it may have no idea of the alleged violations. Put otherwise, the first a company learns of an investigation is usually when it gets the CID.[v] 

TRIPARTITE TEAM 

Such enforcement puts huge pressure on a company. One reason for the pressure is that there is an unyielding timeline for document production and appropriate responses.[vi] This is the reason why I referred you to an attorney who is steeped in handling the CID process. 

You must retain a lawyer who is capable of vetting relevant information, identifying witnesses and knowledgeable people in the company, and determining the legal violations implicated in the investigation. Importantly, the attorney must ensure compliance with the CID while also advising the company of any legal and factual risks. The appropriate legal counsel should be experienced in understanding UDAAP (for instance, the “unfair” and “deceptive” prongs), including, but not limited to, public consent orders, CFPB administrative adjudications, district court opinions, the CFPB examination manual, published guidance, and relevant CFPB policy statements. 

I have often said that the best tactical response to a CID is to establish a Tripartite Team, as follows:

Construction to Permanent Disclosures

Jonathan Foxx

Managing Director

Recently, we have seen an uptick in inquiries from some of our clients, colleagues, and requests from media, regarding disclosures for construction to permanent loans. In the inquiries, the specific facts dictated our responses. However, we can point out that Regulation Z permits a creditor to disclose the construction phase and permanent phase of a residential construction loan either as one transaction or as separate transactions. This aspect of the disclosure process seems to cause some confusion, so I would like to dispel with some of the more salient concerns expressed by lenders involved in originating these loan products.

What is the basic structure of construction to permanent mortgage loan transactions?

For the most part, they have two distinct phases that make them similar to two separate transactions. First, the construction period usually involves several disbursements of funds, at times and in amounts often unknown at the beginning of the period. The consumer generally pays only accrued interest until construction is completed. Second, unless the obligation is paid at the time the construction is completed, the loan converts to permanent financing in which the loan amount is amortized just as in a standard mortgage transaction.

So far, so good!

But on July 7, 2017, the CFPB amended Regulation Z to clarify that, for construction-permanent financing transactions, the creditor is required to disclose a Loan Estimate only for the transaction for which it received an application. So, for instance, if the creditor receives an application for construction financing only, the creditor is only required to provide a Loan Estimate for the construction transaction. If the creditor receives applications for separate construction and permanent financing transactions at the same time, then the creditor must provide the Loan Estimate disclosures as either a combined disclosure or separately for each phase of the transaction.

Therefore, the special disclosure rule permits the creditor to give either (A) one combined disclosure for both the construction financing and the permanent financing or (B) a separate set of disclosures for the two phases. The rule is applicable whether the consumer was initially obligated to accept construction only or for both construction and permanent financing. But, if the consumer is obligated on both phases and the creditor chooses to give two sets of disclosures, both sets must be given to the consumer initially, because both transactions would be consummated at that time.

Another issue that seems to perplex construction-permanent loan originators is the allocation of fees.

The following outline may help to clarify the fee allocation structure involved in this loan product. When using this special disclosure rule to disclose as multiple transactions, must allocate fees and charges between the construction and permanent phases of the transaction.

Here is a set of basic fee allocation structures:

• If a creditor discloses a construction-permanent loan as multiple transactions, the creditor must allocate to the construction transaction finance charges and points and fees that would not be imposed but for the construction financing. An example would be where a creditor must include inspection and handling fees for the staged disbursement of construction loan proceeds in the disclosures for the construction phase (viz., not in the disclosures for the permanent phase).
• If a creditor charges separate amounts for finance charges and points and fees for the construction phase and the permanent phase, the creditor must allocate the amounts to the phase for which they are charged.
• If a creditor charges an origination fee for construction financing only but charges a higher origination fee for construction-permanent financing, the creditor must allocate the difference between the two to the permanent phase.
• The creditor must allocate to the permanent financing all other finance charges and points and fees.
• The creditor may allocate in any manner it chooses any fees and charges not used to compute the finance charge or points and fees. Thus, a creditor may allocate in any manner it chooses a reasonable appraisal fee paid to an independent, third-party appraiser. 

There is also this important nuance: if the construction phase consists of a series of advances under an agreement to extend credit up to a certain amount, Regulation Z provides some disclosure flexibility. In this particular case, the creditor may disclose the construction phase as one or more than one transaction – so, it may disclose each advance as a separate transaction or all of the advances as one transaction – and also disclose the permanent financing as a separate transaction.

