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.

Loan Originator Compensation: New Rules

On January 24, 2013, as the last of the Final Rules of the Consumer Financial Protection Bureau (CFPB) rolled out, I offered an outline of all of them, entitled "CFPB's Gang of Seven (Final Rules)".*

I listed them in order of issuance, as follows:

1. Ability-to-Repay (ATR)
2. High-Cost Mortgage (HCM)
3. Escrow
4. Servicing
5. Appraisals for High-Risk Mortgages
6. Copies of Appraisals
7. Mortgage Loan Originator Compensation

Having come through the last two months responding to numerous questions about these Final Rules, I have been able to cobble together some of the most salient questions, regulatory features, and concerns that our clients have expressed about them. And when I have spoken to the media types, it seems that they also have a set of questions and interests that are not being fully addressed in the current dialogue. Of abiding interest is the change relating to loan originator compensation.

With that in mind, I want to provide a brief outline of some loan originator compensation issues, offering additional details garnered from two months in the trenches working through these regulatory issues on behalf of our clients. From time to time, I will have more to discuss about many regulatory changes anticipated in 2013 and 2014. I am going to conduct this review topic by topic, rather than just as specific regulations subject to a final rulemaking.

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IN THIS ARTICLE

Terms and Conditions
Retirement Plans
Factors and Proxies
Dual Compensation
Non-loan Originations Services
Points and Fees
Loan Originator Qualifications
Mandatory Arbitration Clause
Single Premium Insurance
Record Retention Requirements

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Terms and Conditions

By now, there is nary a residential mortgage lender or originator that does not know that, under Regulation Z, loan originator compensation is prohibited from being based upon the terms and conditions of a mortgage loan transaction.

The CFPB has provided new nomenclature for the terminology "transaction terms and conditions," without much changing the prohibition and certain exceptions to the standing rule. The new terminology is "term of a transaction," but now with the clarified meaning that term of a transaction means to include "any right or obligation of the parties to a credit transaction."

The usual cast of regulatory prohibitions continue in force. For instance, loan originator compensation is still prohibited from being based on such things as the interest rate of a loan, or upon the inclusion of additional fees or charges for products or services provided by other parties to the transaction.

And the usual cast of regulatory identifiers of a term of a transaction continue in force. Thus, fees or charges are a term of the transaction if they must be disclosed in the Good Faith Estimate (GFE) or HUD-1 or HUD-1A Settlement Statement (HUD-1). That obviously means to include loan originator or creditor fees or charges for the credit transaction or for a product or service provided by the loan originator or creditor that is related to the extension of credit; and it also means those fees or charges of other parties for any product or service required by the lender as a condition of the extension of credit. Keep in mind, however, that just because a fee or charge is stated on the HUD-1 does not in itself make the fee or charge a term of the transaction.

One rather controversial area involves the off-setting of compensation due to increased costs. The standing rule has provided that loan originator compensation is prohibited from being reduced in response to a change in the transaction terms. This has caused lenders all manner of frustration, not to mention loss of revenues and diminished profits. Yet, the new rule would allow compensation to be reduced in order to offset unexpected increases to estimated settlement costs, otherwise known as "unforeseen circumstances." What is a circumstance that is unforeseen? The imagination reels! But since the CFPB has offered no formal guidance to delineate very specifically what may or may not be an unexpected event, the lender must be extremely careful not to enter these dark waters too briskly.

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CFPB's Gang of Seven (Final Rules)

This has been a busy month for the Consumer Financial Protection Bureau (CFPB). Since the advent of the New Year, the CFPB has issued seven Final Rules that impact residential mortgage loan originations.

The finale was on Sunday, January 20, 2013, when the CFPB issued the seventh Final Rule, one day prior to the deadline set forth in the Dodd-Frank Act (Dodd-Frank), in § 1400(c), for automatic implementation of its Title XIV provisions.

By my count, these are the Final Rules, in order of their issuance:

1. Ability-to-Repay (ATR)
2. High-Cost Mortgage (HCM)
3. Escrow
4. Servicing
5. Appraisals for High-Risk Mortgages
6. Copies of Appraisals
7. Mortgage Loan Originator Compensation 

I recently discussed the Final Rule regarding the Ability-to-Repay. I will soon provide an outline of the CFPB's important Final Rule for Mortgage Loan Originator Compensation.

With regards to the latter, we will be updating the FAQs Outline - Loan Originator Compensation for the rule changes affecting loan origination compensation. For your consideration, I plan to provide soon a useful and practical understanding of the compensation revisions. In the near future, I will notify you of and provide access to the forthcoming article I am publishing on these regulatory guidelines.

In this article, I want to briefly outline this Gang of Seven (Final Rules). Please keep in mind that I am providing a broad sketch of the Final Rules. As is the case with many applications of legal and regulatory compliance, there are numerous statutory requirements and implementation guidelines that bring about consideration of some recourse to a competent risk management professional.

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IN THIS ARTICLE

Chart: Final Rules Compliance Dates
Gang Member # 1: Ability-to-Repay (ATR)
Gang Member # 2: High-Cost Mortgage (HCM)
Gang Member # 3: Escrow
Gang Member # 4: Servicing
Gang Member # 5: Appraisals for High-Risk Mortgages
Gang Member # 6: Copies of Appraisals
Gang Member # 7: Mortgage Loan Originator Compensation

Library

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Chart: Final Rules - Compliance Dates

Let's start first with a chart of the Final Rules and their respective compliance effective dates. I realize that there is considerable interest in the RESPA/TILA integration of mortgage disclosures; however, on November 16, 2012 the CFPB published a Final Rule exempting persons from complying with twelve specified Title XIV mortgage disclosure requirements. The RESPA/TILA disclosure integration is now scheduled for completion in September 2013. Without the aforementioned exemption, these twelve disclosure requirements would actually have taken effect on January 21, 2013.

Chart deals with only the Gang of Seven (Final Rules).

