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New York DFS Obtains Substantial Settlement In Licensing Enforcement Action
On March 31, in an enforcement action with potential implications for a range of financial service providers, the New York State Department of Financial Services (DFS) announced that an insurance holding company agreed to pay a $50 million civil fine to resolve allegations that two of its subsidiaries conducted unlicensed insurance business in the state, and that one of the subsidiaries made false representations about those activities. The Manhattan District Attorney’s Office (DA) announced that the company agreed to resolve a parallel criminal investigation by entering into a deferred prosecution agreement and disgorging $10 million in profits.
The DFS and the DA claim that their coordinated investigations revealed that the subsidiaries used New York-based sales representatives to solicit insurance business for the companies and their affiliates, and to directly sell insurance products in New York to multinational companies, notwithstanding representations to the contrary from the companies. However, the authorities allege, neither company was licensed to conduct business in the state, and both companies used sales representatives who were not licensed as insurance brokers or agents in New York.
In addition, the DFS and the DA assert that one of the subsidiaries, while operating under the control of a different parent company, intentionally misrepresented to the New York State Insurance Department (one of the DFS’s predecessor agencies) that the subsidiary did not solicit business in New York and that its New York staff did not engage in such activities. At the time, in seeking an opinion as to whether it was required to obtain a license, the company asserted that its New York operations were limited to “back office” operations not subject to licensing requirements.
The civil fine in this action is substantially larger than fines typically imposed with regard to state licensing violations in other financial services industries. Notably, the large fine was imposed even after the companies agreed to cooperate in an ongoing investigation of the two subsidiaries’ former parent company. Also significant, the disgorgement order equates to two years’ worth of profits earned in connection with the alleged unlicensed activity. The holding company also agreed to certain restrictions on its business and that of the two subsidiaries pending full compliance with state law.
The DFS is the principal financial industry regulator in the state of New York, with jurisdiction over banks; mortgage lenders, brokers and servicers; consumer lenders; money transfer businesses; insurance companies; and others.
New York Financial Services Regulator Urges More Enforcement Against Individuals, Reaffirms Focus On Nonbank Mortgage Servicers
On March 19, New York State Department of Financial Services (DFS) Superintendent Benjamin Lawsky called on banking regulators to assess whether they are doing enough, particularly with regard to enforcement, to deter or prevent financial crime. In remarks delivered to the Exchequer Club, Mr. Lawsky asserted that true deterrence means focusing not only on corporate liability, but individual accountability. He called on banking regulators to “publicly expose – in great detail – the actual, specific misconduct that individual employees engaged in,” and, where appropriate, ensure individuals face “real, serious penalties and sanctions when they break the law.” Mr. Lawsky is the most recent of several regulators and policymakers to advocate for more individual accountability. Federal enforcement officials, including CFPB Director Richard Cordray and SEC Chair Mary Jo White, have similarly threatened an enhanced enforcement focus on individuals. Earlier this year, U.S. District Judge Jed Rakoff wrote critically of financial fraud enforcement, and suggested “that the future deterrent value of successfully prosecuting individuals far outweighs the prophylactic benefits of imposing internal compliance measures that are often little more than window-dressing.” In addition to his prepared statement on individual enforcement, Superintendent Lawsky devoted a substantial amount of his remarks and Q&A responses to his concerns about nonbank mortgage servicers. He specifically raised concerns about nonbank servicers’ staffing, especially in the context of the single point of contact requirements of the CFPB’s new servicing rules and the agreements certain servicers entered into with the DFS in 2011 and 2012.
Senate Blocks DOJ Civil Rights Division Nominee
On March 5, the Senate voted 47-52 on a procedural motion that would have advanced President Obama’s nomination of Debo Adegbile to serve as Assistant Attorney General, Civil Rights Division. Seven Democrats joined all voting Republicans to defeat the nomination. Mr. Adegbile’s participation in the legal representation of Mumia Abu-Jamal, who was convicted in 1981 of killing a Philadelphia police officer, reportedly played a factor in the voting.
