CFPB Settles Second Loan Originator Compensation Case

BThe Consumer Financial Protection Bureau entered into a stipulated order and final judgment with Franklin Loan Corporation (Franklin) to settle allegations that Franklin paid its employee loan originators compensation based on the interest rates charged on mortgage loans in violation of the Regulation Z loan originator compensation rule. Without admitting or denying the allegations, Franklin agreed to pay $730,000 in connection with the settlement. The CFPB advised in announcing the settlement that it did not seek a civil money penalty based on Franklin’s financial condition and the CFPB’s desire to maximize relief available directly from Franklin to affected customers.

The alleged conduct occurred before January 1, 2014, and was subject to the original loan originator compensation rule adopted by the Federal Reserve Board under Regulation Z. On January 1, 2014, a revised version of the rule adopted by the CFPB under Dodd-Frank became effective.

The CFPB alleges that before the original loan originator compensation rule became effective on April 6, 2011, Franklin would pay its employee loan originators a “commission split” that was between 65 percent and 70 percent of the gross loan fees, that included the origination fee, discount points, and retained cash rebate. According to the CFPB, the retained cash rebate was the portion of the rebate created by a premium interest rate set by the loan originator that was retained by Franklin and not credited to the borrower. The CFPB asserts that this compensation method encouraged the loan originators to place consumers in higher interest rate mortgage loans.

The CFPB also asserts that Franklin realized that the loan originator compensation rule would prohibit this compensation method, as the rule does not permit a loan originator to be compensated based on the terms of a mortgage loan (other than compensation based on a fixed percentage of the loan amount). According to the CFPB, Franklin wanted to continue to pay its loan originators financial incentives to originate high-interest mortgage loans, and devised a new compensation plan. The CFPB alleges that under the new plan, Franklin would pay its loan originators both an upfront commission based on a set percentage of the loan amount and a quarterly bonus paid from the loan originator’s individual “expense account,” and that contributions to the “expense account” were based on a percentage of the retained rebate on each loan.

The CFPB considered the contributions to the expense account, which ultimately were paid to the loan originator as a quarterly bonus, to be based on the interest rates charged on the originator’s loans. The CFPB viewed the bonus payments as compensation that violated the loan originator compensation rule. The $730,000 settlement amount was the total amount of quarterly bonuses that the CFPB asserts were paid by Franklin to its loan originators from June 2011 to October 2013.

This is the second settlement entered into by the CFPB based on alleged violations of the loan originator compensation rule. (We reported previously on the earlier settlement with Castle & Cooke Mortgage.)

The mortgage industry should take note of CFPB activity in this area. The CFPB likely will focus on loan originator compensation during examinations.

Richard J. Andreano, Jr.

Right of Rescission Not Unlimited, Maryland Court of Appeals Holds

The timing and mechanics of rescinding a loan under the Truth and Lending Act (TILA) has been a hotly contested legal issue. As highlighted during the recent oral argument in Jesinoski v. Countrywide Home Loans, Inc. before the U.S. Supreme Court, there are strong policy arguments that support a broad interpretation of the right to rescind. However, the right is not unlimited, as the Maryland Court of Appeals recently explained.

In Burson v. Capps, a borrower negotiated with a lender to refinance his mortgage loan. After rejecting two prior refinance offers, the lender extended the borrower a third refinance package. The borrower initially accepted the package, but before he executed the loan documents, he submitted a notice of rescission to the lender. However, despite submitting the notice, the borrower closed on the loan a few days later.

The borrower ultimately defaulted and the lender initiated a judicial foreclosure. The borrower moved to stay or dismiss the proceeding, arguing that he had rescinded the loan. The trial court rejected the borrower’s argument, permitted the foreclosure sale to occur, and subsequently ratified the sale. The borrower appealed, and the Court of Special Appeals reversed the circuit court’s decision. Despite the logical inconsistency of allowing a borrower to rescind a loan that had not yet been made, the court reasoned that nothing in TILA or its implementing regulation, Regulation Z, prohibited a borrower from rescinding a loan prior to consummation and that TILA should be interpreted broadly to give effect to its broad consumer-protection purpose.