CFPB’s Final Rule: Ability-to-Repay and Qualified Mortgages

Yesterday, I provided an outline of the Consumer Financial Protection Bureau's (CFPB's) Regulatory Agenda for 2013. As if on cue, the CFPB has accommodated us today with the first of its forthcoming issuances.* This pertains to the Final Rule regarding Ability-to-Repay, which leaves the Final Rule issuances this month for Loan Originator Compensation, Mortgage Servicing, and Requirements for Escrow Accounts.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) required that, for residential mortgages, creditors must make a reasonable and good faith determination based on verified and documented information that the consumer has a reasonable ability to repay the loan according to its terms. It also established a "presumption" of compliance for a certain category of mortgages, which was called “qualified mortgages” or "QMs." These provisions are similar, but not identical to, the Federal Reserve Board's (FRB's) 2008 rule and cover the entire mortgage market rather than simply higher-priced mortgages. The FRB proposed a rule to implement the new statutory requirements before authority passed to the CFPB to finalize the rule. 

I have written extensively about Ability-to-Repay and the Qualified Mortgage. 

Please feel free to review these articles.

In this article, I would like to mention the premises used as the reasons for an Ability-to-Repay rule (ATR). Then I will outline the essential features of ATR, followed by a review of the "Qualified Mortgage." Finally, I will provide a general summation in order to provide some context with respect to the Final Rule's implementation.

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IN THIS ARTICLE

Premises for Ability-to-Repay
What is Ability-to-Repay?
What is the Qualified Mortgage?
Types of Qualified Mortgages
Summation

Library

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Premises for Ability-to-Repay

The CFPB believes that when consumers apply for a mortgage they "often struggle to understand how much of a monthly payment they can afford to take on." Thus, according to the CFPB, the consumer may reasonably assume that lenders and mortgage brokers would not make loans to people who cannot afford them. But in the years leading up to the financial crisis, the CFPB asserts that lenders too often made mortgages that could not be paid back.

Therefore, the purpose of ATR is to require lenders to obtain and verify information to determine whether a consumer can afford to repay the mortgage and, per the CFPB, thereby help to restore trust in the mortgage market.

These are the premises upon which the CFPB has established the need for Ability-to-Repay:

-In the lead up to the financial crisis, certain lending practices set consumers up to fail with mortgages they could not afford.

-The deterioration in underwriting standards contributed to dramatic increases in mortgage delinquencies and rates of foreclosures.

-The Dodd-Frank Act recognizes the need to mandate that lenders ensure consumers have the ability to pay back their mortgages.

-The Ability-to-Repay rule protects consumers from risky practices that helped cause the crisis.

In its review of the above-mentioned premises, the CFPB had taken the position that lenders sold no-doc and low-doc loans where consumers were “qualifying” for loans beyond their means. Lenders also "sold risky and complicated mortgages like interest-only loans, negative-amortization loans where the principal and eventually the monthly payment increases, hybrid adjustable-rate mortgages where the rate was set artificially low for years and then adjusted upwards, and option adjustable-rate mortgages where the consumer could 'pick a payment' which might result in negative amortization and eventually higher monthly payments."

In plain English, the CFPB asserts that lenders should not be able to offer no-doc, low-doc loans, otherwise known as “Alt-A” loans, where some lenders made quick sales by not requiring specific, qualifying documentation, yet then offloaded these risky mortgages by selling them to investors.

As it was contended, these actions precipitated the collapse of the housing market in 2008 and the subsequent financial crisis.

Dodd-Frank provides the authority to the CFPB to define criteria for certain loans called “Qualified Mortgages” that are presumed to meet the Ability-to-Repay rule requirements.

The salient observation about ATR is that the CFPB is issuing this rule in order "to ensure that responsible consumers get responsible loans," as well as ensuring that "lenders can extend credit responsibly - without worrying about competition from unscrupulous lenders."

CFPB’s Regulatory Agenda - 2013

As we begin a new year and prepare ourselves for the blizzard of new and revised regulations coming our way, I think it is important for us to consider the regulatory agenda that the Consumer Financial Protection Bureau (CFPB) has set for itself.* As you've heard me say so many times, preparation is protection. So, please undertake a review of the agenda that the CFPB has promised to pursue in the coming months, especially with the view of how best to prepare for the changes that are sure to follow.

It is worth noting that the CFPB reasonably anticipates having certain regulatory matters under consideration during the period from October 1, 2012 to October 1, 2013. And the CFPB will publish updates to its agenda periodically through October 1, 2013. These matters will be under consideration by the CFPB, primarily including various rulemakings mandated by the Dodd-Frank Act, such as several mortgage-related rulemakings and rulemakings to implement the CFPB's supervisory program for nondepository covered persons by, among other things, defining "larger participants" in certain consumer financial product and service markets.

The CFPB is completing several mortgage-related rulemakings in January 2013, even as it continues to assess the need and resources available for additional rulemakings. For instance, the Dodd-Frank Act mandates rulemakings to implement amendments to the Home Mortgage Disclosure Act, and to the Equal Credit Opportunity Act to create a data reporting regime concerning small, women-owned, or minority-owned business lending. Also, the CFPB has inherited proposed rules concerning mortgage loans, home equity lines of credit, and other topics from other agencies as part of the transfer of authorities under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). All of these regulatory changes will require careful planning and clear guidance with respect to implementation.

In this article, I am going to highlight the regulatory changes that the CFPB has moved into their final stages. I offer a brief outline of the regulatory issues and the CFPB's likely resolution. Each of these regulations, now approaching the status of Final Rule, is extraordinarily significant and, in some instances, constitutes formidable challenges.

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IN THIS ARTICLE

Chart

Consumer Financial Protection Bureau -
Final Rule Stage (Selected Rules)

Final Rule Stages

Loan Originator Compensation (Regulation Z)
Mortgage Servicing (Regulation X, Regulation Z)
Requirements for Escrow Accounts (Regulation Z)
TILA Ability To Repay (Regulation Z)
TILA/RESPA Mortgage Disclosure Integration
(Regulation X, Regulation Z)

Library

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Chart: Consumer Financial Protection Bureau

Final Rule Stage (Selected Rules)

This chart provides a quick overview of certain regulatory changes that the CFPB will promulgate this year. The chart also provides the anticipated Final Rule dates.

CFPB Proposes New Servicing Rules - TILA

On September 26, 2012, we notified you about the proposed rules promulgated by the Bureau of Consumer Financial Protection (Bureau) to amend Regulation X, which implements the Real Estate Settlement Procedures Act (RESPA) and the official interpretation of the regulation. These proposed rules seek to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) provisions regarding mortgage loan servicing.

