Wednesday, September 30, 2015

New Volcker FAQs deal with market making compliance and CEO certification

By John M. Pachkowski, J.D.

The Federal Reserve Board has updated its Frequently Asked Questions regarding the application of section 13 to the Bank Holding Company Act of 1956 (BHC Act), commonly referred to as the Volcker Rule, and regulations adopted by the Fed, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation, Securities and Exchange Commission, and Commodity Futures Trading Commission. The Fed noted that while the FAQs apply to banking entities for which the Fed has jurisdiction under section 13 of the BHC Act, they have been developed by staff of all five agencies.

In FAQ No. 17, the agencies’ staff was asked whether a banking entity’s compliance program for market making-related activities may include objective factors on which a trading desk may reasonably rely to determine whether a security is issued by a covered fund. The staff were further asked whether a market maker meets its compliance program requirements by making use of a shared utility or third-party service provider that utilizes objective factors to identify whether a security is issued by a covered fund.

Objective factors. At the outset of their analysis the agencies’ staff noted that a bank relying on the market making exemption to the Volcker Rule must have a reasonably designed compliance program for a trading desk involved in the market making activity. As for the design of the compliance program, the staff added that the trading desk may include “objective factors” on which the trading desk may reasonably rely to determine whether a security is issued by a covered fund. For purposes of the Volcker Rule, “objective factors” are considered to be factual criteria that can be used to reliably identify whether an issuer or a particular type of issuer is a covered fund.

As to the issue of relying on objective factors to determine whether a security is issued by a covered fund, the staff concluded that an objective factor would be whether securities of the issuer were offered in transactions registered under the Securities Act. On the other hand, the staff cautioned that it would not be reasonable for a trading desk to rely solely on either or both the name of the issuer or the title of the issuer's securities. They noted that these factors alone would not convey sufficient information about the issuer for a trading desk reasonably to determine whether a security is issued by a covered fund.

Shared utility/service providers. In responding to whether a banking entity can make use of a shared utility or third-party service provider that utilizes objective factors to identify whether an issuer or a particular type of issuer is a covered fund, the agencies’ staff stated that the shared utility, or a third-party service provider must be subject to independent testing and audit requirements applicable to the banking entity's compliance program. The staff also noted that if the shared utility or third-party service provider is not effective in identifying whether a security is issued by a covered fund, then the banking entity must promptly update its compliance program to remedy any defects issues and, as necessary, take action under Volcker Rule implementing regulations, such as terminating an activity or investment.

 CEO certification. New FAQ No. 18 discusses the timing of when a banking entity is required to submit the annual CEO certification for prime brokerage transactions. The FAQ also discusses the timing issue as to legacy covered funds.

Although the Volcker Rule regulations generally place certain limitations on a banking entity’s relationships with a covered fund, the regulations allow the banking entity to enter into any prime brokerage transaction with any covered fund in which a covered fund managed, sponsored, or advised by such banking entity, or an affiliate, has taken an ownership interest. These prime brokerage transactions are permissible, so long as the conditions enumerated in the final rule are satisfied which includes an annual written CEO certification. For purposes of the Volcker Rule regulations, a “prime brokerage transaction” means any transaction that would be a covered transaction, as defined in section 23A(b)(7) of the Federal Reserve Act that is provided in connection with custody, clearance and settlement, securities borrowing or lending services, trade execution, financing, or data, operational, and administrative support.

To fulfill the certification requirement, a CEO should submit the first certification after the end of the conformance period but no later than March 31, 2016. A banking entity can provide the required annual certification in writing at any time prior to the March 31 deadline to the relevant agency.

The timing of the CEO certification for legacy funds—covered funds sponsored or owned by a banking entity prior to Dec. 31, 2013—must be submitted by March 31 following the end of the relevant conformance period. Since the conformance period currently ends on July 21, 2016, the CEO certification must be submitted by March 31, 2017. However, the Fed has signaled its intentions to further extend the conformance period until July 31, 2017. Therefore, it is conceivable the CEO certification could be submitted by March 31, 2018.
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Financial institutions get to use sword, not shield, in class-action litigation context

By Thomas G. Wolfe, J.D.

Recently, as a plaintiff class in data-breach litigation, various financial institutions have been afforded an atypical vantage point in a class action. In the case of In re: Target Corporation Customer Data Security Breach Litigation, Judge Paul Magnuson of the U.S. District Court for the District of Minnesota granted class certification and the appointment of class representatives and counsel for a class of financial institutions that have brought lawsuits against Target Corporation in connection with the massive breach of the retailer’s computer network in late 2013.

According to the court’s recent ruling, the certified class of financial institutions is described as “[a]ll entities in the United States and its Territories that issued payment cards compromised in the payment card data breach that was publicly disclosed by Target on December 19, 2013.” The plaintiff financial institutions issued payment cards, such as credit and debit cards, to consumers who used those cards at Target stores during the 2013 security breach of consumer-related data.

Among other things, the financial institutions allege that they suffered injury “in the form of replacing cards for their customers, reimbursing fraud losses, and taking various other remedial steps in response to the Target data breach.”

After a Judicial Panel on Multidistrict Litigation consolidated lawsuits concerning the data breach at Target, the case was separated into two “tracks”: one track for consumers and one track for financial institutions. While the track of consolidated cases for consumers has settled (pending final court approval), the track of consolidated cases pertaining to the financial institutions continues. The court appointed Umpqua Bank, Mutual Bank, Village Bank, CSE Federal Credit Union, and First Federal Savings of Lorain as class representatives for the financial institutions.

In light of the Judge Magnuson’s recent ruling, the plaintiff class of financial institutions may proceed in the Multidistrict Litigation to advance their three state-law claims against Target for: (1) negligence in failing to provide sufficient security to prevent the computer hackers from accessing customer data; (2) violation of Minnesota’s Plastic Security Card Act; and (3) “negligence per se” for the violation of the Minnesota statute.

For more information about In re: Target Corp. (D. Minn.) subscribe to the Banking and Finance Law Daily.

Monday, September 28, 2015

TILA says land trust has right to rescind mortgage transaction

By Richard A. Roth, J.D.

A land trust used by a homeowner to hold title to her home was a consumer under the Truth in Lending Act and Reg. Z—Truth in Lending (12 CFR Part 1026), the Illinois Supreme Court has determined. This means the trust should have been given TILA-required disclosures when a reverse mortgage was granted on the home and had a three-year right to rescind the loan transaction when those disclosures were not given, the court said (Financial Freedom Acquisition, LLV v. Standard Bank and Trust Company, Sept. 24, 2015, Burke, A.).

According to the court, the homeowner and the land trust entered into a reverse mortgage transaction in 2009. The mortgage identified the trust as the borrower and mortgagor, although both the trust and homeowner signed the note. The mortgage included a clause making clear the trust had no liability to repay the note and providing that foreclosure was the creditor’s only collection avenue. Since the loan transaction was a reverse mortgage, the loan became due on the homeowner’s death or if she failed to use the home as her principal residence for a year.

According to the opinion, TILA-required disclosures, including a description of her right to rescind the transaction, were given to the homeowner. A set of disclosures was prepared for the trust, but it was not delivered.

The homeowner died less than a year later, and the creditor soon filed a foreclosure suit against the trust, the court continued. The trust responded by notifying the creditor that it was exercising its right to rescind the transaction and, when the creditor did not respond, the trust filed a counterclaim in the foreclosure suit. The counterclaim asserted that the trust had not been given TILA-required disclosures and demanded rescission, damages for the TILA violations, and damages for the refusal to rescind the transaction.

