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Slaying the Monster? Reduced Risk of False Claims Act Prosecution for FHA Lenders

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A&B Abstract:  In an effort to incent large depository institutions to return to FHA lending, the U.S. Department of Housing and Urban Development (“HUD”) and the U.S. Department of Justice (“DOJ”) entered into a Memorandum of Understanding (“MOU”), on October 28, 2019, that delineates HUD’s process for determining whether violations of FHA guidelines should be referred to the DOJ for prosecution under the False Claims Act (“FCA”).  In recent years, HUD and the DOJ have used the FCA to obtain approximately $7 billion in recoveries from FHA lenders, driving depository lenders away from FHA lending.[1]  Since 2010, the percentage of FHA-insured mortgages made by these institutions has dropped from approximately 45% to below 14%.[2]  The result of the MOU, according to HUD Secretary Carson, is that “[t]he monster [of the FCA] has been slayed.”[3]

An Overview of the Memorandum of Understanding

The MOU describes “HUD’s process for determining whether certain conduct by FHA-approved mortgagees should be enforced through administrative proceedings or other remedies directly available to HUD or referred to DOJ to pursue under the FCA.”[4]  To do so, it details a five-step process for how FCA enforcement will be handled going forward.  This process will apply to origination and servicing activities in connection with all single-family mortgage insurance programs, including forward and reverse FHA-insured mortgage loans.  The MOU does not address referral of criminal activity, which is out of scope.

The Five-step Process

(1) Preference for Administrative Action – HUD will review FHA violations to determine whether they are best addressed by administrative action.  “HUD expects that violations will be enforced primarily through HUD’s administrative proceedings, except when action beyond HUD’s administrative capabilities is warranted.”[5]  This would potentially result in administrative fines, though any such fines would be drastically smaller than the civil liability imposed by the FCA.

(2) Referral to MRB – HUD identifies violations of FHA requirements under HUD’s Defect Taxonomy, which is the assessment methodology that categorizes violations of FHA requirements into four severity tiers. When a violation meets HUD’s FCA Evaluation Standards, as discussed below, the violation will be referred to the Mortgage Review Board (“MRB”), which is made up of senior HUD personnel, including personnel from HUD’s office of general counsel and office of the inspector general (“OIG”).  The MRB will evaluate the matter for potential action under the FCA.[6]  The MRB intends to refer FHA mortgagees to DOJ for potential FCA litigation where the following standards are met: (1) Tier 1 (i.e., evidence of fraudulent or materially misrepresented information about which the mortgagee knew or should have known) or equivalent violations exist in at least 15 loans or in loans with unpaid principal balance or claims of at least $2.0 million; and (2) there are aggravating factors warranting pursuit of FCA litigation, such as evidence that the violations are systemic or widespread (collectively, the “FCA Evaluation Standards”).[7]

HUD indicated that it intends to “provide a written referral for FCA litigation to DOJ for any allegations approved by the MRB.”[8] HUD’s position is that it will refer “FCA matters [to] be pursued only where such action is the most appropriate method to protect the interests of FHA’s mortgage insurance programs, would defer fraud against the United States, and would generally serve the best interests of the United States.”[9]

(3) Referred Cases – Where a party other than HUD, such as a qui tam relator (i.e., a private party) or HUD’s OIG, refers a matter to DOJ for potential FCA litigation, or DOJ directly initiates a matter that is based on alleged FHA violations, DOJ will confer with HUD prior to initiating FCA litigation.  The purpose of this step is to ensure DOJ confers and works with HUD during the investigative, litigation, and settlement phases of the matter to obtain HUD’s input, such as whether HUD supports or opposes FCA litigation.  Ultimately, the MOU contemplates that HUD “will make known to DOJ whether and to what extent any alleged defects or violations regarding the relevant FHA requirements are material or not material to the agency so that DOJ can determine whether the elements of the FCA can be established.”

(4) Relator Cases – Where a case is filed by a qui tam relator, HUD may recommend that DOJ seek dismissal of the case if HUD does not support the FCA litigation.  Among other reasons, the MOU contemplates that HUD may recommend dismissal where the:

    • Alleged conduct fails to meet the HUD FCA Evaluation Standards;
    • Alleged conduct does not represent a material violation of FHA requirements; or
    • Litigation threatens to interfere with HUD’s policies or the administration of its FHA lending program and dismissal would avoid these effects.

