Compensation: Coming or Going?

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

Prophecy is above my pay grade, but if I were a betting man - which I'm not! - I would bet on a postponement of the TILA loan officer compensation requirements currently scheduled to go into effect on April 1, 2011. Rarely have I seen such a messy roll out of a regulatory change that actually affects virtually all aspects of the mortgage banking industry in general, and mortgage brokers in particular.

Because I'm not a betting man, I hope for the best outcome for industry stability, but will prepare for the "alternative." Our clients will be as prepared as possible, whatever the situation, come April 1, 2011!

Perfect Storm - Exhibit 1: Congress

The Senate's Committee on Banking, Housing, and Urban Affairs, chaired by Tim Johnson (R-SD), is concerned that "regulators are not allowing adequate time for meaningful public comment on their proposed rules. We also believe that regulators are not conducting rigorous analyses of the costs and benefits of their rules and the effects those rules could have on the economy."

Dated February 15, 2011, the letter was sent by ten members of the Committee to Timothy Geithner of the Treasury, Gary Gensler of the CFTC, Sheila Bair of the FDIC, Ben Bernanke of the FRS, Mary Schapiro of the SEC, and John Walsh of the OCC.

In their letter, the Senators observe what has become abundantly obvious to most industry members: "the unprecedented scope and pace of agency rulemakings under the Dodd-Frank Act make it more important than ever that agencies engage in deliberative and rational rulemaking."

The letter enumerates five questions for the recipients to answer, and here is my abbreviated version:

1. Will the respective agencies provide at least 60 days for public comment on all proposed rules and studies required by the Dodd-Frank Act?

2. What steps are being taken to ensure that the rules you adopt under the Dodd-Frank Act are the least burdensome way to achieve the statutory mandate. (Provide how those steps satisfy the obligations under the Administrative Procedure Act and other applicable statutes to conduct cost-benefit and economic impact analyses.)

3. What steps are being taken to ensure that all empirical data and economic analyses submitted by commenters are thoroughly considered before a final rule is adopted.

4. What steps are being taken to ensure that the respective agency is acting in coordination with other agencies charged with adopting related rules? (How is this coordinating being established?)

5. Given the importance of rigorous cost-benefit and economic impact analyses and the need for due consideration of public comments, would additional time for adoption of the Dodd-Frank Act rules improve the respective agency's rulemaking process and the substance of its final rules?

Perfect Storm - Exhibit 2: SBA Office of Advocacy

The SBA Office of Advocacy has written not one, but two letters to the FRB, expressing concern that the "Federal Reserve has not analyzed properly the full economic impact of the proposal on small entities as required by the Regulatory Flexibility Act (RFA)" and recommending that the FRB prepare an initial regulatory flexibility analysis (IRFA).

The result of the first letter, dated January 13, 2011, brought forth from the FRB a "compliance guide" on January 26, 2011.

I put that FRB issuance in quotes, because (as previously noted) it is 'inadequate, incomplete, and regurgitates most features of the "already known" aspects of the Regulation Z final rule amendments affecting loan officer compensation.' Best as I can tell, the "compliance guide" seemed meant to be a rush-job response to SBA's January 13, 2011 letter. In other words, this "compliance guide" is 'a transparent attempt to satisfy a regulatory requirement, though the dubious result adds little to an overall resolution.'

In response to the FRB's "compliance guide," the SBA issued a second letter on January 26, 2011 to the FRB, noting specifically that the "guide may not meet the requirements of the Small Business Regulatory Enforcement Fairness Act (SBREFA)." The SBA letter points up the flaws in the "compliance guide," suggests that revisions should be made to it, and requests postponement.

The FRB's response to the SBA's second letter is, essentially, silence.

Perfect Storm - Exhibit 3: Lawsuits and Consternation

Several industry groups have expressed an intention to sue the FRB, or pursue some form of judicial recourse, with the aim of preventing implementation of the loan officer compensation rule on April 1, 2011. As but one example, the National Association of Independent Housing Professionals (NAIHP) is threatening to sue the FRB within the next few days. NAIHP has invited the NAMB to join them in their suit against the FRB. 