Trial court dismissal. The trial court judge dismissed the counterclaim. Shortly thereafter, the trust paid the creditor the full amount due on the note and transferred the property to an unidentified third party. The creditor then dismissed the foreclosure complaint, but the trust appealed the dismissal of the counterclaim.

Appellate court proceedings. The appellate court concluded that the rescission demand was timely but that the trust could not rescind the transaction because it was not an obligor. Under TILA and Reg. Z, only obligors have rescission rights, the court said. The mortgage made clear that the trust had no duties under the loan or mortgage, and the trust received no benefit from the transaction, so it was not an obligor. Under those circumstances, only the homeowner could rescind the transaction, the appellate court decided.

The trust had forfeited any claim for damages by not raising those claims on appeal, the court continued. It also suggested that such claims might have been untimely.

The trust appealed the ruling to the state Supreme Court.

Obligors only? The court first noted a discrepancy between TILA and Reg. Z—TILA says that an obligor has the right to rescind a mortgage transaction (12 U.S.C. §1635(a)), while Reg. Z says that “each consumer” whose interest will be subject to the mortgage has a right to rescind (12 CFR 1026.23(2)). Moreover, the staff comments (12 CFR 1026.23) say that “consumer” includes “any natural person” whose interest in the home will be affected, even a person who is not obligated to repay the loan.

As a result, the right to rescind was not restricted to obligors, according to the court. Reg. Z and the staff comments have been in existence since 1968, and if Congress disagreed with the regulation it could have amended TILA, in the court’s opinion. Certainly Congress could have acted when it moved TILA enforcement authority from the Federal Reserve Board to the Consumer Financial Protection Bureau.

Effect of reverse mortgage. The decision was influenced by the fact that the case involved a reverse mortgage. A reverse mortgage is to be repaid only by a sale of the property, the court pointed out. Nobody is personally liable, meaning there is no obligor under the ordinary meaning of the word. That would mean lenders had no duty to provide disclosures to anyone, and no one would have a right to rescind, a conclusion that clearly was contrary to TILA and Reg. Z.

Land trust’s interest. Under Illinois law, the trust held the legal title to the property for the benefit of the homeowner, the court then observed. The homeowner’s real property ownership interest was converted to a personal property interest in the trust. The comments to 12 CFR 1026.2(a) say that consumer credit extended to a land trust is considered to be credit extended to a natural person, the court added.

If property is in a land trust, the trust holds the ownership; in fact, since the beneficiary holds only a personal property interest in the trust, the trust is the only person who holds an interest in the real property. Thus, it is the trust’s interest that is subject to the mortgage, the court reasoned.

If credit to a land trust is considered to be credit to a natural person, and the land trust’s interest is subject to the mortgage, then the trust was entitled to receive the TILA-required disclosures, the court decided. Also, if the disclosures were not given, the trust was entitled to the three-year right to rescind the transaction.

Effect of property sale. The court also rejected the creditor’s argument that the trust’s transfer of the property extinguished the right to rescind. Both TILA and Reg. Z say the right to rescind expires on the sale of the property, but that refers to the exercise of the right as opposed to the enforcement of the right. The trust exercised the right by notifying the creditor of the rescission demand long before it acquired and then transferred the home.

If a transfer of the property ended the ability to enforce the right to rescind, the trust would lose not only the ability to rescind but also the ability to recover damages for the creditor’s wrongful failure to rescind, the court pointed out.

Statutory damages. The trust also wanted statutory damages for the creditor’s failures to provide required disclosures required by TILA and to rescind the transaction on demand. The appellate court had decided that these claims had not been preserved for appeal. The appellate court was wrong, the court said.

The trial court judge dismissed the counterclaim because he decided the trust could not describe a viable claim, meaning he never addressed the issue of statutory damages, the court pointed out. There was no order about the damages claim from which the trust could have appealed, so there was no need to preserve the issue.

The appellate court’s belief that the claims could be untimely was wrong as well, the court said. The claim for statutory damages was filed well within the one-year statute of limitations.

This story previously appeared in the Banking and Finance Law Daily.

Thursday, September 24, 2015

Mortgage rules eased for rural, underserved areas

By Andrew A. Turner, J.D.
The Consumer Financial Protection Bureau has adopted amendments to its mortgage lending rules that are intended to ease burdens on small lenders, especially those operating in rural or underserved areas. The final rule makes changes to the CFPB’s Ability-to-Repay rule, Home Ownership and Equity Protection Act rule, and Escrows rule.
An expanded definition of “small creditor” increases the loan origination limit for small-creditor status from 500 first-lien mortgage loans to 2,000 first-lien mortgage loans. The change also excludes loans held in portfolio by the creditor and its affiliates.
The amendments allow small creditors to include mortgage affiliates when the asset limit is calculated, create a grace period for creditors that no longer operated predominantly in rural or underserved areas during the preceding calendar year, and adjust the time period used in determining whether a creditor is operating predominately in rural or underserved areas to a one-year qualifying period.
Included in the amendments are changes that will:
  • expand the definition of “rural area” to include a county that meets the current definition of rural county or a census block that is not in an urban area as defined by the Census Bureau; and
  • extend, until April 1, 2016, the temporary two-year transition period that allows certain small creditors to make balloon-payment qualified mortgages and balloon-payment high cost mortgages regardless of whether they operate predominantly in rural or underserved areas.
Effective date. The CFPB settled on a Jan. 1, 2016, effective date as it is consistent with the end of the calendar year determinations required to be made in order to determine a creditor’s eligibility for small creditor and small creditor rural or underserved status and for the April 1 grace period.

For more information about CFPB mortgage rules, subscribe to the Banking and Finance Law Daily.

Wednesday, September 23, 2015

Fake payday loan debt collector gets payback

By J. Preston Carter, J.D., LL.M.

The Federal Trade Commission has reached a settlement with Kirit Patel and his company, Broadway Global Master Inc., who the FTC alleged operated a fraudulent debt collection scheme in which they illegally processed more than $5.2 million in payments from consumers for payday loan debts they did not owe. According to the agency’s release, the settlement resolves a complaint the FTC filed in 2012 alleging that callers working with the debt collectors harassed consumers into paying on bogus debts, often pretending to be agents of law enforcement or fake government agencies such as the “Federal Crime Unit of the Department of Justice.” The court subsequently halted the operation and froze the parties’ assets pending litigation.
Settlement. According to the terms of the settlement, Patel and his company will be banned from the debt collection business, among other conditions, and assessed a judgment of more than $4.3 million, although due to their inability to pay, the amount will be suspended upon payment of $608,500, which will be used for consumer redress.
The release noted that Patel pleaded guilty to mail and wire fraud charges brought by the Justice Department in a separate criminal proceeding.
Fake debt collectors. The FTC also published a blog post by Amy Hebert, Consumer Education Specialist, helping consumers identify fake debt collectors. Hebert said a caller may be a fake debt collector if:
  • you don’t recognize the debt;
  • you can’t get a mailing address or phone number for the collector; or
  • you’re threatened with arrest or told you’ll be reported to a law enforcement
  • agency.
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Tuesday, September 22, 2015

PMI deadline set by original price, not post-HAMP modification appraisal

By Richard A. Roth, J.D.

