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Federal District Court Issues First Ever Post-Trial Order Requiring Bank to Reimburse Monoline Insurer over Loans Backing MBS
On February 6, the U.S. District Court for the Southern District of New York found that loans underlying two trusts issued by a Michigan bank breached the representations and warranties in the contracts the bank entered with its bond insurer, and ordered the bank to pay over $90 million, plus interest and attorneys’ fees, to reimburse the insurer for payments made to the bond holders for losses incurred when the loans underlying the trusts defaulted. Assured Guaranty Municipal Corp. v. Flagstar Bank, 11-cv-02375, 2013 WL 440114 (S.D.N.Y. Feb. 6, 2013). The order is the first to impose lender liability for monoline insurer losses based on alleged underwriting defects. The order followed a 12-day bench trial in October 2012 that featured expert testimony presented by the insurer that relied on a statistical sample of the loans in the two pools at issue, and a separate review of certain loan files by the court. The court held that, “despite the unique characteristics of the individual members populating the underlying pool, the sample is nonetheless reflective of the proportion of the individual members in the entire pool exhibiting any given characteristic.” The court then adopted the insurer’s expert’s conclusion that 606 of the 800 loans reviewed were materially defective, while the court determined that the bank was unable to show actual instances where the loan files did not contain material breaches of the underwriting guidelines. Based on the sample loan evidence, the court held that the bank failed to meet its own underwriting requirements in originating the home equity loans that it subsequently pooled and securitized, which eventually defaulted, yielding losses for the insurer. Further, the court held that the bank was made “constructively aware” of the breaches through the insurer’s repurchase demand, yet the bank failed to cure or repurchase.
DOJ Announces Criminal Charges and Penalties for LIBOR Manipulation, Regulators Announce Parallel Civil Enforcement Actions
On February 6, U.S. and U.K. authorities announced that a Japanese financial institution and its British bank parent company agreed to pay roughly $612 million to resolve criminal and civil investigations into the firms’ role in the manipulation of the London Interbank Offered Rate (LIBOR), a global benchmark rate used in financial products and transactions. The U.S. DOJ announced that the Japanese firm agreed to plead guilty to felony wire fraud, admit its role in in the manipulation scheme, and pay a $50 million fine. In addition, the DOJ filed a criminal information and deferred prosecution agreement (DPA) against the parent company for its role in manipulating LIBOR rates and participating in a price-fixing conspiracy in violation of the Sherman Act. As a result, the parent company agreed to pay an additional $100 million penalty, admit to specified facts, and continue to assist the DOJ with its ongoing investigation. The DPA acknowledges the remedial measures undertaken by the bank’s management to enhance internal controls, as well as additional reporting, disclosure, and cooperation requirements undertaken by the bank. Domestic and foreign regulators also announced penalties and disgorgement to resolve parallel civil investigations, including a $325 million penalty obtained by the CFTC, and a $137 million penalty imposed by the U.K. Financial Services Authority.
HUD Proposes Streamlined FHA Inspection and Warranty Requirements, New Jumbo Loan Maximum LTV
On February 6, HUD published a proposed rule that would eliminate two regulations in order to streamline the FHA inspection and warranty requirements. HUD proposes to repeal the regulations requiring a FHA-approved inspector to determine the construction quality of homes for which borrowers seek FHA insurance. HUD acknowledges that the market is sufficiently competitive and regulated to provide quality inspectors without FHA approval. HUD also proposes to remove requirements for borrowers to purchase 10-year protection plans to qualify for FHA insurance for high loan-to-value (LTV) mortgages on newly constructed homes. HUD expects the changes to yield savings for lenders and borrowers, and to eliminate related FHA administrative costs. Public comments are due by April 8, 2013. Also on February 6, HUD published in the Federal Register its previously announced proposal to increase the minimum down payment for FHA-insured loans over $625,500 by setting the maximum LTV ratio at 95 percent. HUD proposed this increase because the FHA Mutual Mortgage Insurance Fund reported a decline from fiscal year 2011. HUD is accepting comments on the proposal through March 8, 2013.
