Strategic Compliance

By Melissa Richards Wallace, Esq. of The Wolf Firm
(Used with permission by Mortgage Banking - November 1998)

The financial services industry has traditionally approached an organization's compliance and quality-control functions as necessary evils. These functions are commonly viewed as part of the overall cost of doing business, necessitated by Congress, by state and federal government supervisory agencies and, increasingly, by consumer groups and the trial lawyers' bar.

As a compliance attorney for the mortgage banking industry, and as a former thrift regulator, my view of these functions challenges the popular notion of them. This article serves as an illustration of what I believe to be true: Compliance and quality-control functions are profit centers, grounded in an organization's effective risk-management program. Income saved by hedging the risk of liability for compliance with the most troublesome federal and state laws truly ensures the longevity and overall value of a mortgage banking company.

The concept of risk management gained popularity in the late 1980s with the onset of the savings and loan crisis and subsequent FSLIC (Federal Savings andLoan Insurance Corporation) bailout. Federal banking agencies found measuring risk, whether it was compliance risk, interest rate risk or other operational risk, was a key factor in assessing an institution's overall safety and soundness.

During the 1990s, the complexion of our financial services industry has changed. Depository institutions have lost market share on the credit side to a nondepository mortgage banking industry, the securities industry and others.

While we do not measure our industry's health, wealth and longevity by "safety and soundness," and while federal regulatory agencies do not wield the power and influence they did 10 years ago (due to fewer depository institutions in this country), risk management remains a key component to the vibrance of our industry.

Compliance risk-management model

In an effective compliance risk-management program, the mortgage banker ranks all federal and state laws under which it operates in order of overall risk of liability. There are two components that make up risk of liability. The first is an assessment of the difficulty of complying with a law: Are the requirements under the law or its implementing regulations unduly vague and subject to varying interpretations, are they too technical to understand and implement with certainty, or are they flat-out impossible to comply with when taken as a whole?

Mortgage industry trade associations spend much time and effort each year defending the industry before national and state legislators authoring bills or amendments to legislation as a result of their constituents' or their own negative experience with mortgage bankers and servicers. (For example: S.1301, the Senate version of bankruptcy reform legislation, includes the "Durbin Predatory Lending Amendment," which would allow a debtor in bankruptcy to wipe out the Section 32 mortgage loan, principal and interest/charges, if it can be shown that a Truth in Lending Act violation occurred.) Imagine what this industry could accomplish if our trade associations could instead invest that time and effort in enlightening legislators as to how instrumental we as an industry are in empowering communities through homeownership and access to credit.

The second component of a lender's risk of liability stems from civil, criminal and administrative liability and penalties resulting from noncompliance, both for the mortgage lender/servicer and its assignees (investors or subsequent holders of all or a portion of a loan; not owners). This component reflects the continuing barrage of consumer-based, class-action lawsuits being filed against the financial services industry, and mortgage bankers in particular, for not complying with federal and state laws.

The mortgage industry spends millions of dollars every year defending lawsuits brought on behalf of purportedly wronged consumers. But more often than not, the benefit from these suits is derived exclusively by the plaintiffs' bar. This risk component also weighs heavily on the marketability of a loan portfolio-the key to an organization's liquidity and financial strength-in assessing the degree to which that liability carries over to assignees.

The following model compliance risk-assessment outline incorporates both components to measuring risk. It also includes a mechanism by which a mortgage banker can take a proactive and strategic approach to operating under statutory and regulatory requirements.

Model Compliance Risk-Assessment Outline:

A. Restate the law/identify the compliance issue(s)
B. Restate the penalties

1. Criminal
2. Civil/class action
3. Liability to assignees
4. Administrative (government enforcement)

C. Assess the compliance risk (incidences or likelihood of violation)-low/ moderate/high
D. Determine strategy for hedging risk (including self-help remedies)

By using this model risk-assessment outline, mortgage bankers can more quickly identify operational weaknesses affecting their bottom line. This can allow them to decisively correct those weaknesses before they result in bad press, consumer lawsuits or government enforcement actions. In short, an effective compliance risk-management program frees up mortgage bankers to do what we all strive for:
provide our communities with access to continually innovative credit programs so that each individual can realize the American Dream of homeownership.