The Court of Appeals reversed. Citing the statutory text, the court explained that the right of rescission belongs to borrowers only “in the case of any consumer credit transaction.” The court examined the text of both TILA and Regulation Z, and concluded the term “transaction” referred to a loan that was consummated. Based on this analysis, the Court of Appeals held that the borrower “could not have rescinded what he had not yet created.” Because the borrower’s notice of rescission was sent before he executed the loan documents, the loan could not be cancelled at that time and the rescission was ineffective. At that point, if the borrower wanted to avoid the loan, he could have refused to sign the loan documents, or could have promptly returned the loan proceeds after closing.

While there is certainly divergent authority regarding the scope of the right to rescind, it is reassuring that the Court of Appeals in Burson looked closely at the text of TILA and Regulation Z to define the limits of the right.

- John G. Kerkorian and Sarah T. Reise

St. Louis County Ordinance Requiring Pre-Foreclosure Mediation Unconstitutional, Missouri Supreme Court Holds

The Missouri Supreme Court recently ruled that a St. Louis County ordinance requiring lenders to mediate with borrowers prior to foreclosure was void ab initio because it was not directed to a matter of purely municipal concern.

A state bankers association challenged the validity of a County ordinance titled “Mortgage Foreclosure Intervention Code.” The ordinance purported to address “the national residential property foreclosure crisis” and its impact on the County’s property values, tax base, budget, assessments, and collection of real property taxes. It implemented a program requiring lenders to provide residential borrowers an opportunity to mediate prior to foreclosure. While the case was pending, the Missouri Legislature enacted a law that expressly prohibited local municipalities from adopting ordinances that would delay enforcement of loan agreements.

The Missouri Supreme Court struck down the ordinance as unconstitutional. Although the Missouri Constitution gives "charter counties," such as St. Louis County, authority over police powers that takes precedence over state legislative authority, such municipal police powers may be exercised only over matters of purely local concern. “Municipal regulations meant to address a national crisis, which affect every state in the country"—such as the impact of foreclosures—"are not a matter of such distinctly local concern that the County is authorized to legislate pursuant to its delegated police power.” Because the County's ordinance went beyond the County's constitutional powers, the Missouri high court held that the ordinance was unconstitutional and void ab initio.

- Joel E. Tasca and Matthew A. Morr

CFPB Issues Bulletin on Consideration of Public Assistance Income in Credit Decisions

The Consumer Financial Protection Bureau has issued a new bulletin (Bulletin 2014-03) that is intended “to remind creditors” of their Equal Credit Opportunity Act (ECOA)/Regulation B obligations regarding consideration of public assistance income and relevant standards and guidelines regarding verification of Social Security Disability Insurance and Supplemental Security Income (together, Social Security disability income).

Based on an accompanying CFPB blog post, the bulletin appears to have been triggered by reports to the CFPB from consumers alleging that lenders were not complying with applicable rules. While the CFPB’s blog post and bulletin are focused on mortgage lending, it is important to note that similar fair lending concerns apply to non-mortgage consumer credit.

The bulletin recites the ECOA and Regulation B ‎rule that prohibits creditors from discriminating in any aspect of a credit transaction because all or part of an applicant’s income derives from a public assistance program, such as Social Security income. The bulletin also notes that Regulation B permits creditors, in a judgmental system of evaluating credit, to consider whether an applicant derives income from public assistance for purposes of determining a pertinent element of creditworthiness. Accordingly, a creditor can consider how long an applicant will likely remain eligible to receive public assistance income.