UK FCA Finalizes New Consumer Credit Rules
On February 28, the UK Financial Conduct Authority (FCA) announced final rules for consumer credit providers, including new protections for consumers in credit transactions. The FCA states that the most drastic changes relate to payday lending and debt management. For example, with regard to “high-cost short-term credit,” the new rules will (i) limit to two the number of loan roll-overs; (ii) restrict to two the number of times a firm can seek repayment using a continuous payment authority; and (iii) require creditors to provide a risk warning. Among other things, the new rules also establish prudential standards and conduct protocols for debt management companies, peer-to-peer lending platforms, and debt advice companies. The policy statement also describes the FCA’s risk-based and proactive supervisory approach, which the FCA states will subject firms engaged in “higher risk business” that “pose a potentially greater risk to consumers” to an “intense and hands on supervisory experience” and will allow the FCA to levy "swift penalties” on violators. The new rules take effect April 1, 2014. The FCA plans next to propose a cap on the cost of high-cost, short-term credit.
Federal Reserve Board Chair Testifies On Enforcement Policy, Virtual Currency Oversight
On February 27, Federal Reserve Board Chairman Janet Yellen made her first appearance as Chair before the Senate Banking Committee. During the course of the question and answer session, Ms. Yellen responded to a recent letter from Senator Elizabeth Warren (D-MA) and Representative Elijah Cummings (D-MD) that encouraged the Federal Reserve Board to play a larger role in major supervisory and enforcement decisions, as opposed to delegating most examination and settlement responsibilities to staff. Chairman Yellen generally agreed that the Board itself should play a larger part in supervision and enforcement and stated that she “fully expects” the Board to make changes to its policies. She added that with regard to legislation recently introduced by Senators Elizabeth Warren and Tom Coburn (R-OK) that would require greater transparency in federal settlements, the Federal Reserve Board intends to look carefully at what it discloses about enforcement actions and settlements and will try to provide more disclosure. Among the numerous other topics covered during the hearing, Chairman Yellen also addressed virtual currency issues, stating the Federal Reserve Board currently has no authority to oversee virtual currency. Her comments followed a letter sent on February 26, 2014 by Banking Committee member Joe Manchin (D-WV) to federal financial and enforcement authorities asking for a complete ban on Bitcoin in the United States. Ms. Yellen stated that while Congress should consider the appropriate legal framework for virtual currency, “there's no intersection at all in any way between Bitcoin and banks that the Federal Reserve has the ability to supervise and regulate. So the Federal Reserve simply does not have authority to supervise or regulate Bitcoin in any way.”
SEC Action Targets Unregistered Cross-Border Brokerage, Investment Advisory Services
On February 21, the SEC released an administrative order against a foreign financial institution that provided cross-border securities services to thousands of U.S. clients. The SEC asserted that the institution’s employees traveled to the U.S. to solicit clients, provide investment advice, and induce securities transactions despite not being registered to provide brokerage or advisory services. The order states that over a period of at least seven years, the institution served as many as 8,500 U.S. client accounts that contained an average total of $5.6 billion in securities assets. The institution admitted it was aware of federal broker-dealer and investment adviser registration requirements related to the provision of certain cross-border broker-dealer and investment adviser services to U.S. clients. After another foreign institution became subject to a federal investigation for similar activities, the institution began to exit the business, though the SEC order states it took years to do so. The order requires the company to disgorge more than $82 million, pay more than $64 million in prejudgment interest, and pay a $50 million civil penalty. In addition, the institution must retain an independent consultant to, among other things, confirm the institution has completed the termination of the business, and evaluate policies and procedures that could detect and prevent similar activity in the future.
CFPB Sues For-Profit Educational Institution Over Private Student Loan Origination Practices
On February 26, the CFPB filed its first enforcement action against a for-profit higher-education company, alleging that the company engaged in unfair and abusive private student loan origination practices.
