Legal Alert

Mortgage Banking Update - June 27, 2024

June 27, 2024

June 27 – Read the newsletter below for the latest Mortgage Banking and Consumer Finance industry news, written by Ballard Spahr attorneys. In this issue, we highlight our Chambers USA award winners and discuss several recent CFPB issues, elder financial exploitation, the Treasury’s RFI on use of AI in financial services, and much more.

National Ranking From Chambers USA Awarded Again to Ballard Spahr’s Consumer Financial Services Group
This Week’s Podcast Episode: What Banking Leaders Need to Know About the U.S. Supreme Court Decision That the Consumer Financial Protection Bureau’s Funding Mechanism is Constitutional–Part I
This Week’s Podcast Episode: What Banking Leaders Need to Know About the U.S. Supreme Court Decision That the Consumer Financial Protection Bureau’s Funding Mechanism is Constitutional–Part II
CFPB Addresses Repeat Offender Unit
CFPB Issues RFI on Mortgage Closing Costs
CFPB Issues Proposal to Prohibit Use of Medical Debt Information in Credit Decisions
Chopra Delivers Testimony to Congress on Semi-Annual Report
VA Announces Temporary Variance Allowing Veterans to Pay Broker Commissions and Announces a Targeted Foreclosure Moratorium
VA Proposes Rules for ARM Loans and Temporary Buydown Agreements
Treasury Issues Request For Information on Use of AI in Financial Services
U.S. Supreme Court Punts Another NBA Preemption Case; This Time to the Ninth Circuit
Colorado Federal Court Issues Preliminary Injunction Prohibiting Colorado From Enforcing DIDMCA Opt-Out to Loans Made to Colorado Residents by Out-of-State State-Chartered Banks
FHA Seeks Comment on Third-Party Originator Fraud With Short Comment Timeframe
FinCEN Issues Reminder to Financial Institutions to Identify and Report Elder Financial Exploitation
U.S. Supreme Court Heightens Relief Standard For NLRB to Obtain 10(j) Injunctions
Looking Ahead

National Ranking From Chambers USA Awarded Again to Ballard Spahr’s Consumer Financial Services Group

I am pleased to report that Ballard Spahr’s Consumer Financial Services Group was once again ranked nationally by Chambers USA: America’s Leading Lawyers for Business in all three national consumer finance categories: Compliance, Enforcement and Investigations, and Litigation. Chambers has consistently ranked our Consumer Financial Services Group ever since it began ranking firms in the U.S. We are one of six firms ranked in all three categories nationally and we are one of only two firms ranked in all national categories and Pennsylvania.

Here is what Chambers USA said about our Group:

Ballard Spahr LLP is an esteemed group noted for its work with banks and non-banks on the full spread of consumer finance regulatory matters, including credit card, mortgage and auto finance issues. Harbors expertise pertaining to areas such as telemarketing, e-commerce, and prepaid cards. Provides robust representation in CFPB enforcement actions, arbitrations, and litigation. Capable of supporting clients at both state and federal regulatory levels.

Our Group is proud of the work it does, and very grateful to our clients for entrusting us to help them develop new products, defend them in private litigation and against enforcement actions, and assist them in navigating the increasingly complex array of federal and state regulations.

Alan S. Kaplinsky

This Week’s Podcast Episode: What Banking Leaders Need to Know About the U.S. Supreme Court Decision That the Consumer Financial Protection Bureau’s Funding Mechanism is Constitutional–Part I

On May 16, 2024, the U.S. Supreme Court ruled that the CFPB’s funding mechanism does not violate the Appropriations Clause of the U.S. Constitution. This two-part episode repurposes a recent webinar. In Part I, we first discuss the SCOTUS decision, the status of the CFPB’s payday lending rule that was at issue in the underlying case, and a potential new challenge to the CFPB’s funding that has been the focus of recent attention. We then discuss four cases still pending before the SCOTUS in which the decisions could impact the CFPB. Next, we discuss the pending lawsuits challenging the CFPB’s final rules on credit card late fees and small business data collection and the changes to the CFPB’s UDAAP exam manual defining “unfairness” to include discrimination, including the background of those cases, their current status, and the non-constitutional legal challenges made by the plaintiffs in those cases. We conclude with a discussion of final and proposed CFPB rules expected to be issued soon and potential non-constitutional legal challenges to those rules.

Senior Counsel in Ballard Spahr’s Consumer Financial Services Group, Alan Kaplinsky, moderates the discussion joined by Partners John Culhane, Richard Andreano, and Joseph Schuster, and Of Counsel Kristen Larson, in the Group.

To listen to Part I of the episode, click here.

On May 16, 2024, the U.S. Supreme Court ruled that the CFPB’s funding mechanism does not violate the Appropriations Clause of the U.S. Constitution. This two-part episode repurposes a recent webinar. In Part II, we first discuss the CFPB’s launch of Fair Credit Reporting Act rulemaking, proposed rule to supervise larger payment providers, proposed rule on personal financial data rights, and interpretive rule on buy-now-pay-later. We next discuss the operation of the Congressional Review Act and its potential impact on final CFPB rules if the November 2024 election results in a change in Administrations. We then discuss the impact of the SCOTUS decision on pending CFPB enforcement actions, the expected proliferation of new CFPB investigations and enforcement actions, and the CFPB’s announced hiring binge. We conclude by sharing our thoughts on what companies can do to prepare for an uptick in CFPB activity and how the CFPB’s increased staffing is likely to impact which companies will be targeted.

Senior Counsel in Ballard Spahr’s Consumer Financial Services Group, Alan Kaplinsky, moderates the discussion joined by Partners John Culhane and Joseph Schuster, and Of Counsel Kristen Larson, in the Group.

To listen to Part II, click here.

To listen to Part I, click here.

CFPB Addresses Repeat Offender Unit

As we recently reported, the CFPB issued its final rule, titled the Registry of Nonbank Covered Persons Subject to Certain Agency and Court Orders Final Rule on June 3, 2024. The CFPB touts the registry as something that will help detect and deter repeat offenders of consumer financial protection laws, even though the registration requirements apply to an entity subject to a single consent order and in full compliance with the order. The registry reaches back to agency and court orders with an effective date of on or after January 1, 2017.

In conjunction with the release of the final rule, the CFPB addressed the formation of a Repeat Offenders Unit:

“Reining in repeat offenders is a priority for the CFPB. Importantly, the CFPB established a Repeat Offender Unit. This national supervision team is responsible for designing and executing comprehensive oversight of supervised entities subject to CFPB law enforcement orders. The Repeat Offenders Unit is actively ensuring that a company, its senior management, and its board of directors are not treating any orders as suggestions. The CFPB is taking a number of steps to identify specific individuals responsible for repeat offenses.”

We understand that the CFPB has reached out to an industry member subject to an older consent order covered by the final rule to inquire about compliance with the order. Companies subject to CFPB consent orders, particularly orders with effective dates on or after January 1, 2017 that are still in effect, may want to get information together demonstrating compliance with the order in advance of the CFPB reaching out to them.

Richard J. Andreano, Jr.

CFPB Issues RFI on Mortgage Closing Costs

The Consumer Financial Protection Bureau (CFPB), recently issued a Request for Information (RFI) related to fees charged by providers of mortgages and related settlement services. In his statement, Director Chopra discussed the impact of the increasing costs on lenders and consumers, and stated that the CFPB plans to address those costs. Comments on the RFI are due by August 2, 2024.

In the RFI, the CFPB states that closing costs, particularly the costs the lender imposes on the borrower, have risen, and from 2021 to 2023, the median total loan costs increased by over 36 percent on home purchase loans. This statement appears to reflect either a misunderstanding of market forces that have significantly contributed to a rise in closing costs, or an intent of the CFPB to ignore those forces to promote an agenda to reshape how the mortgage market imposes bona fide closing costs.