Illustrations of the risk-assessment model

To illustrate how the compliance risk-assessment model works, the following is a presentation of how a mortgage banker might strategically address two federal laws that pose a high compliance risk: Truth in Lending Act (TILA) Section 32 loan disclosure requirements, and the Fair Debt Collection Practices Act (FDCPA).

          Truth in Lending Act-Section 32 Loans

• Restatement of the Law/Regulation. The purpose of TILA is to promote the informed use of consumer credit by furnishing consumers with information regarding the requested credit program, including such terms as "annual percentage rate" (APR) and "finance charge." To address concerns raised by legislators on behalf of constituents about certain "predatory" lending practices involving certain "high-cost, high-fee" mortgage loan programs, the Home Ownership and Equity Protection Act of 1994 (HOEPA) was enacted. HOEPA imposes new, early disclosure requirements and substantive limitations on loans bearing rates or fees above a certain percentage or amount ("Section 32 loans").
  
  
• Two-Part Compliance. There are two parts to complying with the Section 32 loan disclosure requirement: timeliness of disclosure and accuracy of disclosure.

  Timeliness: The Section 32 loan disclosure must be received by the borrower at least three business days prior to loan consummation. There is no statutory or regulatory cure for untimely delivery of the disclosure.

  To hedge compliance risk: Timely delivery-Document the borrower's receipt of the disclosure, i.e., signed acknowledgment of personal delivery, overnight mail receipt or certified letter receipt.

  Untimely delivery-Back-out fees and costs to a level where the loan is no longer deemed to be a Section 32 loan.

  Accuracy: The Section 32 loan disclosure must accurately present the following information: a) The statement: "You are not required to complete this agreement merely because you have received these disclosures or have signed a loan application. If you obtain this loan, the lender will have a mortgage on your home. You could lose your home, and any money you have put into it, if you do not meet your obligations under the loan"; (b) the APR (within prescribed olerance levels); the amount of the regular monthly (or other periodic) payment (no tolerance levels afforded); and (c) for variable-rate transactions, a statement that the interest rate and monthly payment may increase, and the amount of the single maximum monthly payment based on the maximum interest rate that may be imposed during the loan term.

To hedge compliance risk: The Section 32 loan disclosure is deemed to be one of the "material disclosures" for purposes of the right of rescission penalty. Ensure through quality control that all information presented in the disclosure is accurate before signing loan documents. If inaccuracies are discovered before loan funding, issue a corrected disclosure and wait another three business days to sign. If inaccuracies are discovered after loan funding, issue a corrected ection 32 disclosure; a corrected TIL Statement, if needed; and a new Notice of Right to Cancel. The borrower must be given three business days to elect to unwind the loan transaction in order to cut off the three-year rescission period. Backing-out points and fees to render the transaction outside the scope of Section 32 will not cure the inaccurate disclosure.

• Penalty Restatement for TILA Violations

(1) Criminal Penalties: None.

(2) Creditor Liability: Private right of action is afforded both individuals and classes. One-year statute of limitations from the date the alleged violation occurred to institute an action. However, aggrieved borrowers are not precluded from asserting a TILA violation as a defense to a creditor/assignee action to collect the debt brought more than one year after the violation. Successful plaintiffs may recover actual damages; for Section 32 loans, the sum of all finance charges and fees paid by the consumer (unless the creditor can demonstrate that the violation is not material); punitive damages (up to $2,000 per individual; the lesser of $500,000 or 1 percent of net worth if a class); attorney's fees and costs.

(3) Assignee Liability: A private right of action against assignees is afforded to individuals and classes, only if the subject violation is apparent on the face of the disclosure statement (except for involuntary assignments). Same statute of limitations and right to assert TILA violation as a defense to creditor/assignee action. Any civil action for TILA violations in connection with consumer credit transactions secured by real property that may be brought against a creditor may also be brought against assignees.