The automatic termination date of a homeowner’s private mortgage insurance was to be calculated based on the original purchase price of his home, not on the home’s appraised value after the loan was modified under the Home Affordable Modification Program, according to a U.S. District Judge for the Northern District of West Virginia. However, while the mortgage loan servicer had violated the Homeowners Protection Act, its attempts to collect PMI premiums after the correct termination date did not violate the West Virginia Consumer Credit and Protection Act (Rice v. Green Tree Servicing, LLC).

The homeowner bought his home in 2006, borrowing $355,550 against a purchase price of $395,000. Due to the high loan-to-value ratio, he was required to supply private mortgage insurance. The PMI automatic termination date was determined at the time to be Jan. 1, 2016.

A HAMP modification took effect Sept. 1, 2010. The loan was changed from a fixed-rate loan to a step-rate loan, and the principal balance was fixed at $340,123.01.

Loan servicing duties were transferred to Green Tree Servicing on June 1, 2013. Green Tree inferred that a valuation carried out at the time of the HAMP modification produced a value of $237,603, although much of the related documentation could no longer be found. Believing that Fannie Mae servicing guidelines required that appraisal documentation be available, Green Tree obtained a new valuation, which said the home was worth $322,700 in 2013.

Termination date calculation. Under the HPA, a homeowner’s obligation to supply PMI terminates automatically on the date an amortization schedule projects the loan balance should drop to 78 percent of the home’s initial value, assuming the homeowner has made all of the required payments (see 12 U.S.C. §4902(b)). When the homeowner asked to be told his termination date, Green Tree prepared an amortization schedule based on the 2010 loan modification and the 2013 valuation. This yielded an automatic termination date of Feb. 1, 2020.

The homeowner disagreed with that calculation method. He believed that the automatic termination date should have been calculated using an amortization schedule based on the modified loan but the initial purchase price. That yielded a termination date of March 1, 2014, which would save him nearly six years’ worth of PMI premiums.

Fixed rate v. adjustable rate. The judge’s first task was to decide what type of loan was involved. The HPA contemplated two alternatives—a fixed-rate loan and an adjustable-rate loan. The difference was important because the PMI termination date for a fixed-rate loan was to be set based on an amortization schedule created at closing, while the termination date for an adjustable-rate loan was to be set based on “an amortization schedule then in effect.”

The judge agreed with the homeowner that a step-rate loan—a loan with prescheduled interest rate changes—was an adjustable rate loan, even though the dates and amounts of the changes were fixed. Under the HPA, a fixed-rate loan “has an interest rate that is not subject to change,” she said. Since the rate was to change, the loan could not be a fixed-rate loan. An adjustable-rate loan, on the other hand, was a loan “that has an interest rate that is subject to change.”

“Original value.” In order to calculate the automatic termination date, one divides the principal balance of the loan by the “original value of the property securing the loan.” The automatic termination date is the date on which the appropriate amortization schedule says the resulting ratio will drop to 78 percent (see 12 U.S.C. §4901(18)).

But, what was the “original value of the property”? The homeowner argued that the original value was the purchase price, while Green Tree argued that it was the 2013 value set by the valuation required by Fannie Mae’s servicing guidelines.

If the HAMP modification changed terms or conditions of the loan, the HPA says the PMI termination date must be recalculated to reflect the modified terms, the judge said. In this case, the HAMP modification changed some loan terms, but it did not mention the value of the property.

According to the judge, the HPA’s language supported the homeowner’s claim that the original value of the property was not a term or condition of the loan that was changed by the HAMP modification. The act defines “original value” as the lesser of the property’s purchase price or the appraised value, she said, and that amount was $395,000. Moreover, while the HPA provides a different definition in the case of a refinancing, the modification was not a refinancing.

However, the amortization schedule prepared by Green Tree in 2013 was “the amortization schedule then in effect” that was to be used to determine the loan balance, the judge added. It was the most recent schedule and the best that was available under the circumstances.

The modification agreement did not explicitly address changing the original value, and the homeowner never agreed to such a change, the judge decided. She rejected Green Tree’s argument that the termination date was to reset based on the terms and conditions of the modified loan. Rather, the HPA said that the termination date is to be rest to reflect the modified terms and conditions. The original value had not been modified by the HAMP modification and thus remained at $395,000, the amount fixed at the initial loan closing.

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Monday, September 21, 2015

On eve of mortgage disclosure rules, CFPB helps consumers understand mortgages

By Stephanie K. Mann, J.D.

As the effective date of the Consumer Financial Protection Bureau’s mortgage disclosure rule draws near, the bureau is helping consumers understand how the new rules will benefit them. In its blog post, the CFPB emphasized that the new rules will ease the process of taking out a mortgage, helping consumers save money, and ensuring you “know before you owe.”

What’s changed? When the new rules go into effect on Oct. 3, 2015, the following changes will take place:
  • Four overlapping disclosure forms will be streamlined into two forms, the Loan Estimate and the Closing Disclosure. 
  • Consumers will have more time to review closing documents. Currently, lenders must give consumers their HUD-1 Settlement Statement disclosure 24 hours in advance; after October 3, consumers will receive Closing Disclosure three business days before signing the forms and accepting the terms of the mortgage, no request needed. 
These changes will improve the mortgage process by making it easier to understand complicated mortgage terms, making it easier to shop around and compare loan offers from multiple lenders, and allowing consumers to make sure that there are not major changes from the Loan Estimate.

Making mortgages understandable. The CFPB has taken several steps to ensure that consumers fully understand the terms of their mortgage over the last four years. The bureau’s “Your Home Loan Toolkit” has worksheets and conversation starters to help consumers at key points in the mortgage process. Buyers will receive the toolkit when applying for a home purchase mortgage. In addition, while these forms make the process of taking out a mortgage easier, the bureau has also created digital resources to help homebuyers use and understand the Loan Estimate and Closing Disclosure. These tools give definitions of terms like “balloon payments” and “points.” They also show where to look, page-by-page, to check that terms and numbers on both documents match up.

For a better understanding of what it takes to get a mortgage, the bureau has also updated its “Owning a Home” site with an overview of the mortgage process. This step-by-step guide to getting a mortgage takes consumers from creating a budget to filing away important closing documents after they accept the terms and sign on the dotted line. “Owning a Home” also has tools and resources to help homebuyers learn more about loan options, make decisions, and prepare for closing.

Housing counselors approved by the Department of Housing and Urban Development are another great resource, noted the bureau. They can offer independent advice about whether a particular set of mortgage loan terms is a good fit based on your objectives and circumstances, often at little or no cost to you.

Cordray remarks. The "Owning a Home" website expansion will “help consumers shop for a mortgage and go about buying a home, from the very start of the process all the way to the closing table,” according to CFPB Director Richard Cordray. Speaking at the National Association of Realtors, Cordray said that the site guides consumers through the process of meeting with lenders.

Discussing the Closing Disclosure, Cordray expressed concern over misinformation being spread by false claims “that last-minute changes based on walk-throughs or similar circumstances will cause frequent three-day delays in the closing process.” Saying that sellers’ credits will never require a new Closing Disclosure that delays the closing date, he emphasized that a new Closing Disclosure will only be required by three very limited circumstances relating to changes in the loan terms.

Cordray also offered a defense of the CFPB’S “Ability to Repay” rule, which requires lenders to make sure that borrowers have the ability to repay their loans before extending them a mortgage. He remembered predictions from critics that CFPB rules would cause mortgage prices to rise, cut volume, and harm community banks and credit unions. With the rules in place for almost two years, Cordray asserted, “none of those heated claims has come true.”