DOJ, State AGs File Civil Fraud Suits against Ratings Agency over RMBS Ratings; Buckley Offers Complimentary FIRREA Webinar
On February 5, the DOJ filed a lawsuit in the Central District of California against a major credit rating agency, alleging that the firm defrauded investors in residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs) by issuing inflated ratings that misrepresented the securities’ true credit risks, and by falsely representing that its ratings were uninfluenced by its relationships with investment banks. According to the complaint, the agency publicly represented that its ratings of RMBS and CDOs were objective and independent, notwithstanding the potential conflict of interest posed by the agency being selected to rate securities by the investment banks that sold those securities. The complaint alleges that, in fact, fear of losing market share and profits led the company to (i) weaken the ratings criteria and analytical models it used to assess credit risks posed by RMBS and CDOs, and (ii) issue inflated ratings on hundreds of billions of dollars’ worth of CDOs. When CDO’s rated by the agency failed, investors lost billions of dollars. The DOJ brings claims under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), alleging that the company engaged in (i) mail fraud affecting federally insured financial institutions, (ii) wire fraud affecting federally insured financial institution, and (iii) financial institution fraud, and seeks civil penalties up to the amount of the losses suffered as a result of the alleged violations. The DOJ believes such losses total $5 billion to date.
Also on February 5, the attorneys general for at least 12 states and the District of Columbia announced state court actions against a ratings agency in coordination with a parallel federal suit filed on the same day, as described above. The actions announced by the AGs for Arizona, Arkansas, California, Colorado, Delaware, the District of Columbia, Iowa, Maine, Missouri, North Carolina, Pennsylvania, Tennessee, and Washington, allege violations of various state laws related to the same general conduct outlined in the federal complaint, i.e. that the ratings agency defrauded investors, including state pension funds, by inflating ratings of certain RMBS and CDOs for private gain, while publicly maintaining that the ratings were objective assessments of the risks posed by the securities. At least three states, Connecticut, Illinois, and Mississippi, are continuing to pursue similar, previously filed, suits against the same agency.
FTC Obtains Settlement from Cord Blood Bank in Data Theft Action
On February 5, a federal district court in California approved a settlement recently obtained by the FTC, which (i) requires a California-based firm that operates a cord blood bank to establish a comprehensive information security program and submit to security audits by independent auditors every other year for 20 years, and (ii) prohibits the company from misrepresenting its privacy and security practices. The FTC alleged that the firm violated the FTC Act by failing to use reasonable and appropriate procedures for handling customers’ personal information, despite its privacy policy claims to the contrary. Further, the FTC charged that the firm created unnecessary risks to personal information by transporting portable data storage devices containing personal information in a way that made the information vulnerable to theft, and failed to prevent, detect, and investigate unauthorized access to computer networks. According to the FTC, this resulted in a December 2010 breach in which certain portable devices were stolen from an employee’s personal vehicle and the names, gender, Social Security numbers, dates and times of birth, drivers’ license numbers, credit and debit card numbers, and other personal information of nearly 300,000 customers were compromised. The FTC also alleged that certain of the portable devices could have permitted an intruder to access the firm’s network, which contained sensitive personal health information.
Third Circuit Holds Notice Sufficient to Preserve Borrower's Three-Year TILA Rescission Right
On February 5, the U.S. Court of Appeals for the Third Circuit held that a borrower need only provide written notice of intent to rescind a loan within the statutory three-year rescission period to preserve that right; a borrower need not also file a complaint within the three-year period. Sherzer v. Homestar Mortg. Servs., No. 11-4254, 2013 WL 425835 (3rd Cir. Feb. 5, 2013). TILA allows borrowers three years to rescind a loan if the lender fails to provide certain required disclosures. In this case, counsel to the borrowers—who had obtained two mortgage loans from two different lenders—sent a letter to the lenders within three years of the closing date asserting that the lenders materially violated TILA by failing to provide certain disclosures. The letter also notified the lenders that the borrowers were exercising their right to rescind the loans. When the lenders refused to rescind one of the loans, the borrowers filed suit more than three years after closing. On appeal, the court reversed the district court, which had dismissed the borrowers’ rescission claims as untimely. The Third Circuit instead held that (i) nothing in the language of the statute (or its implementing regulation) requires the filing of a court action to invoke the right to rescind, and (ii) valid written notice of rescission within the three-year period is sufficient. The court acknowledged concerns about the practical impacts of such a holding on lenders, but stated it was constrained by the statute’s text. In so holding, the Third Circuit agreed with the position advocated by the CFPB and already adopted by the Fourth Circuit, but split from the Ninth and Tenth Circuits, which have held that a borrower must file a complaint within the three-year period to properly exercise the rescission right. The same issue remains pending in the Eighth Circuit.