According to a statement posted on the NAIHP website, the organization has been preparing legal action against the FRB for almost 2 months. Marc Savitt, the organization's President, states that preparation for their lawsuit has included "interviewing law firms, lining up expert witnesses, research, countless hours of planning and most importantly, raising funds."

In December, the Mortgage Bankers Association (MBA) sent a 19 page, carefully written and comprehensive letter to the FRB's Ben Bernanke  and Sandra F. Braunstein of its Consumer and Community Affairs Division. Under the rubric of "Questions on Federal Reserve Loan Originator Compensation Rule," the MBA lists 42 (sic) topics, plus sub-topics, of concern, confusion, and uncertainty, mixed with requests for clarity, interpretive guidance, and statutory support.

The Impact Mortgage Management Advocacy & Advisory Group (IMMAAG) has been very involved in seeking to "delay implementation until the appropriate impact studies have been concluded "or at least delay implementation to allow for a 'real' guide to be published and to allow the industry to absorb it and get questions answered."

The National Association of Mortgage Brokers (NAMB) has weighed in mightily and has intimated their interest in pursuing a legal remedy if nothing else will work. The NAMB is also threatening now to take "legal action." (Video)

In January, Michael J. D'Alonzo, President of the NAMB sent a letter to the FRB's Bernanke and Braunstein, requesting a delay in implementation of the loan officer compensation requirements, based in part on alleging that the FRB "has no legal basis for treating mortgage broker companies differently than other firms  carrying out the same or substantially similar business operations" and expressly seeking "clarification as to why the Rule permits  one class of mortgage market participants to: (1) receive incentive compensation based upon the type of loan originated; (2)  reduce their own compensation or income in order to capture more business; and (3) remain exempt from restrictions and  prohibitions set forth in the Rule, while other classes of market participants are held to significantly different standards."

Perfect Storm or Safe Harbor

The new loan officer compensation requirements have produced a plethora of webinars, lectures, training videos, questionnaires, surveys, so-called automated solutions, breakout sessions, magazine and news articles - a virtual cottage industry of Google Ads proclaiming "End-to-end mortgage automation solution for bankers and lenders," and "Confused About Dodd-Frank Changes? Sign Up For Onsite/Webinar Training."

In many of the aforementioned venues, speculation is a proxy for regulatory fact. Having a famous speaker or bigwig compliance professional opining on uninterpreted and unclarified TILA statutes makes me uneasy. There just is no replacement for regulatory guidance. Period!

Here's the reality: the largest loan originators and creditors will fend for themselves in this de facto unregulated environment, and all others will fall in line, unless and until the FRB provides clarification or delays implementation. Otherwise, the notion that the large originators get to make the interpretation of federal statutes, in the absence of the FRB interpreting them concisely, unambiguously, and cogently, is all a bit too Darwinian for my taste!

This is precisely why FRB regulations are promulgated: to assure a stable market and to avoid large companies determining for all the other companies what the FRB means. Furthermore, impact of the new loan officer compensation rules on the industry is a fundamental feature of any such foundational change to the residential real estate finance market. How is it even conceivable that such a change can be implemented without comprehensive impact studies required by federal statutes?

This is not a wave, but a tsunami of confusion with no safe harbor in sight - yet!

I am not a prophet, but betting on a delay seems like a good bet!

Be prepared to implement the loan officer compensation rules on April 1, 2011 - and be sure to consult competent compliance professionals for guidance - even if this dynamic environment continues to cause confusion and ambiguity. But, in the absence of the FRB adequately responding to its role in this debacle it is also wise to do what you can to stand up for the greater good of all market participants.

What do you think?

I would welcome your comments.

Please feel free to email me or leave your comments below.