The MOU makes clear that “[w]hile the decision of whether to seek dismissal remains the exclusive authority of DOJ, DOJ will consult with HUD in making such a decision.”[10]

(5) MRB Action – Where the MRB decides to decline referral or recommends against FCA litigation, the MRB may still exercise its discretion to seek administrative action, indemnification, or civil money penalties for any FHA violations.  For example, “HUD may request DOJ approval to file a complaint under the Program Fraud Civil Remedies Act.”[11]

Takeaway:

Given the focus of the MOU, institutions managing regulatory risk and the risk of potential investigations should consider whether alleged FHA violations fall within HUD’s Defect Taxonomy and, if so, whether the violations meet HUD’s FCA Evaluation Standards, as such violations will be referred to the MRB to determine whether FCA litigation is warranted.

Also, the MOU likely provides a new lens for settlement negotiations with HUD and the DOJ.  Disproving systemic or widespread FHA violations could potentially take an investigation off the path towards FCA litigation, dramatically decreasing the cost of settlement.

The MOU is a significant development concerning both HUD’s and DOJ’s approach to FCA litigation.  It could signal reduced FCA litigation related to violations of FHA requirements in the future.  That said, even though the risk of potential FCA prosecution appears to be reduced, it is not eliminated.  Accordingly, it has yet to be seen if Secretary Carson is correct in his prediction that the “monster” of the FCA has been slain.[12]

[1] Ben Lane, Housing Wire, HUD, DOJ changing use of False Claims Act in order to bring big banks back to FHA lending (referencing call with reporters by FHA Commissioner Brian Montgomery) (Oct. 28, 2019).
[2] DOJ Press Release, Departments of Justice and Housing and Urban Development Sign Interagency Memorandum on the Application of the False Claims Act (Oct. 28, 2019).
[3] Ben Lane, Housing Wire, Exclusive: HUD’s Carson on False Claims Act – “The monster has been slayed” (Oct. 28, 2019).
[4] MOU at 2.
[5] MOU at 2-3.
[6] MOU at 3.
[7] Id.
[8] Id.
[9] Id.
[10] MOU at 3-4.
[11] MOU at 4.  The Program Fraud Civil Remedies Act (“PFCRA”), 31 U.S.C. §§ 3801 et seq., is an administrative remedy designed to reach cases of fraud not selected for False Claims Act cases.  The PFCRA imposes civil money penalties and an assessment, of up to twice the claim amount, on “[a]ny person who makes, presents, or submits, or causes to be made, presented, or submitted, a claim that the person knows or has reason to know (A) is false, fictitious, or fraudulent; (B) includes or is supported by any written statement which asserts a material fact which is false, fictitious, or fraudulent; (C) includes or is supported by any written statement that (i) omits a material fact; (ii) is false, fictitious, or fraudulent as a result of such omission; and (iii) is a statement in which the person making, presenting, or submitting such statement has a duty to include such material fact; or (D) is for payment for the provision of property or services which the person has not provided as claimed.”  31 U.S.C. § 3802(a).
[12] See Ben Lane, Housing Wire, Exclusive: HUD’s Carson on False Claims Act – “The monster has been slayed” (Oct. 28, 2019).

Massachusetts Poised to Regulate Student Loan Servicers

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A&B ABstract: Amid growing concerns of a student loan crisis, proposed Massachusetts H. 3977 is worth watching. If enacted, it would provide the Division of Banks and the Attorney General additional regulatory and enforcement authority over student loan servicers. It also would establish a new Consumer Assistance Unit to help consumers address complaints in any area enforced by the Division of Banks.

Discussion

As reported in Housing Wire, student loan debt has reached $1.5 trillion, enough to buy every home in the United States twice.  In response to the foreclosure crisis, Massachusetts enacted robust laws over mortgage servicers and continues to be active in enforcing those laws.  It should come as no surprise then that the Commonwealth is turning its attention to student loan servicers and proposing additional oversight by Office of Attorney General (“Office”) and the Division of Banks (“Division”). While Massachusetts legislators have proposed multiple measures to regulate student loan servicers, H. 3977 is the one to watch in 2019.

