Holidays, a Time for Reflection

This year I feel a heavy heart on the holidays. My greatest heartache comes from the sadness of losing so many of our fellow Americans to the lethal COVID virus. 

And the next few months will show an increase in deaths due to COVID, possibly as much as nearly a half-million by the spring. None of us has ever experienced anything like this loss. It is so huge that my mind has a hard time contemplating its immensity. Each person who has died – some of whom I have known and loved – deserved to be with their family on these holidays. Now it cannot be.

I wrote the Business Continuity Plan Checklist & Workbook, includes COVID-19 Pandemic Response to contribute in my way to helping people to be careful, plan, accept science, set aside hubris, and protect themselves, their families, other employees, and their fellow Americans. I did not charge a fee. A publisher asked if I would sell it. How can one charge for such information that is needed in the middle of a pandemic? 

The document is now on its eighth update, last published on November 5^th, consisting of 211 pages. The ninth update will follow soon, since the federal relief plan has only just now been signed into law. The downloads have exceeded well over a thousand. Yet, I wonder if my effort was effective. I hope so. If it changed a few organizations to act responsibly, even just a few, it was well worth the effort.

We just passed Hanukkah, the Festival of Lights, a time to realize that a little hope goes a long way, like the consecrated lamp oil that was found for use to last a single day in the ancient temple, which had been destroyed; yet the oil burned for eight nights. Perhaps you can see that, against all odds, we should have faith in new beginnings. 

We just passed Christmas, on December 25^th, the date fixed in the fourth century to coincide with the winter solstice; the Eastern church celebrates it on January 7^th. It has been referred to as the Feast of the Nativity. What does Jesus symbolize if not the chance to have faith in new beginnings?

We just passed the beginning of Kwanzaa, on December 26th, the annual celebration of African-American culture dedicated to a striving for the seven principals of unity, self-determination, collective work and responsibility, cooperative economics, purpose, creativity, and faith. It celebrates the festival of "first fruits," a dedication to family, community, and culture - a time to have faith in new beginnings.

And the New Year approaches, inevitably, as a reminder that our time is finite, so we should look within to have faith in new beginnings.

These holidays are joyous but also bittersweet. Joyous because they remind us to have faith in new beginnings; bittersweet because each of them comes with a sense of having lost hope at times, ruminations about challenges that seemed too great to bear – and we reflect on what was lost along the way. 

We put down our path as we walk it. Our path is uniquely ours. Friends and family are part of our joy. We are together, but, ultimately, we are alone to face the consequences of our actions. Psalm 30:5 says, weeping may tarry in the night, but joy cometh in the morning. Let us have hope.

Many people I have spoken to seem to grasp at life continually, but I think living well is learning to let go. It seems natural to grasp, but I think letting go is the way to move from strength to strength. We don’t have to be afraid of letting go because we grow when we let go, we heal when we slough off the coils of the past.

So, for me, the holidays this year are a somber time. I will reflect. I will hug my loved ones with all my might. I will make sure I am in contact with them, too, by remote viewing.

And I will find it within myself to have faith in new beginnings.

Dear friends, clients, colleagues, and subscribers, may this holiday season fill you with faith in new beginnings. Keep open the door to your heart in memory of those who have lost so much this year due to the pandemic. 

Take good care of yourselves and loved ones, so that you stay safe and healthy. We will get beyond these challenges and find new insights to strengthen our souls. Courage.

May you all have a safe, healthy, and joyous New Year!

Best wishes,
Jonathan

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director
Lenders Compliance Group

Violating TILA's High-Cost Provisions

QUESTION
We received a letter from the banking department that accuses us of violating high-cost mortgage provisions. This came from a review of 75 loan files, which they conducted remotely earlier this year. 

This is pretty scary for us. We are a small lender, licensed in only one state, and this kind of action has never happened. 

The violation specifically mentions the added provisions to the high-cost mortgage rule. We want to know more about these added provisions. 

Can you provide some information about the added provisions to the high-cost mortgage rule?