Now we would like to provide an outline of the CFPB's proposed companion regulation (Proposal) to amend Regulation Z, which implements the Truth in Lending Act (TILA), such Proposal meant also to implement the Dodd-Frank provisions regarding mortgage loan servicing.

Specifically, the Proposal implements Dodd-Frank sections addressing:

1) Initial rate adjustment notices for adjustable-rate mortgages (ARMs).

2) Periodic statements for residential mortgage loans.

3) Prompt crediting of mortgage payments.

4) Response to requests for payoff amounts.

Furthermore, the Proposal would amend current rules governing the scope, timing, content, and format of current disclosures to consumers occasioned by the interest rate adjustments of their variable-rate transactions.

The Proposal is extensive, nuanced, and comprehensive, covering many aspects of the TILA statute. Therefore, I will touch on some of the salient features of it. You can access our Library to download the Proposal in its entirety.

Comments Due: On or before October 9, 2012.

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IN THIS ARTICLE

Scope

Nine Major Topics

Small Servicers

Library

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Scope

The Proposal generally applies to closed-end mortgage loans, with certain exceptions.

Under the proposed amendments to Regulation X, open-end lines of credit and certain other loans, such as construction loans and business-purpose loans, are excluded. Under this Proposal to Regulation Z, the periodic statement and ARMs disclosure provisions apply only to closed-end mortgage loans, but the prompt crediting and payoff statement provisions apply both to open-end and closed-end mortgage loans.

Additionally, reverse mortgages and timeshares are excluded from the periodic statement requirement, and certain construction loans are excluded from the ARM disclosure requirements.

The Bureau is seeking comment on whether to exempt small servicers from certain requirements or modify certain requirements for small servicers.

Nine Major Topics

As is the case of the aforementioned RESPA proposal, this Proposal regarding TILA also contains nine major topics.

1. Periodic billing statements.

Dodd-Frank generally mandates that servicers of closed-end residential mortgage loans (other than reverse mortgages) must send a periodic statement for each billing cycle. These statements must meet the timing, form, and content requirements provided for in the rule. The Proposal contains sample forms that servicers could use. The periodic statement requirement generally would not apply for fixed-rate loans if the servicer provides a coupon book, so long as the coupon book contains certain information specified in the rule and certain other information is made available to the consumer. The Proposal also includes an exception for small servicers that service 1,000 or fewer mortgage loans and service only mortgage loans that they originated or own.

CFPB Proposes New Servicing Rules - RESPA

Recently, the Bureau of Consumer Financial Protection (Bureau) issued proposed rules (Proposal) to amend Regulation X, which implements the Real Estate Settlement Procedures Act (RESPA) and the official interpretation of the regulation.

The proposed amendments implement the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) provisions regarding mortgage loan servicing. 

Specifically, this proposal requests comment regarding proposed additions to Regulation X to address seven servicer obligations:

1) Correct errors asserted by mortgage loan borrowers; 

2) Provide information requested by mortgage loan borrowers;

3) Ensure that a reasonable basis exists to obtain force-placed insurance;

4) Establish reasonable information management policies and procedures;

5) Provide information about mortgage loss mitigation options to delinquent borrowers;

6) Provide delinquent borrowers access to servicer personnel with continuity of contact about the borrower's mortgage loan account; and

7) Evaluate borrowers' applications for available loss mitigation options.

The Proposal would modify and streamline certain existing servicing-related provisions of Regulation X. 

For instance, it would revise provisions relating to:

1) A mortgage servicer's obligation to provide disclosures to borrowers in connection with a transfer of mortgage servicing, and

2) A mortgage servicer's obligation to manage escrow accounts (including the obligation to advance funds to an escrow account to maintain insurance coverage and to return amounts in an escrow account to a borrower upon payment in full of a mortgage loan).

The Bureau proposes 'companion' regulations implementing amendments to the Truth In Lending Act (TILA) in Regulation Z (the 2012 TILA Servicing Proposal). We will provide an outline of the 2012 TILA Servicing Proposal in a subsequent newsletter.

Comments Due: On or before October 9, 2012.

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IN THIS ARTICLE

Scope

Nine Major Topics

Small Servicers

Library

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Scope

• The Proposal generally applies to closed-end mortgage loans, with certain exceptions.

• Under the Proposal, open-end lines of credit and certain other loans, such as construction loans and business-purpose loans, are excluded.

• Under the 2012 TILA Servicing Proposal, the periodic statement and adjustable-rate mortgage (ARM), disclosure provisions apply only to closed-end mortgage loans, but the prompt crediting and payoff statement provisions apply both to open-end and closed-end mortgage loans.

• Reverse mortgages and timeshares are excluded from the periodic statement requirement, and certain construction loans are excluded from the ARM disclosure requirements.

• The Bureau is seeking comment on whether to exempt small servicers from certain requirements or modify certain requirements for small servicers.

Nine Major Topics

The Proposal covers nine major topics, as follows:
   
1. Periodic billing statements.

Dodd-Frank generally mandates that servicers of closed-end residential mortgage loans (other than reverse mortgages) must send a periodic statement for each billing cycle. These statements must meet the timing, form, and content requirements provided for in the rule. The Proposal contains sample forms that servicers could use.

The periodic statement requirement generally would not apply for fixed-rate loans if the servicer provides a coupon book, so long as the coupon book contains certain information specified in the rule and certain other information is made available to the consumer. The proposal also includes an exception for small servicers that service 1000 or fewer mortgage loans and service only mortgage loans that they originated or own.
   
2. Adjustable-rate mortgage interest-rate adjustment notices.

Servicers would have to provide a consumer whose mortgage has an adjustable rate with a notice 60 to 120 days before an adjustment which causes the payment to change. The servicer would also have to provide an earlier notice 210 to 240 days prior to the first rate adjustment. This first notice may contain an estimate of the rate and payment change. Other than this initial notice, servicers would no longer be required to provide an annual notice if a rate adjustment does not result in an increase in the monthly payment. The Proposal contains model and sample forms that servicers could use.