Preparing these disclosures is a complicated task, suitable only for compliance professionals. If you need assistance regarding construction to permanent finance transactions, with respect to reviewing your policies, procedures, disclosures, and loan flow process, please contact or email us. There is no initial consultation fee. We're glad to help!

Third-Party Relationships: Compliance Risk

Jonathan Foxx

Managing Director

Lenders Compliance Group

I am often asked if there are significant compliance risks involving third parties in mortgage banking. The answer is: without a doubt! In providing some insight, I will just mention three of the many types of third parties that pose such risks: mortgage brokers, mortgage lenders, and mortgage servicers.

Let’s be clear at the outset: managing third-party risk is critical for providers of consumer financial products and services. This is because financial institutions (“FI”) can be and often are themselves held liable for the practices of third parties acting on their behalf. Where there is contact with the public by third parties, directly or indirectly, on behalf of the FI the risk is substantively greater. From the point of view of technological factors, service providers may be integrated into an FI’s business operations. As such, this can lead to enforcement actions in which certain violations of consumer protection laws are alleged against the service provider and the FI itself!

It is the case that regulators have affirmed their intention to hold companies strictly liable for conduct of their agents. The legal principal invoked is usually the theory of “vicarious liability.” Just a few years ago, in October 2015, the Department of Housing and Urban Development (“HUD”) proposed rules to formally codify third-party liability standards under the Fair Housing Act, including strict vicarious liability for acts of an institution’s agents, as well as direct liability for negligently failing to correct and end discriminatory practices by those agents.[i]

Consider the risk posed by mortgage brokers. For many years, an area that has seen a lot of fair lending enforcement and class action litigation has been the wholesale mortgage lending industry. Since mortgage lenders close loans originated by independent mortgage brokers, regulators and private litigants have brought enforcement actions and lawsuits alleging that lenders have failed to monitor and control discretionary mortgage broker pricing and product selection practices. In these cases, it has been alleged, under the disparate impact theory, that the mortgage lenders have violated the Equal Credit Opportunity Act (ECOA) due to pricing disparities disfavoring racial and ethnic minorities.

In fact, since 2010 there have been several Department of Justice (DOJ) and Consumer Financial Protection Bureau (CFPB) enforcement actions, as well as lawsuits filed by cities, against wholesale mortgage lenders under this theory.[ii]

Most of the mortgage pricing fair lending enforcement actions to date have focused on conduct that predates April 2011, when regulations by the Federal Reserve on loan originator compensation first took effect. I have written extensively on the features of the loan originator compensation requirements that went into effect on April 6, 2011, if you are interested in reading more about these rules.[iii] The loan originator compensation regulations prohibit compensation to mortgage loan originators based on, among other things, discretionary loan pricing or product steering by a broker based on a financial incentive to a product not in the consumer’s interest.[iv]

Although these changes in the law have reduced pricing’s influence on fair lending risk, they have certainly not eliminated the risk entirely. For instance, in December 2015, the DOJ brought an enforcement action against Sage Bank in Massachusetts relating to disparities in revenue earned on retail mortgage loans to minority borrowers compared to that on mortgage loans to non-minority borrowers. What is notable about this action is that it was the first pricing discrimination enforcement action that focused on loans made after the loan originator compensation rules took effect in 2011. Obviously, it demonstrated that regulators are continuing to focus on mortgage pricing discrimination issues.

But fair lending is not the only compliance risk associated with wholesale lending. Other risks include Unfair, Deceptive, or Abusive Acts or Practices (referred to collectively, “UDAAP”) and related areas. In fact, the CFPB issued guidance on UDAAP in its Supervision and Examination Manual of October 2012.[v] With the benefit of time, litigation, guidance, and examinations, among other things, we can say that these risks arise because mortgage brokers play a key role in marketing, discussing product benefits and terms with applicants and guiding their product choices, providing disclosures, completing applications, and gathering documentation in support of the loan applications. It stands to prudent reasoning that, in addition to fair lending, oversight of an FI’s mortgage broker network is critical for mitigating UDAAP risk and managing other compliance requirements.