ANSWER
I understand that you are a bit upset about this situation. In my experience, banking departments do not go out of their way to “accuse” their licensees of violations. Generally, their orientation is geared toward consumer advocacy, and ensuring that supervision and enforcement are maintained across the range of companies in their purview. 

So, trust me, it’s very unlikely that you were singled out. This is just a banking department doing its job. Regulators want their licensees to operate within applicable federal and state guidelines.

Prior to the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), Regulation Z contained a set of restrictive provisions affecting high-fee, high-rate mortgage loans, which generally were referred to as HOEPA (Home Ownership and Equity Protection Act) or Section 32 mortgage loans (because the main provisions were found in Regulation Z § 1026.32).

The Dodd-Frank Act amended the Truth in Lending Act (TILA) to change the name to “high-cost mortgages” or HCMs, expand the scope of coverage, alter the coverage thresholds, and enhance the restrictions and prohibitions, but not until the CFPB amended Regulation Z (TILA’s implementing regulation), thereby promulgating the changes.

On January 13, 2013, the CFPB did just that, adopting its HCM Rule, also known as the January 2013 HOEPA Rule, with implementation delayed until January 10, 2014. Regulation Z requires special disclosures for HCMs and prohibits them from including certain provisions. In addition, consumers have enhanced remedies for violations, including rescission, higher damages, and higher potential liability for purchasers and assignees.

The HCM Rule added the following restrictions:

(1) a general ban of prepayment penalties and balloon payments, with limited exceptions including one for certain balloon loans made by creditors serving rural or underserved areas;

(2) a prohibition of fees for modifying HCMs;

(3) a cap on late fees of 4% of the past due payment;

(4) a prohibition of closing costs rolled into the loan amount;

(5) a restriction on the charging of payoff statement fees;

(6) a ban of certain other practices, such as encouraging a consumer to default on an existing loan to be refinanced by an HCM; and,

(7) a requirement of homeownership counseling before taking out an HCM; and (8) an enhanced requirement that creditors assess repayment ability.

Let me broaden this out a bit by discussing a recent decision in a federal district court in California, where TILA’s HCM provisions were applied. The case is Sundby v. Marquee Funding Group, Inc. [Sundby v. Marquee Funding Group, Inc., 2020 U.S. Dist. (S.D. Cal. Sept. 15, 2020)]

In 2016 and 2017, Sundby and his spouse obtained a loan and then refinanced it, obtaining both loans in the name of Sundby Trust, their family trust, and securing both with their home.

Sundby sued the two lenders for the same three alleged violations of TILA: (1) the inclusion of a prepayment penalty, (2) the inclusion of a balloon payment, and (3) a failure to abide by the ability-to-repay provisions.

After denying the lenders’ motions for summary judgment, the court granted summary judgment for Sundby.

The loans were HCMs because they required prepayment penalties exceeding 2 percent. TILA includes other ways of falling into the HCM category, but one automatic determinant is having a prepayment penalty exceeding 2 percent. The net result, then, is that the HCM violates TILA because it has a prepayment penalty.

The first loan contained a clause requiring the payment of a prepayment penalty equal to at least “90 days of interest from the day of this loan funding,” or $64,109.59, which amounted to more than 2 percent of the loan amount ($2,600,000) or $238,333.37. 

The second loan also carried a prepayment penalty of more than 2% because it required the payment of a prepayment penalty equal to “the difference between Six (6) month(s) of interest” and the interest due as of the “date of the prepayment” if “this loan [for $3,160,000] is paid off or refinanced during the first Six (6) month(s) of the term.” Given that the prepayment penalty could be as high as $150,100.02, it would exceed 2 percent of the loan amount.

This fact – having a prepayment penalty exceeding 2 percent – pushed the loans into the HCM category. It also meant that each loan violated TILA’s HCM prohibition of prepayment penalties.

The loans violated the HCM balloon payment prohibition because each loan required its entire principal and remaining interest due on a single day at the end of the loan and referred to that payment as a “balloon balance.”