OCC - Correcting Foreclosure Practices

On December 20, 2011, the Office of the Comptroller of the Currency (OCC) updated its announcement regarding correcting foreclosure practices. We have previously issued newsletters here, here, and here on this subject and also related matters regarding foreclosure processing.

Earlier in 2011, on April 13, 2011, the OCC, the Board of Governors of the Federal Reserve System (FRB), and the Office of Thrift Supervision (OTS) announced enforcement actions against 14 large residential mortgage servicers and two third-party vendors for unsafe and unsound practices related to residential mortgage servicing and foreclosure processing. The enforcement actions were based on interagency examinations conducted in the fourth quarter of 2010.

Through those enforcement actions (consent orders), federal regulators required servicers to engage independent firms to conduct a multi-faceted review of foreclosure actions in process in 2009 and 2010.

On January 4, 2012, the OCC announced that it was promoting public service advertisements about the Independent Foreclosure Review.

In this newsletter, we will consider several aspects with respect to implementation of the consent orders.

• Independent Foreclosure Review
• Mailings to Consumers
• Deadline for Review Requests
• Independent Foreclosure Auditor
• Eligibility for Review
• Notifying the Public
• Engagement Letters
• Interim Report
• Library

Independent Foreclosure Review

Under the consent orders, independent consultants are charged with evaluating whether borrowers suffered financial injury through errors, misrepresentations, or other deficiencies in foreclosure practices and determining appropriate remediation for those customers.

Where a borrower suffered financial injury as a result of such practices, the agencies' orders require financial remediation to be provided.

Mailings to Consumers 

As part of that program, the 14 mortgage servicers covered by the enforcement actions were required to begin mailings to consumers on November 1, 2011, continuing to December 31, 2011.

The mailings are intended to provide information to potentially eligible borrowers on how to request a review of their case if they believe they suffered financial injury as a result of errors, misrepresentations, or other deficiencies in foreclosure proceedings related to their primary residence between January 1, 2009 and December 31, 2010. The mailings will include a request for review form.

Borrowers may also visit the special Independent Foreclosure Review website for more information about the review and claim process. Telephonic assistance is given at this website.

Deadline for Review Requests

 Review requests must be received by April 30, 2012.

Independent Foreclosure Auditor

An independent foreclosure auditor must be a third-party. The independent foreclosure auditor will assess whether any errors, misrepresentations, or other deficiencies resulted in financial injury to borrowers.

Where a borrower suffered financial injury as a result of such practices, the consent orders require remediation to be provided. 

During the review, customers may be contacted by mortgage servicers for additional information at the direction of the independent consultant.

OCC: Fixing Deficient Foreclosure Practices

Jonathan Foxx
President & Managing Director
Lenders Compliance Group

The Office of the Comptroller of the Currency (OCC) issued a report on November 22, 2011 on the actions by 12 national bank and federal savings association mortgage servicers to comply with consent orders issued in April 2011 to correct deficient and unsafe or unsound foreclosure practices.

The report, entitled Interim Status Report: Foreclosure-Related Consent Orders, summarizes progress on activities related to the independent foreclosure review announced November 1, 2011, as well as other activities to enhance mortgage servicing operations, strengthen oversight of third-party service providers and activities related to Mortgage Electronic Registration Systems (MERS), improve management information systems, assess and manage risk, and ensure compliance with applicable laws and regulations.

Based on information in the relevant OCC issuances, much of the work to correct identified weaknesses in policies, operating procedures, various control functions, and audit processes would be substantially complete in the first part of 2012, but other, longer term initiatives will continue through the balance of 2012.

In addition to the interim report, please note that the OCC also released engagement letters that describe how the independent consultants, retained by the servicers, will conduct their file reviews and claims processes to identify borrowers who suffered financial injury as a result of deficiencies identified in the OCC's consent orders.

For those of you who have not had to respond to and implement a consent order, I would say that the engagement letters are generally pro forma and consistent with similar terms and conditions we require in our own commitments and proposals for such audits and due diligence reviews. As a general proposition, the review process being implemented at some companies may differ from that described in the engagement letters because of subsequent coordination with the OCC to ensure a consistent process among the servicers.   

The engagement letters identify the names of the independent consultants conducting the reviews and include language stipulating that consultants would take direction from the OCC throughout the reviews. In fact, the terms of engagement specifically prohibit servicers from overseeing, directing, or supervising any of the reviews. Limited proprietary and personal information has been redacted.

Newsletter Sections
Interim Report
Engagement Letters
Correcting Foreclosure Deficiencies
Professional Assistance
Library

Interim Report

The interim report summarizes actions taken by national banks and federal savings associations to correct deficiencies in mortgage servicing and foreclosure processing identified in consent orders issued on April 13, 2011, by the Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS) against 12 mortgage servicers.

The OCC took action against eight national bank servicers: Bank of America, Citibank, HSBC, JPMorgan Chase, MetLife Bank, PNC, U.S. Bank, and Wells Fargo. The OTS took action against four federal savings association servicers and two holding companies: Aurora Bank, FSB; EverBank (and the thrift holding company, EverBank Financial Corp.); OneWest Bank, FSB (and its holding company IMB HoldCo LLC); and Sovereign Bank.

The consent orders were based on examiner findings during an interagency review of major residential mortgage servicers conducted in the fourth quarter of 2010.

A summary of the findings of the interagency review is available in the "Interagency Review of Foreclosure Policies and Practices," produced by the OCC, Board of Governors of the Federal Reserve Board (FRB), and OTS.

Engagement Letters
Pursuant to 12 C.F.R. § 4.12(c), the listing order of the engagement letters at the OCC's election has no precedential significance.

The engagement letters were submitted by the independent consultants that were retained by servicers regulated by the OCC. These independent consultants will be conducting foreclosure reviews pursuant to the requirements of the April 13, 2011 consent orders. 

The engagement letters describe how the independent consultants will conduct their file reviews and claims processes to identify borrowers who suffered financial injury as a result of servicer deficiencies identified in the OCC's consent orders.  
Limited proprietary and personal information has been redacted from the engagement letters.

Since the acceptance of the engagement letters in September of this year, the independent consultants have further refined and made adjustments to the processes, procedures, and methodologies outlined in the engagement letters in consultation with OCC supervision staff.

For instance, there were a number of changes made to integrated claims processes to ensure a single, uniform process among the servicers.