In a civil complaint filed in the U.S. District Court for the Southern District of Indiana, the CFPB asserts that the company offered first-year students no-interest short-term loans to cover the difference between the costs of attendance and federal loans obtained by students. The CFPB claims that when the short-term loans came due at the end of the first academic year and borrowers were unable to pay them off, the company forced borrowers into “high-rate, high-fee” private student loans without providing borrowers an adequate opportunity to understand their loan obligations. Moreover, the CFPB claims that the company’s business model is dependent on coercing students into “high-rate, high-fee” private loans, despite the low average incomes and credit profiles of the students, and a 64 percent default rate on such loans.
The company issued a statement denying the charges, criticizing the CFPB’s decision to file suit, and challenging the CFPB’s jurisdiction. The statement describes the suit as an “aggressive attempt by the Bureau . . . to extend its jurisdiction into matters well beyond consumer finance” and expresses the company's intent to “ vigorously contest the Bureau's theories in court.”
The complaint details a number of alleged “high-pressure” origination tactics the CFPB claims resulted in part from the compensation structure the company established for its financial aid staff, which included commissions based on loan origination volume. The complaint also details the loan programs at issue, asserting that the programs were ostensibly run by third parties, but were controlled and guaranteed by the company, which allowed it to establish lenient lending criteria to maximize student participation. The company also is alleged to have misrepresented to prospective students the company’s accreditation and the placement rates and salaries of its graduates.
For certain students who did not obtain private student loans to pay-off the short-term company product and instead carried balances on the short-term credit through graduation, the CFPB asserts the company offered a “graduation discount” if the borrowers agreed to pay off some or all of the balance in a lump sum rather than through an installment plan. The CFPB reasons that to the extent the lump sum discounts were not applied to the installment plans, such discounts constituted finance charges subject to TILA’s disclosure requirements. The CFPB asserts that the company failed to clearly and conspicuously disclose those charges in writing to borrowers who opted not to pay a lump sum and instead entered into installment plans.
The CFPB brings claims for violations of the Consumer Financial Protection Act’s prohibitions on unfair and abusive practices, as well as for violations of TILA. In addition to injunctive relief, the CFPB is seeking unspecified monetary relief, including restitution for harmed borrowers, disgorgement, rescission, and civil money penalties.
CFPB Continues RESPA Enforcement With Action Against Nonbank Lender
On February 24, the CFPB announced that a nonbank mortgage lender agreed to pay an $83,000 penalty to resolve violations of RESPA’s Section 8. The lender primarily offers loss-mitigation refinance mortgage loans to distressed borrowers. According to the consent order, after the lender ceased obtaining funding for its loans from two subsidiaries of a hedge fund, the lender continued to split loss-mitigation and origination fees with the subsidiaries on 83 additional loans originated over an eight-month period, even though neither subsidiary provided financing or any other service in any of those transactions.
The lender self-reported the violation, admitted liability, and provided information related to the conduct of others, which the CFPB stated has facilitated other enforcement investigations. In addition, the consent order requires the lender make its “officers, employees, representatives, and agents” available for interviews and testimony, and to produce all non-privileged documents requested by the CFPB, “in connection with this action and any related judicial or administrative proceeding or investigation commenced by the Bureau or to which the Bureau is a party.” The company also cannot apply for a tax deduction or credit for the penalty, and cannot seek indemnification from any source. The CFPB indicated that the lender’s self-reporting and cooperation, which were consistent with the Bureau’s Responsible Business Conduct bulletin, played a part in mitigating the penalty.
This consent order is another public action the CFPB has taken under RESPA’s Section 8, although this action appears to be the first under Section 8(b) of RESPA, which prohibits fee-splitting and the payment and receipt of unearned fees. The CFPB has previously enforced Section 8(a), which prohibits referral fees and kickbacks, most recently in the case of a mortgage company that allegedly made inflated rental payments in exchange for mortgage referrals. The Bureau’s Section 8(b) action emphasizes the CFPB’s commitment to enforcing all of the aspects of Section 8, particularly against nonbank lenders.