The lenders also violated TILA by failing to adequately assess Sundby’s ability to repay. The applications for the loans did not include income or assets other than the subject property and listed only $7,200 monthly income, $5,840 expenses, $15,000 in non-property assets, and $40,000 in non-mortgage liabilities to service a $3,160,000 loan with $833.89 daily interest.

The parties included no additional evidence substantiating the lenders’ efforts to test or analyze Sundby’s ability to pay the loan. Given the lack of information available to the lenders, the lack of other evidence to indicate their due diligence, and the lenders’ failure to contest the ability to pay violation, the court granted summary judgment for Sundby as to the ability to repay.

So, what does this decision tell us? 

The case involved the restrictions and prohibitions that were added by the HCM Rule. 

Regulation Z already included, and still includes, other prohibitions, including prohibitions of negative amortization, advance payments, default interest rates, and non-actuarial rebates.

Jonathan Foxx, Ph.D., MBA

Chairman & Managing Director

Lenders Compliance Group

Criminal Liability in TILA

QUESTION
I am the General Counsel of a small bank in the Midwest. 

Bank lawyers typically focus on the civil liability provisions of TILA. However, I think we have a blind spot when it comes to criminal liability. 

I am catching up on criminal liability with respect to TILA violations. I hope you can start me off in the right direction. 

How can criminal liability arise in violations of TILA?

ANSWER
It may be worthwhile to consider criminal liability in viewing violations of the Truth in Lending Act (TILA).

TILA § 112 specifies:

“Whoever willfully and knowingly (1) gives false or inaccurate information or fails to provide information which he is required to disclose under the provisions of [TILA] or any regulation issued thereunder, (2) uses any chart or table authorized by the Consumer Financial Protection Bureau (CFPB) under section 1606 of this title in such a manner as to consistently understate the annual percentage rate determined under section 1606(a)(1)(A) of [TILA], or (3) otherwise fails to comply with any requirement imposed [by TILA], shall be fined not more than $5,000 or imprisoned not more than one year, or both.” (My emphasis.)

It is worth noting that this TILA provision rarely sees the light of day, but it is available. A case comes to mind where the U.S. Court of Appeals for the 2nd Circuit affirmed its use against a payday lender. The case is United States v. Moseley. Let’s use this case as a learning tool toward understanding the application of criminal liability to a TILA violation. [United States v. Moseley, 2020 U.S. App. (2nd Cir. Nov. 3, 2020)]

For about ten years, Moseley ran a payday loan business, using several domestic and foreign loan entities, including entities in Nevada, the Federation of St. Kitts and Nevis (“Nevis”), and New Zealand, where no usury statutes existed. Moseley and his employees administered the enterprise solely from offices located in Kansas City, Missouri.

In 2014, the CFPB shut the business down on the basis of the illegalities that became the subject of Moseley’s prosecution.

Moseley’s business had offered small-dollar, short-term, unsecured loans in amounts up to $500. The business charged “fees” that functioned as interest payments. Using the Internet, Moseley’s business directly credited the borrower’s bank account with the loan principal by using the borrower’s private banking information. 

For each “loan period,” Moseley charged a $30 fee for each $100 of the borrower’s total loan amount. The business automatically deducted these fees from the borrower’s bank account and credited them to Moseley’s entity at the end of the first loan period.

Unlike the debited fees, repayment would not automatically occur. Unless the borrower affirmatively acted to pay off the principal by the end of the 2-week loan term, the loan would be “refinanced,” (sic) and the term automatically extended. 

For each extension, an additional equal fee would be debited against the borrower’s account and credited to Moseley’s business. Consequently, absent an affirmative act by the borrower to pay off the principal, Moseley would continue debiting the account each 2-week period, and the result could, and on occasion did lead to total finance charges of $780 on the original $100 loan, in effect an approximate yearly interest rate of 780%, none of which would be credited toward repayment of principal.

As if that wasn’t bad enough, Moseley took his scheme further by actually implementing a separate scheme that almost certainly reduced his chances for acquittal. A potential borrower searching for short-term cash would enter personal information online in a “lead generator” website maintained by a third party hired by Moseley’s business. The “lead generator” website was one in which a potential customer could express an interest in a loan but was not provided loan terms and was not actually agreeing to receive a loan. Upon receiving an expression of interest, the lead generator would forward the prospective borrower’s information to Moseley’s business.