A New Licensing Obligation

Effective in January 2021 H. 3977 would  provide that “[n]o person shall directly or indirectly act as a student loan servicer” without obtaining a license from the Division unless exempt. A “student loan servicer” is defined broadly to include

companies that collect payments on a student loan, respond to customer service inquiries, and perform other administrative tasks associated with maintaining a student loan, disburse money from the student loan track student loans while borrowers are in school, process payments, respond to borrower inquiries and information requests, accept applications and process changes in repayment plans, deferments, forbearances, or other activities to prevent default, maintain student loan records, ensure the administration of loans in compliance with federal regulations and other legal requirements.

An exemption is available for banks, credit unions and their wholly owned subsidiaries as well as operating subsidiaries where each owner of the operating subsidiary is wholly owned by the same bank or credit union. It is unclear if the Commonwealth will require passive investors to become licensed.

Other Provisions of Note

While the measure doesn’t impose substantive practice requirements, it includes other provisions of note.

First, it imposes a minimum two-year record retention requirement and requires a servicer to produce records within five business days of a request from the Commissioner of Banks (“Commissioner”) or the Student Loan Ombudsman.

Second, it gives the Commissioner broad investigation and enforcement authority. Of note, the Commissioner may revoke or refuse to renew a student loan servicer licensed if he finds two or more violations during a one-year licensing period.  Further, a violation of federal law would constitute a violation of Massachusetts law. The Commissioner also may impose an administrative penalty of up to $50,000 per incident.;

Third, the measure prohibits a student loan servicer from engaging in unfair or deceptive acts. A violation of this law is also a violation of Chapter 93A, the Commonwealth’s UDAP law that allows for treble damages.

The Student Loan Ombudsman

Following the examples set by other states (including Maine, Maryland, New Jersey and New York) and the CFPB, the measure would establish as of September 1, 2020, a “student loan ombudsman” within the Office .  The Ombudsman’s responsibilities include helping borrowers explore repayment options, apply for federal programs, avoid or remove a default, resolve billing disputes or garnishments, obtain loan account details, stop harassing collection calls and apply for discharges.  The Ombudsman also would disseminate educational materials and share information with the Division.

The Consumer Assistance Unit

As of September 1, 2020, the measure would establish a new Consumer Assistance Unit housed within the Division.  The Unit would have broad authority to help consumers address complaints in (i) any area the Commissioner has authority to regulate involving state-chartered banks and credit unions, check cashers, foreign transmittal companies, sales finance companies, mortgage lenders, brokers, originators, and student loan servicers, or (ii) other areas as the Commissioner deems appropriate.

Takeaway

Student loan servicing is on the radar of Massachusetts regulators.  Companies should be mindful of H. 3977. Additionally, with the creation of the Consumer Assistance Unit and with H. 3977 granting broad investigation and enforcement authority to the Commissioner, we expect to see increased scrutiny and enforcement actions relative to student loan servicers.

Supreme Court to Decide CFPB’s Constitutionality

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A&B ABstract: On October 18, 2019, the Supreme Court granted certiorari in Seila Law v. CFPB to decide the constitutionality of the Consumer Financial Protection Bureau’s leadership structure.[1]  Significantly, the Court also ordered the parties to brief and argue a second question: “If the Consumer Financial Protection Bureau [“CFPB”] is found unconstitutional on the basis of the separation of powers, can 12 U.S.C. § 5491(c)(3) [which permits the President to remove the Director of the CFPB only for cause] be severed from the Dodd-Frank Act?”[2]

A decision on these two questions could significantly affect every financial institution or entity regulated by the CFPB.

