Consumer Financial Services Alert - October 2, 2012

The CFPB announced that it and the FDIC have issued a consent order against a bank, alleging violations of federal consumer protection laws for deceptive marketing of its add-on products (i.e., payment protection, credit score tracking, identity theft protection and wallet protection). Director Richard Cordray noted that the CFPB and FDIC had listened to numerous recorded sales calls by the bank’s in-house and third-party telemarketers and found that the telemarketers “spoke unusually fast when explaining the cost and product terms,” and “processed purchases without consent of consumers.”

The consent order calls for civil money penalties of $14 million and up to $200 million in restitution to the bank’s customers. Similar to the CFPB’s first public enforcement action, which alleged similar violations of federal consumer protection law (see July 24, 2012 Alert), the consent order also requires a compliance program, including designation by the bank’s board of who in bank management will be responsible for the review and approval of all marketing and solicitation materials, a training program, and monitoring of all third parties (e.g., telemarketing vendors and product program administrators).  The bank’s board must also establish an oversight committee. Finally, under the consent order, the bank is required to provide the FDIC’s Regional Director, the CFPB’s Assistant Director of the Office of Enforcement, and the CFPB’s Regional Director with quarterly progress reports addressing each provision in the consent order and “detailing the form, manner, results and dates of any actions taken to secure compliance with the provisions” of the consent order. The CFPB also released a factsheet on the consent order.

The CFPB recently denied a petition to set aside a civil investigative demand. The ruling, the first of its kind, is the result of a petition filed by the subject—a mortgage lender—of an investigation into whether the practice of ceding premiums from private mortgage insurance companies to captive reinsurance subsidiaries of mortgage lenders violated the Real Estate Settlement Procedures Act and the Consumer Financial Protection Act. In its civil investigative demand, the CFPB’s Enforcement Team requested interrogatories and documents in five areas: (1) the mortgage lender’s captive reinsurance contracts, terms, and negotiations; (2) referrals of business from the mortgage lender to mortgage insurance providers; (3) financial statements reflecting funds ceded to the mortgage lender’s captive reinsurer by mortgage insurers and reinsurance claims paid or projected; (4) actuarial, accounting, and other analyses of the legitimacy of the captive reinsurance arrangements; and (5) promotion and marketing of captive reinsurance arrangements. The mortgage lender vigorously opposed the CFPB’s request and filed a petition challenging portions of the CID, such as that insufficient notice of the purpose of the investigation was provided, and that the CID was overbroad and imposed an undue burden (e.g., covers its entire mortgage business).

In denying the petition to set aside the CID, the CFPB first noted that CIDs serve the important function of closing the “substantial information gap” between the CFPB and a subject company. According to the CFPB, the CFPA and its implementing regulations authorize it to issue a CID whenever it “has reason to believe” that the subject has information or documents “relevant to a violation.” Citing Oklahoma Press Publ’g Co. v. Walling, 327 U.S. 186, 209 (1946), the CFPB noted its broad latitude in the use of investigative subpoenas, which facilitate the CFPB’s determination of the likelihood that a potential violation has occurred and/or is occurring. In reaching its decision, the CFPB concluded that the mortgage lender did not meet the standard set by courts in challenging an administrative subpoena as overbroad—that the information sought was irrelevant to the investigation or caused an undue burden. Of importance is the CFPB’s apparent admonishment of the subject company for failing to make a “good faith effort” to negotiate the terms of the CID, serving as a cautionary tale to future parties of the importance of the mandatory meet and confer requirements prior to filing a petition to modify or set aside a CID.

The CFPB announced the members of its Consumer Advisory Board—required under Dodd-Frank to advise and consult with the CFPB in the exercise of its functions under federal consumer financial laws and to provide information on emerging practices in the consumer finance products and services industry; the Community Bank Advisory Council and Credit Union Advisory Council—established under the CFPB’s authority under Dodd-Frank to establish advisory councils, these councils are expected to facilitate interactions between “community banker and credit unions, and CFPB staff”; and the Academic Research Council, which advises the CFPB on its research analysis and data collection. The first meeting of the CAB took place September 27-28, 2012 in St. Louis Missouri; and the CAB is expected to meet at least twice a year. The CFPB also released the charters for the CAB, CBAC, CUAC, and the Academic Research Council.

