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.