When we move from a consideration of risks associated with mortgage brokers to those posed by mortgage lenders the risk profile is neither better nor worse, but, as the saying goes, it is different. Much risk tends to congregate around fair lending in secondary market transactions. For instance, in the case Adkins v. Morgan Stanley, plaintiffs alleged that the policies and procedures of Morgan Stanley, which had purchased loans from subprime loan originator New Century Mortgage Company, had created a disparate impact on African-American borrowers. If as alleged, this would be a violation of the Fair Housing Act (FHA), ECOA, and state law.[vi] Although the court dismissed the ECOA claims as time-barred, it allowed the FHA claims to proceed, holding that plaintiffs’ allegations were sufficient to state a claim of disparate impact discrimination. In the ruling, the court stated that the FHA expressly applies to secondary market purchasing of mortgage loans. It further emphasized allegations relating to Morgan Stanley’s warehouse lending commitments, on-site due diligence of New Century loans, demand for loans with alleged “high-risk” features, and instructions to originate no-documentation loans when it appeared that the applicant could not afford the loan. In its conclusion, the court noted that the evidence was sufficient to support claims that Morgan Stanley’s policies “set the terms and conditions on which it would purchase loans from New Century” and that these terms and conditions had resulted in a disparate impact when they caused New Century to issue toxic loans to the plaintiffs.

In the case In re Johnson, a Chapter 13 debtor alleged that a loan originator had targeted minority borrowers for predatory loans, and that the purchasers and assignees “were involved in this enterprise of selling toxic loans and targeting vulnerable minorities” because the loans were originated with securitization as the ultimate goal.[vii] Although the court dismissed the complaints on the ground that the plaintiff had not alleged sufficient facts to support the claims, it did not summarily reject the proposition that a secondary market purchaser could be held liable under ECOA or the FHA.[viii]

My point is that fair lending scrutiny of not only mortgage lenders, but also their investors, will likely increase in the coming years as new Home Mortgage Disclosure Act (HMDA) reporting requirements, finalized in October 2015, will provide greater insight into the role of investors in the loan origination process.

Legal Entity Identifiers and HMDA 2018: Questions and Answers

Jonathan Foxx
Managing Director

The Legal Entity Identifier (“LEI”) is a unique 20-character code that identifies distinct legal entities which engage in financial transactions. The LEI is a global standard, designed to be non-proprietary data that is freely accessible to all. Many financial institutions have not obtained a Legal Entity Identifier (LEI).

A financial institution must provide with the following information in its HMDA submission on or after January 1, 2018:

 i.  Its name;

ii.  The calendar year the data submission covers pursuant to paragraph (a)(1)(i) of this section or calendar quarter and year the data submission covers pursuant to paragraph (a)(1)(ii) of this section;

iii. The name and contact information of a person who may be contacted with questions about the institution's submission;

iv.  Its appropriate Federal agency;

v.  The total number of entries contained in the submission;

vi.  Its Federal Taxpayer Identification number; and

vii. Its Legal Entity Identifier (LEI) as described in § 1003.4(a)(1)(i)(A)

[Emphasis added. See 5(a)(3)(vii)—Legal Entity Identifier (LEI)]

For purposes of the submission requirement, “appropriate Federal agency” means the appropriate agency for the financial institution as determined pursuant to § 304(h)(2) of the Home Mortgage Disclosure Act [12 U.S.C. 2803(h)(2)] or a financial institution subject to the Consumer Financial Protection Bureau's (“Bureau”) supervisory authority under § 1025(a) of the Consumer Financial Protection Act of 2010 [12 U.S.C. 5515(a)].

If your financial institution needs an LEI, the GMEI Utility is endorsed by the Global LEI Foundation and also has a search function. There are some frequently asked questions on their website and we provide below a few highlights derived from that resource.

-     Who can register the financial institution? You must currently be an employee of the financial institution you are registering and also authorized by the financial institution to register for an LEI. Alternatively, financial institutions may use a third party through an assisted registration process. The person registering the financial institution will need a user account, which may be created here.

-     What information is needed to register? The basic information listed in the ISO 17422, such as the financial institution’s legal name, registered address, headquarters address, legal form, and so forth.

-    What is the cost? The GMEI Utility charges $200 for each registration request plus a $19 surcharge. To maintain and keep the LEI registration active, the fee for each registration is $100 plus a $19 surcharge. For more information, visit the FAQs specific to payment.

