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Federal Reserve OIG Criticizes CFPB's Supervision Program
On April 1, the Federal Reserve Board’s Office of Inspector General (OIG), which also is responsible for auditing the CFPB, issued a report that is critical of the CFPB’s supervisory activities and recommends that the CFPB take specific actions to strengthen its supervision program. The report shares concerns raised by entities having been through the examination process.
The report covers the CFPB’s supervisory activities from July 2011 through July 2013, including 82 completed examinations (excluding baseline reviews), which yielded 35 reports of examination and 47 supervisory letters. Of those 82 completed examinations, 63 were of depository institutions, and 19 were of nondepository institutions.
Among the findings, the OIG concludes that:
- The CFPB failed to meet reporting timelines. CFPB staff routinely failed to meet internal timeliness requirements for submitting draft examination products to headquarters. These failures resulted in a “significant number of examinations outstanding for longer than 90 days,” which the OIG believes creates unacceptable uncertainty for supervised institutions.
- The CFPB failed to consistently use standard compliance rating definitions. In two out of eight examinations sampled, CFPB staff edited standard ratings definitions to omit information and add qualifying language, including in one ECOA examination report altering the FFIEC’s definition for a 3 rating to state that no “overt” discriminatory acts or practices were identified. In that instance, examiners flagged as a potential fair lending violation the discretion accorded the institution’s customer service representatives to grant fee waivers. The CFPB required the institution to create policies and procedures that limit the discretion of customer service representatives to grant fee waivers, but the examination report did not indicate “whether the CFPB identified any discriminatory acts or practices, suggesting that the CFPB did not reach a definitive conclusion as to whether fee waivers had been granted on a discriminatory basis.” The OIG concluded that “inserting the word ‘overt’ creates the appearance that the CFPB deviated from the standard template language to qualify its rating of the supervised institution, calling into question the appropriateness of the assigned rating.” The report states that the CFPB has since reviewed examination ratings and determined that adjustments were not necessary.
- The CFPB failed to timely record examination milestones. The report states that the CFPB has not adopted a requirement for the timely recording of examination data. To assess timeliness, the OIG used seven days as a standard. The OIG found that at least 25% of examination milestones were not recorded within seven days, and that in eight instances, examination milestones were not recorded for more than 200 days after their occurrence. In addition, CFPB staff entered dates before the milestone occurred 109 times.
- The CFPB’s examination reporting policy is not current. The report states that the CFPB has not updated its examination reporting policy since the CFPB reorganized its supervision offices in December 2012. In addition, the policy does not reflect the CFPB’s current definition for the “completion of field work”, which is a key milestone because it initiates the reporting process. Notably, a senior CFPB official advised the OIG that the CFPB is still determining the most effective process for reviewing examination reports.
- The CFPB and prudential regulators can improve coordination. The report notes that the CFPB and prudential regulators do not formally share supervisory actions documented outside of an examination report, which excludes prudential regulators from commenting on other supervisory actions. The OIG notes that only 19% of closed examinations of depository institutions resulted in reports of examination, and that of the CFPB’s examinations of depository institutions that resulted in a matter requiring attention, only 30% were documented in reports of examination. The remaining 70% were documented in supervisory letters or baseline reviews and, therefore, were not formally shared with the prudential regulators. Further, for institutions subject to continuous monitoring, the CFPB states that it shares findings with the prudential regulator at the end of the examination cycle. The OIG observes, however, that as of July 2013, none of the continuous full-scope examinations had been finalized or shared with the prudential regulators. The OIG believes that the CFPB’s current approach increases the risk that regulators will not receive important supervisory information and increases the likelihood of duplication of efforts and other inefficiencies.
The OIG also found that (i) the CFPB did not consistently retain evidence of required communication with prudential regulators; (ii) the CFPB regions use different and inconsistent practices for scheduling examination staff and do not track examination staff hours; and (iii) the CFPB has not finalized its examiner commissioning program.
The report states that since the OIG completed its field work in October 2013, the CFPB has assured the OIG that it has taken steps to address certain of the findings, including streamlining the report review process and reducing the number of examination reports that have not been issued. The OIG plans to conduct follow-up activities to assess whether the CFPB’s subsequent actions address the OIG’s findings and recommendations.