Correcting Foreclosure Deficiencies

Independent Foreclosure Review

As part of those consent orders, federal regulators required servicers to engage independent firms to conduct a multi-faceted review of foreclosure actions in process in 2009 and 2010.

Under the orders, independent consultants are charged with evaluating whether borrowers suffered financial injury through errors, misrepresentations, or other deficiencies in foreclosure practices and determining appropriate remediation for those customers. Where a borrower suffered financial injury as a result of such practices, the agencies' orders require financial remediation to be provided.

As part of that program, 14 mortgage servicers covered by the enforcement actions will begin mailings November 1, 2011 that will continue through the end of the year. The mailings are intended to provide information to potentially eligible borrowers on how to request a review of their case if they believe they suffered financial injury as a result of errors, misrepresentations, or other deficiencies in foreclosure proceedings related to their primary residence between January 1, 2009 and December 31, 2010. The mailings will include a request for review form.

Borrowers may also visit the Independent Foreclosure Review for more information about the review and claim process. Furthermore, assistance with the form and answers to questions about the process are available at 1-888-952-9105, Monday through Friday from 8 a.m. to 10 p.m. (ET) and Saturday from 8 a.m. to 5 p.m. (ET).
Requests for review must be received by April 30, 2012.

The third-party consultant will assess whether any errors, misrepresentations, or other deficiencies resulted in financial injury to borrowers. Where a borrower suffered financial injury as a result of such practices, the consent orders require remediation to be provided. 

During the review, customers may be contacted by mortgage servicers for additional information at the direction of the independent consultant.

Professional Assistance

Library

Interim Status Report: Foreclosure-Related Consent Orders
November 2011

Interagency Review of Foreclosure Policies and Practices
April 2011

New Mortgage Servicing Practices

On August 10, 2010, the New York State Banking Department issued new regulations that address the business practices of mortgage loan servicers and establish additional consumer protections for homeowners.

Part 419 of the Superintendent's Regulations, which went into effect on October 1, 2010, were a follow-up to the adoption of Part 418 in July 2009, which established standards and procedures for the registration of mortgage loan servicers in New York. The regulations implement certain provisions of the Mortgage Lending Reform Law enacted in 2008 to address the foreclosure crisis and establish greater consumer protections for subprime and high-cost home loans.

Recently, Benjamin M. Lawsky, the Superintendent of Financial Services of New York's Department of Financial Services and Banking Department, announced that the Department had entered into two agreements with certain servicers to implement new servicing practices. The Department considers these new servicing requirements to be landmark changes, and they form the basis of the new Mortgage Servicing Practices.

In the first instance, Superintendent Lawsky announced on September 1, 2011 that Goldman Sachs Bank, Ocwen Financial Corp, and Litton Loan Servicing LP agreed to adhere to the new Mortgage Servicing Practices. The agreement, entitled "Agreement on Mortgage Servicing Practices," was required by the Department as a condition to allowing Ocwen's acquisition of Litton, the Goldman Sachs mortgage servicing subsidiary. With the Litton acquisition, Ocwen's mortgage servicing entity, Ocwen Loan Servicing, LLC becomes the 12th largest servicer in the nation. The servicer has 60 days from the date of the acquisition to implement the provisions and requirements of the Mortgage Servicing Practices.

In the second instance, Superintendent Lawsky announced on November 10, 2011 that Morgan Stanley and its mortgage servicer Saxon, American Home Mortgage Servicing, and Vericrest Financial had agreed to the new Mortgage Servicing Practices.

The changes are substantial and clearly the Department is committed to enforcing them. Maybe you would suggest other changes. In any event, these servicing requirements will benefit both the consumer and the mortgage industry.

It is likely that these new Mortgage Servicing Practices will become a model in other states.

The following is a brief review of these new practices.

OVERVIEW

The Department has consumer protection concerns relating to practices "highlighted in the media" that have been prevalent in the mortgage servicing industry generally, including but not limited to, (1) the practice of "Robo-signing," (2) referring to affidavits in foreclosure proceedings that falsely attest that the signer has personal knowledge of the facts presented therein and/or were not notarized in accordance with state law; (3) weak internal controls and oversight that may have compromised the accuracy of foreclosure documents; (4) unfair and improper practices in connection with loss mitigation, including improper denials of loan modifications; and, (5) imposition of improper fees by servicers, among others.

OUTLINE OF PRACTICES

-Document Execution and Accuracy of Documentation
-Ownership of Note, Foreclosures
-Quality Assurance and Audits
-Oversight of Third Party Vendors
-Staffing
-Training
-Notices, Single Point of Contact and Modifications for Transferred Servicing Files
-Borrower Communication
-Independent Evaluation of Loan Modification Denials
-Restrictions on Dual Tracking
-Application of Payments
-Servicing Fees
-Force-Placed Insurance
-Compliance with Federal and State Law

PROHIBITED PRACTICES

• "Robo-signing," where servicer staff signed affidavits stating they reviewed loan documents when they had not actually done so.

• Weak internal controls and oversight that compromise the accuracy of foreclosure documents.

• Referring borrowers to foreclosure at the same time as those borrowers are attempting to obtain modifications of their mortgages or other loss mitigation.

• Improper denials of loan modifications.

• Failing to provide borrowers with access to a single customer service representative, resulting in delays or failure of the loss mitigation process.

• Imposition of improper fees by servicers.

SPECIFIC CHANGES

1) End Robo-signing and impose staffing and training requirements that will prevent Robo-signing.

2) Require servicers to withdraw any pending foreclosure actions in which filed affidavits were Robo-signed or otherwise not accurate.

3) End "dual tracking", for instance referring a borrower to foreclosure while the borrower is pursuing loan modification or loss mitigation, and prohibit foreclosures from advancing while denial of a borrower's loan modification is under an independent review, which is also required by the agreements.

4) Provide a dedicated single point of contact representative for all borrowers seeking loss mitigation or in foreclosure so borrowers are able to speak to the same person who knows their file every time they call.

5) Require servicers to ensure that any force-placed insurance be reasonably priced in relation to claims incurred, and prohibit force-placing insurance with an affiliated insurer.

6) Impose more rigorous pleading requirements in foreclosure actions to ensure that only parties and entities possessing the legal right to foreclose can sue borrowers.