The Constitutionality of the CFPB

In response to the 2008 financial crisis, Congress passed the Dodd-Frank Act, which included the Consumer Financial Protection Act (“CFPA”) and created, arguably, one of the most powerful federal agencies to have ever existed—the CFPB.[3]  This power emanates from the CFPB’s single director structure, the CFPB’s broad rulemaking and enforcement authority, and the fact that the CFPB’s Director is insulated from removal except for cause.  Since the CFPB’s inception, there have been numerous challenges to the constitutionality of what is known as the “for-cause” removal provision of the CFPA, which permits the President to remove the Director of the CFPB, not at will, but only “for inefficiency, neglect of duty, or malfeasance in office.”[4]  Challenges have been brought in courts in the Second, Third, Fifth, Ninth, Tenth, Eleventh, and D.C. Circuits.[5]

One of the most significant challenges to the CFPB’s constitutionality occurred before an en banc D.C. Circuit in PHH Corp. v. CFPB.  There, a majority of the D.C. Circuit held that the CFPB’s leadership structure was constitutional, reversing the three-judge-panel decision written by now-Justice Kavanaugh.[6]   Justice Kavanaugh then dissented from the en banc opinion that reversed the original decision. In his dissent, he again concluded that the CFPB’s leadership structure was unconstitutional because the Director’s power and authority were “massive in scope, concentrated in a single person, and unaccountable to the President.”[7]  It is unclear whether Justice Kavanaugh will choose to recuse himself in Seila Law, given that he has already ruled on the issue of the CFPB’s constitutionality in PHH Corp., though he is not required to do so.

One of the most recent challenges, and the one to be reviewed by the Supreme Court, was raised by the law firm Seila Law.  As explained in a previous post,[8] Seila Law involves Seila Law’s refusal to comply with a CFPB civil investigative demand (“CID”).  When the CFPB moved to enforce the CID in federal district court, Seila Law argued that the CFPB’s structure was unconstitutional and, as a result, the CID was unenforceable.  While the CFPB prevailed before the district court, and on appeal to the Ninth Circuit, with the argument that the CFPB’s leadership structure was constitutional, it has since asserted the new position that the for-cause removal provision is unconstitutional.[9]  The Supreme Court has now taken up Seila Law’s petition for certiorari.

The Severability Question

While Seila Law petitioned for certiorari on the issue of whether the CFPB’s leadership structure is unconstitutional, the obvious follow-up question is what happens as the remedy if it is.  That is, what happens if the Supreme Court strikes down the CFPA’s for-cause removal provision?  Recognizing this, when the Supreme Court granted certiorari in Seila Law, it sua sponte also ordered the parties to brief and argue the additional question of whether the for-cause removal provision is severable from the remainder of the CFPA, if the CFPB’s leadership structure is found unconstitutional on the basis of separation of powers.

This is significant because if the Court holds that the provision is not severable, it could strike down the entire CFPA, resulting in any number of drastic consequences.  For example, the Court could strip the CFPB of its enforcement powers or hold that all of the CFPB’s actions to date were ultra vires.  At least one amicus litigant in Seila Law has already made arguments to this end.  The State of Texas’s amicus brief on the certiorari issue took the position that the for-cause removal provision renders the CFPB unconstitutional and, as a result, there is no obligation for Seila Law to answer the CFPB’s CID.[10]

If the provision is found to be severable, then the CFPB likely would proceed with business as usual, even if its structure is held unconstitutional because the remedy would be to make the CFPB’s Director removable at the will of the President.  This is the position the CFPB has taken in recent statements agreeing that its leadership structure is unconstitutional.[11] The CFPB has largely relied on the fact that the Dodd-Frank Act contains a severability clause, which states that “[i]f any provision of this Act . . . is held to be unconstitutional, the remainder of this Act . . . shall not be affected thereby.”[12]  As such, the CFPB has stated that “a Supreme Court decision holding that the for-cause removal provision is unconstitutional should not affect the Bureau’s ability to carry out its important mission [of consumer protection],” because “if the Court holds the for-cause removal provision unconstitutional, the CFPA should remain ‘fully operative’ and the Bureau would ‘continue to function as before, just with a Director who ‘may be removed at will by the President.’”[13]

Notably, though it is unclear what position the Justices will take on the severability issue, Justice Kavanaugh’s original decision in PHH Corp., and his dissent in the en banc review, also touched on severability, finding that “[a]s to remedy . . . [t]he Supreme Court’s Free Enterprise Fund decision and the Court’s other severability precedents require that we sever the CFPB’s for-cause provision, so that the Director of the CFPB is supervised, directed, and removable at will by the President.”[14]

Takeaway

After years of litigation, and conflicting court decisions, the Supreme Court has finally agreed to take on the question of whether the CFPB’s leadership structure is unconstitutional and, if so, what the remedy should be.  That said, even if the CFPB’s leadership structure is found to be unconstitutional, at least one conservative Justice is already on record with the conclusion that the for-cause provision is severable (though Justice Kavanaugh could elect to recuse himself).  While the ultimate outcome is unclear, this case promises to be a major development in the arena of consumer finance and administrative law.