SBA - 2nd Request to Postpone New LO Compensation Rules

Yesterday I notified you about the so-called "small entity compliance guide" issued on January 26, 2011 by the Federal Reserve Board. 

The "Guide" is inadequate, incomplete, and regurgitates most features of the "already known" aspects of the Regulation Z final rule amendments affecting loan officer compensation. 

That rule is scheduled to go into effect on April 1, 2011.

As you may know, I am writing an article on this subject - which will be published in March 2011 in the National Mortgage Professional Magazine - so I am watching this issue pretty closely and have had numerous discussions with industry members, such as compliance counsel, corporate officers, mortgage loan originators, and even a few lobbyists and politicians.

It is now clear to me that FRB's "Guide" is probably meant to be a response to the January 13, 2011 letter from the SBA's Office of Advocacy, which expressed concern, among other things, that the "the Federal Reserve has not analyzed properly the full economic impact of the proposal on small entities as required by the Regulatory Flexibility Act (RFA)." That is, the "Guide" is a transparent attempt to satisfy a regulatory requirement, though the dubious result adds little to an overall resolution.

Let's read the basis for the authority of the SBA's Office of Advocacy (Advocacy), as stated in its January 13, 2011 letter that: (My emphasis) 

• "Congress established the Office of Advocacy under Pub. L. 94-305 to represent the views of small business before Federal agencies and Congress. Because Advocacy is an independent office within the Small Business Administration (SBA), the views expressed by Advocacy do not necessarily reflect the views of the SBA or of the Administration. Section 612 of the Regulatory Flexibility Act (RFA) requires Advocacy to monitor agency compliance with the Act, as amended by the SBREFA. In 1980, Congress enacted the RFA after determining that uniform federal regulations produced a disproportionate adverse economic hardship on small entities. In order to minimize the burden of regulations on small entities, the RFA mandates that federal agencies consider the potential economic impact of federal regulations on small entities.
• In 1996, Congress amended the RFA with SBREFA. Among other things, SBREFA requires agencies to provide plain English compliance guides to clearly explain each final rule that has a significant economic impact on a substantial number of small entities. The intent of section 212 of SBREFA is to ensure that small businesses have a way to understand complex and technical federal regulations."

Advocacy's January 13, 2011 letter recommended that the Board publish a "compliance guide in the immediate future and extend the time for small entities to comply to reflect the delay in the availability of the guide." 

Obviously, Advocacy must have believed that the FRB would provide a robust and comprehensive compliance guide. But that has not been forthcoming, while the effective date of April 1, 2011 draws ever closer.

Today, February 1, 2011, Advocacy issued yet another letter to the FRB, again asking for a postponement and this time specifically enumerating the expectations of what constitutes satisfaction of compliance with Section 212(a)(4) of SBREFA, the section that sets up the requirements of a compliance guide.

The following outline provides my brief synopsis of Advocacy's letter to the FRB.

Best wishes,
Jonathan

Synopsis of Advocacy Letter  

Citation

(4) Compliance actions.
(A) In general.--Each guide shall explain the actions a small entity is required to take to comply with a rule.
(B) Explanation.--The explanation under subparagraph (A)--

(i) shall include a description of actions needed to meet the requirements of a rule, to enable a small entity to know when such requirements are met (emphasis added); and

(ii) if determined appropriate by the agency, may include a description of possible procedures, such as conducting tests, that may assist a small entity in meeting such requirements, except that, compliance with any procedures described pursuant to this section does not establish compliance with the rule, or establish a presumption or inference of such compliance.

(C) Procedures.--Procedures described under subparagraph (B)(ii)--

(i) shall be suggestions to assist small entities; and

(ii) shall not be additional requirements, or diminish requirements, relating to the rule.

(5) Agency preparation of guides.
The agency shall, in its sole discretion, taking into account the subject matter of the rule and the language of relevant statutes, ensure that the guide is written using sufficiently plain language likely to be understood by affected small entities. Agencies may prepare separate guides covering groups or classes of similarly affected small entities and may cooperate with associations of small entities to develop and distribute such guides. An agency may prepare guides and apply this section with respect to a rule or a group of related rules.