CFPB Director Richard Cordray summed up the CFPB’s RESPA enforcement stance, stating: “These types of illegal payments can harm consumers by driving up the costs of mortgage settlements. The Bureau will use its enforcement authority to ensure that these types of practices are halted. We will, however, also continue to take into account the self-reporting and cooperation of companies in determining how to resolve such matters.”
FinCEN Director Discusses 2014 Priorities
On February 20, in remarks to the Florida International Bankers Association Anti-Money Laundering Conference, FinCEN Director Jennifer Shasky Calvery reviewed FinCEN’s key initiatives over the past year and outlined priorities going forward. She discussed FinCEN’s efforts with regard to virtual currency risks and stated that it is important for financial institutions that deal in virtual currency to put effective AML/CFT controls in place. She noted that it is also important for all stakeholders to keep virtual currency concerns in perspective given the relatively small size of the market. FinCEN is growing increasingly concerned with third party money launderers who layer transactions, create or use shell or shelf corporations, use political influence to facilitate financial activity, or engage in other schemes to infiltrate financial institutions and circumvent AML controls. FinCEN intends to pursue such actors regardless of where they are located. Director Shasky Calvery also reiterated concerns about securities firms that offer services similar to banks, and promised continued focus on threats posed by trade-based money laundering. With regard to its policy initiatives, FinCEN intends to engage stakeholders in a discussion of “balancing the policy motivations behind data privacy and secrecy laws in different jurisdictions with the need for an appropriate level of transparency to combat money laundering and terrorist financing.” The Director noted that this issue is particularly critical in the area of correspondent banking.
CFPB Deputy Director Promises Vigilant Supervision, Enforcement Of Mortgage Servicing Rules
On February 19, CFPB Deputy Director Steve Antonakes spoke at the Mortgage Bankers Association’s annual servicing conference and detailed the CFPB’s expectations for servicers as they implement the new servicing rules that took effect last month.
Mr. Antonakes’s remarks about the CFPB’s plans to supervise and enforce compliance with the new rules are the most assertive to date. Until now, the CFPB’s public position has been that “in the early months” after the rules took effect, the CFPB would not look for strict compliance, but rather would assess whether institutions have made “good faith efforts” to come into “substantial compliance.”
Mr. Antonakes clarified this position, stating that “[s]ervicers have had more than a year now to work on implementation” of “basic practices of customer service that should have been implemented long ago” and that “[a] good faith effort . . . does not mean servicers have the freedom to harm consumers.” He went on to state that “[m]ortgage servicing rule compliance is a significant priority for the Bureau. Accordingly, we will be vigilant about overseeing and enforcing these rules.”
Default Servicing and Foreclosures
Specifically, the CFPB expects that, “in these very early days,” servicers will (i) identify and correct “technical issues”; (ii) “conduct outreach to ensure that all consumers in default know their options”; and (iii) “assess loss mitigation applications with care, so that consumers who qualify under [a servicer’s] own standards get the loss mitigation that saves them – and the investor – from foreclosure.” Mr. Antonakes acknowledged that “foreclosures are an important part of the business, but they shouldn’t happen unless they’re necessary and they must be done according to relevant law. We expect the new rules to go a long way to reduce consumer harm for all consumers with mortgages, especially as these rules work in concert with the existing prohibition against unfair, deceptive, and abusive practices.”
Servicing Transfers
Mr. Antonakes specifically detailed expectations concerning mortgage servicing rights transfers. He stated that the CFPB expects servicers to “pay exceptionally close attention to servicing transfers and understand [that the CFPB] will as well. . . . Our rules mandate policies and procedures to transfer ‘all information and documents’ in order to ensure that the new servicer has accurate information about the consumer’s account. We’re going to hold you to that. Servicing transfers where the new servicers are not honoring existing permanent or trial loan modifications will not be tolerated. Struggling borrowers being told to pay incorrect higher amounts because of the failure to honor an in-process loan modification – and then being punished with foreclosure for their inability to pay the incorrect amounts – will not be tolerated. There will be no more shell games where the first servicer says the transfer ended all of its responsibility to consumers and the second servicer says it got a data dump missing critical documents.”