For more information about Know Before You Owe, subscribe to the Banking and Finance Law Daily.

Friday, September 18, 2015

FOMC: Economy is expanding, but interest rates remain unchanged

By Thomas G. Wolfe, J.D. and Lisa M. Goolik, J.D.

During its meeting yesterday, the Federal Open Market Committee chose not to raise interest rates, stating that although economic activity “is expanding at a moderate pace,” inflation remains low.  The Committee also indicated that it is keeping a close eye on the global economy.

"Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term."

Economic outlook. The FOMC reported that economic activity “is expanding at a moderate pace.” Among the more positive highlights:
  • The labor market has continued to improve, “with solid job gains and declining unemployment.”
  • Labor market indicators show that underutilization of labor resources “has diminished since early this year.”
  • Household spending and business fixed investment have been “increasing moderately.”
However, net exports have been "soft," and inflation “continued to run below the Committee's longer-run objective, partly reflecting earlier declines in energy prices and decreasing prices of non-energy imports.” Further, while market-based measures of inflation compensation “remain low,” survey-based measures of longer-term inflation expectations “have remained stable.”

The FOMC noted that it is “monitoring developments abroad” as well.

Asset purchases. The FOMC communicated that it is “maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.” In the FOMC’s view, by keeping the Committee's holdings of longer-term securities at sizable levels, the policy “should help maintain accommodative financial conditions.”

Federal funds rate. In addition, the FOMC continued to maintain the current, low-target range for the federal funds rate at 0- to .25-percent. As for how long it will maintain this target range, the FOMC stated that it “will assess progress—both realized and expected—toward its objectives of maximum employment and 2 percent inflation.” According to the FOMC, this assessment “will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.”

The FOMC anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen “some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.” Still, the FOMC anticipates that “even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.”

FOMC member Jeffrey M. Lacker voted against the action, preferring to raise the target range for the federal funds rate by 25 basis points.

Graphical illustration. In addition to its statement, the FOMC released charts and graphs depicting its economic projections. The chart depicts the economic projections of the individual Federal Reserve Board Members and Federal Reserve Bank Presidents based on the current monetary policy, including the projected change in GDP, unemployment, and inflation.

For more information about the FOMC, subscribe to the Banking and Finance Law Daily.

Thursday, September 17, 2015

Debt relief organization operations stopped by CFPB-secured preliminary injunction

By Katalina M. Bianco, J.D.

The Consumer Financial Protection Bureau has obtained a preliminary injunction against three individuals whom the bureau alleges ran a debt-relief scheme that charged consumers illegal up-front fees while providing little or no relief. The injunction also halts the operations of four companies the individuals used under a variety of different business names. According to the CFPB, the organization, referred to as World Law Group, took at least $67 million from 21,000 consumers before any services were performed and seldom obtained any relief.

The CFPB’s complaint claims that Orion Processing, LLC, Family Capital Investment & Management LLC, World Law Debt Services, LLC, and World Law Processing, LLC, under eight different business names, constituted “an interelated network of companies that have common business functions.” The three individuals are the owners or operators of the four companies.

Debt-relief scheme. According to the complaint, the World Law Group organization promised that a team of attorneys would negotiate debt settlements on behalf of consumers. Consumers were told to stop paying their bills and instead make a single monthly payment to World Law, which would use the funds to pay the consumers’ debts. However, World Law actually kept much of this money as fees.

While 99 percent of World Law’s customers paid up-front fees in some form, these fees actually are banned by the Telephone Sales Rule, the bureau says.

Preliminary injunctions. The U.S. District Court for the Southern District of Florida issued two preliminary injunctions that together cover all three individuals and all four companies. One order applies to Bradley James Haskins, an attorney who is the purported Chairman of World Law Group. The other applies to Derin Scott and David Klein, said to be owners and officers.

The orders temporarily ban all of the individuals and companies from any participation in debt relief services and from any efforts to collect fees from consumers for such services. They are ordered to disable, but preserve, any website that was used in the business. Also, debt relief business-related assets of the defendants are frozen, except that any assets located off-shore are to be repatriated and disclosed to the CFPB.

For more information about CFPB enforcement activity, subscribe to the Banking and Finance Law Daily.

Wednesday, September 16, 2015

Timing of request key to marshaling of liens

By Lisa M. Goolik, J.D.

A creditor, West Central FS, Inc., could not force a senior creditor, First Community Bank (FCB), to marshal its lien against a couple’s bankruptcy estate so that West Central’s secured claim in the debtors’ crops and equipment could be enforced against the proceeds from a sale of the debtors’ equipment that were distributed to FCB in 2011. Under the equitable doctrine of marshaling, a creditor that has a claim to two funds to satisfy his debt may not apply them in a way that defeats another creditor who may resort to only one of the funds. Although FCB also held a secured claim in the proceeds from the sale of the debtors’ farm realty, the U.S. District Court for the Central District of Illinois concluded that, at the time of West Central’s motion in 2013, marshaling was not an appropriate remedy. Because the funds were already distributed, there were no longer two funds in the debtors’ estate to satisfy FCB’s lien—a crucial element for marshaling (Ferguson v. West Central FS, Inc., Sept. 11, 2015, Shadid, J.).

Background. The debtors filed a petition for Chapter 12 bankruptcy protection in 2010. At the time, FCB had a mortgage against the debtors’ farm and a perfected security interest in their equipment and crops in the amount of $297,000. West Central held a perfected junior security interest in the equipment and crops for approximately $176,000, but did not have a claim against the farm realty.

In an attempt to pay off their debts, the debtors sold their equipment in August 2010 for $170,000. In 2011, FCB requested that the net equipment proceeds be distributed to it, and West Central requested that the bankruptcy court require FCB to marshal its liens against the realty to free up the proceeds of equipment and crops for West Central’s junior lien. Finding that it would be “grossly inequitable” to force the senior creditor, FCB, to accept a long-term secured claim in the realty, the bankruptcy court denied the request and ordered the equipment proceeds to be distributed FCB.

When the debtors were unable to confirm a Chapter 12 plan, largely due to significant tax liabilities, they voluntarily converted their case to Chapter 7. After conversion, the Chapter 7 trustee sold the debtors’ farm, and FCB received $128,000 in satisfaction of the remainder of its claim. Including the property transferred from the bankruptcy conversion, the estate was left holding $246,000. 

Noting the court had previously indicated that liquidation of the farm might change its decision, West Central renewed its argument that FCB be forced to marshal its liens against the realty, effectively treating FCB’s distribution in 2011 as if paid from the sale of the farm and allowing West Central to recover from the remaining estate. Over the objections of the debtors, trustee, and the United States (seeking to recover its tax bill), the bankruptcy court granted West Central’s request. 

Two funds. According to the court, the traditional elements of marshaling are: (1) the existence of two creditors of the same debtor; and (2) the existence of two funds belonging to a common debtor; with (3) only one of the creditors having access to both funds; and with (4) the absence of prejudice to the senior secured creditor if the doctrine is applied. While it was undisputed that West Central satisfied the first element, the court concluded that West Central failed to prove the remaining three elements.

At the time that West Central’s restated request for marshaling was granted, the debtors did not have two funds available to them, said the court. Although West Central believed the debtors held two funds stemming from the liquidation of the real estate and sale of the crops and equipment, the court noted that the proceeds from the crops and equipment were no longer part of the estate when the bankruptcy court ordered marshaling in 2013—they were already distributed to FCB in 2011.