Once payment is processed, the GMEI will validate the financial institution using public sources. Once this process is complete, it takes about three business days for an LEI to be issued in the GMEI database. Overall, the GMEI Utility’s FAQs state that most requests are “cleared” within three to five business days.

It is advisable to review the CFPB’s HMDA implementation webpage for more information.

Frequently Asked Questions

Q: Why do we need an LEI?

A: The Bureau has taken the position that an LEI could improve the ability to identify a financial institution reporting data and correlate it to its corporate configuration. In addition, the Bureau has stated that “facilitating identification of a financial institution's corporate family could help data users identify possible discriminatory lending patterns and assist in identifying market activity and risks by related companies.” By facilitating identification, this requirement apparently is also meant to help data users identify whether financial institutions are serving the housing needs of their communities. [§ 1003.5(a)(3)]

Q: Should we be getting our LEI as soon as possible? Can we get an LEI before we have to start using it, or do we have to use it as soon as we obtain it?

A: We recommend that you obtain your LEI by the first or second quarter of 2017. There is no reason to delay. We don’t anticipate the price to change. However, you must have an LEI for all loans submitted for HMDA on or after January 1, 2018.

Q: Do you anticipate the Uniform Loan Identifier ("ULI") to be calculated by Loan Origination Systems?

A: We do anticipate that many LOSs will offer to provide this number. However, it is very possible that they may leave this to the vendor collecting your HMDA data. Some concern has been raised about commercial or consumer systems needing such a programming solution. It is our understanding that the Bureau is evaluating this requirement with respect to a compliance effective date for calculating and verifying the ULI and ensuring it has not been previously used.

CFPB's Compliance Bulletin and Policy Guidance 2016-02 - Service Providers: Questions and Answers

Jonathan Foxx

Managing Director

Lenders Compliance Group

On Wednesday, October 26, 2016, the CFPB issued updated guidance on service providers, based on its previous issuance of April 13, 2012, titled CFPB Bulletin 2012-03, Subject: Service Providers (“Bulletin”), that had been published in the Federal Register. The Bulletin is a statement of policy that articulates considerations relevant to the Bureau’s exercise of its supervisory and enforcement authority. This new issuance is published in the Federal Register and is titled Compliance Bulletin and Policy Guidance 2016-02, Service Providers (“Guidance”).

Click HERE for a copy of the Guidance and the Bulletin.

Essentially, this updated guidance provides additional clarifications regarding how supervised entities are to manage their risk management program for service providers. It is meant to clarify that “the depth and formality of the risk management program for service providers” may vary depending upon the service being performed (i.e., the service provider’s size, scope, complexity, importance and potential for consumer harm) and the performance of the service provider in carrying out its activities in compliance with Federal consumer financial laws and regulations. 

Much of the guidance is a reiteration of the Bulletin, with a reminder that “while due diligence does not provide a shield against liability for actions by the service provider, it could help reduce the risk that the service provider will commit violations for which the supervised bank or nonbank may be liable.” This reiterating of the Bulletin seems to have been made necessary because, although other CFPB Bulletins were published in the Federal Register, it appears that the Bureau did not previously publish Bulletin 2012-03 when it was issued.

I have said all along how important it is to work with an outsource due diligence company, if a financial institution is not going to adequately equip and staff an in-house evaluation function, which means ensuring the presence of competent risk management professionals and the required research tools. This is why we established VendorsCompliance Group as the an outsource evaluator that would be far more than a compilation service. 

These compilation services that hold themselves out as evaluators for vendor management purposes are just putting together and providing a compilation rating. That is simply insufficient, viewed from the standpoint of effective due diligence. Vendors Compliance Group does not merely compile information and documentation, which is only a first step, but also it actually evaluates and risk rates service providers by means of hands-on reviews conducted by risk management professionals using state of the art research methodologies. The evaluator actually is often personally in contact with the bank or nonbank to ensure that there is a strong and steady flow of transaction information. 

When Vendors Compliance Group risk rates a service provider, the supervised bank or nonbank can be sure that it is a rigorously derived, vendor compliance risk rating, provided by a due diligence methodology which stands up to regulatory scrutiny.

Let’s review some basics, as set forth in the Guidance. 

I am going to frame this outline in the form of Questions and Answers for the sake of ensuring a broad understanding of the Bureau’s expectations with respect to service provider evaluations. I will use the Guidance as the source document.

