First Circuit Ruling in Foreclosure Litigation May Help Lenders Facing HAMP-Related Claims

The law is well settled that borrowers do not have a direct right of action under the Home Affordable Modification Program (HAMP) against a lender that fails to offer a loan modification. A split of authority continues, however, on whether a lender owes a borrower either a contractual obligation or a tort-based duty of care in its negotiation and consideration of a borrower's loan modification application. Last month, the U.S. Court of Appeals for the First Circuit joined the fray by issuing a decision that should be helpful to lenders facing common law HAMP-related claims.

Specifically, in MacKenzie v. Flagstar Bank, FSB, the First Circuit affirmed the district court's dismissal of the borrowers' breach of the implied covenant and negligence claims. The borrowers had alleged, among other things, that the lender violated the implied covenant of good faith and fair dealing by proceeding with the foreclosure sale after they submitted a completed HAMP application.

The complaint alleged the borrowers were intended third-party beneficiaries of the Servicer Participation Agreement (SPA) between the lender and Fannie Mae (acting as agent for the U.S. Department of the Treasury). The borrowers also alleged that the lender owed them a duty as third-party beneficiaries of the SPA and breached its obligations under the HAMP and other government programs the SPA incorporates.

The First Circuit held the implied duty of good faith that arises from the mortgage "is tied directly to the mortgagee's contractual right to exercise a power of sale" and simply requires the lender to sell the property for the "highest value possible." In addition, because the borrowers were not third-party beneficiaries of the SPA, the court held they could not base a claim for negligence on that agreement. Finally, the court held that because "[t]he relationship between a borrower and lender does not give rise to a duty of care under Massachusetts law," the borrowers could not premise a negligence claim solely on an alleged HAMP violation.

Other state and federal courts have dismissed common law claims premised on a breach of HAMP on the same or similar grounds as did the First Circuit in MacKenzie. For example, some courts have held that HAMP extends no legal rights to borrowers—including the benefit of the covenant of good faith—because borrowers are not parties to HAMP and have no independent authority to enforce it. By contrast, other courts have determined that the lender could owe a borrower a duty of care in negotiating or processing a loan modification application, the breach of which could result in a negligence-based claim.

Still, the law in this area remains unsettled. Both lenders and servicers would be well advised to seek legal counsel in setting servicing protocols and defending against allegations of a breach of HAMP or other claims derivative of such a breach.

- John G. Kerkorian, Lisa A. Lee, and Justin Angelo  


N.Y. Attorney General Announces Newly Formed Financial Crimes Bureau, Appoints Its New Chief

New York Attorney General Eric T. Schneiderman recently announced the establishment of a new Criminal Enforcement and Financial Crimes Bureau and the appointment of a veteran financial crimes prosecutor, Gary Fishman, as its chief. The new bureau, which expands the Attorney General's former Criminal Prosecution Bureau, will focus on prosecuting complex and large-scale financial crimes.

According to Mr. Schneiderman's announcement, the reorganization will focus on combatting crimes in the banking and mortgage sectors, as well as other typical "white collar" crimes, such as securities and investment fraud, money laundering, tax crimes, and insurance fraud. The Attorney General stated that the newly created bureau "will ferret out the bad actors in our critically important financial sector in order to protect our economy and investors. Financial industry leaders who play by the rules deserve a level playing field, and those bad actors who seek to take advantage of their competitors and their neighbors must be stopped and punished."

The new bureau also will form a Financial Intelligence Section. The Attorney General explained that its purpose will be "to initiate investigations into illicit financial activities and track the flow of suspicious funds by reviewing banking, regulatory, law enforcement, and open-source data to identify trends that will enhance the investigation and prosecution of financial crime schemes."

The new head of the bureau, Mr. Fishman, has almost 20 years of experience as a prosecutor. He joined the Attorney General's Office in 2012, serving as Senior Investigative Counsel to the Division of Criminal Justice. Previously, he was the managing director of a private investigatory firm, where he conducted and supervised complex investigations on behalf of institutional clients. He also was a 15-year prosecutor in the Manhattan District Attorney's Office, where he served as the Principal Deputy Chief of the Major Economic Crimes Bureau.

Attorney General Schneiderman's creation of this bureau, headed by a seasoned white-collar prosecutor, is a major commitment to enhanced criminal investigation and enforcement in the financial industry under New York state laws and regulations. This focus may be especially significant for the banking and financing industries, particularly in the mortgage sector, all of which have extensive activities in New York. Banks, lenders, mortgage servicers, and other financial institutions, as well as their officers and executives, may be subjected to heightened scrutiny in New York in the coming days.