In anticipation of the February 7, 2013 effective date for the remittance transfer rule created by the Dodd-Frank Act—designed to implement consumer protections for certain electronic transfers of funds to other countries—the CFPB has released a list of countries for which an exception to the rule’s disclosure requirements applies. In general, the remittance transfer rule requires disclosure of, among other things, the exact amounts to be received in a foreign currency, fees, and taxes; estimates of these amounts are permitted in certain situations. One situation where estimates are allowed is when the provider cannot determine exact amounts because of the laws of the recipient country. The CFPB has interpreted the exception to apply to the laws of Aruba, Brazil, China, Ethiopia and Libya. The list will be reviewed and revised as appropriate, but no country will be removed from this list earlier than May 1, 2013 and 90 days advance notice will be provided. The CFPB is seeking comments on whether the right countries have been included in the list, and input on other countries that should be included. Comments for the May 1, 2013 update are due by February 15, 2013.

The CFPB will also host a webinar on the requirements under the new remittance transfer rule on October 16, 2012.

Director Richard Cordray testified before both the House Committee on Financial Services and the Senate Committee on Banking, Housing and Urban Affairs about the CFPB’s semi-annual report (see August 7, 2012 Alert). Mr. Cordray’s testimony discussed generally the CFPB’s activities for the period of January 1, 2012 through June 30, 2012, including the CFPB’s focus on mortgage servicing and “larger participants.” When questioned about industry calls for a safe harbor or rebuttable presumption under the impending qualified mortgage rule by members of the Committee on Financial Services, Mr. Cordray stated that the CFPB had not yet decided whether it would adopt a safe harbor rule to its impending qualified mortgage rule. Members of the House Committee on Financial Services were also concerned with the impact of the ability-to-pay rules, including, for example, the ability of stay-at-home spouses to obtain credit. Mr. Cordray testified that the CFPB plans to issue a new rule to correct this unintended consequence of the ability-to-pay rules.

The CFPB is seeking comments on its request for emergency processing and approval of the collection of information related to the short-form credit agreement Pentagon Federal Credit Union plans to begin using this fall. The CFPB has requested emergency approval and processing on the ground that using the normal clearance procedures would prevent collection of the necessary information that would aid in the “development of and revisions to its approach to improving the readability of credit card agreements.” Comments are being solicited on: (1) whether the collection of information is necessary for the proper performance of the function of the CFPB; (2) the accuracy of the CFPB’s estimate of the burden of the collection of information; (3) ways to enhance the quality, utility, and clarity of the information to be collected; and (4) ways to minimize the burden of the collection of information on respondents. Comments are due by October 18, 2012.

The CFPB released a study comparing credit scores sold to creditors and those sold to consumers. The CFPB study, required by the Dodd-Frank Act, found that about one in five consumers is likely to receive a score that is meaningfully different than the score a creditor would receive. A score is considered meaningfully different if the consumer is likely to qualify for credit offers different than those the consumer would expect to get based on the score purchased. For this subset of consumers, the study concluded that the score discrepancies could cause harm to consumers because they, not aware of the discrepancies, may waste time and money shopping for loans for which they are not qualified. The study recommends that consumers avoid relying on scores they purchase as the sole basis for assessing their creditworthiness, shop around for credit options before making a decision, and check their credit report for accuracy and dispute errors. Additionally, the study suggests that providers of scores should ensure that the potential for score differences is clear to consumers.

The House Committee on Small Business has released CFPB Director Richard Cordray’s responses to questions raised by the Committee on the potential costs posed to the mortgage lending industry for compliance with forthcoming regulations aimed at simplifying the cost disclosure process. The CFPB will implement a new rule requiring disclosure of key loan terms and associated costs on simplified, standardized forms to be presented to borrowers at multiple stages of the borrowing process. According to the responses, the CFPB estimates total costs to the mortgage banking industry of approximately $100 million, resulting mostly from necessary software upgrades and retraining of staff. Mr. Corday acknowledged that much of this cost likely will be passed on to consumers, but nonetheless insisted that charges per borrower would be low and that the industry would eventually benefit from decreased compliance costs as a result of simpler disclosure forms and quicker, more efficient origination practices.

The CFPB released its draft five-year strategic plan, which outlines four goals over the next five years, including:

• Preventing financial harm to consumers while promoting good practices that benefit consumers;
• Empowering consumers to live better financial lives;
• Informing the public, policymakers and the CFPB’s own policymaking with data driven analysis of consumer finance markets and behavior; and
• Advancing the CFPB’s performance by maximizing resource productivity and enhancing impact. 