Q: Why is a service provider evaluation necessary?

A: The Bureau expects supervised banks and nonbanks to oversee their business relationships with service providers in a manner that ensures compliance with Federal consumer financial law, which is designed to protect the interests of consumers and avoid consumer harm. 

Q: What is the governing statute for the definition of a Federal consumer financial law?

A: Section 1002(14) of the Dodd- Frank Act (12 U.S.C. 5481(14)).

Q: What institutions are expected to evaluate their service providers?

A: Supervised banks and nonbanks, as follows:

• Large insured depository institutions, large insured credit unions, and their affiliates (12 U.S.C. 5515); and
• Certain non-depository consumer financial services companies (12 U.S.C. 5514). 

Q: What service providers are expected to be evaluated?

A: The following supervised entities are to be evaluated:

• Service providers to supervised banks and nonbanks (12 U.S.C. 5515, 5514); and
• Service providers to a substantial number of small insured depository institutions or small insured credit unions (12 U.S.C. 5516).

Q: Specifically, how is the term “service provider” defined by the Bureau?

A: “Service provider” is generally defined in Section 1002(26) of the Dodd-Frank Act 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.’’ (12 U.S.C. 5481(26)) A service provider may or may not be affiliated with the person to which it provides services.

Going after the Big Cheese (PHH takes on CFPB’s Director)

As many of you know, I have been following the PHH dispute with the CFPB virtually from its inception. Although PHH is a large organization, let’s face it, this is still like a mouse (PHH) squeaking at an elephant (CFPB)! The bite, in this instance, happens to be a $109 million penalty that the CFPB is assessing against PHH.

Reduced to the least common denominator, this is a fight against the authority vested in the Director of the CFPB, or, better said, the authority that the Director presumes to have vested in himself versus a play at arrogating to himself certain authority that he simply does not have.

Going after the Big Cheese himself is no mean feat!

But PHH has assembled a highly skilled and prominent legal team.

And there are amici curiae on both sides.

Let me back up a few steps and give a wider angle. PHH appealed to the DC Circuit Court because the Bureau’s Director Richard Cordray raised a $6 million penalty for mortgage insurance kickbacks - such penalty issued by an administrative law judge - to a whopping $109 million.

To ensure that the information presented at bar was applicable to Dodd-Frank, the hearing judges required the Bureau to provide answers in oral arguments regarding substantive provisions as to the president’s authority to remove the CFPB director only for cause, and, importantly, about how the Court should view an administrative agency led by a single director rather than the more typical commission structure.

Today is the day for those oral arguments!

Here’s one bottom line that may come from the foregoing aspects of the dispute: if the Bureau loses, the Director may find that his authority, presumed or otherwise, will be vitiated.

An access point to the litigation is to challenge the constitutionality of the Bureau itself! Areas of contention, right from the inception, have been the supposed, czarist-like construct of having a single director in charge of the Bureau, plus the view that the CFPB’s funding should come from congressional appropriations rather than from the Federal Reserve’s own budget.

Is it surprising that the DC Circuit recently required the Bureau to be prepared to face questions about whether Dodd-Frank’s provision - stating that the president can remove the CFPB director only for “inefficiency, neglect of duty, or malfeasance in office” - passed constitutional muster? Actually, I don’t think so. After all, the Bureau has been challenged on these issues all along and there is clearly an interest in determining the scope of authorities vested in the Director. If adjudication seems to reach to an unassailable decision, the viability of claims involving the CFPB’s constitutionality may be finally resolved. Or maybe not! The Supreme Court would be the next step along this circuitous path to a decision.

Should we be surprised that the Court is looking for answers about potential remedies for any problems that the applicable provision brings, including potentially removing it from the statute and allowing the president to remove the CFPB director without any specific cause?

Again, I am not surprised. If it turns out that the cures (remedies) are worse than the infection (overreaching authority) and the treatment needs to be changed, the Court will need to determine the extent to which such changes could affect the Director’s authority.

HMDA Highlights

HMDA Highlights

Last month I published an article on the changes coming in Regulation C,[1] the implementing regulation of the Home Mortgage Disclosure Act.[2] The article can be viewed here and downloaded here or here.

I would like to highlight a few of the salient features for you.