(4) Three-Year Right of Rescission on Non-Purchase Money Loans: As discussed earlier, the Section 32 loan disclosure is considered one of the "material disclosures" (Footnote 48 to Reg. Z, Sec. 226.23(a)). If the loan is a certain refinance or junior-lien mortgage loan, borrowers-as well as all other individuals having an ownership interest in the residence-have the right to cancel the transaction within three business days of the later of loan consummation, delivery of a properly completed Notice of Right to Cancel (NRC), or the delivery of all material disclosures. Failure to provide an accurate Section 32 loan disclosure will extend the rescission period from three business days to up to three years.

(5) Administrative Enforcement: Enforcement of TILA is administered primarily by the Federal Trade Commission (FTC) and by federal banking agencies. Agencies may seek injunctive relief, civil money penalties, supervisory agreements and other enforcement actions.

• Compliance Risk Rating. High, due to technical nature of law and regulations, coupled with civil liability and right of rescission penalty for creditors and assignees.

• Hedging Risk (self-help remedies). TILA allows creditors and assignees to avoid liability by timely implementing self-help remedies to correct TILA violations. Action to correct TILA violations must be taken prior to institution of private or administrative enforcement action and within 60 days of the creditor or its assignee's actual discovery of the violation. The affected borrower must be notified in writing of the violation, and adjustments must be made to the person's loan account to ensure that the borrower will not be required to pay more than the charge actually disclosed, or the dollar equivalent of the APR actually disclosed, whichever is lower.
  
  Fair Debt Collection Practices Act
  
  
• Restatement of the Law/Compliance Issue(s). The Federal Fair Debt Collection Practices Act (FDCPA) was enacted to protect consumer debtors from abusive and unfair debt collection practices by debt collectors. While the FDCPA does not apply to mortgage loan servicers generally, it does apply to servicers and assignees acquiring loans and servicing rights for loans already in default. The following are important distinctions to understanding the scope of FDCPA coverage:
  
  (1) What is debt? "Debt" is any obligation of a consumer to repay money, the purpose of which is primarily for personal, family or household (as opposed to business or investment) purposes. The character of the debt, consumer or nonconsumer, is not determined by the type of collateral security for the mortgage loan.
  
  To hedge compliance risk: Assume that all mortgage debt is a consumer debt, unless there is certain knowledge to the contrary.
  
  (2) Debt Collector vs. Creditor. Debt collectors are subject to FDCPA coverage and civil penalties; creditors are not. A debt collector is any person who regularly collects or attempts to collect debts owed or due (or asserted to be owed or due) another. In contrast, a creditor is any person who offers or extends credit creating a debt or to whom a debt is owed. Creditor examples include lenders attempting to collect defaulted loans they originated; lenders collecting defaulted loans that were not in default at the time the loan was acquired; and loan servicers collecting defaulted loans that were not in default when loan servicing was acquired. "Creditor" does not, however, include any person or entity who receives an assignment or transfer of a debt in default solely for the purpose of collecting the debt for another. Thus, mortgage loan servicers who receive delinquent accounts for collection are deemed to be a debt collector under FDCPA.
  
  To hedge compliance risk: Unless servicers maintain data as to whether the loans for which servicing rights were acquired were in default at the time of acquisition/assignment, assume all loans acquired for servicing and collection were in default as of the acquisition/assignment date.
  
  (3) The "Miranda" Warning. A debt collector must disclose clearly in the initial communication (verbal or written) with the debtor that "the debt collector is attempting to collect a debt" and "any information obtained will be used for that purpose." All subsequent communications must contain an affirmative disclosure that the loan servicer is a debt collector.
  
  To hedge compliance risk: Install a separate telephone line that contains an initial recorded message restating the "Miranda" warning, to receive collection-related calls. For calls initiated by a servicer's collection staff, prepare an initial communication script or format to be used that contains the warning.
  
  (4) Debt-Validation Notices. A written notice must be sent out no later than five days from the date of the initial communication, restating the debt owed and giving the debtor 30 days from receipt to dispute the validity of the debt. The notice must be written in a fashion to enable even the "least sophisticated" debtor to understand it. During that 30-day period, the debt collector cannot take any action that would overshadow or contradict the validation notice.
  