The CFPB plans to reach its first goal—of preventing financial harm—through regulations and supervision. The CFPB will use performance indicators such as the number of supervision activities opened and the contributions of local and state law enforcement officials in reporting violations of consumer protection laws. The CFPB is seeking comments from the public on its strategic plan. Comments are due by October 25, 2012.

The Federal Financial Institutions Examination Council announced the availability of 2011 data on mortgage lending transactions as required under the Home Mortgage Disclosure Act. The CFPB, as one of the agencies within the FFIEC, also issued a press release on the availability of the data. HMDA requires financial institutions to annually disclose data about their lending operations including their applications, originations, and purchases of home purchase loans, refinancings, and home improvement loans. HMDA requires institutions to provide information on the loan (i.e., purpose of the loan); the property location; applicant information (i.e., ethnicity, race, gender and annual income); pricing-related data (i.e., rate spread between APR and average prime offer rate); and other optional data (e.g., reasons for loan denial).

Robert Schoshinski, Assistant Director of the Division of Privacy and Identity Protection of the FTC, testified before the House Subcommittee on Financial Institutions and Consumer Credit. The central theme of Mr. Schoshinksi’s testimony was that strong enforcement of the Fair Credit Reporting Act remains one of the FTC’s top priorities. The testimony highlighted a number of areas, including: (1) the agency’s commitment to educating consumers and businesses about consumer reports, credit scores and their rights and obligations under the FCRA; (2) the FTC’s recent FCRA enforcement work; (3) the problems faced by consumers with limited or no credit history, referred to as “thin files,” and the agency’s continued interested in marketplace products currently using alternative data to provide consumers with greater access to credit opportunities; and (4) the impact of medical debt on consumer reports and credit scoring models.

The FTC announced the release of final changes to Part 2 (Investigations) and Part 4 (Attorney Discipline) of its Rules of Practice, reflecting public comments received after the notice of proposed rulemaking was published in January of this year. The final changes to Part 2 seek to streamline the FTC’s investigatory process by, for example, requiring parties to meet and confer with FTC staff within 14 days to resolve electronic discovery issues relating to subpoenas and civil investigative demands, and relieving parties of their obligations to preserve documents related to an FTC investigation after a year passes with no written communication from FTC staff. The final changes to Part 4.1(e) clarify the agency’s procedures for evaluating allegations of attorney misconduct. The changes to both Parts 2 and 4 become effective November 9, 2012 and, with respect to Part 4, will apply to any alleged attorney misconduct that occurs on or after such date.

The Office of the Inspector General of the Federal Housing Finance Agency released a report evaluating the FHFA’s and Freddie Mac’s loan repurchase program since the initial report was issued in September 2011. The OIG concluded that both the FHFA and Freddie Mac have addressed the issues raised in the initial report by adopting “a more expansive review process.” The initial report found shortcomings in Freddie Mac’s quality control process including overlooking of loans in default, The report concluded by recommending that FHFA and Freddie Mac continuing to improve its loan review process in light of the original findings.

The OCC issued supervisory guidance on the risk management and reporting requirements for rental properties. The guidance bulletin is applicable to investor-owned, one- to four-family residential real estate lending where the primary repayment source for the loan is rental income. The guidance requires that banks have credit risk management policies and processes for the risks specific to investor-owned, one-to four family residential real estate lending that cover, among other things, underwriting and loan identification and portfolio monitoring expectations.

The FDIC announced that it revised the classification system for citing violations identified during compliance examinations to promote better communication with institutions and consistency in the classification system. The revised classification system replaces the current two-level system with a three-level violation system. According to the FDIC, the key purpose of the revision and the addition of a third level of violation is to effectively communicate the level of severity of violations so that supervised institutions may “appropriately prioritize efforts” to address identified issues.

Under the new classification system, the violations are classified as “Level 3/High Severity,” “Level 2/Medium Severity” and “Level 1/Low Severity.” Level 3 violations are those that “have resulted in significant harm to consumers or members of a community” and may result in restitution to consumers in excess of $10,000. Level 3 violations also include “pattern or practice” violations of anti-discrimination law. Level 2 violations are those that reflect systemic, recurring, or repetitive errors that represent a failure of the bank to meet a key purpose of the underlying statute or regulation. The effect on consumers of a Level 2 violation may be “small, but negative” or potentially negative, if left uncorrected. The FDIC will seek restitution of $10,000 or less for Level 2 violations. Level 1 violations include those relatively minor violations that are isolated or sporadic, or a systemic violation that is unlikely to affect consumers or the underlying purposes of the regulation or statute. Level 1 violations will not be reflected in the FDIC’s final report of examination if they are appropriately addressed by the bank during the examination and do not reflect a weakness in the bank’s compliance system. The revised classification system is effective on examinations commenced on or after October 1, 2012.