In addition, when the proceeds were distributed to FCB, West Central’s security interest in the debtor’s crops and equipment ceased to exist, leaving West Central as an unsecured creditor. Accordingly, because the only monies that remained were from the proceeds of the sale of the realty, FCB was the only remaining lienholder.

Lastly, although West Central argued marshaling can be applied, despite injury to any third parties, as long as it does not prejudice creditors with an equal or senior interest, the court concluded that West Central was not on equal footing at the time marshaling was ordered. After the distribution, FCB remained a secured creditor, whereas West Central was an unsecured creditor.

Failure to object. While noting that there are few winners in bankruptcy, the court also noted that West Central could have taken additional steps to protect its interest. After the bankruptcy court denied its initial request for marshaling and allowed distribution of the equipment and crops proceeds to FCB, West Central should have filed an objection to the distribution of the equipment and crops proceeds, wrote the court. Had West Central objected and prevailed, the funds would have stayed in the estate, and there would have arguably been two funds available when the real estate was sold.

For more information about creditors' rights in bankruptcy, subscribe to the Banking and Finance Law Daily.

Tuesday, September 15, 2015

FDIC’s potential recovery against title insurance companies limited to foreclosure deficiency judgments

By Thomas G. Wolfe, J.D.

In connection with several real estate transactions that the Federal Deposit Insurance Corporation characterized as fraudulent “flip transactions,” the FDIC, as receiver for a bank, contended that it was entitled to damages beyond the total amount of the combined deficiency judgments that the bank had obtained at foreclosure sales of the pertinent properties. Judge Andrea Wood of the U.S. District Court for the Northern District of Illinois disagreed, ruling that the FDIC’s potential recovery of damages against certain title insurance companies would be limited, under Illinois law, to the sum total of the deficiency judgments—should the FDIC ultimately demonstrate the companies’ liability.

By way of background, in the recent case of Federal Deposit Insurance Corporation v. Chicago Title Insurance Company (N.D. Ill., Sept. 9, 2015), Founders Bank had served as the lender/mortgagee for the applicable real estate transactions. In its capacity as receiver for Founders Bank, the FDIC alleged that the title insurance companies “acted negligently and breached contractual and fiduciary duties in their role as closing agent” for the transactions, and that the companies’ agents engaged in negligent or fraudulent activities. Further, the FDIC claimed that a separate real estate company, acting as the property appraiser in each of the transactions, was liable for negligence and breach of contract.

In its lawsuit against the various companies, the FDIC not only sought recovery of the deficiency judgments entered in favor of Founders Bank, the FDIC also sought recovery of certain losses it sustained on the sale of the properties and certain constructions costs it incurred after the sale of the properties. In response, the title insurance companies asked the court to limit the amount of potential damages that could be recovered by the FDIC on its theories of liability to the sum of the deficiency judgments that Founders Bank had obtained at the foreclosure sales.

Translating the different stances of the parties into monetary terms, the FDIC maintained that the “total aggregate loss” by Founders Bank on the pertinent properties was approximately $6.15 million. In contrast, the title companies asserted that the FDIC’s damages should be limited to approximately $3.88 million—the sum of the applicable deficiency judgments—because the bank placed credit bids on the properties at issue. The court agreed.

In reaching its decision in favor of the title companies, the court reviewed the Illinois practice of “credit bidding” that allows a foreclosing lender to bid on the pertinent property at auction. In the court’s estimation, absent some showing of fraud or malfeasance concerning the foreclosure proceeding or the credit bid process itself, a credit bid “generally stands as a conclusive measure of the property’s value, even with respect to third parties.” Accordingly, the court emphasized that this rule “does not cause any undue prejudice to a lender, who can avoid all of these consequences by bidding what it believes the property is actually worth.”

At the same time, during the present stage of the litigation, the court was not yet called upon to address whether the FDIC would be limited in the same way as to any potential recovery against the real estate appraisal company.

For more information about the FDIC's rights and duties as a receiver, subscribe to the Banking and Finance Law Daily.

Monday, September 14, 2015

Debtor's efforts to induce financing prevented discharge of debts

By Lisa M. Goolik, J.D.

A couple that provided a loan to an individual debtor and his business could not avoid the discharge of their claim against the debtor’s bankruptcy estate under the theory that the debtor’s offer of a UCC-1 financing statement as security for the loan was fraudulent in light of the subsequent termination of the filing without the couple’s consent. However, the evidence substantiated the couple’s claim that the debtor misrepresented his financial condition in order to induce the couple to extend the loan. As a result, the U.S. Bankruptcy Court for the District of Oregon concluded that the couple was entitled to an exception to the debtor’s discharge of claims under the Bankruptcy Code, and the debtor was prevented from discharging the debt (In re Holman, Sept. 8, 2015, Dunn, R.).

Background. In early 2011, the couple was introduced to the debtor through a mutual friend. The couple had funds that they wished to invest, and the debtor's business was in a "cash crunch." The couple agreed to loan the debtor $300,000, which was secured by a trust deed on the debtor's home, an assignment of the debtor's $300,000 business life insurance, and a UCC filing on business assets. Although the couple had some experience in the banking industry, they were unfamiliar with a UCC financing statement. 

During the negotiations, the debtor presented the couple with an unsigned personal financial statement, stating that the debtor had assets with a total value of $6.8 million and liabilities totaling $866,000, for a net worth of almost $6 million. The debtor's business was valued as an asset worth $5 million, and the debtor’s home was valued at $775,000, with a mortgage balance of $450,000, reflecting equity of $325,000. The couple testified that they reviewed the financial statement before deciding to make the loan and relied on the financial statement in making their decision.

The loan closed on or about the end of February 2011 and was documented by a promissory note, a deed of trust the debtor’s home, a UCC-1 filing with the Oregon Secretary of State’s office, and an assignment of the debtor’s life insurance policy.

The debtor made at least six payments prior to requesting a deferral in August 2011. After the 60-day deferral period passed, the debtor made only a few sporadic payments and the last interest check received by the couple was in October 2012.

In the meantime, unbeknownst to the couple, on Aug. 18, 2011, around the same time as the debtor’s request for a deferral, the UCC-1 was terminated. Although the termination statement indicated that it was authorized by the couple, the couple testified that they knew nothing about the termination. At the same time, the debtor’s business received secured loans from two other creditors. While the debtor denied any knowledge as to who authorized the UCC-1 to be terminated, the court noted that the evidence indicated that the UCC-1 was terminated by counsel for the debtor’s business.

After the debtor followed his business into chapter 7 bankruptcy, the couple sought an exemption under the Bankruptcy Code that would prevent the debtor from discharging the couple’s claim.  

Exemption for fraud. Section 523(a)(2)(A) of the Bankruptcy Code excepts from a debtor’s discharge debts for money obtained by “false pretenses, a false representation or actual fraud.” The couple argued the offer of the UCC-1 as security was fraudulent or illusory in light of the subsequent termination of the UCC-1 without the couple’s authorization or consent.

However, the court concluded the evidence did not support the couple’s claim. “However suspicious the circumstances of the unauthorized termination of the UCC-1, the evidence does not establish that [the debtor] intended to terminate the UCC-1 and default on the Loan payments at the outset of the Loan transaction,” wrote the court. In fact, the court characterized the initial negotiations regarding the UCC-1 as “the blind leading the blind.”