Essentially, HMDA serves three purposes: (1) it provides public and public officials with information to help determine whether financial institutions are serving the housing needs of the localities in which they are located and to assist public officials in their determination of where to distribute public sector investments to improve the private investment environment; (2) it requires the reporting of racial characteristics, gender, and income information on applicants; and (3) it identifies possible discriminatory lending patterns and enforcing anti-discrimination statutes. 

In 2010, the Dodd-Frank Act amended HMDA to expand the scope of information compiled, maintained and reported. In August 2014, the CFPB proposed amending Regulation C to implement the Dodd-Frank changes.

The CFPB chose not to adopt several data points specified in the Dodd-Frank Act and included a few on its own. Take the following summary listing of the changes made by the CFPB’s October 2015 Regulation C amendments (hereinafter, “Rule”) as a tool to be used along with my article and the CFPB’s own promulgated guides and issuances regarding the HMDA changes.

Institutional Coverage

Although it is not required by the Dodd-Frank Act, the CFPB nevertheless adopted uniform loan-volume thresholds for depository and non-depository institutions, which require an institution to report data if it originated in each of the two preceding calendar years at least 25 closed-end mortgage loans or at least 100 open-end lines of credit, assuming the institution meets the other criteria for coverage.

Institutions that meet only the closed-end threshold are not required to report open-end lending, and institutions that meet only the open-end threshold need not report closed-end lending.

The regulation retains the other coverage criteria for depository institutions, which require reporting by depository institutions that satisfy an asset-size threshold ($44 million in 2015), have a branch or home office in an MSA on the preceding December 31, originated at least one first-lien home purchase loan or refinancing secured by a one- to four-unit dwelling in the previous calendar year, and satisfy a “federally-related” test (i.e., the institution is federally insured or regulated or the loan previously mentioned was insured, guaranteed, or supplemented by a federal agency or intended for sale to FNMA or FHLMC).

For non-depository institutions, the above loan-volume threshold test replaces the current loan-volume or loan-amount test and Regulation C retains the criterion that the institution must have a branch or home office in an MSA on the preceding December 31.

Transactional Coverage

Also not required by the Dodd-Frank Act, the Rule adopts a dwelling-secured standard for reporting all loans or lines of credit for personal, family, or household purposes, whether the purpose of the loan is to finance the property serving as security or another property. Accordingly, the amendments discard the purpose test that previously required the reporting of home improvement loans, whether or not dwelling-secured. Among other things, this makes the reporting of dwelling-secured consumer open-end credit mandatory (no longer optional).

Most commercial-purpose transactions are subject to Regulation C reporting only if they are for the purpose of home purchase, home improvement, or refinancing (i.e., the Rule retains Regulation C’s traditional purpose test only for commercial-purpose transactions). The regulation does not apply to home improvement loans not secured by a dwelling, or agricultural-purpose loans/lines of credit. The regulation now uses the term “covered loans” as a shorthand term to refer to the universe of loans covered by HMDA.

·         The CFPB specifically noted that Regulation C does not require the reporting of loan modifications. There are two exceptions for which HMDA reporting is required because they represent new debt obligations in substance if not in form:[3] (1) assumptions, including successor-in-interest transactions (this differs from CFPB interpretations under TILA Regulation Z); and (2) New York consolidation, extension, and modification agreements (CEMAs) used in place of refinancings (this only refers to CEMAs made under § 255 of the New York Tax Law). The CFPB recognized that its determination that these New York CEMAs must be reported departs from past FRB guidance that they did not need to be reported. The CFPB noted that this Regulation C definition of the term “modification” differs from that of Regulation B, which defines it to include the granting of credit in any form, including the renewal of credit and the continuance of existing credit in some circumstances.

·         The amendments revise the definition of “dwelling.” Briefly put, the definition includes primary residences, second homes, investment properties (homes), multifamily properties, and manufactured home communities (whether or not any individual homes also secure the loan). The term excludes recreational vehicle parks, recreational vehicles, and pre-1976 mobile homes. The regulation retains the existing discretion for financial institutions to determine the primary use for multifamily properties (such as mixed-used properties with five or more individual dwelling units). Properties that provide long-term housing with related services such as a combined medical care component are reportable, while properties that provide medical care are not (consistent with the exclusion of hospitals).

Recess Appointment Gambit

By Jonathan Foxx

President & Managing Director

Some people just won’t take No for an answer!