- Scott M. Himes


Washington Amends Its Consumer Loan Act Licensing Regulations

The Washington Department of Financial Institutions (Department) recently issued a new rule clarifying the licensing requirements for individual managers of Consumer Loan Company Licensees. The new rule became effective on January 1, 2014.

The rule states that a Consumer Loan Company Licensee's managers, including branch managers, must be licensed individually as MLOs if they conduct any of the following activities:

  • Take residential mortgage loan applications, negotiate the terms or conditions of residential mortgage loans, or hold themselves out as being able to conduct these activities
  • Supervise a licensee's loan processors or underwriting employees
  • Supervise a licensee's licensed MLOs

In response to questions from the industry, the Department issued guidance clarifying the new rule, which includes several significant points:

  • All Washington MLOs must work from a licensed location.
  • Any manager who directly supervises loan processor or underwriting employees must hold an MLO license. That manager's MLO license can be from any state, however. 
  • Any manager who directly supervises Washington-licensed MLOs must themselves hold a Washington MLO license.
  • Regarding managers who directly supervise Washington-licensed MLOs, loan processors, or underwriters, the Department requires licensure of the day-to-day operational supervisors.
  • A written supervisory plan must be kept as part of a licensee's business books and records. This plan must include consideration of the location of the supervisor and the employees supervised, the number of employees supervised, and the volume of work performed by the supervised employees.

Separately, the Department amended an existing rule related to office licensing requirements. According to the revised rule, no licensing is required for offices that solely provide loan processing or underwriting or other back-office services on loans and only have incidental contact with borrowers. Any location where a licensed MLO works must be licensed, however.

Despite the Department's guidance, a number of issues remain unclear, including the number of employees a single, licensed manager can oversee, and whether employees can be managed from an MLO at another location. While not entirely clear, based on the interplay of the two rules, it appears that the Department contemplates a possible scenario in which processing and underwriting activity can occur at an unlicensed location, and be managed by a licensed MLO working out of a different, licensed location.

Reid F. Herlihy and Marc D. Patterson


FTC Continues Aggressive FCRA Enforcement against Data Brokers

The Federal Trade Commission continues to aggressively enforce the Fair Credit Reporting Act (FCRA) against data brokers, as shown by its recent settlement with TeleCheck Services, Inc. The settlement requires TeleCheck to pay a $3.5 million civil penalty (matching the FTC's second largest penalty in a FCRA case).

TeleCheck, a check authorization service company, is deemed a "data broker" by the FTC because it compiles, maintains, and sells sensitive consumer information. The FTC also deems the check authorization recommendations that TeleCheck provides to merchants to be "consumer reports," making TeleCheck a "consumer reporting agency" (CRA) under the FCRA.

The FTC's press release announcing the TeleCheck settlement describes the matter as "part of a broader initiative to target the practices of data brokers." According to recent FTC testimony to Congress, that initiative includes ongoing examination of data broker privacy practices as well as aggressive enforcement. Recent FTC enforcement activity has included warning letters to providers of rental histories and an enforcement action against an employment background screening company. Like the TeleCheck settlement, all of these actions focus on data broker compliance with the FCRA.

The FCRA requires a merchant who rejects a consumer's check based on TeleCheck's recommendation to give the consumer an adverse action notice. In addition to other mandated disclosures, the notice must advise the consumer that the rejection was based on TeleCheck's information and that the consumer has the right to dispute that information with TeleCheck.

The FTC's complaint charged that TeleCheck violated the FCRA's requirement for it to conduct, upon receiving a consumer's dispute, a reasonable reinvestigation to determine the accuracy of the disputed information. Among TeleCheck's alleged unlawful actions were:

  • Incorrectly informing consumers that the FCRA only allows them to dispute the transaction amount or date and whether services were rendered
  • Instructing consumers who stated that they did not authorize a transaction to, under certain circumstances, contact the merchant rather than initiating a reinvestigation by TeleCheck
  • Under certain circumstances, refusing to reinvestigate and/or clear information disputed by a consumer alleging fraud unless the consumer provided a police report identifying the suspect and agreed to participate in the suspect's prosecution

The complaint also alleges that TeleCheck failed to comply with various FCRA timing requirements for reinvestigations. These requirements include the 30- or 45-day periods for completing reinvestigations, as well as the five-business-day time period for notifying furnishers of disputed information and notifying consumers of the results of either a completed reinvestigation or when a reinvestigation was terminated because the dispute was determined to be frivolous or irrelevant. In addition, TeleCheck was alleged to have failed to promptly correct errors in its consumer files.