  To hedge compliance risk: Debt-validation notices must be presented in a simple, clear and concise manner (on an even easier readability level than an average daily newspaper). It is acceptable to recommend that the debtor seek advice from legal counsel if he or she does not understand any part of the letter. Send debt-validation notices via means where the date of receipt can be tracked (overnight mail, certified mail; not facsimile transfer). Do not threaten to take or, in fact take, formal action to collect the debt within the 30-day period (i.e., foreclosure). Debt-validation disclosures must appear in equal or larger type size as the rest of the letter.
  
  
• Penalty Restatement for FDCPA Violations.
  
  (1) Criminal Penalties: None.
  
  (2) Debt Collector Liability: For those assignees and loan servicers found to be acting as debt collectors, the FDCPA affords private right of action for both individuals and classes. Successful plaintiffs may recover actual damages; discretionary damages (up to $1,000 per individual; the lesser of $500,000 or 1 percent of net worth if a class); attorney's fees and costs.
  
  (3) Administrative Enforcement: Enforcement of the FDCPA is administered primarily by the FTC, as well as by the federal financial services regulatory agencies, including HUD. Administrative enforcement actions may include assessment of civil money penalties, cease-and-desist orders and supervisory agreements with provisions requiring affirmative actions to correct violations.
  
  
• Compliance Risk Rating. High, due to the law's vagueness and operational impracticality, coupled with private right of action for individuals and classes for civil liability.

• Hedging Risk (self-help remedies). Implement the FDCPA's "bona fide error" defense. Under FDCPA, a debt collector may not be held liable upon showing by a preponderance of evidence that the violation was not intentional and that it resulted from a bona fide error, notwithstanding the maintenance of procedures reasonably adapted to avoid such error (i.e., focusing on the statute's vagueness and contradictory provisions rendering overall compliance impossible). Have written policies and procedures in place and correctly implemented; regularly train your collection staff. Review the Federal Trade Commission's Official Staff Commentary, which serves to clarify and expound on FDCPA provisions.
  
  A final word
  
  The mortgage banking industry operates under a myriad of federal and state laws governing loan negotiation, origination and servicing. Creating a risk-management program to support strategic awareness and implementation of these laws-from highest to lowest compliance risk-can save the industry millions of dollars each year. In addition, a risk-management program changes the focus from trying to influence our government representatives to somehow simplify or dismiss these laws altogether (a practical impossibility), to making better use of the laws already on the books.
  
  Properly trained (and compensated) compliance and quality control personnel are the key to a successful risk-management program. Embrace them.
  
  Attorney Melissa Richards Wallace manages the Compliance and Licensing Practice Group at The Wolf Firm, a law corporation based in Newport Beach, California. Wolf & Richards concentrates its practice on issues involving the real estate finance industry and is a charter member of the USFN.
   

For further information please contact:

Melissa Richards Wallace
The Wolf Firm 
A Law Corporation 
18 Corporate Plaza Drive 
Newport Beach, CA. 
Tel: (949) 720-9200. 
Fax: (949) 720-9250

The Wolf Firm, A Law Corporation, is an "AV" rated law firm which concentrates on providing superior legal services to the mortgage banking  industry. The firm's national clientele includes many of the largest mortgage bankers in the country, as well as a variety of savings banks, commercial banks, commercial finance companies, credit unions, and the Resolution Trust Corporation. With a staff of approximately forty individuals, including attorneys, certified paralegals, legal secretaries, administrators, clerical personnel, and a full time computer systems analyst, the firm represents its clients on a wide range of matters including all aspects of both residential and commercial/multifamily mortgage loan origination and servicing, securitization, regulatory compliance, bankruptcy, and litigation related to the foregoing in both federal and state courts throughout California. For more routine matters, such as residential bankruptcies, evictions and receiverships, The Wolf Firm has developed extremely cost-effective and efficient programs using specially trained paralegals and computer technology to assist its attorneys in handling these matters at rates that are the most competitive in the State of California and, through its membership in the USFN, the Firm is able to arrange similar services in virtually every state in the nation.

This article is intended as a general discussion and should not be construed or used as legal advice or a legal opinion. Should you seek legal advice, you should consult with your own attorney.

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The Wolf Firm
A Professional Law Corporation
18 Corporate Plaza Drive
Newport Beach, California  92660
(949) 720-9200 Phone
(949) 720-9250 Fax
E-Mail us at Alan_Wolf@wolffirm.com

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