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.
House Financial Services Ranking Member Unveils Housing Finance Reform Alternative
On March 27, Congresswoman Maxine Waters (D-CA), Ranking Member of the House Financial Services Committee, released draft legislation to reform the housing finance market. Congresswoman Waters also released a summary of the proposal and a section-by-section analysis of the bill. The proposed bill, titled the Housing Opportunities Move the Economy (HOME) Forward Act of 2014, offers a counter to a bill already approved by the committee—without any Democratic votes—that would replace Fannie Mae and Freddie Mac with a secondary market funded only by private capital. In certain ways, the HOME Forward Act parallels legislation recently unveiled by the leaders of the Senate Banking Committee. Like its Senate counterpart, Ms. Waters’s bill would establish an insurance fund to provide an explicit government guarantee for certain mortgage-backed securities. Also, similar to the Senate bill, Congresswoman Waters’s proposal would require private backers to take the first 5 percent of any loss (the Senate bill requires private backers to take the first 10 percent of any loss) before the government guarantee is activated. But unlike the Senate bill, which would allow for a variety of issuers to access the mortgage backed security market, the HOME Forward Act would create a co-op of lenders with exclusive authority to issue government-backed MBS. In further contrast to the Senate bill, the HOME Forward Act includes a “waterfall” plan for distribution of Fannie Mae’s and Freddie Mac’s earnings in conservatorship to (i) Treasury Senior Preferred shares; (ii) any reserve funds needed in connection with wind-down of Fannie Mae and Freddie Mac; (iii) outstanding Affordable Housing Fund payments; and (iv) existing preferred and common shareholders, including Treasury as holder of warrants. The HOME Forward Act also would eliminate rigid affordable housing goals and replace them with a broad based duty to serve requirement.
HUD Releases Recertification Deadline for FHA Mortgagees
On March 26, HUD presented a webinar regarding upcoming changes to the online system used by FHA mortgagees to certify, pay annual fees, and report other information. Specifically, the Lender Electronic Assessment Portal (LEAP) will be replacing LASS, Lender Approval and Cash Flow Account Set Up in FHA Connection. Per Mortgagee Letter 2013-42, due to the online system being unavailable during the transition, the recertification and annual fee requirement for mortgagees with Fiscal Years ending on December 31, 2013, has been extended until June 9, 2014, thirty-days following the LEAP “Go-Live” date of May 9, 2014. All other mortgagees will have 90 days after their fiscal year end to submit recertification. Among other changes to the recertification process, LEAP will require mortgagees to indicate which certifications they cannot complete and submit supporting documents specific to each instance in which the mortgagee cannot recertify. In addition, FHA is consolidating Title I and II ID numbers for all mortgagees that share a common Tax Identification Number. The first phase of the consolidation will take place on Monday, March 31, 2014, and will result in all mortgagee profile information and loan history for existing Title I IDs to be transferred to the new IDs. Additional information, including corporate officers, EFT Account numbers and Historical Approval dates will be consolidated on LEAP’s “Go-Live” date on May 9, 2014. Finally, LASS will not be available after March 31, and any pending recertification or filing in LASS will be inaccessible. However, FHA employees will have access to LASS and can work with mortgagees on an individual basis to complete those filings. During an April 18 to May 9 transition period, mortgagees must request changes to their profiles via hard copy requests to HUD’s Officer of Lender Activities and Program Compliance.
OCC Issues Asset-Based Lending Booklet
On March 27, the OCC issued the Asset-Based Lending (ABL) booklet, which is new to the Comptroller’s Handbook. The booklet provides guidance to examiners and bankers on ABL activities and risks, prudent credit risk management and underwriting expectations, credit administration, and credit risk rating. It also provides risk-based expanded examination procedures related to structures, credit analysis, evaluating borrower liquidity, establishing a borrowing base and prudent advance rates, collateral controls and monitoring systems, and credit risk rating considerations. The booklet further includes transaction examples to assist with the assessment of credit risk.