7) For borrowers found to have been wrongfully foreclosed, require servicers to ensure that their equity in the property is returned, or, if the property was sold, compensate the borrower.

8) Impose new standards on servicers for application of borrowers' mortgage payments to prevent layering of late fees and other servicer fees and use of suspense accounts in ways that compounded borrower delinquencies and defaults.

9) Require servicers to strengthen oversight of foreclosure counsel and other third party vendors, and impose new obligations on servicers to conduct regular reviews of foreclosure documents prepared by counsel and to terminate foreclosure attorneys whose document practices are problematic or who are sanctioned by a court.

Learning to Play the HARP

A week ago the Obama Administration announced revisions to the Home Affordable Refinance Program (HARP).

Better late than never! Actually, coming three years belatedly, a change to HARP may bring some relief to homeowners and the economy.

But is it a viable solution?

As you may know, I have written extensively about the failure of both the Home Affordable Modification Program (HAMP) and HARP.

Is the new and improved version of the two-year old HARP a quick fix or yet another boondoggle in the making?

Real Estate and Jobs

Last week's announcement stems from the revisions developed by the Federal Housing Finance Agency (FHFA), the GSE's overseer, with feedback from lenders, mortgage insurers and other mortgage industry participants. In a sense the revisions are a patent admission that the economy simply will not regain its strength without a robust real estate market; or, put another way, jobs will not return unless a strengthened real estate market returns.

The linkage of real estate to jobs has roots in the MBS World, a murky realm way below the revisions contemplated by the Administration and the homeowners' needs.

The Federal Reserve has a central place in the MBS World, since it is permitted to participate in the agency MBS financial instruments, and not permitted to participate in buying equity, real estate, or corporate debt.

Remember: MBS yields are the primary trigger in the formation of mortgage rates. The safest financial instruments, of course, are Treasuries; so, relative to Treasuries, the margin or spread between mortgage rates and yields on 10-year Treasuries has continued to move upward. When the Fed makes its MBS purchase, it thereby reduces mortgage interest rates, compressing those relative margins. Operationally speaking, then, a so-called target for mortgage rates is set in this manner.

Ostensibly, lower mortgage rates lead to refinances and the concomitant diminution of financial pressure on homeowners who have been trapped in the housing crisis with underwater mortgages, because such reduction both lowers the cost of debt service through refinance and supports purchases of houses, which creates demand - and thus an increase in pricing - for housing.

What Went Wrong?

To date, a tiny percentage of seemingly eligible borrowers have refinanced through HARP.

In my estimation, these are the factors that led to the HARP failure:

-Resistance: the refusal by some second lienholders to subordinate themselves to the first mortgagee.

-Fear: the GSEs might "put back" the new loans if they subsequently move into default, which causes constrained underwriting.

-Restrictions: the original MI being applied to the new loan, particularly if the new loan has a different servicer.

-Reluctance: homeowners afraid of being rejected, lack of public awareness, and insufficient news about program information.

Also, it is common knowledge that lenders have rejected all but the most creditworthy borrowers from taking advantage of HARP, out of reluctance to take on the risk of existing representations and warranties; however, this may yet find a solution (see below).

Plans and Suggestions

In this latest version of HARP, there is an extension of the program's mandates through December 2013. As a quick overview, I think it's fair to describe HARP as a temporary program by the GSEs, the primary goal of which is to permit borrowers whose loans are currently guaranteed by the GSEs to be refinanced, despite the fact that these loans are significantly higher than 80LTV.

There are some important revisions, perhaps the most important being the removal of the 125LTV ceiling. In addition, in many cases a new appraisal is eliminated, fees to borrowers are lowered, and the GSEs are waiving some lender representations and warranties (about which we will know more by November 15, 2011, when the program guidelines are issued).

I think the revisions to representations and warranties are needed and justified, inasmuch as all loans eligible under HARP have been seasoned for more than three years, and defects in a loan usually show up in the first few years of the loan. So, the risk - and the implications for representations and warranties - is certainly much lower at this point.

As to homeowners' reluctance and lack of information, although the HARP revision does not require it, I think the GSEs should communicate with potentially eligible borrowers and let them know that their loans are eligible under HARP at current mortgage rates.

With respect to the resistance of second lienholders, many studies suggest that second liens are no longer a major barrier to refinancing. It is very important that second lienholders participate in the program, because refinancing the first lien ameliorates the condition of the second lien, due to the fact that it frees up funds that can be used for second lien servicing.

The MI issue is a thorny one. The fact is, notwithstanding the foregoing, borrowers with MI will have fewer options than others to refinance. It remains to be seen how the proposal to waive aspects of the representations and warranties will incentivize servicers to resolve the MI debacle.

A Macroeconomic Solution

So, can revamping HARP bring new jobs and stabilize the real estate market?

One study I have read, a CBO research paper, estimates that a revised HARP, structured along the lines I've outlined above, would (1) result in $428 billion additional refinancings with annual savings to households of $7.4 billion, (2) would have a small positive effect on the GSEs' net worth, and (3) would have a small net cost to the government of less than $1 billion (which, in any event, is subsumed by the Fed's prepaid MBS portfolio).

The overall effect is to create a stimulus, since HARP beneficiaries will have higher marginal means to create demand, that is, their consumption will more than offset the opposing demand from existing MBS investors (i.e., financial institutions). Based on the studies I have read, if HARP increased GDP by as little as $1 billion per year for two or three years, the additional tax revenues would significantly exceed the costs. So, the macroeconomic effect would be net positive and stimulative.

Finally, if mortgage rates were sustained by the 2% to 2.5% range that has been a trending indicator, when combined with the HARP revisions, there would be a very substantial boost of mortgage loan originations, perhaps enough of a boost to a sizeable part of the GSE portfolio. Such an impetus would mean a re-set of trillions of dollars in asset value, and a yearly reduction in household interest expenses into the many billions.

The Fed's Role

As I see it, the Fed can weigh in forcefully in supporting the HARP revisions.

For instance, if the Fed purchased as much as $2 trillion of new MBS, then existing MBS holders would be displaced into investing that $2 trillion elsewhere. Hence, such re-investment would lead to an increase in stock prices, reduction in debenture yields, increase in real estate values, and higher foreign currency values.