Has the FRB met its Obligations?

Points raised by Advocacy include:

• Concern that the FRB has not met the obligation to "include a description of actions needed to meet the requirements of a rule, to enable a small entity to know when such requirements are met."

• The guide does not have sufficient information to enable a small entity to know when the requirements have been met.

• The guidance answers almost none of the questions that the industry has about the rule and view it as simply a summary of a complex issue and not guidance on how to comply with the requirements of the rule.

• The FRB has an obligation to provide the industry with a description of the actions needed to comply with Regulation Z in a manner specific enough that will enable a small entity to know if it has met the requirements of the rule.

The FRB should amend the compliance guide to provide appropriate instructions.

Facilitating Revisions to the Guide

Points raised by Advocacy include:

• Advocacy is available to facilitate a meeting between the small entities and the FRB in terms of clarifying which issues the small entities believe need clarification and guidance.
• Advocacy believes that such a meeting would not only benefit the small entities, but it would provide the FRB with some insight into the problematic areas of the rule.

Consumer Advocacy

Points raised by Advocacy include:

• It is important for consumers to receive services from businesses that fully comprehend the requirements of this rule.
• Issuing a proper compliance guide not only helps the small entities, it also assists the Board in meeting its goal of protecting consumers.

Postponement Request

Points raised by Advocacy include:

• Because the effective date of the rule is rapidly approaching at a time that industry does not feel as though it has workable guidance, Advocacy once again encourages the FRB to postpone the implementation date for small entities.
• A delay to educate small entities on the proper implementation of the requirements of the rule will benefit the entities and the consumers who utilize their services.

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Letter from SBA Office of Advocacy to Federal Reserve Board
February 1, 2011

FRB's Loan Officer Compensation "Guidance"

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 January 26, 2011, the Federal Reserve Board issued a "Guide" - a "small entity compliance guide"  required under Section 212 of the Small Business Regulatory Enforcement Fairness Act of 1996 (SBREFA), as amended. 

I have placed "Guide" in quotes because I haven't seen such a perfunctory and virtually useless issuance from the FRB in quite a long time in a matter of such consequence!

It seems to me that the "Guide" is more of a reaction to the January 13, 2011 letter from the SBA's Office of Advocacy, which expressed concern, among other things, that the "the Federal Reserve has not analyzed properly the full economic impact of the proposal on small entities as required by the Regulatory Flexibility Act (RFA)."

If this is meant to be a response to that letter, and to comply with the SBREFA, it falls far short of the mark; and, in any event, it surely doesn't seem to fulfill the statutory requirements carefully reasoned in the SBA's letter. 

Much of the FRB "Guide" is no more than a regurgitation of the "already known" aspects of the Regulation Z amendments affecting loan officer compensation. I doubt our clients will get much help from this document!

The SBA's letter recommended that the Board publish a compliance guide in the immediate future and extend the time for small entities to comply - now scheduled for April 1, 2011 - to reflect the delay in the availability of the guide. 

To quote directly from the SBA letter:

• "Small entities have indicated that the requirements of some of these changes are unclear and confusing. They are concerned that the lack of clarity may lead to problems in compliance.

• Advocacy reviewed the Board's website. Advocacy commends the Board for having a SBREFA compliance guide page on its website. However, although there are compliance guides for Regulations C, D, E, F, H, I, J, L, M, O, P, R, V, X, AA, BB, CC, DD, and GG, Advocacy was unable to find a compliance guide for Regulation Z."

Nevertheless, at this time it does not appear that a delay is being seriously considered.

In reviewing our Library and Archives, it appears that we have well over 300 documents on the subject of loan officer compensation. So I decided to open a new section in the Library devoted to COMPENSATION - MLOs. Over time, it will receive more and more relevant documents. Check back or bookmark the page, if you want to keep track of this controversial subject.