The most recent fool’s errand is offered thanks to the irrepressible, litigious efforts of the State National Bank of Big Spring, Texas, and two advocacy groups, conservative think tank Competitive Enterprise Institute and the 60 Plus Association.

In State National Bank of Big Spring et al. v. Geithner et al. (U.S. District Court, DC, Case 1:12-cv-01032), the plaintiff seeks to disabuse the Consumer Financial Protection Bureau (“Bureau”) of its constitutionality.

Here is one of the lawsuits that started droning high and mighty soon after the Bureau received its enumerated authorities in the summer of 2011.

The bank sued in June 2012, arguing that the Bureau has an inordinate amount of power because (1) the Bureau’s director can't be removed at will, and (2) the agency's funding is routed around the congressional appropriations process.

A little over a year later, in August 2013, the case was booted, only to be resuscitated in July 2015 by the D.C. Circuit, since the appeals court found the bank has standing to challenge the Bureau’s constitutionality – based on the fact that the Bureau regulated the remittance market, which is the bank’s business. That said, there had been no enforcement action.

Lacking an enforcement action to protest, maybe the bank just wanted to get out in front of the problem before it started!

The bank went forward with a summary judgment challenge in November 2015.

In any event, about the 2012 suit’s allegation: the claim is that the law creating the Bureau, Title X of the Dodd-Frank Wall Street Reform and Consumer Protection Act, is unconstitutional. The bank claimed the president's inability to remove the Bureau’s director without good cause violates the separation of powers doctrine, a claim, the Bureau argues, that ignores Supreme Court precedent.

This gambit has been pushed hither and yon for some time. For instance, right from the start there has been a challenge to the recess appointment of Richard Cordray to be the Bureau's first director. President Barack Obama used a recess appointment to put Mr. Cordray in charge of the Bureau, albeit only after mostly Republican senators refused to vote on his nomination. Their opposition was based on the structure and congressional oversight of the Bureau, not really at all based on Mr. Cordray’s credentials.

But Conservatives have long held that the recess appointment violated the Constitution, engendering the recess appointment itself by keeping the Congress technically open by holding a series of pro forma sessions, gaveling in sessions for minutes or seconds, in order to meet the lowest bar for being open for business.

So, we’re back in court!

Now, the Bureau has asked a Washington, D.C., federal court for summary judgment. Filing last Friday, the Bureau asserts that the bank’s challenge to the Bureau's constitutionality can't get around long-standing precedent supporting legislators' authority to create independent agencies.

Here’s two of the pivotal quotes:

“SNB’s arguments that Title X violates constitutional separation-of-powers principles rest on policy arguments with no support in the constitutional text or judicial precedent.” 

“The challenged provisions of Title X – considered either individually or collectively – are consistent with Articles I and II of the Constitution, as they have been interpreted and applied by the Supreme Court.”

The Bureau argues that the Supreme Court had ruled in 1935, in Humphrey’s Executor v. United States, that Congress has the authority to create independent agencies with overseers appointed by the president who can only be removed for good cause.

Thus, asserts the Bureau, the authority is grounded in the establishment of the Federal Communications Commission, which was at issue in that case, or any of several other federal agencies, including the Securities and Exchange Commission, that are considered to have been created under the same authority.

Given precedent, the Bureau’s view is that, whether or not the Bureau is headed by a single, appointed director or several commissioners (or multiple directors or a phalanx of overseers), is entirely irrelevant and nugatory. In defending the single appointee, the Bureau’s brief states: “If anything, it should be easier for the president to hold accountable a single officer than several.” 

Furthermore, the Bureau stated that the foregoing argument didn't appear in the bank's complaint and that it can't raise the claim now in its own motion for summary judgment filed in early November. Indeed, it is argued that the bank was not harmed by the rules approved by Director Cordray, and, in cases where the bank claims it was harmed, invalidating them would not serve to correct the injuries alleged by the bank.

From a regulatory perspective, the Bureau is correct with respect to the validity of rules approved by the Bureau’s director. Even if the court were to consider the validity of rules approved by Director Cordray during his recess appointment, the D.C. Circuit has upheld such rules when later ratified by an agency.

I think you can see how this Hatfields and McCoys battle can get very complicated.

I expect this species of litigation to find its way into the dustbin of history.

Still, as Alexander Pope said, "Hope springs eternal in the human breast."