Seila Law will likely be scheduled for oral argument in early 2020, with a decision following in the coming summer.  For now, we will be monitoring the case for developments, including what arguments rise to the top during the briefing process.

[1] https://www.supremecourt.gov/search.aspx?filename=/docket/docketfiles/html/public/19-7.html (Oct. 18, 2019).
[2] Id.
[3] See 12 U.S.C. § 5491.
[4] See 12 U.S.C. § 5491(c)(3); see e.g., CFPB v. Nationwide Biweekly Admin., No. 18-15431 (9th Cir.); CFPB v. CashCall, Inc., No. 18-55479 (9th Cir.); CFPB v. All Am. Check Cashing, Inc., No. 18-90015 (5th Cir.); CFPB v. RD Legal Funding, LLC, No.18-2860 (2d Cir.); Community Fin. Servs. Assoc. v. CFPB, No. 1:18-cv-0295 (W.D. Tex.); CFPB v. Ocwen Fin. Corp., No. 9:17-cv-80495 (S.D. Fla.); BCFP v. Progrexion Mktg., Inc., 2:19-cv-00298 (D. Utah); CFPB v. Navient Corp., 3:17-cv-101 (M.D. Pa.).
[5] See CFPB v. Nationwide Biweekly Admin., No. 18-15431 (9th Cir.); CFPB v. CashCall, Inc., No. 18-55479 (9th Cir.); CFPB v. All Am. Check Cashing, Inc., No. 18-90015 (5th Cir.); CFPB v. RD Legal Funding, LLC, No.18-2860 (2d Cir.); Community Fin. Servs. Assoc. v. CFPB, No. 1:18-cv-0295 (W.D. Tex.); CFPB u. Ocwen Fin. Corp., No. 9:17-cv-80495 (S.D. Fla.); BCFP v. Progrexion Mktg., Inc., 2:19-cv-00298 (D. Utah); CFPB v. Navient Corp., 3:17-cv-101 (M.D. Pa.).
[6] PHH Corp. v. Consumer Fin. Prot. Bureau, 881 F.3d 75 (D.C. Cir. 2018) (en banc).
[7] PHH Corp., 881 F.3d 75, 166 (Kavanaugh, J., dissenting).
[8] https://www.alstonconsumerfinance.com/cfpb-changes-tack-on-for-cause-removal-provision/.
[9] See CFPB v. Seila Law, No. 19-7 (S. Ct. ), CFPB Br. on Pet. for Cert. (filed Sept. 17, 2019).
[10] See CFPB v. Seila Law, No. 19-7 (S. Ct.), Texas Amicus Br. on Pet. for Cert. at 16.
[11] See September 17, 2019 Letters from Director Kraninger to Speaker Pelosi and Majority Leader McConnell (quoting Free Enterprise Fund v. Public Co. Accounting Oversight Bd., 561 U.S. 477, 508 (2010)).
[12] See 12 USCS § 5302 (“If any provision of this Act, an amendment made by this Act, or the application of such provision or amendment to any person or circumstance is held to be unconstitutional, the remainder of this Act, the amendments made by this Act, and the application of the provisions of such to any person or circumstance shall not be affected thereby.”).
[13] See September 17, 2019 Letters from Director Kraninger to Speaker Pelosi and Majority Leader McConnell (quoting Free Enterprise Fund v. Public Co. Accounting Oversight Bd., 561 U.S. 477, 508 (2010)).
[14] PHH Corp., 881 F.3d 75, 167 (Kavanaugh, J., dissenting).

South Carolina Revisiting Borrower Preference Requirements

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A&B ABstract: The South Carolina Department of Consumer Affairs  (“Department”) announced that it is soliciting comments on proposed Regulation 28-75, which would provide mortgage lenders with additional guidance on the state’s attorney and insurance agent borrower preference requirements.