During the 2021 to 2023 period cited by the CFPB, mortgage interest rates rose substantially, housing prices rose dramatically, and worldwide inflation developed. In a statement by trade associations responding to the RFI, they pointed to “significant home-price appreciation and swift inflation.” These market forces significantly contributed to the rise in closing costs for various reasons, including (1) consumers were paying discount points and temporary buydown fees to lower the interest rate, which did not occur with as great a frequency during the prior period of low interest rates, particularly in 2020 and 2021, (2) the practice of lenders paying closing costs in return for charging a higher interest rate subsided, (3) the increase in housing prices also lead to an increase in costs tied to the loan amount or housing price, and (4) overall costs increased because of inflation.

The CFPB also noted that because “[m]any of these costs are fixed and do not change based on the size of the loan, [the result is] an outsized impact on borrowers with smaller mortgages, such as lower income or first-time homebuyers.” Further, the CFPB states that increased credit reporting fees create challenges for lenders, pushing them to potentially evaluate fewer applications or absorb the costs themselves. The CFPB noted that lenders do not have options regarding credit report fees because, in many cases, they are required to obtain “tri-merge” reports in order to sell loans in the secondary market or maintain insurance from federal programs. According to the CFPB, one midsize lender reported an increase for the hard-pull tri-merge report from $50 to $110 in the last two years, and a large lender reported an increase from under $30 to over $60. In December 2023, the Mortgage Bankers Association raised concerns about the rising costs of credit reports.

The CFPB goes on to discuss origination fees, which can include charges for processing the application, underwriting and funding the loan, and other administrative services. The CFPB claimed that lenders can vary which costs they include in the interest rate or origination charge and which they charge separately, “further complicating borrowers’ ability to compare costs across loan products.” The CFPB did not acknowledge the disclosure of closing costs required by the TILA/RESPA Integrated Disclosure (TRID) rule at the time of application and before closing, nor that in announcing the October 2020 report on its assessment of the rule the CFPB stated “[t]he evidence available for the assessment indicates that the TRID Rule improved consumers’ ability to locate key information, compare terms and costs between initial disclosures and final disclosures, and compare terms and costs across mortgage offers.”

In their statement responding to the RFI, the trade associations noted that “the industry invested considerable resources” to implement the TRID rule and that after the CFPB’s assessment of the TRID rule the CFPB praised the rule “for improving borrower understanding and facilitating the ability to shop among lenders.” The trade associations then stated that if “the CFPB is now modifying its previous position and is considering changing this complex regulatory disclosure regime, a rule-making process governed by the Administrative Procedure Act – and supported by a robust cost-benefit analysis – is the only appropriate vehicle to initiate that work. Such a rule-making process would allow for the proper level of engagement to produce changes that benefit consumers and do not add compliance costs and lead to negative unintended consequences.”

The CFPB requests comments on the impact closing costs have on borrowers and the mortgage market, including the degree to which they add overall costs or otherwise cause borrower harm. Specifically, the CFPB requests comment on the following:

Are there particular fees that are concerning or cause hardships for consumers?
Are there any fees charged that are not or should not be necessary to close the loan?
Provide data or evidence on the degree to which consumers compare closing costs across lenders.
Provide data or evidence on the degree to which consumers shop for closing costs across settlement providers.
How are fees currently set? Who profits from the various fees? Who benefits from the service provided? What leverage or oversight do lenders have over third-party costs that are passed onto the consumer?
Which closing costs have increased the most over the past several years? What is the cause of such increases? Do they differ for purchase or refinance? Please provide data to support if possible.
What is driving the recent price increases of credit reports and credit scores? How are different parts of the credit report chain (credit score provider, national credit reporting agencies, reseller) contributing to this increase in costs? What competitive forces are or can be brought to bear on these costs? What are the impacts on consumers of the increased costs?
Would lenders be more effective at negotiating closing costs than consumers? Are there reports or evidence that are relevant to the topic?
What studies or data are available to measure the potential impact closing costs may have on overall costs, housing affordability, access to homeownership, or home equity?

Loran Kilson & Richard J. Andreano, Jr.

CFPB Issues Proposal to Prohibit Use of Medical Debt Information in Credit Decisions

The steady drumbeat of steps during Rohit Chopra’s tenure as CFPB Director to call into question the reliability and predictability of medical debt information in credit underwriting reached a crescendo last week with the CFPB’s issuance of a proposed rule to eliminate the exception in Regulation V (which implements the Fair Credit Reporting Act) that currently allows creditors to obtain and use medical debt information in connection with credit eligibility determinations. The proposal would also generally prohibit consumer reporting agencies (CRAs) from including medical debt information on consumer reports. The proposal would be effective 60 days after publication of a final rule in the Federal Register. Comments on the proposal are due by August 12, 2024.

The proposal would make the following key changes:

Regulation V currently contains a definition of “medical information.” While the existing “medical information” definition covers information about medical debts, the proposal would add “medical debt information” as a new defined term. Under the new definition, “medical debt information” would be a subset of “medical information” that is defined as “[m]edical information that pertains to a debt owed by a consumer to a person whose primary business is providing medical services, products, or devices, or to such person’s agent or assignee, for the provision of such medical services, products, or devices. Medical debt information includes, but is not limited to medical bills that are not past due or that have been paid.”
Regulation V currently contains a “financial information exception for obtaining and using medical information” that generally allows creditors to obtain and use information about medical debts “in connection with any determination of the consumer’s eligibility, or continued eligibility, for credit” so long as certain conditions are met. The proposal would remove that exception and add a new exception to the other existing “specific exceptions for obtaining and using medical information” that would allow a creditor to use “medical information” for credit eligibility determinations only if the following three conditions are met:

The medical information relates to income, benefits, or the purpose of the loan, including the use of proceeds. Medical information relating to income and benefits, includes, for example, the dollar amount and continued eligibility for disability income, workers’ compensation income, or other benefits related to a health or medical condition that is relied on as a source of repayment;
The medical information is used in a manner and to an extent that is no less favorable than the creditor would use comparable information that is not medical information in a credit transaction; and
The creditor does not take the consumer’s physical, mental, or behavioral health, condition or history, type of treatment, or prognosis into account as part of the determination of the consumer’s eligibility, or continued eligibility, for credit.

The proposal would add a new provision to Regulation V that would prohibit CRAs from furnishing a consumer report that includes medical debt information to a creditor unless the following two conditions are met:

The CRA has reason to believe the creditor intends to use the medical debt information consistent with one of the specific exceptions; and
The CRA is not otherwise prohibited, such as by state law, from furnishing information in a consumer report that would meet the definition of “medical debt information.”

Under the current financial information exception in Regulation V, a creditor can consider medical information relating to expenses, assets, and collateral, including the value, condition, and lien status of a medical device that may be collateral for a loan when making credit eligibility decisions. The effect of the proposed removal of the financial information exception from Regulation V would be to prohibit creditors from obtaining and using medical information relating to expenses, assets, or collateral in making credit eligibility decisions, unless a specific exception applies. In its discussion of the proposal, the CFPB states that it “understands that medical information related to a consumer’s assets and collateral generally refers to medical equipment serving as an asset or as collateral for a loan, which a creditor may potentially seize or anticipate could be liquidated to pay off a loan.” It further states that “such medical equipment is often necessary and potentially lifesaving. Given the importance of medical assets and collateral to a consumer’s well-being, the CFPB has preliminarily determined that the financial information exception should not apply to information about medical assets and collateral.” The CFPB asks for comment on its proposed approach regarding medical information relating to expenses, assets, and collateral and states that it is particularly “interested in feedback from creditors and their representatives about whether they take medical devices as collateral or into consideration as assets that may be used by consumers to pay a future debt obligation, and if so, the business justification for doing so.”