UK's HM Treasury Unveils Bank Break-Up Legislation, Expects Passage Next Year
On February 4, Britain’s HM Treasury introduced legislation—entitled the Banking Reform Bill—that would provide regulators with new authority to break up a bank if its investment activities put deposits at risk. The legislation goes a step beyond previously proposed policies that would merely require banks to separate retail banking from investment banking. Under the proposed legislation, in addition to requiring that institutions ring-fence deposits, the Bank of England could force an institution to sell off certain businesses if it determines that the institution has failed to protect retail banking activities from high-risk investments. The bill also would, among other things, provide depositors preference if a bank becomes insolvent, and set new leverage caps. The introduction of the bill is the first step in the legislative process, which Britain’s Chancellor of the Exchequer stated he expects to be finalized next year.
Republican Senators Reiterate Opposition to CFPB Nomination, Demand Structural Reforms
On February 1, Republican Senators sent a letter to President Obama to reaffirm their position that the CFPB lacks transparency and accountability, and that until structural reforms are implemented, the 43 signatories will continue to block consideration of any nominee for CFPB director. Specifically, the letter states that (i) the CFPB director-led structure should be replaced by a bipartisan board of directors, (ii) the CFPB should be subject to the annual congressional appropriations process, and (iii) prudential regulators should be empowered to serve as a safety and soundness check to CFPB actions. Also on February 1, Senator Rob Portman (R-OH), who opted not to sign the letter to President Obama, sent a separate letter to CFPB Director Cordray to highlight the “commonsense reforms” to the CFPB that the two previously have discussed, including a change in the CFPB’s governance structure. The letter states that Mr. Cordray “noted…leadership by a bipartisan board provides some stability and continuity in regulation over time.” On February 7, Senator Portman reportedly is aiming to serve as a liaison between the White House and congressional Republicans on Mr. Cordray’s pending nomination and potential CFPB reforms. The only other Republican Senator not to sign the letter to President Obama was Senator Bob Corker (R-TN).
State Law Update: Virginia Amends Broker Licensing Rule
Recently, the Virginia State Corporation Commission adopted regulations proposed by the Bureau of Financial Institutions to clarify that individuals engaged in the business of a loan processor or underwriter, who do not otherwise engage in mortgage broker activities, are not mortgage brokers subject to state licensing requirements. The final rule also (i) broadens the scope of prohibited activities for licensees, (ii) establishes requirements for licensees’ outsourcing of loan processing and underwriting, (iii) requires licensees to update its NMLS loan originator sponsorship information following changes in originator status, (iv) adds a definition for “refinancing” that includes any loan modification, and (v) expands the Bureau’s enforcement authorities. The amended regulations took effect January 28, 2013.
Virginia Federal Court Applies Continuing Violation Theory to Extend FHA Statute of Limitations
On January 29, the U.S. District Court for the Western District of Virginia invoked the continuing violation theory in refusing to bar an otherwise untimely Fair Housing Act discrimination claim. Nat’l Fair Hous. Alliance, Inc. v. HHHunt Corp., No. 11-131, 2013 WL 335877 (W.D. Va. Jan. 29, 2013). The case against the defendant architect centered on the design and construction of two apartment complexes in North Carolina. The parties agreed that the FHA’s two year statute of limitations had not run on claims relating to one of the projects. Standing alone, the claims relating to the other apartment complex were outside the two year limitation. The plaintiffs argued, however, that the two allegedly wrongful designs together established a pattern or practice of discriminatory acts, the last of which having occurred within the statutory time frame, served to save all claims from the time limitation. The court found this theory viable and denied the defendant’s motion for summary judgment. In doing so the court held that multiple design and construction projects that are “sufficiently related” can constitute a pattern or practice that warrants extending the statute of limitations period. Whether the two apartment construction projects at issue were so related, the court reasoned, raised a genuine issue of material fact that prevented summary judgment.