The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) has had a tremendous impact on the financial services industry since its passage in 2010. The law, drafted as legislation aimed at protecting consumers, has unintentionally (or perhaps intentionally) disrupted the daily operations of businesses from Wall Street to Main Street. One aspect that is radically affected is that of residential mortgage loan originations.
Through Dodd-Frank, the Consumer Financial Protection Bureau (“CFPB”) has been armed as the single-director arbiter of the new myriad of financial regulations being implemented under the expansive law. Last November 28, the CFPB released a bulletin warning financial firms to be cautious about incentives offered to company representatives over products and services they provide to their clients, and the “intended and unintended” effects and risks they pose.
The notice amounted to a warning shot to the mortgage industry. The bulletin comes on the heels of a 2015 memo from Calvin Hagins, deputy assistant director for originations at the CFPB, where he alerts the industry that loan officer compensation will be a top enforcement concern of the CFPB moving forward.
The main driver of this enforcement is Subtitle A of Title XIV of Dodd-Frank, which amends the Truth-In-Lending Act (“TILA”) with regards to mortgage loan originator compensation. The CFPB has issued a slew of new rules under TRID, HMDA, and other regulations; however, no significant changes to the loan originator compensation rule have been issued just yet.
The Loan Originator Compensation Rule
The CFPB issued its final loan originator compensation rule (“Rule”) back on January 20, 2013. The Rule attempts to restrict loan officer compensation and so-called “steering” tactics, where the loan originator tries to place a borrower into a more expensive product that generates more commission. The final rule revised the TILA requirements above the existing prohibition that loan origination compensation not be tied to the terms and conditions of the transaction.
CFPB’s final rule went into effect January 1, 2014, and clarifies established compensation provisions of Regulation Z as follows: Defines “a term of transaction” as “any right or obligation of the parties to a credit transaction.” This requirement stipulates that a mortgage originator cannot receive compensation based on the interest rate, terms of the loan, or by steering a consumer to a third-party affiliate, such as title insurance or appraisal.
Prohibits compensation based on a “proxy” for the term of a transaction. The stipulation is meant to prevent evasion on the part of a broker to receive compensation based on the originations of another individual.
The purpose of the loan originator compensation rule is to enhance oversight and enforcement of requirements and to restrict “double dipping” by mortgage brokers and loan originators who are more concerned about commissions than the consumer’s well-being.
Prohibits loan originator compensation based on the offset of the cost of a change in transaction terms. This is meant to prevent originators from receiving compensation by the changing of loan terms. However, an originator is allowed to defray compensation to offset borrower-incurred settlement costs.
Prohibits a loan originator from receiving compensation based upon the profitability of a transaction or pool of transactions. Simply put, a loan originator cannot receive bonus compensation based on a particular type of mortgage product.
A loan originator is not able to receive compensation from both a consumer and related party for the same transaction. Under this rule, however, mortgage brokers may still pay commission above that which they are receiving from the consumer (points), provided that compensation not be based on the terms of the transaction.
Section 1403 of the Dodd-Frank Act contains general verbiage that prohibits consumers from paying upfront points and fees on a transaction where compensation is paid by someone other than the consumer (i.e. mortgage broker). However, Dodd-Frank also authorizes the CFPB to waive the requirement if it determines that doing so would be in the interest of the consumer.
According to the CFPB, the purpose of the Rule is to enhance oversight and enforcement of Regulation Z requirements and to restrict “double dipping” by unscrupulous mortgage brokers and loan originators who are more concerned about commissions than the consumer’s well-being. The primary goal of the rule is to disrupt the correlation between loan terms and the amount of compensation an originator receives. The CFPB felt that pricing tools such as the yield spread premium, along with other bonus structures, provided a tempting pathway for loan originators to financially benefit to the detriment of the borrower.
Additional CFPB Enforcement Examinations
There have only been a few major enforcement actions taken by the CFPB since the Rule was implemented, however, that should not forego the fact that the CFPB is keenly aware that some compensation rules are routinely not being followed.
The consumer watchdog agency has filed suit against several loan originators for compensation violations. These violations include: bonuses paid based on the interest rate of a loan; commissions and bonuses paid based on the loan profits and proceeds received from settlement costs; and payments made to affiliated marketing companies based on the amount of profits the mortgage broker received from the sale of certain loan types.
It is the view of the CFPB that the incentive programs of these companies violated TILA, and prompted loan officers and employees to steer consumers into lending products or services they would otherwise not have sought. The penalties for some of these violations amounted to millions in civil fines and tens of millions in refunds to consumers.
Effect on Daily Operations
It is clear that the CFPB, empowered with both investigative and enforcement authority under Dodd-Frank, is focusing squarely on mortgage origination compensation structures meant to incentivize the origination of new business. While we do not know yet what is coming down in the form of new rules or stepped-up enforcement efforts, we do know that the CFPB is expanding its oversight and investigation into the operational aspects of mortgage brokers to ensure compliance.
The main sticking point is compensation based on the interest rate and terms of a transaction. The CFPB is examining companies that attempt to mask their employee compensation through the use of bonus payouts, expense accounts, and other payments that are based on the specific types of products sold. In fact, the final rule is written so broadly that the CFPB can consider many compensation packages worthy of examination into how they contribute to a loan originator’s production habits.
Mortgage brokers and loan originators need to be well aware of the risks poised by complex compensation packages that may violate, or appear to violate, any of the provisions established under Dodd-Frank and the CFPB. The mere appearance of impropriety may invite more scrutiny from federal regulators. Mortgage brokers should familiarize themselves with the requirements of the Rule, and develop well-written and clear internal guidelines and pay structures that adequately compensate loan originators without crossing that fine line.