The CFPB has said that it will publish separate proposed rules on the other FCRA changes under consideration later this year. Those include broadening the definition of consumer reporting agency to include data brokers, limiting the permissible purposes for which credit reports can be furnished, and changing the rules governing the resolution of consumer disputes about their credit reports.

John L. Culhane, Jr. & Joseph Schuster

Chopra Delivers Testimony to Congress on Semi-Annual Report

On June 4, 2024, the CFPB issued its Semi-Annual Report to Congress covering the period beginning April 1, 2023 and ending September 30, 2023. On June 12, 2024, CFPB Director Chopra appeared before the Senate Banking Committee for a hearing, “The Consumer Financial Protection Bureau’s Semi-Annual Report to Congress.” On June 13, 2024, Director Chopra appeared before the House Financial Services Committee for a hearing, “The Semi-Annual Report of the Bureau of Consumer Financial Protection.”

Senate Banking Committee Hearing

The Senate Hearing opened with U.S. Senator Sherrod Brown (D-OH), Chairman of the Senate Banking Committee reading a prepared statement followed by Ranking Member Tim Scott (R-SC) reading a prepared statement. Senator Brown applauded the CFPB actions and addressed the recent U.S. Supreme Court decision upholding the constitutionality of the CFPB’s funding mechanism, the proposed rule on medical debt reporting, “junk fees,” servicemembers and veterans. Senator Brown concluded:

This is why it’s so critical that we have the Consumer Financial Protection Bureau. Wall Street has lawyers and lobbyists. Working people have the CFPB. I will always fight for its work that gets money back into people’s bank accounts, that stops bad actors from cheating honest families, and that stands up for consumers when they may have nowhere else to turn.

Senator Scott remarked that “it sounds like we’re talking about two completely different agencies” and raised concerns about the CFPB’s lack of accountability and independence, the litany of lawsuits, the civil investigative demand process, and political coordination. Senator Scott addressed the realities of the consumer impact from the “junk fee” rules:

You’re not protecting consumers or saving people money, instead you’re peddling a false narrative that the Biden administration is doing something to reduce the actual costs. But then, reality hits, and we realize this administration’s actions simply shift who saves and who pays. It is well past time we end this “junk fees” narrative and focus on the junk philosophy behind them. With every action taken, there are trade-offs, and those trade-offs have consequences .In this case, the administration is trading a punchy headline proclaiming they are saving families money today, while actually building higher costs down the road.

Next, Director Chopra read his prepared statement to the Committee, which focused on CFPB initiatives on financial data, medical debt, and credit cards. He remarked that the CFPB will finalize the open banking rules in the fall.

Senator Brown inquired whether any of the large card issuers showed their math in the comments submitted to the CFPB and Director Chopra stated that they did not and the loophole allowed the issuers to receive $10B in extra income. When Senator Brown asked whether the CFPB research suggests that credit card companies can lower interest rates and still be profitable, Director Chopra replies yes.

Senator Scott asked Director Chopra about how many civil investigative demands have been issued under his leadership. Director Chopra remarked that he did not have exact numbers and the enforcement actions have shifted from small actors to large actors. In shifting to “junk fees” Senator Scott remarked that if the credit card late fees and overdraft fee structure goes away they will replaced with something else to maintain profitability or you stop offering products and force consumers to go to unregulated markets. Senator Scott inquired about the inconsistent approach between the government and private sector and why late fees are okay for the IRS but not for business. Without answering the question, Director Chopra replied that “junk fees” are a huge problem in our economy and a bipartisan issue in need of reform.

When Senator Jack Reed (D-RI) asked about the supervision of buy now pay later firms and whether the CFPB needed additional authority, Director Chopra stated, “we have some authority but we are happy to work with you for more authority.” In addressing credit reporting for buy now pay later, Director Chopra re-conveyed concerns from auto and mortgage lenders about consumers’ ability to afford the loans if they know what loans people have and that it is not a requirement of federal law to report loans.

Senator Mike Round (R-SD) inquired whether the CFPB believes that Regulation E requires refunds to consumers that authorize the transfer but the transfers were fraudulently induced. Director Chopra stated that the line is blurry and that Regulation E has some framework but network rules also apply.

In response to questions from Senator Tina Smith (D-MN) about what the CFPB is doing with the Justice Department to address redlining, Director Chopra acknowledged that redlining actions are hard to do case by case basis, the CFPB is working with the industry to determine where barriers exist, and it is clear that more work needs to be done..

We previously blogged about the questioning by Senator John Kennedy (R-LA) about the CFPB’s being funded when the Federal Reserve hasn’t had combined earnings since September 2022.

Senator Elizabeth Warren (D-MA) used most of her five minutes to attack Republicans’ opposition to the CFPB’s continued work on the Biden agenda. She also asked about the CFPB’s focus on mortgage “junk fees.” Chopra confirmed that both mortgage lenders and consumers are concerned about the inflated costs and fees to close on a house.

Senator Katie Britt (R-AL) asked whether the CFPB planned to publish the 1071 data it was collecting. Director Chopra indicated that the data collection has been significantly delayed and the CFPB is not going to make a determination until after they conduct a privacy assessment but confirmed that the CFPB would not publish any identifying information.

House Financial Services Committee Hearing

The House Hearing opened with Chairman Patrick McHenry (R-NC) reading a prepared statement followed by Congresswoman Maxine Waters (D-CA) reading a prepared statement. Next, Director Chopra read his prepared statement to the Committee, which focused on CFPB initiatives on credit cards, medical debt, and open banking. He said, “We are eager to work with the House Financial Services Committee to do more to protect against abuse and misuse of data, including by enshrining stronger protections into law.”

Chairman McHenry remarked:

Director Chopra, under your leadership, this so-called independent agency has become an arm of President Biden’s political operation. Data, facts, economics, and sound analysis take a backseat to politically favorable talking points. Even the Washington Post has called the numbers ‘fuzzy’ surrounding how much consumers could actually save if so-called junk fees were cut. You’ve taken your eye off the ball of consumer financial protection and are instead chasing the shiny political object. We’ve seen how this one ends. It’s never a good outcome for our financial system or the American people.

In speaking with Chairman McHenry on data privacy laws, Director Chopra stated, “the [GLBA privacy] notice is not effective when it comes to meaningful control.” In speaking with Congressman Byron Donalds (R-FL), Director Chopra said, “I would argue in privacy disclosures that disclosures are not enough.” He indicated that the Section 1033 proposed rules will be finalized in October.

Congresswoman Waters discussed the proposed medical debt rule and “junk fees.” In response to “junk fees,” Chopra stated, “Markets work best when people can see the price up front and compare it.” As we have mentioned numerous times credit card late fees and overdraft fees that are being attacked as “junk fees” are disclosed upfront using CFPB model forms.

Congressman Blaine Luetkmeyer (R-MO) asked, “Junk fees, which really is not a legally enforceable term and something you guys have made up – by your definition, are late fees. I have here a letter here from Nicholas Anthony at the Cato Institute; 101 late fees charged by the government. Have you looked into any government late fees at all?” Director Chopra indicated that he would support looking into a lot of those late fees charged by government.

Congressman Emanuel Cleaver, II (D-MO) raised concerns about a particular credit union’s discriminatory practices based on race and asked whether Director Chopra supported a similar community reinvestment assessment process for the credit union space. Chopra indicated that the majority of mortgage lending is outside of banks and he supports stronger CRA requirements for other mortgage lenders.

In response to several inquiries about the auto loan data collection, Director Chopra indicated some hesitancy to move forward with the collection and stated that the CFPB does not have authority to bring enforcement actions against auto dealers.

Congressman William Timmons (R-SC) commented on the wild swings in policy after elections and how it is impeding U.S. businesses. Director Chopra replied, “Under the law, it shouldn’t have been that different. There have been different approaches. We are more focused rule of law approach. We try to enforce the rule as you wrote it.”