The bulletin warns that fair lending concerns may arise if a creditor requires documentation beyond that required by applicable agency or secondary market standards and guidelines to demonstrate that Social Security disability income is likely to continue, such as the nature of an applicant’s disability or a letter from the applicant’s physician. According to the CFPB, prohibited disparate treatment can exist if a creditor imposes documentation requirements on public assistance recipients beyond those it imposes on other applicants. The CFPB further comments that disparate impact liability can arise if an income verification standard has a disproportionately negative impact on applicants receiving public assistance income.

The bulletin discusses the consideration of Social Security disability income for purposes of the Regulation Z ability-to-repay/qualified mortgage rule. It references Appendix Q, which allows for verification of such income by means of a Social Security Administration benefit verification letter and states that a creditor can consider such income as “effective and likely to continue” if the letter does not give a defined expiration date within three years of loan origination.

The bulletin also discusses relevant HUD and VA standards for, respectively, FHA-insured and VA-guaranteed mortgage loans, and Fannie Mae and Freddie Mac guidelines for mortgage loans eligible for purchase.

- Richard J. Andreano, Jr.

FTC Continues Regulatory Scrutiny of the Debt Buying Industry

The Federal Trade Commission (FTC) recently obtained temporary injunctions against two passive debt buyers, which are companies that buy and sell debt portfolios and exclusively use third-party debt collectors. In complaints filed against the companies, the FTC alleged that the debt buyers had engaged in unfair practices under Section 5 of the FTC Act.

The FTC joins other federal regulators focusing on the debt buying industry, such as the Office of the Comptroller of the Currency, which recently issued guidance on consumer debt sales, and the Consumer Financial Protection Bureau, which is expected to release next year proposed regulations that will address debt buying. Any company that sells or purchases debt should be monitoring these regulatory developments carefully and incorporating any guidance into their company’s existing compliance management systems.

The defendants in the FTC action are Cornerstone and Company, LLC, and Bayview Solutions, LLC (Bayview Solutions is not related to Bayview Asset Management or Bayview Loan Servicing). The FTC alleges that the companies, during the course of trying to sell debt portfolios, exposed consumers’ personal information on a website that serves as an interactive marketplace where members of the debt buying and collection industry exchange information about debt portfolios.

Generally, debt sellers post only summary information about the portfolios they are offering, such as the type of debt, number of individual debts in the portfolio, the total face value of the debt, general age of the debt, and the number of collection agencies that previously attempted to collect the debt. In some instances, sellers may also post sample portions of their portfolios, but personal information is redacted or masked.

According to the FTC complaint, the defendants posted the personal information contained in the debt portfolios, in the form of Excel spreadsheets, on the website without encryption, appropriate redaction, or any other security measures. The FTC alleges that consumers’ bank account and credit card numbers, birth dates, contact information, employers’ names, and information about the consumers’ alleged debts were posted on the public website.

Although the FTC acknowledged that certain information may have been redacted, it alleges that all the other information revealed about each consumer in the Excel spreadsheet would allow bad actors to easily extract the redacted information. The FTC alleges that the disclosures violate the consumers’ privacy, put them at risk of identity theft, and expose them to “phantom” debt collection (a practice involving fraudulent parties trying to extract payments from consumers without authority to collect the debts). The temporary injunctions entered against each debt buyer require the defendants to notify the affected consumers and explain how they can protect themselves against identity theft and other fraud.

In conjunction with the enforcement action against these two companies, the FTC has also offered the following best practices for all companies seeking to sell debt portfolios:

