Financial Services Litigation & Investigation Monitor : Financial Services Lawyer & Attorney : Perkins Coie Law Firm : Government Investigations, Class Actions

The 2,000 page Dodd-Frank Wall Street Reform and Consumer Protection Act is ready for its final test:  a full vote by the House and Senate.  The New York Times wrote on Friday (June 25, 2010):

The deal between House and Senate negotiators, sealed just before sunrise on Friday, imposes new rules on some of the riskiest business practices and exotic investment instruments. It also levies hefty fees on the financial services industry, essentially forcing big banks and hedge funds to pay the projected $20 billion, five-year cost of the new oversight that they will face. And it empowers regulators to liquidate failing financial companies, fundamentally altering the balance between government and industry.

The sponsors of the legislation expect that Congress will approve the legislation this week and that President Obama will sign it by the Fourth of July.

The financial reform bill expands the federal government's role in the enforcement and oversight of consumer protection laws and consumer lenders.  The lynchpin of the bill is the creation of a Consumer Financial Protection Bureau (CFPB) with significant regulatory authority.   The CFPB will be part of the Federal Reserve, and led by a director appointed by the President and confirmed by the Senate.  Other key elements of the CFPB include: 

• Examination and enforcement authority.  The CFPB would have authority to examine and enforce regulations for banks and credit unions with assets of over $10 billion and all mortgage-related businesses (lenders, servicers, mortgage brokers, and foreclosure scam operators), payday lenders, and student lenders as well as other large non-bank financial companies, such as debt collectors and consumer reporting agencies. Banks and Credit Unions with assets of $10 billion or less will be examined for consumer complaints by the appropriate regulator. 
• Consolidation of consumer protection enforcement.  The CFPB would coordinate consumer protection responsibilities currently handled by the Office of the Comptroller of the Currency, Office of Thrift Supervision, Federal Deposit Insurance Corporation, Federal Reserve, National Credit Union Administration, the Department of Housing and Urban Development, and Federal Trade Commission.
• Lending discrimination.  The CFPB would oversee the enforcement of federal laws intended to ensure the fair, equitable and nondiscriminatory access to credit for individuals and communities, including the Fair Housing Act and Equal Credit Opportunity Act. 
• Consumer Hotline.  The CFPB would run a national consumer complaint hotline establishing a toll-free number to report problems with financial products and services.
• Coordination with bank regulations.  The CFPB would coordinate with other regulators when examining banks to prevent undue regulatory burden.

The bill also includes provisions that significantly impact residential mortgage lending, including underwriting considerations and disclosure requirements:

• Lenders would be required to provide additional disclosures to consumers on mortgages, including disclosure of the maximum a borrower could potentially pay on a variable rate mortgage.
• Lenders would be required to consider a borrower's "ability to repay" a mortgage during the underwriting process.
• Lenders could not pay brokers "yield spread premiums" or other financial incentives for certain loan types. 
• Pre-payment penalty terms would be prohibited.
• The bill includes enhanced penalties for mortgage lenders and brokers who violate certain consumer protection laws, including penalties up to the equivalent of three-years of interest payments and damages, plus attorney’s fees.
• The bill expands consumer protections for certain high cost mortgages, going beyond the current requirements in HOEPA.

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June 24, 2010 - Marketwatch.com reports that Morgan Stanley & Co. agreed to pay $102 million to  settle allegations that it aided and abetted subprime lender New Century Financial Corp. in taking advantage of consumers.  Massachusetts Attorney General Martha Coakley's office announced the settlement on Thursday.  According to its press release, the AG "alleged that Morgan entered the subprime arena in Massachusetts by offering funding to retail lenders that specialized in loans to less-qualified borrowers. Morgan provided billions of dollars to subprime lender New Century, which used Morgan funds to target lower-income borrowers and lure them into loans that consumers predictably could not afford to pay...Some Morgan Stanley investment bankers referred to New Century as Morgan’s 'partner' in the subprime lending business."