When Congressman Zach Nunn (R-IA) asked about whether the Section 1071 data collection of 81 points was creating a treasure trove for cyber actors, Chopra disagreed. He stated, “I appreciate what you are saying. I have to disagree with the 81 data points. We believe that the points that are being collected are directly in line with the statute.”

Both the Senate and House will permit follow up questions to be submitted by members and answers to be submitted by Director Chopra.

Kristen E. Larson & Alan S. Kaplinsky

VA Announces Temporary Variance Allowing Veterans to Pay Broker Commissions and Announces a Targeted Foreclosure Moratorium

Buyer-Broker Commissions

In connection with its guaranteed home loan program, the Department of Veterans Affairs (VA) recently adopted a temporary local variance allowing veterans to pay the commission of the real estate broker or agent assisting them (a “buyer-broker”). VA also recently urged servicers to implement a targeted foreclosure moratorium through year end, which would extend, with modifications, a previously announced moratorium.

Based on recent settlements involving how listing real estate brokers or agents may offer to split their commission with the buyer-broker, there was concern in the mortgage industry that this may result in buyers having to regularly pay the buyer-broker’s commission, contrary to the common current practice of the seller paying an amount that compensates both their broker and the buyer-broker. One concern centered on the VA guaranteed home loan program, which imposes significant limitations on what fees may be paid by the veteran. Recently, VA addressed that concern in Circular 26-24-14 by announcing a temporary local variance that will allow veterans to pay for certain buyer-broker charges.

VA advises that the local variance allows veterans to pay reasonable and customary amounts for any buyer-broker charges (including commissions and any other broker-related fees), subject to the following:

The home the veteran is purchasing is an area where listing brokers are prohibited from setting buyer-broker compensation through multiple listing postings, or buyer-broker compensation cannot be established by or flow through the listing broker.
Buyer-broker charges are not included in the loan amount.
Buyer-broker charges paid or to be paid by the veteran must be considered in determining whether the veteran has sufficient liquid assets to close the loan.

While an invoice is not required to support the buyer-broker charge, the total amount paid by the veteran is to be disclosed in lines 1 through 3 of section H (Other) on the Closing Disclosure. Lenders will need to be mindful of the TILA/RESPA Integrated Disclosure (TRID) rule requirement to disclose charges for which there is no dedicated line in alphabetical order.

VA advises that it considers the buyer-broker representation agreement to be part of the sales contract package. As a result, VA expects lenders to upload the agreement as part of the package lenders use when requesting an appraisal. VA also expects lenders to retain the agreement in the loan file

VA notes that the temporary variance does not prevent the seller of the home from paying for the veteran’s buyer-broker charges. VA also reminds lenders that it does not treat the seller’s payment of buyer-broker charges as a seller concession.

VA advises that it “will develop a more permanent policy, through a new notice-and-comment rulemaking, as the real estate brokerage market restabilizes and new practices take hold.”

Foreclosure Moratorium

As previously reported, late last year VA issued Circular 26-23-25 announcing that it “is strongly encouraging a foreclosure moratorium on all VA-guaranteed loans through May 31, 2024.” Additionally, VA urged “servicers to cease initiating, continuing, and/or completing foreclosures on all VA-guaranteed loans during this moratorium.” One reason for the request was that VA was developing a VA Servicing Purchase (VASP) program as an option for borrowers who cannot be assisted through other home retention options, and the moratorium would provide time for the program to be developed and then implemented. We previously reported on the launch of the VASP program, as well as other VA loss mitigation efforts. Servicers were able to implement the VASP program beginning May 31, 2024, and VA expects servicers to fully implement the program not later than October 1, 2024.

In Circular 26-24-12, VA announced that it “strongly encourages servicers to implement, through December 31, 2024, a targeted foreclosure moratorium.” Pursuant to the targeted moratorium, servicers are to cease initiating, continuing, and/or completing foreclosures on VA-guaranteed loans unless one or more of the following exceptions apply:

The loan is secured by property that is vacant or abandoned.
The servicer has documented that the borrower desires neither to retain homeownership nor avoid foreclosure.
The servicer has not received a monthly payment for at least 210 days, and the borrower is not responding to the servicer’s outreach attempts.
The servicer has evaluated the borrower for all home retention options but has determined that no home retention option, including the VASP program, or alternative to foreclosure will work for the borrower.

For loans covered under the targeted moratorium, servicers are expected to continue loss mitigation efforts and offer reasonable solutions to resolve the delinquency. Additionally, VA states that “[i]n order to avoid damaging the credit records of Veterans, servicers are encouraged to avoid negative credit reporting, where permissible under applicable law, on affected loans.”

VA advises that for borrowers affected by COVID-19, servicers should offer Loan Deferments, Disaster Extend Modifications, and COVID-19 Refund Modifications, as described in Circulars 26-24-2 and 26-24-3. VA also advises that these options may be offered to a borrower, without regard to the respective Circular’s rescission date, until the servicer is able to implement the VASP program or through September 30, 2024, whichever is sooner.

VA also provides the following warning to servicers:

“Before loan termination, VA reviews the loan to help ensure that the borrower has received a reasonable opportunity to retain home ownership and avoid foreclosure. If VA identifies a servicer that is not properly servicing loans, the servicer may be subject to special audit and potential enforcement action(s). Therefore, VA reminds servicers to continue following VA’s updated guidance and instructions on how to best utilize available home retention options, including COVID-19 home retention options and VASP, as outlined in Circulars and the VA Servicer Handbook M26-4. VA also reminds servicers to consider other options in consultation with VA including for example, extended repayment plans (i.e., 9-months or longer) and COVID-19 Refund Modifications that achieve less than a 10 percent reduction in principal and interest payments.”

Richard J. Andreano, Jr.

VA Proposes Rules for ARM Loans and Temporary Buydown Agreements

The U.S. Department of Veterans Affairs (VA) recently proposed rules under its home loan guaranty program regarding adjustable rate mortgage (ARM) loans, hybrid ARM (h-ARM) loans and temporary buydown agreements. Comments are due August 20, 2024.

ARM Loans and H-ARM Loans

The VA’s rules currently provide that “Interest rate adjustments must occur on an annual basis, except that the first adjustment may occur no sooner than 36 months from the date of the borrower’s first mortgage payment.” In contrast, current statutes governing VA home loans provide that (1) the interest rate on ARM loans must adjust on an annual basis, and (2) the interest rate on h-ARM loans must be fixed for a period of not less than the first three years of the mortgage term, and after the fixed period then must adjust on an annual basis. Nevertheless, the VA advises in the preamble to the proposed rule that it has been guaranteeing loans on the basis provided for in the statute. To conform existing VA regulations with VA home loan statutory provisions, the proposed rule provides that (1) the interest rate on ARM loans must adjust on an annual basis starting from the date of the veteran’s first scheduled monthly mortgage payment due date, and (2) for h-ARM loans the first adjustment must not occur sooner than 36 months from the date of the veteran’s first scheduled monthly mortgage payment due date, and after the fixed interest rate period adjustments must occur on an annual basis.

Consistent with current VA rules, changes in the interest rate would need to correspond to changes in the weekly average yield on 1 year (52 weeks) Treasury bills adjusted to a constant maturity, although the language of the index provision would be updated.

With regard to the method of implementing a rate adjustment, the proposed rule would replace the language of the existing rule providing for “adjustments to the borrower’s monthly payments’’ with ‘‘adjustments to the [V]eteran’s scheduled monthly payment amount” to clarify that adjustments may only be made by changing the payment amount and not, for example, the number of payments.