In particular, the court noted that there was no evidence that the couple relied on the offer of the UCC-1 as partial security because “they had no idea what a UCC-1 was or how it worked.” The couple admittedly took no steps to ascertain whether the filing of the UCC-1 provided them with any real security for repayment of the loan. 

False financial statement. Although the couple was not able to demonstrate they relied on the debtor’s offer of the UCC-1, they were not without recourse. Section 523(a)(2)(B) excepts from discharge debts arising from the debtor’s intentional use of a false financial statement on which the creditor reasonably relied. A creditor must establish that the debtor knew the representations in the financial statement were false, or that the representations were so recklessly made as to satisfy that standard, and that the representations were made with the intent to deceive.

The court concluded that the evidence showed that the financial statement prepared and submitted to the couple by the debtor included net worth and home equity values that were “grossly and recklessly inflated” to induce the couple to make the loan. Not only were the liabilities on the debtor’s home understated by almost $100,000, but the debtor did not list any liabilities for his business. The court determined that based on his experience as a business owner, the debtor had to know that including the value for his business without including its corresponding liabilities grossly overstated the net value of his business.

Moreover, the circumstances surrounding the loan supported the conclusion that the debtor intended to deceive the couple in order to quickly close on the loan. “The circumstances supporting that finding include that [the debtor] apparently had exhausted his possibilities for obtaining more conventional financing for [his business]. If he had not, why would he be approaching private lenders like the [couple] and offering them “hard money” rates of interest?” The court also stated that it was reasonable to assume that the debtor had already borrowed what it could from more conventional sources, none of which were reflected on the financial statement.

As a result, the debtor was prevented from discharging the debt owed to the couple.

For more information about the rights of secured creditors in bankruptcy, subscribe to the Banking and Finance Law Daily.

Friday, September 11, 2015

CFPB helps servicemembers protect their credit while on active duty

By J. Preston Carter, J.D., LL.M.

The Consumer Financial Protection Bureau has released a Fraud Alert Fact Sheet that provides servicemembers with information about getting protective alerts inserted into their credit reports when they are away from home. The CFPB Blog post notes that protections include signing up for an Active Duty Alert and a security freeze.

The CFPB reports that since October 2012, over 650 active-duty servicemembers have submitted complaints to the bureau about their credit reports, and one in six of those complaints involved reports of identity theft or account misuse. However, out of those over 650 complaints, less than 1 percent reported putting an Active Duty Alert in place before leaving for active duty.

The CFPB’s Fraud Alert Fact Sheet details the three kinds of alerts that are available: Active Duty Alert, Initial Alert, and Extended Alert. Each alert notifies users of the servicemember’s credit report of the potential for fraud or identity theft. Under each, the lender has to take reasonable steps to verify the identity of someone who requests new credit in the servicemember’s name approving it.

Active Duty Alert. This alert is available for a person in the military, on active duty, and assigned to service away from the servicemember’s usual duty station. The alert notifies credit reporting companies of the servicemember’s military status, which limits new credit offers while he or she is away. The alert lasts for 12 months, unless the requestor removes it. Also, the servicemember’s name will be removed for two years from nationwide credit reporting agencies’ prescreening lists for credit offers and insurance.

Initial Fraud Alert. This Alert is available if a servicemember has a “good-faith suspicion” that he or she has been or will be a victim of identity theft or fraud. The CFPB notes that this alert is a good first step for someone worried that his or her identity has or will be stolen. This alert provides a servicemember with the right to request a free credit report that will enable the person to “keep an eye out for anything suspicious.”

Under the Initial Fraud Alert, lenders are notified of the alert and must take reasonable steps to verify a requester’s identity before approving new credit. The alert lasts for 90 days, unless removed sooner.

Extended Fraud Alert. This is available for a servicemember who has been a victim of identity theft and has filed a qualifying “identity theft report” with one of the CRAs at With this alert, lenders must use the information provided by the servicemember to verify a credit requester’s identity before approving new credit.

The alert lasts seven years, unless the servicemember removes it sooner. Also the servicemember has a right to two free consumer reports from each CRA during the first 12 months, in addition to the free annual report all consumers are entitled to. Also, the servicemember’s name will be removed for five years from the CRAs’ pre-screening lists for credit offers and insurance.

Security Freeze. The bureau’s Fraud Alert Fact Sheet also mentions that servicemembers can completely prohibit the release of their credit files to potential new lenders by placing a security freeze on their files. Requirements for doing this vary by state

For more information about financial protections for servicemembers, subscribe to the Banking and Finance Law Daily.

Wednesday, September 9, 2015

Trade groups see unverified data as obstacle to normalization of CFPB complaint data

By Andrew A. Turner, J.D.

Multiple trade associations have taken the opportunity to caution the Consumer Financial Protection Bureau on the need to publish only accurate and reliable information that will not mislead consumers in its consumer complaint database. The CFPB had sought input on ways to enable the public to more easily understand company-level information and make comparisons by "normalizing" the raw complaint data it makes available via its Complaint Database. The comment period closed Aug. 31, 2015.

American Bankers Association. The CFPB should refrain from efforts to “normalize information derived from consumer complaints unless and until it has adopted measures to promote the accuracy and integrity of the complaint information posted on its website,” according to the ABA. It recommends that the CFPB work with financial institutions to identify metrics by which complaint information could be normalized. Because normalization may require new, confidential, and proprietary information from financial institutions, the ABA cautioned that the CFPB should demonstrate the utility of the normalized data before subjecting institutions to a new mandate.

Consumer Bankers Association. The CFPB has a duty to improve the accuracy of the complaint data, according to the CBA. The trade association urges the CFPB to shift their focus and verify the data before they work to normalize it. “While industry has long advocated for normalization, we continue to be concerned consumers are being misinformed by unverified data; stress the importance of cautiously assessing how to properly normalize data; and urge the Bureau to adopt informed disclosures to promote transparency in the marketplace.”

The CBA recommended that the bureau establish an appeals process similar to that of the Consumer Product Safety Commission. Specifically, the CBA urges the CFPB to authenticate the substance of the database by establishing a mechanism in the private company Portal for companies to flag communications that do not amount to complaints, and thus should be eliminated from the database.

Independent Community Bankers of America. While ICBA has expressed its understanding of the CFPB’s intent to provide consumers meaningful metrics for comparing data regarding the providers of financial services and products, it believes that the bureau must address important data integrity and information security concerns before undertaking any normalization of complaint data. The trade association also urges the bureau to open any proposed data normalization metrics to public comment. Finally, ICBA recommends that if the CFPB moves forward with this normalization initiative, it should use overall market share by product type as the metric for data normalization.

ACA International. In its comments, ACA International, the Association of Credit and Collection Professionals, stressed that to the extent the complaint database remains publicly available and held out as a source for informed decision making, it is critical that the CFPB develops and implements a transparent normalization process to make the presentation of complaint data fairer, less confusing, and more meaningful.

Center for Capital Markets Competitiveness. The CCMC also emphasized the normalization of the data in the bureau's complaint database in a way that makes the database and the reports derived from it less misleading. The bureau should then build from this initial step and finally put its complaints database on a sound footing, said the trade association.

Consumer Relations Consortium. In response to the bureau’s request for feedback, CRC members have expressed their belief that two elements are most important for any attempted normalization: type of accounts worked and size of the organization. However, using just those two elements is insufficient, said the comment letter. At least two additional elements, balance range and age of debt, are best utilized as initial sub-categories. Thereafter there are numerous other types of sub-categories to the sub-categories, recommended CRC.