Determination of Borrower Preferences

Section 37-10-102 of the South Carolina Consumer Protection Code requires a creditor to ascertain and comply with the consumer’s preference as to the legal counsel the consumer wants to hire to conduct the transaction. The requirement is not new – it was enacted in 1976 and amended in 1996 – but it is vigilantly enforced by state regulators.  Despite the Department’s issuance of numerous guidance documents (most recently in February 2017, as discussed in a previous client advisory), the requirement still presents compliance challenges to mortgage lenders.

According to regulators, satisfying Section 37-10-102 requires: (i) providing consumers the notice of the right to select an attorney and insurance agent within three days of an application; (ii) ascertaining these preferences before loan closing; and (iii) assuring that the borrower-chosen providers execute the loan closing. ‘

The Department recognizes a safe harbor, of sorts, if the lender provides the borrower with a form (based on Consumer Protection Code Administrative Interpretation 10.102(a)-8302) and the form is fully completed and signed and dated by the borrower.

The statute is designed to ensure that lenders do not improperly force or steer borrowers to an attorney. But what happens when a borrower states his or her preference to the lender, rather than including it on the form? Or if the borrower truly doesn’t have a preference?  Must a lender require a borrower to select an attorney when the borrower doesn’t have a choice?  The Department is poised to provide additional clarity to the industry. However, the Department’s announcement is light on details, merely noting that a future regulation may clarify creditors’ responsibilities and provide definitions.

Takeaway

Additional guidance from the Department is a welcome development.  Interested parties should submit written comments by 5 p.m. on October 29, 2019 to Kelly Rainsford, Deputy of Regulatory Enforcement, South Carolina Department of Consumer Affairs, P.O. Box 5757, Columbia, SC 29250.

Agencies Raise Appraisal Threshold Exemption

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A&B ABstract:

A new rule from the federal banking regulators reduces the number of residential mortgage transactions for which an appraisal is required.  The rule also incorporates changes to federal appraisal requirements made by the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018.

On September 27, 2019, the Federal Deposit Insurance Corporation, the Board of Governors of the Federal Reserve System, and the Office of the Comptroller of the Currency (the “Agencies”) issued a much-anticipated Final Rule increasing the threshold below which an appraisal is not required for a residential mortgage transaction from $250,000 to $400,000.  (The announcement parallels a similar increase in the de minimis thresholds for commercial transactions that the Agencies announced in April 2018.)  The rule takes effect October 9, 2019 (the day after publication in the Federal Register), except as otherwise noted below.

Background

The Agencies first promulgated regulations and guidance required by Title XI of the Financial Institutions Reform, Recovery, and Enforcement Act (“FIRREA”) in 1994.  While FIRREA generally requires a regulated lending institution to obtain an appraisal to support any “federally related transaction,” the Agencies have identified more than a dozen categories of appraisals that are exempt.  Until the recent rule adoptions, the $250,000 de minimis threshold had remained unchanged since its creation.

Impact of the Rule

The Final Rule does not impact the requirement that a regulated lending institution obtain an evaluation of the property, consistent with the Agencies’ regulations and the Interagency Appraisal and Evaluation Guidelines, for transactions below the de minimis threshold.  Notably, broker price opinions and automated valuation models (“AVMs”), which FIRREA separately addresses, among the valuation products that do not meet that standard.

In addition, the Final Rule creates a new exemption from the appraisal requirement.  Consistent with the Regulatory Relief Act, effective January 1, 2020, the Agencies will no longer require an appraisal for a rural residential mortgage loan transaction that meet the qualifications set forth in 12 U.S.C. § 3356.

Finally, effective January 1, 2020, the Final Rule requires that appraisals performed in connection with federally related transactions be subject to appropriate review for compliance with the Uniform Standards of Professional Appraisal Practice.

Takeaway:

The increased appraisal exemption thresholds are welcome news for the residential and commercial mortgage markets.  The augmented exemption will be especially helpful to originators of smaller loans (such as second-lien home equity lines of credit) and fix/flip, non-owner-occupied loans that typically have smaller transaction values.  However, lenders should note the requirements for evaluations (still required for exempt transactions) – a topic that is drawing increased attention.