With rate adjustments, consistent with current VA rules the new index value would be added to the margin and then rounded to the nearest one-eighth of one percent. With regard to the amount of rate adjustments, the proposed rule would add provisions specifically for h-ARM loans that provide as follows:

For loans with an initial fixed interest rate period of less than 5 years (a) no single annual adjustment to the interest rate may result in a change in either direction of more than 1 percentage point from the interest rate in effect for the period immediately preceding that adjustment, (b) index rate changes in excess of 1 percentage point may not be carried over for inclusion in an adjustment in a subsequent year, and (c) adjustments to the interest rate over the entire term of the loan are limited to a maximum increase of 5 percentage points from the initial interest rate.
For loans with an initial fixed interest rate period of 5 or more years (a) no single annual adjustment to the interest rate may result in a change in either direction of more than 2 percentage points from the interest rate in effect for the period immediately preceding that adjustment, (b) index rate changes in excess of 2 percentage points may not be carried over for inclusion in an adjustment in a subsequent year, and (c) adjustments to the interest rate over the entire term of the loan are limited to a maximum increase of 6 percentage points from the initial interest rate.

The proposed rule would add a provision expressly addressing underwriting requirements with ARM loans and h-ARM loans for cases in which a loan must be underwritten under general VA standards. Under the provision (1) for ARM loans lenders would be required to use an interest rate not lower than 1 percentage point above the initial interest rate, and (2) for h-ARM loans lenders would be required to use an interest rate not lower than the initial interest rate. Lenders would be permitted to underwrite loans based on rates higher than the minimum specified rates to account for other applicable credit and risk factors.

The proposed rule would modify an existing rule requiring that the veteran be provided with a pre-loan disclosure that must contain specified information regarding the adjustable rate terms by replacing the list of required information with a reference to certain Loan Estimate disclosure requirements under the TILA/RESPA Integrated Disclosure (TRID) rule. Consistent with the existing pre-loan disclosure requirements, the lender would be required to obtain the veteran’s signature on the Loan Estimate, and retain a copy of the signed Loan Estimate in the lender’s permanent record on the loan. Under the TRID rule, obtaining the borrower’s signature on the Loan Estimate is optional.

The proposed rule would replace the existing annual disclosure provision with a provision that incorporates ARM loan adjustment notice requirements under Regulation Z. Lenders would need to make a copy of the notices part of the lender’s permanent record on the loan.

The proposed rule also would implement various other conforming and clarifying changes.

Temporary Buydown Agreements

The proposed rule would add a new provision addressing requirements and limitations for temporary buydown agreements. The provision would prohibit the inclusion of buydown funds in the loan amount would, and also prohibit the use of temporary buydown agreements “as a cash-advance on principal, such as through subsidizing payments through an above market interest rate, discount points, or a combination of discount points and above market interest rate.” The provision would limit the use of temporary buydown agreements to fixed rate loans.

The provision would impose the following requirements regarding terms of temporary buydown agreements:

The buydown arrangement could be in effect for up to the first 36 monthly payments on the loan.
Changes in the monthly payment could occur only on an annual basis.
Each change in the monthly payment could not increase the payment by more than the equivalent of a one percentage point increase in the interest rate.

The temporary buydown funds would need to be held in a separate escrow account, and the funds in the account could be used only to pay the monthly buydown payments in accordance with the temporary buydown agreement. If the loan terminates during the temporary buydown period, the remaining funds would need to be credited to the outstanding indebtedness. If the loan is assumed during the buydown period, the buydown funds would need to be paid out of the account on behalf of the new borrower in accordance with the temporary buydown agreement.

Lenders would be required to underwrite the loan at the interest rate stated on the mortgage note. However, a temporary buydown agreement could be treated as a compensating factor if there are indications that the veteran’s income used to support the loan application will increase to cover the yearly increases in loan payments or that the buydown plan is being used to offset a short-term debt.

Lenders would be required to provide veterans with a clear, written explanation of the temporary buydown agreement. The explanation would need to include a description of the number of monthly payments for which the assistance will run, the total payment assistance amount, and the monthly payment schedule reflecting the amount of each monthly buydown payment and the veteran’s monthly payment.

Richard J. Andreano, Jr.

Treasury Issues Request For Information on Use of AI in Financial Services

The U.S. Department of the Treasury (Treasury) has released a Request for Information on the Uses, Opportunities, and Risks of Artificial Intelligence (AI) in the Financial Services Sector (RFI). Written comments are due by August 12, 2024.

AI is a broad topic and the term is sometimes used indiscriminately; as the RFI suggests, most AI systems being used or contemplated in the financial services sector involve machine learning, which is a subset of AI. The RFI implicitly concedes that Treasury is playing “catch up” and quickly needs to learn more about AI and how industry is using it. The RFI discusses a vast array of complex issues, including anti-money laundering (AML) and anti-fraud compliance, as well as fair lending and consumer protection concerns – particularly those pertaining to bias.

The Press Release and Related Remarks: What the RFI Seeks to Accomplish

In the press release for the RFI, Under Secretary for Domestic Finance Nellie Liang stated that Treasury is seeking to understand

. . . . how AI is being used within the financial services sector and the opportunities and risks presented by developments and applications of AI within the sector, including potential obstacles for facilitating responsible use of AI within financial institutions, the extent of impact on consumers, investors, financial institutions, businesses, regulators, end-users, and any other entity impacted by financial institutions’ use of AI, and recommendations for enhancements to legislative, regulatory, and supervisory frameworks applicable to AI in financial services. Treasury is seeking a broad range of perspectives on this topic and is particularly interested in understanding how AI innovations can help promote a financial system that delivers inclusive and equitable access to financial services.

Relatedly, during recent remarks at the Financial Stability Oversight Council Conference on Artificial Intelligence and Financial Stability, Secretary of the Treasury Janet Yellen announced that the use of AI by financial companies was nearing the top of the agenda for Treasury due to both the tremendous opportunities and significant risks posed by AI. Opportunities presented by AI include enhancement of efforts to combat fraud and illicit finance through AI’s ability to detect anomalies, and its capacity to improve efficiency, accuracy, and access to financial products. Risks presented by AI include vulnerabilities arising “from the complexity and opacity of AI models; inadequate risk management frameworks to account for AI risks; and interconnections that emerge as many market participants rely on the same data and models.” Further, according to Secretary Yellen, “[c]oncentration among vendors developing models, providing data, and providing cloud services may also introduce risks, which could amplify existing third-party service provider risks.” Finally, building AI systems by using insufficient or faulty data can create or perpetuate bias.

The RFI Builds on Prior Work Relating to AI and the Financial Sector

The RFI begins by stating that it seeks to build on work that Treasury has done to date, and describes prior reports and outreach relating to AI. They include:

A November 2022 report, Assessing the Impact of New Entrant Non-bank firms on Competition in Consumer Finance Markets, which found that many non-bank firms were using AI to expand their capabilities and service offerings, which created new data privacy and surveillance risks. “Additionally, the report identified concerns related to bias and discrimination in the use of AI in financial services, including challenges with explainability – that is, the ability to understand a model’s output and decisions, or how the model establishes relationships based on the model input – and ensuring compliance with fair lending requirements; the potential for models to perpetuate discrimination by using and learning from data that reflect and reinforce historical biases; and the potential for AI tools to expand capabilities for firms to inappropriately target specific individuals or communities (such as, low- to moderate-income communities, communities of color, women, rural, tribal, or disadvantaged communities).” As noted below, the issue of “explainability” is also important in regards to using AI in AML compliance.
A December 2023 RFI soliciting input on developing a national financial inclusion strategy, which included questions related to the use of AI in the provision of consumer financial services.
A March 2024 report on AI and cybersecurity, which identified opportunities and challenges that AI presents to the security and resiliency of the financial services sector, and outlined next steps to address AI-related operational risk, cybersecurity, and fraud challenges.
The 2024 National Strategy for Combating Terrorist and Other Illicit Financing, which found that “innovations in AI, including machine learning and large language models such as generative AI, have significant potential to strengthen anti-money laundering/countering the financing of terrorism (AML/CFT) compliance by helping financial institutions analyze large amounts of data and more effectively identify illicit finance patterns, risks, trends, and typologies.”
The December 2018 Joint Statement on Innovative Efforts to Combat Money Laundering and Terrorist Financing issued by the Financial Crimes Enforcement Network (FinCEN) and the federal banking agencies, “which encouraged banks to use existing tools or adopt new technologies, including AI, to identify and report money laundering, terrorist financing, and other illicit financial activity.”