I think you can guess where this scheme was going!

Moseley would then have his employees attempt to contact the potential borrower by phone and try to obtain borrower approval for making a loan. If phone contact was made, the employee would explain the loan’s terms to the borrower, who could then accept or decline a loan offer. If the potential borrower did not answer the phone, the employee would leave a voicemail message about the offer, and the loan would be approved and made anyway, even absent the borrower’s consent.

How was that possible?

It was possible because individuals provided banking information at the get-go, in their inquiry to the lead generator, without having established a business relationship or entered into an agreement. Moseley’s business would then deposit the loan principal into the borrower’s account and begin deducting fees as described above.

In testimony at trial, one of Moseley’s employees estimated that the business never made direct contract with about 70 percent of eventual borrowers. Although all borrowers eventually received loan documents by email, the e-signatures on those documents were falsified. 

Also at trial, Moseley tried to show that borrowers “e-signed” the agreements when they inquired about loans. The government introduced substantial evidence to the contrary, from which, according to the court, the jury could have concluded that those borrowers whom Moseley’s staff did not contact by phone had no notice of loan terms and had no opportunity to accept or reject those terms before the related credits and debits began.

In an attempt to avoid state criminal usury caps, Moseley incorporated entities offshore and edited the online loan agreements to include a “choice of law” provision specifying that the law of one of the three jurisdictions (Nevada, Nevis, or New Zealand) governed the transaction. A "choice of law" or "governing law" provision in a contract allows the parties to agree that a particular state's laws will be used to interpret the agreement, even if they live in (or the agreement is signed in) a different state.

The disclosures in Moseley’s loan documentation included a box labeled “Total of Payments,” described as the “amount you will have paid after you have made the scheduled payment.” The figure displayed in this box was the sum of the loan principal and a single “fee.” The Total of Payments disclosure did not indicate that no repayment of the principal was actually “scheduled” to occur, nor did it indicate that indefinitely recurring finance charges were “scheduled” to occur. Rather, text in fine print below the disclosure box advised that the single payment of loan principal and a single finance charge whose sum it displayed would become “scheduled” only if the borrower signed a specified separate form and “fax[ed] it back to our office at least three business days before your loan is due.” As a result, the Total of Payments disclosure was inaccurate for any borrower who did not affirmatively and timely act by sending a facsimile to pay off the loan principal.

Here's where we enter the realm of criminal liability. A jury convicted Moseley of violating the Racketeer Influenced and Corrupt Organizations Act (RICO) and TILA § 112. The district court sentenced Moseley primarily to 120 months in prison and ordered him to forfeit $49 million.

The 2nd Circuit affirmed. After affirming the RICO conviction, the 2nd Circuit agreed that the jury also had sufficient basis to find that Moseley “willfully and knowingly…[gave] false or inaccurate information or fail[ed] to provide information which he [was] required to disclose [by TILA].”

The Total of Payments disclosure included just one finance charge in addition to the loan principal amount, notwithstanding Moseley’s knowledge and intention that, unless the borrower acted, the total he or she would pay would amount to much more than a single finance charge, and that the Total of Payments had no upper limit at all (except that Moseley’s business generally and arbitrarily viewed a loan as repaid after 40 or 45 charges).

TILA-compliant disclosures must reveal the total of payments under the payment schedule set at the time of loan disbursement, not under an illusory payment schedule achievable only after the borrower undertakes steps described in the fine print.

I would also suggest that the jury rationally could have found that it was inaccurate and misleading for Moseley’s Total of Payments to show disclosure of just the loan principal plus one finance charge, especially in view of the fact that no such payment was actually scheduled. The court noted that the fact that the total of payments amount could be difficult to predict, and would vary from borrower to borrower, did not exempt Moseley from the obligation to disclose the potentially limitless “scheduled” amount.