For more information about the CFPB'S handling of consumer complaints, subscribe to the Banking and Finance Law Daily.

Tuesday, September 8, 2015

Miami wins battle in predatory mortgage suit against nationwide banks

By Richard A. Roth, J.D.

The U.S. Court of Appeals for the Eleventh Circuit has overturned the dismissal of Miami’s suit claiming that Bank of America, Citigroup, and Wells Fargo harmed the city through what was termed “a decade-long pattern of discriminatory lending in the residential housing market.” Three separate opinions—one resolving the same issues against each of the three banking organizations—said that the city could sue the banks under the Fair Housing Act, had described injuries caused by the claimed violations, and could rely on the continuing violation doctrine to extend statutes of limitations that otherwise would have ended the suits (City of Miami v. Bank of America Corp., City of Miami v. Citigroup, Inc., City of Miami v. Wells Fargo & Co., Sept. 1, 2015, Marcus, S.).

Pattern of predatory lending. As described by the opinions, Miami’s complaints claimed the three banks engaged both in redlining—which the opinion described as refusing to make loans to minority borrowers on the same terms that were available to nonminority borrowers—and reverse redlining—which was described as making loans to minority borrowers on exploitative terms. The banks refused to make loans to minority borrowers on terms similar to those available to white borrowers with comparable credit qualifications, offered loans only on predatory terms, and refused to extend refinancing loans to minority borrowers on terms similar to those available to white borrowers, Miami claims.

The city added that the banks’ loan officer compensation practices encouraged these practices. In the case of Bank of America and Wells Fargo, the city offered confidential witnesses who gave evidence describing how the banks’ executives led loan officers to target minority borrowers for more expensive, high-risk loans.

Statistical data also were offered to establish that minority borrowers paid more for loans than comparable white borrowers and were more likely to go into foreclosure.

Claimed FHA violations. The banks’ lending practices violated the FHA in two ways, the city said. First, they amounted to intentional discrimination against black and Hispanic borrowers. Second, they had a disparate impact on those borrowers, resulting in a disproportionate number of foreclosures on their properties and a disproportionate number of predatory loans in their neighborhoods.

Miami claimed several types of damages from the violations. Properties that the banks foreclosed on lost value, and the foreclosures also reduced the value of surrounding properties, the city said. This resulted in reduced property tax revenues. Also, the city had to pay higher police, fire protection, and garbage collection costs to deal with problems presented by the often vacant properties that had been foreclosed on.

Trial court results. The federal district court judge to whom the cases were assigned dismissed all three. The judge offered the same reasoning in each case:
  • Miami did not have statutory standing to sue under the FHA because it was not within the law’s zone of interests.
  • Miami had not described any injuries that were proximately caused by the banks’ activities.
  • The alleged violations all were outside of the FHA’s two-year statute of limitations, and the city had not described any violations within that two-year span.
After the judge rebuffed its effort to amend the complaints to address the deficiencies, the city appealed.

Constitutional standing. Before addressing the district court judge’s decisions, the appellate court first considered whether the city had standing to sue under Article III of the U.S. Constitution. Article III standing goes to the question of subject matter jurisdiction and thus had to be considered even though the district court judge had dismissed the suits on other grounds, the appellate court said.

For Miami to have Article III standing to sue the banks it had to demonstrate three factors: that it had suffered an injury in fact; that the injury had been caused by the banks’ actions; and that the court had the ability to impose a remedy for that injury. The banks disputed the second factor.

The city had described an injury that was “fairly traceable” to the claimed FHA violations, the appellate court decided. Despite the banks’ assertions that other factors caused the foreclosures and resulting neighborhood deterioration—such as the housing market decline and vandalism—the city’s chain of causation was plausible enough to describe causation.

Proving causation of the injuries might be difficult, the court conceded, but that was an issue for a later time.

Zone of interests. A person whose interests fall within the zone of interests that a law is intended to protect can sue for a violation of that law, the appellate court said. Some laws protect a broader range of interest than others. The question was whether Miami’s interests were within the zone of interests that Congress intended the FHA to protect. Using the act’s terminology, was Miami an “aggrieved person”?

After reviewing more than 40 years of precedent, the court decided the city was an aggrieved person. While the zone of interests to be protected by the FHA perhaps is unclear, it should be interpreted to be as broad as is permitted under Article III of the Constitution, the court decided. Recent decisions by the U.S. Supreme Court might hint that the zone of interests is narrower, but they did not clearly overrule contrary direct precedent because they interpreted other laws.

Since Miami had described Article III standing, and the FHA’s zone of interests was the same as Article III standing, the city’s interests were within the act’s zone of interests, the court reasoned.

Proximate causation. The district court was correct in saying that proximate causation is required by the FHA, the court said. However, the city’s claims were sufficient to satisfy the requirement.

Contrary to Miami’s argument, the city had to do more than just satisfy the Article III requirement that it describe an injury that was fairly traceable to the predatory lending pattern that it was complaining about. A suit under the FHA is akin to a tort suit, which would require that proximate cause be shown, the court said.

The city claimed that the predatory lending practices caused it to lose tax revenue and forced it to increase its expenditures. The banks claimed that such damages would have been at most indirectly caused, not proximately caused, by the lending practices. The court disagreed with the banks.

While proximate cause is difficult to define precisely, what it requires depends on the statute in question, the court observed. Requiring the city to prove a direct relationship between the banks’ lending practices and the city’s injuries would be inconsistent with the FHA, which was to be interpreted broadly to facilitate the accomplishment of its purposes.

The proper standard under the FHA is foreseeability, the court then said. If the banks were engaging in a pattern of predatory lending, as the city claimed, they would reasonably have been able to foresee that their actions would cause the injuries the city described. There might be several links in the city’s chain of causation, but none of those links were unforeseeable, the court said.

Continuing violation. The FHA has a two-year statute of limitations that begins to run on the date a loan is closed. Since the suit was filed on Dec. 13, 2013, that ordinarily would mean a suit could be only address loans that closed after Dec. 13, 2011. None of the loans specifically described in any of the city’s three complaints were alleged to have satisfied the requirement.

According to the appellate court, Miami conceded that its original complaints did not satisfy the time limit. However, the city argued that it should be permitted to file an amended complaint that would do so. The district court judge never ruled on the adequacy of the proposed amended complaint because, he believed, his zone of interests and proximate cause rulings made doing so unnecessary.

Having reversed those rulings, the appellate court instructed the district court judge to consider whether the City’s proposed amended complaint would satisfy the statute of limitations issue by describing a continuing violation. The court also decided to provide “guidance” to help the judge in his deliberations.

Miami should be allowed to sue under a continuing violation theory as long as a single act of discrimination that was part of a discriminatory policy occurred within the two-year time limit, the appellate court advised the district court judge. The city’s case was not based on a single act of discrimination, but rather on alleged longstanding unlawful lending practices that extended into the limitations period. While the specific factors that made the loans discriminatory might have changed over time, “The fact that the burdensome terms have not remained perfectly uniform does not make the allegedly unlawful practice any less ‘continuing’,” the court said.

The city was to be allowed to amend its complaint, the appellate court instructed the judge, and the statute of limitations issue should be considered after that.

Similar litigation. Los Angeles has filed comparable suits against some of the same banking organizations. A 2014 federal district court decision has allowed the city to proceed with its claims against Citigroup.