The RFI observes that Section 6209 the Anti-Money Laundering Act of 2020 requires Treasury to issue a rule specifying standards for testing technology and related internal processes designed to facilitate effective compliance with the BSA by FIs. This rulemaking has yet to occur. The RFI further notes that FinCEN hosted a FinCEN Exchange in February 2023 to discuss how AI is used for monitoring and detecting illicit financial activity, and that FinCEN “regularly engages financial institutions on the topic through the BSA Advisory Group Subcommittee on Innovation and Technology, and BSAAG Subcommittee on Information Security and Confidentiality.”

These steps by FinCEN are positive. However, and as we have blogged (here, here, here and here), FinCEN and other regulators have been talking for years about encouraging “technological innovation” in regards to AML compliance programs. But as we have observed, for these aspirational statements to have real-world meaning, it is incumbent for regulators – and, perhaps most importantly, for front-line examiners from the banking regulatory agencies – to allow financial institutions room for error in the implementation of new technologies such as AI. Some financial institutions may be reluctant to pursue technological innovation such as AI because they are concerned that examiners will respond negatively or will make adverse findings against the financial institution if the new technology creates unforeseen problems. Similarly, some financial institutions may be concerned that new technologies may reveal unwitting historical compliance failures that otherwise would not have been uncovered, and which then will haunt the financial institution in the absence of some sort of regulatory safe harbor. Further, it may be difficult for examiners, used to traditional technologies, to become comfortable with the “explainability” of the outputs and decisions of an AML compliance system using AI, because AI necessarily involves a system that operates at a speed that is exponentially beyond humans’ ability to think. New technology can be costly, so the benefits of using AI for AML compliance need to be clear.

Thus, for innovation to succeed and be utilized to a meaningful degree, on-the-ground expectations and demands by regulators must be tempered. It is critical for financial institutions to engage with regulators, but regulators also must be responsive, agile, and knowledgeable. With these considerations in mind, we turn to the substance of the RFI and its specific requests.

Definitions and Areas of Focus

Treasury takes broad view of what is a “financial institution” (FI) for the purposes of the Request, and includes not just traditional FIs covered by the Bank Secrecy Act (BSA) but also financial technology companies, or fintechs, and “any other company that facilitates or provides financial products or services under the regulatory authority of the federal financial regulators and state financial or securities regulators.” The RFI also makes clear that it seeks information from many stakeholders, including consumer and small business advocates, academics, and nonprofits.

The RFI provides the following definition of AI, as set forth in 15 U.S.C. § 9401(3):

[A] machine-based system that can, for a given set of human defined objectives, make predictions, recommendations or decisions influencing real or virtual environments. Artificial intelligence systems use machine and human-based inputs to perceive real and virtual environments; abstract such perceptions into models through analysis in an automated manner; and use model inference to formulate options for information or action.

Treasury is focused on the latest developments in AI involving machine learning models that learn from data and automatically adapt and improve with minimal human interference, rather than relying on human programming. This includes emerging AI technologies involving deep learning neural networks such as generative AI.

Treasury hopes to learn through its request what types of AI models and tools FIs are actually using. Specifically, the RFI seeks insights into the uses of AI by FIs in the following areas:

Provision of products and services.
Risk management. This is a broad topic and includes “credit risk, market risk, operational risk, cyber risk, fraud and illicit finance risk, compliance risk (including fraud risk), reputation risk, interest rate risk, liquidity risk, model risk, counterparty risk, and legal risk, as well as the extent to which financial institutions may be exploring the use of AI for treasury management or asset-liability management[.]”
Capital markets.
Internal operations.
Customer service.
Regulatory compliance. This includes “capital and liquidity requirements, regulatory reporting or disclosure requirements, BSA/AML requirements, consumer and investor protection requirements, and license management[.]”
Marketing.

The Requests for Information

The RFI sets forth 19 questions, which are often detailed and consist of multiple, complex questions. Prior to outlining the 19 questions, the RFI provides a few pages of general discussion regarding four topics which are addressed, in various forms, by the questions themselves: potential opportunities and risks; explainability and bias; consumer protection and data privacy; and third-party risk (referencing the federal banking agencies’ June 2023 interagency guidance on third-party risk management). As to explainability and bias, the RFI expresses this concern:

Financial institutions may have an incomplete understanding of where the data used to train certain AI models and tools was acquired and what the data contains, as well as how the algorithms or structures are developed for those AI models and tools. For instance, machine-learning algorithms that internalize data based on relationships that are not easily mapped and understood by financial institution users create questions and concerns regarding explainability, which could lead to difficulty in assessing the conceptual soundness of such AI models and tools.

We will highlight only a few of the 19 questions in the RFI, and our descriptions will be general:

Treasury wants to understand how AI use can differ across FIs of different sizes and complexity, and expresses concern that small FIs may face barriers to the use of AI. Question 4 therefore seeks comment on those barriers and how small FIs intend to mitigate any associated risks.

Question 5 asks how AI has provided specific benefits to “low-to-moderate income consumers and/or underserved individuals and communities (such as, communities of color, women, rural, tribal, or disadvantaged communities).” Question 5 likewise asks how AI has improved fair lending and consumer protection. Questions 9 and 10 in part ask the converse. Question 9 asks about the risks posed by AI to low-to-moderate income consumers and underserved individuals and communities, such as falling prey to “predatory targeting” by AI or discrimination related to lending and other consumer-related activities, and what are FIs doing to mitigate these risks. Question 10 asks what FIs are doing to address any increase in fair lending and consumer protection risks, and how existing legal requirements can be strengthened or expanded.

Question 6 asks if AI for FIs is being developed in-house, by third parties, or through open-source code. Through this question, Treasury appears concerned that the same AI models and tools will exist across multiple FIs (potentially because that outcome may lead to additional risk if there are issues with a particular AI).

Question 7 asks how FIs are expecting to apply risk management to the use of AI and emerging AI technologies. In its request, Treasury appears concerned with gaps in human oversight of AI and the ability of humans to understand AI outputs to prevent bias.

Question 11 focuses on increases to data privacy risk, and how existing data privacy protections, such as those in the Gramm-Leach-Bliley Act, can be strengthened.

Question 12 addresses fraud risk. It asks “[h]ow are financial institutions, technology companies, or third-party service providers addressing and mitigating potential fraud risks caused by AI technologies? . . . . Given AI’s ability to mimic biometrics (such as a photos/video of a customer or the customer’s voice) what methods do financial institutions plan to use to protect against this type of fraud (such as, multifactor authentication)?” Relatedly, Question 13 asks how stakeholders “expect to use AI to address and mitigate illicit finance risks? What challenges do organizations face in adopting AI to counter illicit finance risks? How do financial institutions use AI to comply with applicable AML/CFT requirements? What risks may such uses create?”

Questions 15 through 17 pertain to third-party risks, including risks involving data confidentiality.

Question 19 asks about how differences in approaches between the United States and other jurisdictions pose concerns for managing AI-related risks on an enterprise-wide basis.

Throughout the RFI, Treasury seeks input as to legislative or regulatory steps that might be taken in relation to AI. It is very likely that Treasury will issue regulations related to AI, although it is very unclear what form such regulations would take, or what exact topics would be addressed.

