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:

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.

Waiting for the CFPB

My sources tell me that the Consumer Financial Protection Bureau (CFPB) will soon announce substantial monetary penalties and other administrative actions against a large nonbank. I guess it is inevitable that when such an announcement is finally out and about, humans  - and especially the financial services type humans - will be easily aroused to panic - which means the nascent, CFPB exam preparation industry will receive a steroidal boost. And the frisson of dismay and frenzy will be stirred up even further by the ambulance chasers, running to the rescue, with their merry band of products and services to quell the indomitable, bureaucratic brute.

There are plenty of compliance and law firms scouring the horizon for new clients that seek CFPB exam readiness. Indeed, I know of one such firm that has made fear-mongering into a fine art, whirring about and speaking at industry events where a surfeit of anxiety and angst may be supremely generated. As the affrighted crowd bounds into the arms of these ushers of deliverance, seeking the aegis of their singular protection, they are quite sold on a full scale risk assessment and sempiternal, on-going monitoring. But the prospective clients, sore at the loss of money in this endeavor, need not be too vexed, inasmuch as they do get action plans, some risk assessment tools, and assorted bric-a-brac of one-size-fits-all templates "specially drafted" for their own unique purposes.

Our industry is a strong bunch, survivors of the toughest real estate cycles, and accustomed to adapting to regulatory mandates. We have seen the largest fall and the lowest rise. We push back, when needed; and we push forward, when appropriate. We know that our industry is the backbone of the economy. Our future will not be compromised by cold sweat and consternation.

So, when considering the legal and regulatory compliance requirements of the CFPB, how alarmed and apprehensive should we be?

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Trembling before the Tsar

In the Tsardom of Russia, most people never met the Tsar. They met his agents, which at the time meant the duly constituted orders of functionaries who acted in accordance with the law. The people who did meet the Tsar, even nobles, were known (and even expected) to tremble in his presence. Like the custom required by English kings, the people who stood in the presence of the Tsar stated their views, when called upon to speak, and, upon finishing their statements, they left the reception chamber by bowing and slowly backing out of the room, always facing the Tsar. This kind of obeisance showed respect for the established order and reflected the insuperable power and primacy of the monarchy.

But we do not live in a monarchy and the CFPB is not the Tsar.

We need not tremble before the CFPB!

There are a set of guidelines that the CFPB requires for implementation by lenders, mortgage brokers, servicers, and others in the financial services sector. Most of these guidelines are not particularly ponderous, unless the foregoing entities hadn't been implementing them all along. It is not as if we do not know the importance of fair lending or proper data collection pursuant to the Home Mortgage Disclosure Act (HMDA). There is no real mystery regarding compliance with advertising rules. Every company is keenly aware of the mandates set forth in the Real Estate Settlement Procedures Act (RESPA) and the Truth in Lending Act (TILA).

At this point in the industry's growth, who does not know about the importance of risk controls and risk mitigation? Who does not know about the central importance of responsible and knowledgeable management? How many companies willfully ignore consumer complaints?

A whole generation of bankers, lenders, brokers, and servicers have cultivated a heightened sensitivity to the Fair Credit Reporting Act (FCRA) and Fair & Accurate Credit Transaction Act (FACTA), Gramm-Leach-Bliley Act (GLBA), Bank Secrecy Act and Anti-Money Laundering Program requirements, Equal Credit Opportunity Act (Regulation B), Home Ownership & Equity Protection Act (HOEPA), Secure & Fair Enforcement for Mortgage Licensing Act (SAFE Act), the Fair Housing Act, the Anti-Predatory Lending Act, the National Do-Not-Call Registry, and monitoring third party service providers (sometimes neutrally referred to as "vendor management").

These are the sorts of areas about which the CFPB has an interest in ensuring consumer financial protection. None of the aforementioned is strange or new to anybody who has been paying attention!

I have said many times that 'Preparation is Protection' - and most companies associated with residential mortgage loan originations and servicing have been preparing, thus protecting themselves, for a long, long time. Many have been through numerous state and federal banking examinations, responding, where needed, with corrective actions. Not a few have retained competent mortgage risk management firms or in-house compliance advisors. Even those who cannot afford compliance counsel have participated in one way or another in conferences, conventions, and training venues in order to be educated in regulatory developments. Everybody now knows unequivocally that sales are cemented to compliance.

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Who's afraid of the big bad wolf?

As I wrote recently, the CFPB has considerable enforcement powers. Among other things, it can rescind or reform contracts, require the refunding of money to a consumer and demand other forms of restitution, mandate the disgorgement and refunding of various types of assets, compel the return of real property, cause fees and other compensation to be disgorged for unjust enrichment, require the payment of damages or other monetary relief, cause public notification regarding a violation, limit the activities or functions of alleged violators, and, of course, exact civil monetary penalties.