  • No public disclosure of debtor information. The FTC has concluded that there is no legitimate business reason for publicly posting debt portfolios or making consumer information publicly available in any other way without proper privacy safeguards.
  • Store debt portfolios securely. The FTC recommends both physical and digital protections for this information, such as keeping paper copies in a locked room or in a secure cabinet; limiting employee access; keeping portfolios in password-protected files; and making sure all devices with access to the information have reasonable security measures.
  • Minimize the amount of consumer information shared with prospective buyers. Potential buyers may need access to some of the sensitive data in a portfolio to evaluate whether to make a purchase, but such information should be kept to a minimum. Debt sellers should also conduct due diligence on any potential buyers to confirm their identity before sharing any personal information.
  • Transfer data securely. When transferring data to a potential or final buyer, files should be encrypted or password-protected.
  • Dispose of data safely. Hard copies should be burned, pulverized, or shredded. Electronic files should be deleted in a manner that prevents computer criminals from recreating any deleted files.
  • Establish a breach policy. The FTC expects companies to start thinking about how to respond to a data breach before it occurs.
  • Use the free resources available from the FTC. The FTC enforcement actions, guidance, and other publications provide insight that companies should incorporate into their compliance management systems, such as Protecting Personal Information: A Guide for Business and Information Compromise and the Risk of Identity Theft.

- Kim Phan

FCC Accepting Comments on ABA Petition To Exempt Fraud Notifications from TCPA Requirements

The Federal Communications Commission (FCC) recently issued a Public Notice requesting comments on a petition by the American Bankers Association (ABA) to exempt time-sensitive informational calls to mobile devices from the Telephone Consumer Protection Act's (TCPA’s) prior express consent requirements. The initial comments are due by December 8, 2014, and any reply comments must be submitted by December 22.

The TCPA requires companies using an automatic telephone dialing system (autodialer) or sending prerecorded calls to mobile devices to obtain consumers' prior express consent before making such calls. However, TCPA Section 227(b)(2)(C) authorizes the FCC to exempt, by rule or order, calls made to a mobile device if the called party is not charged for the call. The FCC recently used this authority for the first time when it ruled that package delivery notifications could be sent to consumers without their prior express consent. In that order, the FCC permitted delivery companies to send free informational text messages to consumers without their prior express consent, but only if the message complied with certain requirements.

The ABA's petition requests that the FCC use its authority to exempt four types of informational calls from the TCPA's consent requirements:

  • Fraud and identity theft alerts
  • Data security breach notices
  • Remediation messages to mitigate identity theft
  • Money transfer notifications

The ABA states that these types of notifications and calls "are critical to financial institutions' efforts to prevent fraud and identify theft." It argues that these calls must be made in a timely manner, and sending these notices via text message increases the probability that consumers will receive and open them. The ABA also asserts that an exemption is needed because of the threat of TCPA litigation.

The ABA petition would establish requirements on these informational calls similar to ones the FCC previously imposed on the exempt package delivery notifications:

  • Calls will only be made to consumers to whom the alert is directed.
  • Calls will identify the financial institution sending the call and will include the institution's contact information.
  • Calls will not contain any telemarketing, solicitation, or advertising content.
  • Calls will be concise unless a consumer response is needed.
  • Financial institutions will send no more calls than necessary.
  • Recipients of money transfer notifications may opt out of receiving future notifications.

The FCC seeks comments on whether the requested exemptions allow the financial services industry to reduce privacy and security risks to consumers. The FCC also asks whether it should modify the ABA's proposed requirements or if additional requirements or restrictions are needed. Attorneys in Ballard Spahr's Consumer Financial Services and Privacy and Data Security Groups stand ready to assist financial institutions with submitting comments to the FCC.

- James N. Duchesne

Montana Announces License Renewal Fees

The Montana Department of Administration (Department) has adopted changes to mortgage license renewal fees. According to the amendment, the Department realized that, due to an oversight, renewal fees for the 125 mortgage servicers and 128 mortgage servicer branches licensed in Montana were not set forth in original rule. The new fees applicable for the year 2015 are:

  • Mortgage Broker Entity
  • Mortgage Broker Branch
  • Mortgage Lender Entity
  • Mortgage Lender Branch
  • Mortgage Loan Originator
  • Mortgage Servicer
  • Mortgage Servicer Branch


- Marc D. Patterson

Copyright © 2014 by Ballard Spahr LLP.
(No claim to original U.S. government material.)

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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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