In advance of any action from Treasury, FIs should proactively implement compliance and oversight regimes of their AI projects from the beginning. FIs should ensure adequate human oversight and testing of AI-related products; as AI continues to develop over time, any AI-based products should undergo regular testing by financial institutions. FIs also should be careful to avoid creating or using AI that will result in harm to disadvantaged groups (with a particular focus on lending and other consumer-facing products). Finally, FIs should consider whether to invest in developing AI in-house versus using third-party applications – Treasury is clearly concerned about data privacy risks and potential global risks of AI causing problems across multiple FIs, as well as ensuring that any AI is tailored to the specific circumstances and risks facing a particular FI.

Peter D. Hardy & Nathaniel Botwinick

U.S. Supreme Court Punts Another NBA Preemption Case; This Time to the Ninth Circuit

On June 10, 2024, the U.S. Supreme Court granted the petition for a writ of certiorari and issued a summary disposition in Flagstar Bank, N.A. v. Kivett. The U.S. Supreme Court vacated the judgment and remanded the case to the Ninth Circuit for further consideration in light of the court’s recent decision in Cantero v. Bank of America, N.A. Similar to Cantero, the Kivett case involved a California law that requires lenders to pay interest on mortgage escrow accounts. In 2018, in Lusnak v. Bank of America, N.A, the Ninth Circuit ruled the NBA does not preempt California’s law requiring interest to be paid on mortgage escrow accounts. The U.S. Supreme Court declined to review the Ninth Circuit’s decision in Lusnak. In Kivett, the Ninth Circuit concluded its prior ruling in Lusnak required a finding that the National Bank Act (NBA) does not preempt California’s interest on mortgage escrow account law. The later-decided Second Circuit case in Cantero reached an opposite conclusion and created a circuit split.

On May 30, 2024, in a unanimous decision, the U.S. Supreme Court reversed Cantero v. Bank of America, N.A., and remanded it back to the Second Circuit and instructed the appellate court to analyze whether New York’s law requiring lenders to pay interest on mortgage escrow accounts is preempted under the Dodd-Frank Act by applying the Barnett Bank standard. No bright line test for preemption was articulated by the Court; instead, the Court relied on Barnett Bank and its earlier precedents dealing with National Bank Act (NBA) preemption. On remand, the Ninth Circuit and Second Circuit must conduct a “nuanced comparative analysis” under Barnett Bank and “[i]f the state law prevents or significantly interferes with the national bank’s exercise of its powers, the law is preempted.”

The First Circuit also has an interest-on-escrow case pending before it, which was stayed awaiting the outcome of Cantero and Kivett. With the Court’s decision in Cantero, the parties in Conti v. Citizens Bank, N.A. have proposed a new briefing schedule.

With no bright line test, the Barnett Bank analysis as to whether a state law like California and New York’s interest on escrow accounts “prevents or significantly interferes” with a national bank’s powers could vary based on fact intensive analysis. We will monitor the First, Second, and Ninth Circuit’s decisions in these three cases.

Ballard Spahr is hosting a webinar on July 11, 2024 from 12:00-1:00 ET titled, “By Passing Buck to Second Circuit, U.S. Supreme Court Leaves National Bank Preemption in Limbo.” In this webinar roundtable, we have brought together four distinguished lawyers—who filed amicus briefs in the Cantero case—to share their insights on the U.S. Supreme Court’s opinion, the opinion’s impact on NBA preemption analyses, the expected outcomes from the remanded and stayed cases, how national banks should make NBA preemption determinations, and whether we can expect further review by the U.S. Supreme Court. Register here.

Kristen E. Larson & Alan S. Kaplinsky

Colorado Federal Court Issues Preliminary Injunction Prohibiting Colorado From Enforcing DIDMCA Opt-Out to Loans Made to Colorado Residents by Out-of-State State-Chartered Banks

The Colorado federal district court hearing NAIB, et al v. Weiser, et al., the lawsuit filed by three consumer financial services industry trade groups challenging Colorado’s opt-out legislation, has granted the plaintiffs’ motion for preliminary injunction. As interpreted by the defendant State officials, Colo. Rev. Stat. § 5-13-106 (Opt-out Law), ), which is due to take effect on July 1, purports to apply Colorado’s interest rate and fee limits to interstate loans made by federally insured out-of-state state-chartered banks to Colorado borrowers. The preliminary injunction provides that Colorado is preliminarily enjoined from enforcing its interest rate and fee limits “with respect to any loan made by the plaintiffs’ members, to the extent the loan is not “made in” Colorado and the applicable interest rate in Section 1831d(a) exceeds the rate that would otherwise be permitted.”

The law at issue in the case is the Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA). Section 521 of DIDMCA (codified at 12 U.S.C. Section 1831d(a)) applies to insured state banks and tracks Section 85 of the National Bank Act, the statute establishing interest rate authority for national banks, generally allowing banks to charge interest at the rate allowed in the state of their location or a floating rate that is 1 percent above a prevailing Federal Reserve discount rate, whichever is higher, and preempts lower state law interest rate limits. In Marquette, a unanimous decision issued just 15 months prior to DIDMCA’s enactment, the U.S. Supreme Court held that Section 85 allows national banks to “export” the rate authorized in states where they are located on loans made to borrowers in other states. Subsequent case law has construed DIDMCA Section 521 in pari materia with Section 85, thereby granting insured state banks the same rate exportation authority as national banks.

Section 525 of DIDMCA allows states to enact laws opting out of Section 521’s preemptive effect with respect to loans “made in” the enacting state. The novel question that the Colorado court was asked to decide is what it means for a loan to be “made in” in Colorado for purposes of the scope of Colorado’s Opt-out Law or, more specifically, where a loan is “made” in the case of loans to Colorado residents by insured state banks located in other states. The court stated that “[t]hese questions have yet to be decided by any court” and “have been open questions since the statute’s inception.”

The plaintiff industry groups contended that, for purposes of Section 525, loans to Colorado residents by insured state banks located in other states should be deemed “made in” the bank’s home state or the state where key lending functions occur. Colorado argued that, for purposes of Section 525, a loan is “made in” both the borrower’s state and the state where the lender is located. (The FDIC filed an amicus brief in support of Colorado taking the same position as to where a loan is made.)

In ruling on the plaintiffs’ preliminary injunction motion, the court first rejected Colorado’s arguments that the plaintiffs lacked standing, their claims were not ripe, and the plaintiffs’ lawsuit could not proceed because there was no private right of action available to them to enforce the rights created by Section 521. The court gave two principal reasons for its conclusion that the plaintiffs had made a strong showing that they are substantially likely to succeed on the merits of their Section 521 claim.

First, the court concluded that the plaintiffs’ reading of “loans made in” Colorado found strong support in the plain language of Section 521 when viewed in the context of the statutory scheme as a whole. Colorado argued that a loan is “made” by both the bank and the borrower. The plaintiffs argued that, while a borrower “obtains” or “receives” a loan, only the bank “makes” a loan. The court found that the plaintiffs’ view was “more consistent both with the ordinary colloquial understanding of who ‘makes’ a loan, and, more importantly, with how the words ‘make’ and ‘made’ are used consistently throughout the text of the Federal Deposit Insurance Act, including the [DIDMCA] amendments, as well as throughout the rest of Title 12 of the United States Code, which governs ‘Banks and Banking’ and includes the National Bank Act.” More specifically, the court found that:

Taken as a whole, the consistent use of “make” and “made” throughout the statutory text indicates that the plain and ordinary answer to the question of who “makes” a loan is the bank, not the borrower. It follows, then, that the answer to the question of where a loan is “made” depends on the location of the bank, and where the bank takes certain actions, but not on the location of the borrower who “obtains” or “receives” the loan. (emphasis included).
*****
The plain language of Section 1831d’s opt-out provision, viewed in the context of the statutory scheme as a whole, indicates that loans are ‘made’ by the bank, and that where a loan is ‘made’ does not depend on the location of the borrower.