A recent study, conducted by the San Francisco Fed, clearly shows that Fed purchases upward of 2$ trillion would increase GDP by more than 2% in two years and create 3 million new jobs. If the HARP refinance revisions are factored in, the overall stimulative effect would be much larger, perhaps as high as creating 4 million new jobs.

Moving forward robustly with the HARP revisions would surely lead us to conclude that the new and improved version, though coming about belatedly, is not too little, too late.

What do you think?

Please feel free to comment!

CFPB Issues Supervision and Examination Manual

On October 13, 2011, the Consumer Financial Protection Bureau (CFPB) issued its Supervision and Examination Manual - Version 1.0 (Manual). This is the first edition of a guide devoted to how the CFPB will supervise and examine consumer financial service providers under its jurisdiction for compliance with Federal consumer financial law.

The Manual is divided into three parts:

Part 1: Describes the supervision and examination process.

Part 2: Contains examination procedures, including both the general instructions and the procedures for determining compliance with specific regulations.

Part 3: Provides templates for documenting information related to supervised entities and the examination process, including examination reports.

Unfortunately, at this time Part 1 and Part 2 are only available as website pages. Part 3 is available in PDF.

However, we have created a Directory and Compendium.

At this time, Part 1 and Part 2 are only available as website pages.

Part 3 is available in PDF.

In preparing our Audit and Due Diligence procedures for our clients, we have combined all three parts into a single Directory with links to each section's text and website links. There are over 700 pages in this compendium.

Our compendium provides:

• Directory: All Sections
• Contents: Links to Compendium Text
• Contents: Links to CFPB Website Text

We are pleased to share this compilation with you for free.

Due to the huge size of the compendium - over 13 MBs - it must be downloaded from our secure Extranet. If you are interested in obtaining this compendium, please request it and we'll send you the download instructions.

Supervision and Examination Manual - Version 1.0

OUTLINE

Part I - Compliance Supervision and Examination

Supervision and Examination Process
    Overview
    Examinations

Part II - Examinations Procedures
Compliance Management Review

Unfair, Deceptive or Abusive Acts or Practices
    Narrative
    Examination Procedures

Equal Credit Opportunity Act
    Narrative
    Examination Program
    Interagency Fair Lending Examination Procedures
    Interagency Fair Lending Examination Procedures – Appendix

Home Mortgage Disclosure Act
    Narrative
    Examination Procedures
    Home Mortgage Disclosure Act Checklist

Truth in Lending Act
    Narrative
    Examination Procedures
    Appendix A: High-Cost Mortgage (§ 226.32) Worksheet

Real Estate Settlement Procedures Act
    Narrative
    Examination Procedures
    Checklist

Homeowners Protection Act
    Narrative
    Examination Procedures

Consumer Leasing Act
    Narrative
    Consumer Leasing Act Examination Procedures
    Consumer Leasing Act Checklist

Fair Credit Reporting Act
    Narrative
    Examination Procedures

Fair Debt Collection Practices Act
    Narrative
    Examination Procedures

Electronic Fund Transfer Act
    Narrative
    Examination Procedures
    Checklist

Truth in Savings Act
    Narrative
    Examination Procedures
    Checklist

Privacy of Consumer Financial Information (GLBA)
    Narrative
    Examination Procedures
    Examination Procedures Attachment
    Checklist

Mortgage Servicing Examination Procedures

Part III - Examination Process Templates
    Templates
    Entity Profile
    Risk Assessment
    Supervision Plan
    Examination Scope Summary
    Examination Report
    Examination Report cover
    Examination Report cover letter

LIBRARY

Consumer Financial Protection Bureau

Supervision and Examination Manual
Version 1.0
Announcement

October 13, 2011

Wells Fargo's "Seventeen Worthless Mortgages"

COMMENTARY: by JONATHAN FOXX

Jonathan Foxx is a former Chief Compliance Officer of two publicly traded financial institutions, and the President and Managing Director of Lenders Compliance Group, the nation’s first full-service, mortgage risk management firm in the country.

On March 1, 2011, the US Court of Appeals (Fourth Circuit) filed a Per Curiam opinion. In Wells Fargo Bank, N.A. v Old Republic Title Insurance Company, Wells Fargo sought to recover the value of "seventeen worthless mortgages" - the Court's own words! - it purchased from Financial Mortgage, Inc. (FMI), a mortgage banker, in the secondary mortgage market. The scheme involved Title Pro, an agent of Old Republic, colluding with FMI to fraudulently close the real estate transactions underlying Wells Fargo's mortgages. Wells Fargo claimed that Old Republic was contractually bound to indemnify Wells Fargo for its losses. 

The Court ruled in favor of Old Republic! Let's learn why.

Commentary and Outline

This Commentary offers a brief outline. I am leaving out citations, where possible, for ease of reading. This outline is not meant to be comprehensive, authoritative, or relied upon for legal advice. It offers only a brief synopsis of the argumentation. For citations, exhibits, and argumentation, read the judicial decision (below).

The Scheme

FMI originated mortgages and drew on its warehouse lines from several financial institutions. After the warehouse lenders advanced funds to FMI for a mortgage loan, FMI would then sell the mortgage to secondary investors, use the proceeds to pay back the warehouse lenders, and thereby replenish its lines of credit.

So far, so good.

But this is where the plot thickens.

Beginning May 2004, Wells Fargo entered into a standard Loan Purchase Agreement with FMI. This Agreement set forth the terms required by Well Fargo to purchase from FMI numerous residential mortgage loans secured by a note and deed of trust on real property, properly recorded and free from prior liens.

However, the very mortgages purchased by Wells Fargo from FMI failed at their inception, because FMI misrepresented to Wells Fargo that the mortgages were recorded in Virginia's public records system, providing Wells Fargo with first and exclusive priority over all other creditors. Eventually, Wells Fargo discovered that it actually had unsecured and/or subordinate positions on these loans, because they were not recorded nor free from the prior liens.

An Agency Agreement       

Old Republic, like most title insurance companies, appoints agents to act on its behalf to sign, countersign and issue commitments, binders, title reports, certificates, guarantees, title insurance policies, endorsements, and other agreements under which the insurer assumes liability for the condition of title.