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Speaking at a June 23, 2010 Brookings conference, the Department of Justice's Assistant Attorney General for the Civil Rights Division made clear that investigating and prosecuting lending discrimination is a top priority for his administration.  As reported on mainjustice.com, AAG Thomas Perez reaffirmed the DOJ's commitment to increased oversight and enforcement of the financial industry, as well as close interaction among the federal regulators that police the financial systems.

Mr. Perez also reiterated that his division will use the "disparate impact" theory to file lending discrimination case.  “The government must be a credible deterrent,” he said. “Our Fair Lending Unit will use every tool in our arsenal, including but not limited to disparate impact theory.”  Perez made similar remarks at the May 2010 Legal Issues Conference of the Mortgage Banker's Association.  The disparate impact theory, as articulated in U.S. Supreme Court's 1971 decision Griggs v. Duke Power Co., 401 U.S. 424 (1971), allows a plaintiff to challenge a facially neutral practice that has an unjustified adverse impact on members of a protected class; evidence of an intent to discriminate is not required.  The DOJ's reliance on the disparate impact theory as the sole basis to file a lending discrimination case signals a marked departure from its prior lending discrimination cases, none of which relied exclusively on disparate impact.  The department's aggressive approach will undoubtedly lead to a significant increase in enforcement cases and litigation in this area.  And lenders anticipating this change in enforcement are wise to adapt their compliance program accordingly. 

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June 23, 2010:  The Los Angeles Times reports that Senate and House negotiators are close to reaching agreement on the creation of a new consumer protection agency as part of the financial services overhaul legislation working its way through Congress and expected to be presented to President Obama for signature within the coming weeks.  According to the report, lawmakers are working out a compromise that would mostly exempt car dealers from the new agency's oversight.  Legislators have reportedly agreed to house the independent agency at the Federal Reserve.

 

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June 16, 2010.  The former chief executive of Taylor Bean & Whitaker has been indicted with orchestrating a massive equity and MBS fraud scheme tied to TBW's borrowings from Colonial Bank, a depository it tried to take control of last summer using TARP money.   The indictment alleges that Lee Bentley Farkas and co-conspirators "tried to steal $553 million" through the TARP program. According to court documents, Farkas also personally misappropriated more than $20 million from TWB and Colonial Bank. 

Read more: Orlando Business Journal

The Securities and Exchange Commission filed a related case against Farkas alleging that he sold more than $1.5 billion in fabricated or impaired mortgage loans and securities to Colonial Bank. The SEC’s complaint charges Farkas with violations of the antifraud, reporting, books and records and internal controls provisions of federal securities laws.

According the SEC's statement, through Taylor Bean & Whitaker Mortgage Corp. Farkas sold more than $1.5 billion worth of fabricated or impaired mortgage loans and securities to Colonial Bank.

Those loans and securities were falsely reported to the investing public as high-quality, liquid assets.  Farkas also was responsible for a bogus equity investment that caused Colonial Bank to misrepresent that it had satisfied a prerequisite necessary to qualify for TARP funds. When Colonial Bank's parent company — Colonial BancGroup, Inc. — issued a press release announcing it had obtained preliminary approval to receive $550 million in TARP funds, its stock price jumped 54 percent in the remaining two hours of trading, representing its largest one-day price increase since 1983.

 Read more:  Businessweek.com (Former Taylor Bean Chief Farkas Charged With Fraud)

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The Florida attorney general's office has launched a civil investigation against Fidelity National Financial Inc. and Lender Processing Services Inc. to review allegations that the companies used fabricated assignments in foreclosure cases.  According to the AG's summary of the case, the office is reviewing whether "bogus assignments" of mortgages were created in order that foreclosures may go through more quickly and efficiently.