At this time, I am completing an article that will be published in the March 2011 edition of National Mortgage Professional Magazine, the country's premier magazine of the mortgage industry. The article will cover, comprehensively and practically, the salient features of loan officer compensation that will become effective on April 1, 2011. 

Moreover, my article will provide clear guidelines to assist mortgage loan originators in understanding and applying compensation requirements. 

In the meantime, we will watch the situation closely and provide updates, where needed.

Best wishes,
Jonathan Foxx

Some Highlights of the "Guide"

Definitions of a Loan Originator and Mortgage Broker:

• All persons who originate loans, including mortgage brokers and their employees, as well as mortgage loan officers employed by depository institutions and other lenders.

Payments based on transaction terms or conditions:

• Prohibits a creditor or any other person from paying, directly or indirectly, compensation to a mortgage broker or any other loan originator that is based on a mortgage transaction's terms or conditions, except the amount of credit extended.
• Compensation can neither be increased nor decreased based on the loan terms or conditions.
• When the creditor offers to extend a loan with specified terms and conditions (such as rate and points), the amount of the originator's compensation for that transaction is not subject to change, based on either an increase or a decrease in the consumer's loan cost or any other change in the loan terms.
• The amount of credit extended is deemed not to be a transaction term or condition of the loan for purposes of the prohibition, provided the compensation payments to loan originators are based on a fixed percentage of the amount of credit extended. (Such compensation may be subject to a minimum or maximum dollar amount. The minimum or maximum amount may not vary with each credit transaction.)
• Creditors may use other compensation methods to provide adequate compensation for smaller loans, such as basing compensation on an hourly rate, or on the number of loans originated in a given time period.
• An originator that increases the consumer's interest rate to generate a larger yield spread premium can apply the excess creditor payment to third-party closing costs and thereby reduce the amount of consumer funds needed to cover upfront fees. (There is no prohibition from using the interest rate to cover upfront closing costs, as long as any creditor-paid compensation retained by the originator does not vary based on the transaction's terms or conditions.)

Payments by persons other than the consumer:

• If compensation is received directly from a consumer in a transaction, no other person may provide any compensation to a loan originator, directly or indirectly, in connection with that particular credit transaction.
• Payments made by creditors to loan originators are not payments made directly by the consumer, regardless of how they might be disclosed under HUD's Regulation X, which implements the Real Estate Settlement Procedures Act (RESPA).

Prohibition on steering and allowance of Safe Harbor:

• Prohibits a loan originator from "steering" a consumer to a lender offering less favorable terms in order to increase the loan originator's compensation.

• Provides a safe harbor to facilitate compliance:

To be within the safe harbor, the loan originator must obtain loan options from a significant number of the creditors with which the originator regularly does business.

The loan originator can present fewer than three loans and satisfy the safe harbor, if the loan(s) presented to the consumer otherwise meet the criteria in the rule. For each type of transaction, if the originator presents to the consumer more than three loans, the originator must highlight the loans that satisfy the criteria specified in the rule.

The safe harbor is met if the consumer is presented with loan offers for each type of transaction in which the consumer expresses an interest (that is, a fixed rate loan, adjustable rate loan, or a reverse mortgage); and the loan options presented to the consumer include:

(A) the loan with the lowest interest rate for which the consumer qualifies;

(B) the loan with the lowest total dollar amount for origination points or fees, and discount points, and

(C) the loan with the lowest rate for which the consumer qualifies for a loan without negative amortization, a prepayment penalty, interest-only payments, a balloon payment in the first 7 years of the life of the loan, a demand feature, shared equity, or shared appreciation; or, in the case of a reverse mortgage, a loan without a prepayment penalty, or shared equity or shared appreciation.

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FRB - Small Entity Compliance Guide - Regulation Z:
Loan Originator Compensation and Steering,
12 CFR 226 (1/26/11)
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