On the other hand, a recent, scathing decision utterly rejected Los Angeles’s claims against Wells Fargo, relying on the Supreme Court decision in Texas Dept. of Housing and Community Affairs v. Inclusive Communities Project, Inc., to determine that the city had failed to prove the bank had a policy that resulted in discrimination or that there was a statistical relationship between the bank’s lending practices and any alleged discrimination.

The Eleventh Circuit noted that the Inclusive Communities Project decision could apply to Miami’s suit but did not offer an opinion on how the decision could affect the suit.

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Thursday, September 3, 2015

Student loan aid on schedule as students head back to school

By Katalina M. Bianco, J.D.

As the new school year kicks off, the Department of Education and Consumer Financial Protection Bureau are taking a closer look at student financial aid. Thus far, the industry is not making the grade.

The Department of Education has been hard at work implementing the Obama Administration’s Student Loan Aid Bill of Rights. In today’s Treasury Notes, Treasury reposts a DoE blog post detailing its latest steps toward helping student loan borrowers manage their loan debt.

Last year, President Obama launched an initiative intended to ensure strong consumer protections for student loan borrowers and issued a Presidential Memorandum as a step toward implementation of the plan. In March of this year, the president created the Student Loan Aid Bill of Rights, and In July, the DoE announced it was expanding the program with plans to provide an additional six million federal loan borrowers access to student loan payments capped at 10 percent of income.

DoE activities. Since its update last month, the DoE has taken further action to put the initiative in place. Federal Student Aid (FSA) released the recommendations from an interagency task force on best practices in performance based contracting to better ensure that servicers help borrowers make affordable monthly payments. As directed by the Presidential Memorandum, the task force reviewed input from its members in July and consulted with the CFPB and other agencies experienced in the areas of performance-based contracts, student lending, and servicing.

CFPB steps up. The CFPB has updated its consumer advisories to caution students about college-sponsored banking accounts and debit cards. The bureau is concerned that students are not comparison shopping for the best loan terms but simply buying what's offered on campus. While it's not a foregone conclusion that a partnership between college and financial institution may not be best for students, the CFPB advises students to refrain from automatically signing on the dotted line before doing a bit of due diligence.

For more information about student financial aid, subscribe to the Banking and Finance Law Daily.

Wednesday, September 2, 2015

Atlanta Fed: Financial regulatory legislation is a ‘relatively rare’ event

By John M. Pachkowski, J.D.

Larry D. Wall, Executive Director of the Center for Financial Innovation and Stability at the Federal Reserve Bank of Atlanta, has released a commentary examining why major pieces of financial regulatory legislation are relatively rare events and also discussed the implications for analysts trying to contribute to future financial regulatory policy.

Difficulties in passage. In his commentary, entitled “Large, Complex Financial Regulation,” Wall noted there a number of reasons passing financial regulatory legislation is difficult. The legislative process provides those dedicated to stopping a bill “numerous avenues for blocking its adopting into law.” Also, beneficiaries of the status quo have an incentive to use their political influence to block new legislation that might erase their benefits. Wall added, “Furthermore, most voters are likely to be uninterested in financial regulatory topics, viewing them as arcane and remote from their day-to-day lives. As a result, new financial legislation, especially major legislation that increases costs for existing firms or decreases safety net benefits, is difficult to pass.

Prompt passage. Although Wall cited reasons for difficulty in passing financial regulatory legislation, he pointed out that “nevertheless new restrictive legislation is sometimes passed.” This type of legislation tends to be a response to a scandal or crisis. The author cited the Sarbanes-Oxley Act of 2002 that was passed in response to the Enron and WorldCom accounting scandals and the Dodd-Frank Act in response to the 2007-2009 financial crisis.

Wall noted that time immediately after a scandal creates a condition favorable to the passage of new legislation since it creates pressure to act promptly and a failure to do so would see the public's interest in the topic will likely fade as time passes, and those opposed are likely to regain some of their political strength.

Delegation of rule-making. The difficulty of passing new regulatory legislation also has important implications for the delegation of rule-making power to the regulatory agencies. Wall observed, “Given the likely difficulty of passing such revisions through the legislative process, Congress may often find it more effective to give the regulators broad grants of authority that allow the regulatory agencies to make needed revisions without seeking legislative approval.”

Policy analysis. Finally, Wall’s commentary concluded that it would be advantageous to develop policy recommendations in advance of the next crisis so that analysts can focus on the implications of different policies rather than just the immediate impact of a policy on one type of risk and/or on one type of intermediary.

To achieve this, Wall suggested four important considerations:

  1. Policy recommendations should focus on identifying and maintaining the flow of critical services rather than focusing on the fate of any specific class of institutions.
  2. When developing recommendations substantially to reduce or eliminate a type of risk in one set of institutions is important to consider where that risk will migrate to within the financial system.
  3. In evaluating who will ultimately bear risk, the goal should be to have risk end up where it lowers the probability and/or reduces the cost of a systemic crisis.
  4. Policy analysts should recognize that policy changes will not only induce desired responses but also unintended responses designed to lower regulatory costs and raise safety net subsidies. Analysts are unlikely to anticipate fully all of the responses, but should at least seek to identify and mitigate the more obvious of the unintended responses.

For more information about financial regulatory regulation, subscribe to the Banking and Finance Law Daily.

Tuesday, September 1, 2015

Could mortgage servicers' 'delinquency advances' relieve borrowers of debt payments and prevent foreclosure?

By Thomas G. Wolfe, J.D.

In a recent case, Ouch v. Federal National Mortgage Association, the U.S. Court of Appeals for the First Circuit was called upon to address a unique appeal by a proposed class of borrowers who, despite being delinquent on their mortgage loan payments, contended that certain loan servicers made payments on their respective mortgage debts by making a number of contractually mandated "delinquency advances" to certain trustees who held the promissory notes and mortgages under trusts generated by pooled, mortgage-backed securities. Notably, the borrowers argued that the mortgage-holders and loan servicers lacked the power to foreclose against them because the borrowers had not technically defaulted on their respective mortgage loans as a result of the loan servicers' "delinquency advances."

While the First Circuit characterized the borrowers' theory as "crafty," the court ultimately rejected their argument that the mortgage servicers' "delinquency advances" correspondingly relieved the borrowers of making payments on the mortgage debt in those same amounts. Rather, the First Circuit agreed with the federal trial court that the mortgage loan servicers did not make any payments “on behalf of” the borrowers.

Because the pertinent promissory notes in the case qualified as negotiable instruments, the federal appellate court construed the Massachusetts Uniform Commercial Code provision (§3-602) governing the payment of negotiable instruments. The court determined that the loan servicers did not act with the requisite intent to satisfy the borrowers' applicable debts. Moreover, in reviewing the applicable trust agreements and the factual record, the court further determined that the "delinquency advances" were clearly viewed by the loan servicers and trustees as "temporary, stop-gap measures to keep principal and interest flowing to the trustees and the investors."

Consequently, the First Circuit determined that the borrowers' clever theory did not prevail. Because the court ruled that the loan servicers' "delinquency advances" were not made on behalf of the borrowers and the borrowers were not relieved from their obligation to pay those mortgage debts, the borrowers were in default on their loans. In turn, given those defaults, the loan servicers and/or trustees were entitled to foreclose. As the First Circuit related, without the underpinning that the servicers' payments were made "on behalf of" the borrowers, "the rest of the borrowers' argument falls like a house of cards."

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