The Federal Housing Finance Agency announced proposed guarantee fee pricing adjustments in Connecticut, Florida, Illinois, New Jersey and New York for mortgages owned or guaranteed by Fannie Mae or Freddie Mac. Fannie Mae and Freddie Mac charge guarantee fees in the form of upfront payments and ongoing payments to compensate for the credit risks they undertake when they own or guarantee mortgages. The proposed fee increases in the five states, which would take effect in 2013, result from higher default/foreclosure-related carrying costs compared to the national average. Factors that the FHFA considered important in this decision were the length of time needed to obtain marketable title, property taxes that must be paid during the period after foreclosure, and legal and operational expenses incurred during that same period after foreclosure. As a result of variances from the national average, the FHFA is proposing to increase upfront guarantee fees by 15 basis points in Illinois; 20 basis points in Florida, Connecticut and New Jersey; and 30 basis points in New York. The increased guarantee fees can be passed along to borrowers in the interest rate, which would result in increased monthly payments on a 30-year, fixed-rate mortgage of $200,000 of $3.50 to $7.00.

The FHFA is also seeking public input regarding: (1) whether the standard deviation is a reasonable basis for identifying states that are significantly more costly than the national average; (2) whether finer distinctions should be made between states; and (3) whether an upfront fee or an upfront credit should be assessed in every state based on its relationship to the national average. Comments are due by November 26, 2012.

A Maryland intermediate level appellate court held that a lender could not avail itself of the protections of a bona fide purchaser, which protects a person’s interest in property that the person purchases without notice of prior equities, when the lender was on constructive notice of an action affecting title to the real property at the time the lender acquired its lien. Here, the borrower obtained a loan on property that, while deeded to him, was the subject of an ongoing action by his deceased mother’s estate, which was seeking to impose a constructive trust on the property. The borrower ceased making loan payments once the constructive trust was imposed. The lender filed a foreclosure action, and the estate representative filed a motion to stay and dismiss the foreclosure action alleging that the lender’s lien was invalid. The lower court denied the motion to stay and dismiss, finding that the lender’s actual notice and bad faith were disputed material facts. On appeal, the Court held that the action pending at the time of the loan served as constructive notice under the doctrine of lis pendens, which precluded the lender from the protection of a bona fide purchaser. As a result, the Court reversed and remanded the case with instructions to dismiss the foreclosure action.

The United States Court of Appeals for the Third Circuit has dismissed putative class action alleging violations of the Fair Debt Collection Practices Act, among other claims. Plaintiff, a mortgage borrower, alleged that a foreclosure law firm violated the FCDPA by failing to withdraw its foreclosure complaint after plaintiff had entered into a loan modification agreement. Affirming the District Court’s dismissal of the FDCPA claim on statute of limitations grounds, the Third Circuit strictly applied the FDCPA’s one year limitations period. Plaintiff had alleged that her FDCPA claim did not accrue until the defendant knew or reasonably should have known of its violation (i.e., after plaintiff had entered into a modification agreement). The Third Circuit rejected plaintiff’s formulation of the FDCPA, noting, with approval, prior rulings that the FDCPA is a strict liability statute that imposes liability “without proof of an intentional violation.” Holding that this language created a “straightforward, objective standard,” the Third Circuit affirmed the dismissal of plaintiff’s claim on grounds that applying a subjective standard for accrual of an FDPCA claim based on a defendant’s hypothetical knowledge of its violation was incompatible with the strict liability operation of the statute. Also of significance, the Third Circuit held that the limitations period on plaintiff’s claims was not tolled during the FDIC’s review of her claims against the lender, noting that plaintiff’s claims were not subject to tolling because they were not claims against the assets of the failed bank and because the lender’s receivership began after the case was removed to the District Court.