Jonathan Foxx, Ph.D., MBA

Chairman & Managing Director

Lenders Compliance Group

Guidance versus Regulations

QUESTION
We appreciate your weekly FAQs. It is printed and handed out to staff in our Monday compliance meetings. Thank you for your dedication to our compliance needs.

In one of our meetings recently, there was quite a bit of discussion about the difference between regulations and guidance. The consensus was that regulations must be followed, but guidance is not required to be followed.

The thinking was that regulatory guidance would become regulations, so we should just follow them anyway.

Our question is, what’s the difference between regulations and guidance?

ANSWER
First and foremost, thank you for reading our FAQs. We have provided this labor of love for many years because of our philosophy to serve our clients and the mortgage community more broadly. In fact, our very motto – Creating a Culture of Compliance® – is reflective of our commitment and vision.

Your question is a good one. Regulations and guidance are not synonyms, but they are closely aligned. I will offer some insight into the difference by considering a current regulatory proposal. 

The Federal Reserve, Consumer Financial Protection Bureau, Federal Deposit Insurance Corporation, National Credit Union Administration, and Office of the Comptroller of the Currency are asking for comment on a proposal that outlines and confirms the agencies' use of supervisory guidance for regulated institutions.

The proposal would codify the 2018 Interagency Statement Clarifying the Role of Supervisory Guidance (“2018 Statement”) that clarified the differences between regulations and guidance. The 2018 Statement reiterated well-established law by stating that, unlike a law or regulation, supervisory guidance does not have the force and effect of law. 

The agencies do not take enforcement actions or issue supervisory criticisms based on noncompliance with supervisory guidance. Instead, supervisory guidance outlines supervisory expectations and priorities or articulates views regarding appropriate practices for a given subject area.

Thus, in contrast to supervisory guidance, regulations do have the force and effect of law, and enforcement actions can be taken if regulated institutions violate the regulations. Regulations are also generally required to go through a notice and comment process.

To amplify this outline further, the agencies had issued the 2018 Statement on September 11, 2018, to explain the role of supervisory guidance and describe the agencies’ approach to supervisory guidance. An interesting feature of the 2018 Statement was its view that agencies issue various supervisory guidance types to their respective supervised institutions, including, but not limited to, interagency statements, advisories, bulletins, and policy statements, questions and answers, and frequently asked questions.

To be clear, supervisory guidance outlines the agencies’ supervisory expectations or priorities and articulates the agencies’ general views regarding appropriate practices for a given subject area. Supervisory guidance often provides examples of practices that mitigate risks or that the agencies generally consider to be consistent with safety and soundness standards or other applicable laws and regulations, including those designed to protect consumers.

It is also worth noting that the agencies stated in the 2018 Statement that supervised institutions sometimes request supervisory guidance. That guidance is essential to providing clarity to these institutions in a transparent way that ensures consistency in the supervisory approach.

Here’s the important takeaway: the 2018 Statement restates existing law and reaffirms the agencies’ understanding that supervisory guidance does not create binding, enforceable legal obligations. Furthermore, it reaffirms that the agencies do not issue supervisory criticisms for violations of supervisory guidance, and the appropriate use of supervisory guidance by the agencies.

Specifically, in this particular interagency statement, the agencies also expressed their intention to (1) limit the use of numerical thresholds in guidance; (2) reduce the issuance of multiple supervisory guidance on the same topic; (3) continue efforts to make the role of supervisory guidance clear in communications to examiners and supervised institutions; and (4) encourage supervised institutions to discuss their concerns about supervisory guidance with their appropriate agency contact.

Financial institutions must use regulatory guidance constructively to be prepared for regulatory scrutiny. Implementing guidance provides certainty and transparency to financial institutions. 

In effect, by following regulatory guidance, a financial institution anticipates the agencies’ supervisory criticisms relating to identifying the practices, operations, financial conditions, or other matters that could have a negative effect on the safety and soundness of the financial institution; could cause harm to consumers; or could cause violations of laws, regulations, final agency orders, or other legally enforceable conditions.

Jonathan Foxx, Ph.D., MBA

Chairman & Managing Director

Lenders Compliance Group