A debt collector affiliated with TeleCheck also was charged with violating the FCRA. The FTC alleged that the collector failed to comply with the FTC's "Furnisher Rule," which requires furnishers of consumer information to CRAs to establish and implement reasonable procedures regarding such information and consider the rule's guidelines. The complaint alleges that the debt collector failed to consider the guidelines in its written policies and procedures regarding the accuracy of information it furnished to TeleCheck. In addition to payment of the $3.5 million civil penalty, the settlement includes injunctive relief that requires TeleCheck and the collector to comply with relevant FCRA and Furnisher Rule requirements.

- Barbara S. Mishkin


OCC Releases Guidelines on 'Heightened Expectations' for Large National Banks and Savings Associations

The Office of the Comptroller of the Currency (OCC) recently released proposed amendments to its Part 30 regulations, which reflect the agency's "heightened expectations" for large banks. That release, styled as an "Interim Final Rule," contains detailed risk-management standards for institutions with more than $50 billion in assets. It also places greater responsibility on board members, particularly independent directors, to ensure that the rules are followed and to require that banks have independent audit and risk-management officers who can go straight to the board with concerns.

There is concern that these rule changes could be applied more broadly across the industry. As we noted in a previous alert dealing with new OCC standards for third-party relationships, Comptroller Thomas J. Curry alluded to the "heightened expectations" in his September 2013 speech to an American Banker symposium. While the Interim Final Rule, like the Comptroller's speech, is targeted at large institutions, there is a strong likelihood that, over time, there will be a "trickle down" effect that will result in many of these guidelines being relied on by examiners—and imposed upon smaller institutions—as "best practices." 

Furthermore, in the Interim Final Rule OCC has explicitly reserved authority to apply the guidelines to an institution with less than $50 billion in assets if the OCC determines that it is highly complex or otherwise presents a heightened risk. For these reasons, we are encouraging all depository institutions—regardless of size—to analyze these guidelines and begin planning a compliance program tailored to their size, risk profile, and complexity.

The proposed "heightened expectation" standards have intentionally been issued in the form of guidelines, rather than as rules, to give OCC more flexibility in determining whether to require the institution to submit a formal remediation plan. The standards are authorized by Section 39 of the Federal Deposit Insurance Act, which authorizes the appropriate federal banking agency to prescribe safety and soundness standards in the form of either regulations or guidelines. The standards are enforceable under existing provisions in the Part 30 regulations.  

The Interim Final Rule's guidelines apply to any national bank, federal savings association, or insured federal branch of a foreign bank, so long as it has average total consolidated assets of $50 billion or more measured on the basis of average total consolidated assets for the previous four calendar quarters. Unlike other regulatory regimes predicated on asset size, once that threshold is crossed, there is no turning back—even if the institution has four quarters with less than $50 billion in total consolidated assets.

The guidance calls for a much more rigorous governance framework (the Framework) for enterprise-wide risk management and identifies discrete roles to be played by such components as front line units, independent risk management, and internal audit. The bank can share its parent's Framework if there is 95 percent overlap; otherwise, it must have its own Framework. The bank should also have a comprehensive, written risk appetite statement that serves as the basis for the Framework. This statement should include both qualitative components and quantitative limits.

A much more proactive role is expected for the directors, who are required to:

  • Oversee the bank's compliance with safe and sound banking practices
  • Establish and implement an effective Framework
  • Provide active oversight of management (including critical evaluation of management's recommendations and decisions by questioning, challenging, and, where necessary, opposing management's proposed actions)
  • Exercise sound, independent judgment

In addition, the board of directors should have at least two independent members who are not part of the bank's or the parent company's management. These independent directors should be given ongoing training on the panoply of the bank's products, services, business lines, and risks, as well as on laws, regulations, and supervisory requirements applicable to the bank.

OCC is requesting comment on all aspects of the Interim Final Rule. Further, consistent with OCC's efforts to integrate the former Office of Thrift Supervision regulations, the release is also requesting comment on its proposal to make Part 30 and all of its appendices applicable to federal savings associations and to remove as superfluous Part 170, which contains comparable regulations that apply to federal savings associations. The deadline for comments is 60 days from the date of publication in the Federal Register (which occurred on January 27, 2014).