But, in terms of the remedies mentioned above, none of these administrative actions is really new. Virtually every state banking department in the country has most of these enforcement powers. Nearly all prudential regulators have many such authorities. Banks and nonbanks that have undergone routine examinations are not an unsuspecting lot, completely unprepared for the kinds of detailed review that the CFPB conducts. Having watched the CFPB in action, I can say that a firm that is adequately prepared for a state or federal examination should be prepared for a CFPB examination.

Is the CFPB's examination a bit more detailed? Yes. But most of the exam requirements are re-treads or the kinds of state and federal banking information and documentation requests or guidelines that are mostly customary and pro forma.

The Enforcement Powers of the Consumer Financial Protection Bureau

For several months, the Consumer Financial Protection Bureau (“CFPB” or “Bureau”) has implemented a spate of enforcement actions against banks and nonbanks. My interest in this article is neither to re-litigate those cases nor single out any particular financial institution for further scrutiny.* Sometimes we must learn our lessons at somebody else’s expense, rather than to castigate another for unseemly conduct. None of us, however, is absolved of the responsibilities, the violations of which could lead to enforcement actions against us or the financial institution where we are employed.

It is important, therefore, to have some sense of what is meant by the term “enforcement,” especially with respect to the CFPB’s authorities. The CFPB received a host of enumerated laws and related authorities on July 21, 2011[i], and, pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), a concomitant set of defined rules were established[ii] that gave the Bureau numerous enforcement powers, including the powers to conduct investigations and implement enforcement actions to enforce federal consumer financial law.[iii]

For instance, Section 1052 of the Dodd-Frank authorizes the CFPB to engage in joint, interagency investigations and requests for information, including matters relating to fair lending. Though the statute specifically provides that, “where appropriate,” the Bureau may conduct “joint investigations” with the Secretary of Housing and Urban Development, the Attorney General of the United States, or both, it also sets forth lengthy provisions governing subpoena powers and civil investigative demands.

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IN THIS ARTICLE

Hearings and Adjudications

Scope of Legal Remedies

Blowing the Whistle on Violations

Policy Statement and Whistleblower Protection

Locking Horns with the Department of Labor

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Hearings and Adjudications

On November 7, 2011, the Bureau issued CFPB Bulletin 2011-04 (entitled “Enforcement”),[iv] the first in a series of bulletins relating to policies and priorities of the Bureau’s Office of Enforcement. The Bulletin announced that before the CFPB commences an enforcement proceeding, it may (or may not) give the subject of the proceeding notice of the nature of the potential violations and may (or may not) offer the subject the opportunity to submit a written statement in response. The Bulletin also gave specific instructions regarding the submission requirements of the written statement, such as the paper size, spacing, font size, and length, while also mandating that the response had to be received by the CFPB by no more than 14 calendar days after the notice.[v]

Almost a year after the CFPB received its authorities, it adopted rules, on June 29, 2012, regarding the procedures it expected to follow when investigating whether a “person” (a legal term for an individual or entity) is or has been engaged in conduct that would constitute a violation of any provision of federal consumer financial law.[vi]

Indeed, Dodd-Frank authorizes[vii] the Bureau to conduct hearings and adjudication proceedings to ensure or enforce compliance with the following applicable items:

• Title X, which established the Consumer Financial Protection Bureau as an independent agency within the Board of Governors of the Federal Reserve System, including any rules prescribed by the CFPB under Title X; and
• “… any other Federal law that the Bureau is authorized to enforce, including an enumerated consumer law, and any regulations or order prescribed thereunder, unless such Federal law specifically limits the Bureau from conducting a hearing or adjudication proceeding and only to the extent of such limitation.”

Furthermore, Section 1053 of Dodd-Frank sets forth the rules for Cease-and-Desist proceedings and enforcement orders.

Statutorily, Dodd-Frank authorizes the CFPB to apply to the United States district court within the jurisdiction of which the principal office or place of business of the person is located, for the purposes of enforcing any effective bulletin or notice, outstanding notice, or order.

Thus it was that, soon after the Bureau announced its rules for investigating violations, in July 2012 the CFPB announced its first enforcement action. That action consisted of a consent order in which Capital One agreed to refund $140 million to 2 million customers and pay a $25 million penalty. The enforcement was the consequence of alleged deceptive marketing tactics used by Capital One’s vendors to coax consumers into paying for add-on products when they activated their credit cards.[viii]

Dodd-Frank authorizes the CFPB to commence a civil action against any person who violates a federal consumer financial law and to impose a civil penalty or to seek all appropriate legal and equitable relief including a permanent or temporary injunction.

When commencing a civil action, the Bureau must notify the Attorney General and, with respect to a civil action against an insured depository institution or insured credit union, the appropriate prudential regulator. Except as otherwise permitted by law or equity, no action may be brought under Title X more than three years after the date of discovery of the violation.

Indeed, the CFPB published an interim rule regarding its awarding of attorney fees and other litigation expenses in certain situations, as required by the Equal Access to Justice Act.[ix]