Parties in a putative class action alleging that defendant improperly raised annual percentage rates charged to its credit card holders have reached a $10 million settlement. Plaintiff alleged that defendant had sought to raise the APR on her credit card to more than double the “fixed” rate stated in her card agreement. According to plaintiff, the bank offered her the option of accepting the increased rate or canceling her credit card despite plaintiff’s insistence that she had never missed a payment. Plaintiff filed suit on behalf of a putative class of 132,000 credit card customers, alleging violation of the California Business and Professions Code and the Truth in Lending Act. Defendant subsequently agreed to settle the lawsuit for 40% of the claimed damages, including attorneys’ fees and payment to the named plaintiff.

A Texas appellate court reversed a trial court’s judgment in favor of a lender, upon a finding that the lender failed to establish that the disposition of collateral was commercially reasonable. Citing Texas common law, the Court noted that in an action for deficiency judgment, while a lender may establish commercial reasonableness by generally pleading that “all conditions precedent have been performed or have occurred,” where it does and a debtor lodges a specific denial, the burden of establishing reasonableness shifts back to the lender. The Court found that the defendant-appellant failed to present legally sufficient evidence. In reaching its decision, the Court held that the lender’s business records were insufficient because they did not indicate how the vehicle was sold or “‘the method, manner, time, place and other terms’ of the sale.” The Court also noted that the lender did not offer evidence of the reasonableness “safe harbors” contained in Article 9 of the UCC.

The United States District Court for the District of Massachusetts dismissed a putative class action on grounds that plaintiff’s claims were preempted by federal law. Plaintiff alleged that the bank’s requirement that all borrowers obtain insurance equal to the amount owed on their loans violated a Massachusetts statute forbidding lenders from requiring borrowers to purchase insurance greater than the replacement cost of the property. Plaintiff claimed that he had overpaid for insurance by approximately $500 dollars per year as a result of defendant’s requirement. Defendant responded by arguing that any state law purporting to limit the amount of insurance that a federal savings bank can require is preempted by the Home Owner’s Loan Act.

The Court’s opinion dismissing the case is noteworthy for two reasons. First, the Court denied plaintiff’s motion to remand the case to state court, holding that defendant had established the amount in controversy necessary for federal jurisdiction under the Class Action Fairness Act. In seeking remand, plaintiff argued that only $2.1 million was in controversy, based on his alleged damages and the estimated size of the putative class. The Court rejected this argument, noting that plaintiff sought treble damages under the Massachusetts unfair practices statute, thereby making the theoretical amount in controversy in excess of $6 million—above the CAFA jurisdictional minimum. This ruling presents a satisfying result, and should serve as a reminder to plaintiffs that courts will hold them to the consequences of their pleadings, for better or for worse.

Second, the Court employed a straightforward application of federal preemption in the banking context, holding that the text of HOLA “definitively preempts any state law purporting to impose requirements regarding the ‘ability of a creditor to require or obtain private mortgage insurance, insurance from other collateral or other credit enhancements.’” As a federal savings bank, defendant’s practice of requiring insurance equal to the value of the loan is subject only to the terms of HOLA, making any state laws that would impose additional limitations inapplicable to defendant.

The United States District Court for the Southern District of Alabama dismissed a case challenging a loan servicer’s exemption from TILA’s requirement that borrowers be informed within 30 days of the change in ownership of their loans.  The Court held that the assignment of a mortgage to a loan servicer for purposes of foreclosure falls within TILA’s “administrative convenience” exemption from the 30-day notice requirement. Plaintiff alleged that defendant, the servicer of his loan, violated TILA by failing to provide notice within 30 days of the assignment of his mortgage to another servicer. (Plaintiff had defaulted on his loan and defendant took the assignment in anticipation of foreclosure on the plaintiff’s property.) Defendant countered that, as a loan servicer, it was exempted from the notice requirement by the “administrative convenience” safe harbor provided under TILA, which provides that a loan servicer shall not be treated as a new owner of a consumer obligation where it takes assignment of the obligation “solely for the administrative convenience of the servicer in servicing the obligation.”

Holding defendant to be exempt under this provision, the Court rejected plaintiff’s definition of matters “solely for administrative convenience” as overly narrow, noting instead that a plain reading of the term “administrative convenience” encompassed any transfer of ownership done “to make it less difficult for the defendant to perform a servicing duty.” The Court also noted that the Code of Federal Regulations does not define the term, leaving courts to determine the scope of the application based on the language of the TILA statute itself. The ruling is significant because it offers a concrete and specific application of the “administrative convenience” exemption in the context of a transfer in advance of foreclosure.