Over the last several years, borrowers in default have alleged that a lender or assignee may not foreclose without producing the original note.  Courts have generally rejected the "show me the note" defense by applying basic legal principles applicable to negotiable instruments.  See, e.g., Diessner v. Mortgage Electric Registration Services, 618 F.Sup.2d 1184, 1187 (D.Ariz. 2009)("...district courts have routinely held that Plaintiff's 'show me the note' argument lacks merit.")  The Florida AG's investigation, regardless of the outcome, may spawn yet another basis for defaulting borrowers to delay or defeat loss mitigation efforts of lenders and servicers.  

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Bloomberg's Businessweek.com reports that the FBI and other agencies have warned that short-sale schemes, including one known as "flopping," may spread following a plunge in home values that has left homeowners owing more than their properties are worth. The scams threaten to deepen losses for lenders increasingly using short sales as an alternative to foreclosure. According to the article, “flopping” involves hiring a mortgage broker to generate an artificially low property value.  This false value is then used to convince banks to accept a short sale for that amount to a straw buyer.  The buyer conceals from the lender that she has lined up a higher offer, and then quickly resells the property for a profit.  Two Connecticut real estate agents are scheduled to be sentenced in U.S. District Court after pleading guilty to this type of fraud scheme, according to the Businessweek article.

A study by real estate data and research company CoreLogic Inc. found that “flopping” occurs in more than 1 percent of short sales and may cost lenders $50 million in 2010, reported Businessweek.  Neil Barofsky, special inspector general for the Troubled Asset Relief Program, wrote in an April 20 report to Congress that recent efforts to increase short sales may also increase incentives for fraud.  

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Reuters.com reports that on Monday (June 7, 2010) the Financial Crisis Inquiry Commission probing the financial crisis subpoenaed Goldman Sachs, after the firm allegedly flooded the commission with 2.5 billion pages of records in response to an earlier request.  According to FCIC Chairman Phil Angelides, in response to an earlier document request Goldman produced 5 terabytes of records, with each terabyte containing 500 million pages of digitized records.  The subpoena includes requests for documents and witnesses concerning Goldman’s synthetic and hybrid collateralized debt obligations and "the ABACUS transactions."

According to its website, the FCIC "is a bipartisan commission that has been given a critical non-partisan mission — to examine the causes of the financial crisis that has gripped the country and to report our findings to the Congress, the President, and the American people." 

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According to a June 7, 2010 New York Times article, the FTC announced that two Countrywide mortgage-servicing companies agreed to pay $108 million to resolve charges that they collected excessive fees from homeowners.  The FTC alleged that Countrywide charged excessive fees to homeowners who were behind on their mortgage payments, in some cases asserting that borrowers were in default when they were not.

In addition, the FTC said in its statement announcing the settlement that Countrywide at times imposed a new round of fees on homeowners who had recently emerged from bankruptcy protection, sometimes threatening the consumers with a new foreclosure.   The case was brought with the assistance of the U.S. Trustee.

The FTC charge alleges that when homeowners fell behind on mortgage payments and were in default on their loans, Countrywide ordered property inspections, lawn mowing, and other services meant to protect the lender’s interest in the property.  However, according to the FTC complaint, rather than hire third-party vendors to perform the services, Countrywide created subsidiaries to hire the vendors that marked up the price of the services charged by the vendors.  The mark-ups were then passed on to the borrower. The complaint alleges that the company’s strategy was to increase profits from default-related service fees in bad economic times.

The settlement requires Countrywide to pay $108 million for refunds to homeowners that the FTC alleges Countrywide overcharged before July 2008.

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The ABA and some state bar associations have asked for changes to the U.S. Senate's version of financial services reform legislation because it contains broad language that may regulate attorneys' practices.  According to a recent ABA Journal article, while the House version of the reform legislation includes a specific exemption for lawyers and their direct employees, the Senate version does not.   The ABA article notes that, under the Senate bill, an attorney who simply holds a trust account may be subject to federal regulator oversight.

On June 15, the House-Senate conference committee will begin negotiating changes to the two bills. The House bill, H.R. 4173 is called the Wall Street Reform and Consumer Protection Act of 2009, while the Senate's version (S.3217) is called the Restoring American Financial Stability Act of 2010.

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