State AGs, Mexico Agree To Form AML Working Group
On March 25, California Attorney General (AG) Kamala Harris announced that she and four other state AGs—Suthers (CO), Bondi (FL), Cortez Masto (NV), and King (NM)—signed a letter of intent with the President of the National Banking and Securities Commission of Mexico to establish a bi-national working group on money laundering enforcement. The working group will be tasked with (i) establishing the scope of coordination between Mexico and U.S. state AGs on money laundering enforcement issues; (ii) developing a plan for mutual technical assistance and training on combating money laundering; and (iii) sharing best practices on money laundering enforcement techniques and other enforcement issues of mutual concern, including the impact of money laundering on the border region of the U.S. and Mexico.
C.D. Cal. Court Holds Overnight Delivery Companies Covered By RESPA
On March 21, in a suit brought by borrowers who had paid overnight delivery fees at closing, the U.S. District Court for the Central District of California held that the overnight delivery services provided by certain delivery companies to a parent company of various escrow companies were “settlement services” under RESPA and concluded that borrowers had pleaded facts sufficient to establish that defendant parent company may have violated RESPA by accepting marketing fees from certain delivery companies in exchange for “referring”—via its escrow subsidiaries—overnight delivery business to those delivery companies. Henson v. Fidelity Nat’l Fin. Inc., No. 14-cv-01240, slip op. (C.D. Cal. Mar. 21, 2014). In this case, the defendant parent company’s allegedly required its escrow subsidiaries to use certain delivery companies in connection with loan closings. Defendant parent company, in turn, allegedly received a marketing fee from those delivery companies based on the volume of business it sent to the delivery companies through its escrow subsidiaries. On the parent company’s motion to dismiss, the court held that the overnight delivery service was a “settlement service” under RESPA given that Regulation X specifically lists a “delivery” as a settlement service if provided in connection with a real estate settlement. The court further held that a “referral” under RESPA need not be linked to particular transactions and thus that a RESPA violation could occur where a master agreement required subsidiaries to use certain delivery service providers in exchange for a marketing fee received by a parent company. However, the court agreed with the defendant that the borrowers failed to adequately plead either a split of an unearned fee or that defendant did not perform any service in exchange for the marketing fee it received. Thus the court denied, in part, and granted, in part, the defendant’s motion to dismiss.
IRS Will Treat Convertible Virtual Currency as Property, Not Currency
On March 25, the IRS issued a notice in which it stated that, for federal tax purposes, bitcoins and other convertible virtual currencies are treated as property rather than currency. The IRS added that a third party that settles payments made in virtual currency on behalf of a substantial number of unrelated merchants that accept virtual currency from their customers may be a third party settlement organization (TPSO) and thus subject to IRS information reporting requirements. The IRS addressed several questions related to the use of virtual currency in the notice but acknowledged that there may be other questions regarding virtual currency not addressed that warrant consideration. The IRS is therefore accepting public comment on other types or aspects of virtual currency transactions that should be addressed by the IRS in future guidance. The notice does not specify a deadline for submitting such comments.
FinCEN Guidance Updates FATF AML/CFT Deficient Jurisdictions List
On March 25, FinCEN issued an advisory notice, FIN-2014-A003, in which it provided guidance to financial institutions for reviewing their obligations and risk-based approaches with respect to certain jurisdictions. The Financial Action Task Force (FATF) recently updated its lists of jurisdictions that appear in two documents: (i) jurisdictions that are subject to the FATF’s call for countermeasures or Enhanced Due Diligence as a result of the jurisdictions’ Anti-Money Laundering/Counter-Terrorist Financing (AML/CFT) deficiencies, or (ii) jurisdictions identified by the FATF as having AML/CFT deficiencies. The advisory notice (i) summarizes the changes made by the FATF; (ii) provides specific guidance regarding jurisdictions listed in each category; and (iii) reiterates that if a financial institution knows, suspects, or has reason to suspect that a transaction involves funds derived from illegal activity or that a customer has otherwise engaged in activities indicative of money laundering, terrorist financing, or other violation of federal law or regulation, the financial institution must file a Suspicious Activity Report.
FHFA's Former Acting Director Announces Departure
On March 24, the FHFA announced that former Acting Director Ed Demarco will leave the agency at the end of April. Mr. Demarco has been assisting with the leadership transition since former Congressman Mel Watt was sworn in as FHFA Director in early January.