Consumer Finance Insights
November 24, 2014

CFPB to Lender: Bonuses Indirectly Tied To Loan Interest Rates Are Compensation

According to the CFPB, Franklin Loan Corporation paid its loan officers $730,000 in quarterly bonuses over 26 months – but the bonuses were allegedly based in part on the interest rates on loans, thus violating the Loan Originator Compensation Rule in Regulation Z.  As a result, the CFPB entered into a consent order with Franklin this month, requiring the company to pay $730,000 in monetary relief to customers.

Before the compensation rule took effect in 2011, Franklin paid its loans officers a commission that varied based on the interest rates for loans, according to the Complaint the CFPB filed in federal court in California on November 13, 2014.  Under that old compensation plan, Franklin paid commissions based partly on a cash “rebate” that depended on the interest rate of loans, according to the CFPB.  “Loans with higher interest rates generated higher rebates,” the CFPB alleged in the complaint.  Loan originators had discretion whether to pass the rebates on to borrowers.  If they retained the rebate, a portion of it was included in their commission.

The compensation rule prohibited lenders from basing compensation on the terms of a loan, and so Franklin scrapped that commission practice.  The new commission practice was okay: Franklin began paying its loan originators commission based on a set percentage of the loan amount, according to the CFPB’s complaint.  The Loan Originator Compensation Rule does not prohibit paying loan originators a fixed percentage of a loan amount.

But the rebates, which were tied to interest rates, allegedly continued to impact loan officer compensation in the form of bonuses.  Between June 2011 and October 2013, CFPB alleged that Franklin’s loan originators were paid quarterly bonuses that violated the compensation rule because they were indirectly and partly based on interest rates.  As a bonus, Franklin gave each loan officer a portion of the money in an individual expense account.  The expense account, in turn, was partly funded with money from the retained rebates.  Those rebates, as noted above, were based on the interest rates for loans; higher interest rates generated higher rebates.  If loan originators chose to retain the rebates, then the interest rates on the loans indirectly influenced the amount of their bonuses.

Franklin agreed to the November 13 consent order because, its president told a California newspaper, “the cost to litigate was more expensive than the fine,” and so “we made a business decision to move on.”  The consent order does not actually require Franklin to pay a fine – which the CFPB attributed to Franklin’s “financial condition” – but Franklin does have to make the $730,000 payment to the CFPB for relief to affected customers.  The $730,000 figure represents the amount of quarterly bonuses that Franklin Loan Corporation paid to its loan originators.  Based on the CFPB’s complaint, it appears that the bonuses were only partly based on rebates that depended on interest rates, but the consent order requires Franklin to pay the entire amount of the bonuses.  

Franklin nevertheless appeared to do better than the previous lender CFPB sued for violations of the Loan Officer Compensation Rule.  That suit, one year earlier, against Castle & Cooke Mortgage, LLC, was also based on a quarterly bonus system in which higher interest rates generated higher bonuses.  The resulting consent order in that case required the lender to pay over $9 million to consumers and a $4 million civil penalty.

The two consent orders show the CFPB’s interest in whether lenders are compensating loan officers based on the terms of the loans – and that scrutiny includes any indirect methods by which interest rates or other terms might affect total compensation, including bonuses.  Although the bonuses in Franklin’s case were issued before 2014, the January 2014 amendments to the Loan Originator Compensation Rule included stronger language clarifying that lenders cannot base compensation on factors indirectly affecting interest rates or other loan terms.  As a result, lenders should note that the rule states: “[i]f a loan originator’s compensation is based in whole or in part on a factor that is a proxy for a term of a transaction, the loan originator’s compensation is based on a term of a transaction” and the CFPB looks very closely at compensation structures to police compliance with this rule.

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