In Old Republic's Agency Agreement with TitlePro, the latter was expressly prohibited from acting as an agent of Old Republic when, on some occasions, TitlePro might serve as a settlement agent. That is, when TitlePro performed such services, the Agency Agreement expressly prohibits TitlePro from acting as an agent of Old Republic.

FMI and TitlePro - Two Ways to Collude

Version One (Variations on a Theme) - 3 Bogus Mortgages

1) FMI secures a buyer of land or a refinancing opportunity.
2) FMI then sends the necessary mortgage documents to TitlePro.
2) TitlePro then uses the loan documents to create the appearance of loan closings (i.e., completing a HUD-1 Settlement Statement, et cetera).
3) TitlePro is now able to obtain funds from FMI's warehouse lenders (which does not include Wells Fargo).
4) After obtaining the funds, TitlePro fails to use those funds to clear title or pay off the pre-existing mortgage.
5) TitlePro transfers the funds to FMI.
6) For many transactions, FMI also creates multiple, unrecorded "first" mortgages on each property by having borrowers sign multiple sets of "original" loan documents at closing. (I'll call these "first" mortgages "bogus mortgages.")
7) FMI fabricates the notes.
8) FMI sells these unrecorded bogus mortgages to several secondary investors, including Wells Fargo.
9) In each of these transactions, FMI fails: (a) to disclose the existence of the other bogus mortgages with prior liens to purchasers of these mortgages and (b) to record the mortgages it subsequently sold.
10) Wells Fargo deals with FMI exclusively, sending payment for the notes directly to FMI's accounts.
11) Wells Fargo does not interact with TitlePro or Old Republic in any way.

Version Two - 14 Bogus Mortgages

1) TitlePro fills out a HUD-1 Settlement Statement and receives loan proceeds from the warehouse lender.   
2) The HUD-1 Settlement Statements requires TitlePro to use these funds to pay off the prior mortgages on the properties.
3) TitlePro fails to pay off the prior mortgages and release them of record.
4) TitlePro also fails to record the new mortgage in favor of FMI that "secured" the notes eventually sold to Wells Fargo.
5) In each of these transactions, FMI fails: (a) to disclose the existence of the other bogus mortgages with prior liens to purchasers of these mortgages and (b) to record the mortgages it subsequently sold.
6) Old Republic does not issue policies on these transactions, because Old Republic's Commitment letters requires the prior mortgages to be "paid and released of record" as a condition of issuing the title insurance policies.
7) For some of these transactions, Old Republic also issues a standard-form closing protection letter (CPL), agreeing to reimburse FMI for losses arising out of an issuing agent's misconduct in closing a transaction.

Scammed!

Wells Fargo now possesses seventeen worthless mortgages, all of which are presently in default.

District Court

When Wells Fargo began this action back in March 2009, it alleged six claims: (1) breach of contract; (2) a business conspiracy in violation of Virginia Code; (3) common law civil conspiracy; (4) fraud; (5) violations of Virginia's Wet Settlement Act, and (6) negligence. For all but the breach of contract claims, Wells Fargo alleged that TitlePro acted as Old Republic's agent when it closed the disputed transactions.

The District Court granted summary judgment to Old Republic because:

1) It rejected Wells Fargo's contention that Virginia's Consumer Real Estate Settlement Protection Act (CRESPA) made Old Republic liable, reasoning that CRESPA does no more than authorize non-attorneys, including title agents, who meet specific statutory conditions to serve as settlement agents.

2) It held that TitlePro did not have actual agency authority because the Agency Agreement explicitly prohibited TitlePro from acting as a settlement agent on Old Republic's behalf.

3) In accordance with Virginia law, it rejected Wells Fargo's theory of apparent authority, reasoning that Wells Fargo did not reasonably rely on Old Republic's conduct or statements allegedly cloaking TitlePro with apparent authority to act as a settlement agent on Old Republic's behalf.   

For these reasons, the District Court also granted summary judgment to Old Republic on the conspiracy, Wet Settlement Act, and fraud claims.

Plus:

4) The District Court rejected the breach of contract claim, reasoning that Old Republic could assert the same defenses against Wells Fargo as it could against the assignor of the contract, FMI, and one such defense -- fraud -- shielded it from contractual liability. (The District Court also ruled that the negligence claim failed because, in negligence claims, the common law duty protecting person or property does not extend to Wells Fargo's acquisition of worthless notes. Wells Fargo did not challenge this holding on appeal.)

Appeals Court

Wells Fargo appealed, arguing that:

(1) an assertedly "ambiguous" agency agreement and Old Republic's course of conduct raise genuine issues of material fact as to the scope of TitlePro's agency;

(2) the District Court misinterpreted CRESPA;

(3) TitlePro furthered the conspiracy by issuing title insurance instruments, as authorized by Old Republic, thus making the latter liable in conspiracy; and,

(4) a provision in Old Republic's title insurance policy absolved Wells Fargo (an innocent purchaser for value) of any fraud-based defenses Old Republic may have against FMI.

Yet the Appeals Court upheld the District Court's ruling. Why?

Back to that Agency Agreement

So, why did the Appeals Court affirm the District Court?

Because there are two provisions of the Agency Agreement, though seeming to conflict with each other, which rather serve separate, but complementary ends.

On one hand, a section requires TitlePro to record documents "necessary to insure the interest," not every document necessary to close the transaction. The primary purpose of this settlement-like duty is to "minimize the risk of loss under the title insurance policies," not create a general agency relationship capturing all the agent's settlement activities.

On the other hand, in another section, Old Republic unequivocally withholds consent for TitlePro to act as an agent when TitlePro performs "any escrow, closing or settlement" services. Courts throughout the country, including those interpreting Virginia law, agree that such an express limitation on agency duties controls.

Accordingly, Wells Fargo ran out of luck and Old Republic was off the hook.

Justice Served?

On November 13, 2008, the owner of FMI, Vijay Taneja, pled guilty to one count of conspiracy to commit money laundering in violation of federal law and received a sentence of 84 months imprisonment, to be followed by three-years of supervised release.

But what about that little matter of those "seventeen worthless mortgages?"

Click for the Per Curiam Opinion.

What do you think?

I would welcome your comments.

Please feel free to email me at any time.