- Keith R. Fisher


Volcker Rule Agencies Issue Interim Final Rule Exempting TruPS-backed CDOs

The five agencies that jointly issued the final regulation implementing the Volcker Rule (the Final Rule) in December recently issued an interim final rule (the Interim Rule) that exempts collateralized debt obligations backed by trust-preferred securities, also known as TruPS CDOs, from the Final Rule's broad restrictions.

As noted in a previous alert, inclusion of these securities within the coverage of the Final Rule led to a petition for judicial review filed by some banks and the American Bankers Association (ABA). While the Interim Rule will provide relief to smaller banking entities that qualify for the exemption, it is narrowly drawn and will not cover all similarly situated institutions.

The agencies that promulgated the Volcker Rule (collectively, the Agencies) are the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), the Commodity Futures Trading Commission (CFTC), and the Securities and Exchange Commission. Though only the three bank regulators (OCC, the Federal Reserve, and FDIC) were named respondents in the litigation, the two market regulators (SEC and CFTC) also participated in this effort to resolve the dispute.

The petitioners in the litigation assert that TruPS CDOs are debt securities, whereas the Volcker Rule, enacted by Section 619 of the Dodd-Frank legislation, is targeted only at equity investments. Another provision of Dodd-Frank, Section 171 (commonly referred to as the Collins Amendment), grandfathered, for purposes of regulatory capital, TruPS CDOs issued before May 19, 2010, by holding companies with $15 billion or less in total consolidated assets.

The Agencies are attempting to reconcile Volcker Rule interests with those of the Collins Amendment. The Interim Rule does not formally amend the Final Rule but co-exists as a separate but complementary regulation. It provides that the covered fund restrictions of the Final Rule are inapplicable to a banking entity's owning an interest in, or sponsoring, any issuer of TruPS CDOs provided three conditions are met:   

  • The issuer was established, and the interest was issued, before the Collins Amendment grandfathering date, May 19, 2010.
  • The banking entity reasonably believes that the offering proceeds received by the issuer were "invested primarily" in "Qualifying TruPS Collateral."
  • The banking entity acquired the interest on or before December 10, 2013 (the date the Final Rule was issued), or acquired the interest in the course of a merger with or acquisition of a banking entity that itself acquired the interest on or before that date.

Regarding the second condition, according to the Agencies, the term "invested primarily" focuses on securitizations where a majority of the offering proceeds were invested in "Qualifying TruPS Collateral." Such collateral is defined as "any trust preferred security or subordinated debt instrument issued prior to May 19, 2010 by a depository institution holding company that, as of the end of any reporting period within 12 months immediately preceding the issuance of such trust preferred security or subordinated debt instrument, had total consolidated assets of less than [$15 billion] or issued prior to May 19, 2010 by a mutual holding company."

According to the Agencies, the exemption is targeted only at issuers formed primarily for the purpose of investing primarily in "Qualifying TruPS Collateral." The exemption will not, however, cover obligations that display some similarities with TruPS CDOs, such as debt securities of collateralized loan obligations.

Following issuance of the Interim Rule, the ABA announced that it was dropping its request for emergency judicial relief but will maintain the litigation, at least for now, while the association consults with its membership on the "impact and implications" of the Interim Rule.

The Interim Rule is open for comment. Some issues worthy of comment are:  

  • Whether the exemption should be enlarged to cover issuers that were not formed (primarily or otherwise) for the purpose of "investing primarily" in "Qualifying TruPS Collateral"
  • Whether the Interim Rule is fully consistent with both the Volcker Rule and the Collins Amendment

Ballard Spahr's Consumer Financial Services Group and Bank Regulation and Supervision Group include experienced lawyers who, among other things, counsel banking clients and their boards of directors and senior management on a variety of transactional and compliance issues and have already over the past two years provided advice and counsel to clients on the basis of the Proposed Volcker Rule. The firm also assists clients in the preparation and filing of comments in agency rulemaking proceedings.

- Keith R. Fisher


DID YOU KNOW?

Illinois Revises Residential Mortgage License Act Regulations

The Illinois Division of Banking recently amended the regulation controlling application fees under the Mortgage License Act. As a result of the change, made on January 17, 2014, an exempt entity registration fee has been added for each application for initial registration or annual renewal in the amount of $2,700. The amendment also changes the requirement to include an MLO's state license number to the use of the unique identifier in the NMLS in loan brokerage agreements and loan logs.

The amendment is effective immediately. 

- Marc D. Patterson


Copyright © 2014 by Ballard Spahr LLP.
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This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.



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