Second, while commenting that the policy arguments and persuasive authorities cited by the parties were “mostly inconclusive or irrelevant and therefore unhelpful,” to the extent they shed light on the issues, the court found that they nevertheless provided support for the conclusion that loans are “made” by the bank and that where a loan is “made” depends on where the bank is located and takes various actions but not on the borrower’s location. The court found that Colorado’s and the FDIC’s reliance on certain Dormant Commerce Clause cases was misplaced because “they address the separate issue of when one state may constitutionally regulate an activity involving conduct that occurs in another state.”

The court found that the plaintiffs satisfied the other requirements for a preliminary injunction. It found the plaintiffs had made a strong showing that their members would suffer irreparable harm if an injunction was not granted. The plaintiffs argued that absent an injunction, they would have to stop offering their loan products to certain Colorado customers and once gone, those customers and their goodwill, as well as the goodwill of the banks’ business partners, might be gone forever, resulting in a type of intangible damages that may be incalculable and for which a monetary award could not provide adequate compensation.

The court also found that the balance of harms weighed in the plaintiffs’ favor because national banks could continue making loans to Colorado residents with interest rates and fees above Colorado limits. The court concluded that because national banks could continue making such loans, the Opt-out Law would place plaintiffs’ members at a disadvantage with respect to national banks while only providing marginally more protection from higher interest rates to Colorado residents. In addition, the court found that the public interest favored enjoining enforcement “of likely invalid provisions of state law.”

By its terms, the preliminary injunction appears to apply only to loans made by members of the three plaintiff trade groups. However, faced with the district court’s well-reasoned opinion, we do not expect Colorado to initiate an action to enforce the Opt-out Law against a non-member insured state bank located in a state other than Colorado or for a plaintiff’s attorney to initiate a class action on behalf of Colorado borrowers who obtain loans from such a non-member insured state bank. In any event, if an effort is made by other trade groups to have the preliminary injunction extended so that it applies to all insured state banks located in states other than Colorado, we would expect the district court to grant such relief.

We have previously blogged about bills introduced in several states that are similar to the Opt-out Law and purport to opt-out of Section 521 of DIDMCA. Hopefully, the Colorado opinion will give pause to legislators in those states who will realize that such legislation will only adversely affect state banks that are located in their states.

Colorado has 30 days to appeal the district court’s decision to the Tenth Circuit.

Ballard Spahr, on behalf of the American Bankers Association and the Consumer Bankers Association, submitted an amicus brief in support of the plaintiffs’ motion for preliminary injunction.

Alan S. Kaplinsky, Burt M. Rublin, Ronald K. Vaske, John L. Culhane, Jr., Joseph Schuster & Mindy Harris

FHA Seeks Comment on Third-Party Originator Fraud With Short Comment Timeframe

On June 17, 2024, FHA announced in draft Mortgage Letter 2024-12 a proposed revision to its Defect Taxonomy to clarify that fraud or material misrepresentation involving a sponsored Third-Party Originator (TPO) is a Tier 1 severity defect in connection with loans insured under the Title II program. Comments on the proposed revision are due June 24, 2024.

FHA’s Defect Taxonomy is set forth in Appendix 8 to HUD Handbook 4000.1. There are four Tiers of defects that FHA may assign to a finding with regard to an FHA insured loan, with Tier 1 being the most severe and being deemed unacceptable and requiring a lender response. Currently, the Defect Taxonomy provides that findings of fraud or materially misrepresented information can fall into one of two severity tiers:

Tier 1 (indicating that the Mortgagee knew or should have known), or
Tier 4 (indicating that the Mortgagee did not know and could not have known).

The Defect Taxonomy further states that FHA determines if the Mortgagee knew or should have known based on whether:

An employee of the Mortgagee was involved, and/or;
red flags in the loan file that should have been questioned by the underwriting Mortgagee.

FHA proposes to modify the Defect Taxonomy to provide that FHA determines if the Mortgagee knew or should have known based on whether:

An employee of the Mortgagee or sponsored Third-Party Originator was involved and/or;
red flags in the loan file should have been questioned by the underwriting Mortgagee.

If the proposed revision is adopted, FHA will seek life-of-loan indemnification from Mortgagees when there is evidence of fraud or material misrepresentation involving a sponsored TPO, regardless of whether FHA identifies specific red flags that should have been questioned at underwriting.

Parties seeking to comment on the proposal may do so by completing a Feedback Response Worksheet that is available here. The completed Worksheet may be submitted to a HUD email address, which also is available here.

Richard J. Andreano, Jr.

FinCEN Issues Reminder to Financial Institutions to Identify and Report Elder Financial Exploitation

On June 14, 2024, President Biden declared June 15^th World Elder Abuse Awareness Day. In honor of the day, the Financial Crimes Enforcement Network (FinCEN) reminded financial institutions (FIs) to remain vigilant in identifying and reporting elder financial exploitation (EFE).

In issuing the reminder, FinCEN cited the Financial Trend Analysis (2024 Analysis) it recently performed which focused on patterns and trends identified in Bank Secrecy Act data linked to EFE, which we previously blogged on here. In performing that analysis, FinCEN studied 155,415 suspicious activity reports (SARs) filed by FIs that referred to EFE. Those SARs indicated approximately $27 billion in EFE-related suspicious activity occurred between June 15, 2022 and June 15, 2023.

In its reminder, FinCEN also recommended that FIs refer suspected victims of EFE to the Department of Justice’s National Elder Fraud Hotline and that victims file reports with the Federal Bureau of Investigation’s Internet Crime Complaint Center (IC3).

Although not cited in FinCEN’s reminder, on April 30, 2024, the IC3 issued its own Elder Fraud Report (the IC3 Report) based on complaints it received in 2023. The IC3 Report showed that complaints of EFE to the IC3 increased by 14 percent in 2023, and associated losses increased by approximately 11 percent. However, the FBI noted that many of these crimes go unreported, and it warned that the threat EFE poses is likely much greater.

There are several key takeaways from the IC3 report:

Elder fraud is a costly crime, with fraud against individuals aged 60 and over causing more than $3.4 billion in losses in 2023. The average older victim reported losing nearly $34,000, while 5,920 older victims reported losing more than $100,000.
Older people are disproportionately impacted by scams and fraud, with more than 101,000 victims aged 60 and over reporting these types of crimes in 2023. In contrast, the second most impacted demographic – individuals aged 30-39 years old – filed 88,138 reports with losses totaling over $1.1 billion – less than a third of the $3.4 billion in losses experienced by older victims.
Tech support scams were by far the most widely reported type of EFE, with the next most common type of scam, personal data breaches, being reported less than half as often.
While tech support scams were reported most often, investment scams were the most costly type of EFE in 2023, costing older victims more than $1.2 billion.

While the numbers in the IC3 Report were lower than those in FinCEN’s 2024 Analysis, recall that FinCEN’s analysis studied SAR filings, while the IC3 Report studied complaints of actual fraud (and, as stated previously, most victims do not file reports).

FinCEN’s reminder – especially as accentuated by its 2024 Analysis and the IC3 Report – underscores the costly and growing problem EFE poses. In issuing the 2024 Analysis and its June 2022 EFE Advisory (which we blogged on here), FinCEN has made it abundantly clear that it not only expects FIs to report EFE, but also to protect the elderly against scams. To that end, in addition to identifying and reporting EFE, FIs should develop, implement and maintain internal protocols and procedures for protecting elder account holders.

Beth Moskow-Schnoll

U.S. Supreme Court Heightens Relief Standard For NLRB to Obtain 10(j) Injunctions

A unanimous decision from the United States Supreme Court, issued on June 13, 2024, settles the split among the circuit courts concerning the factors to be considered by a court in considering a request by the National Labor Relations Board (NLRB) to obtain an injunction under Section 10(j) of the National Labor Relations Act (NLRA) against an employer during the pendency of NLRB administrative proceedings and raises the bar that must be satisfied by the NLRB for such injunctive relief

The decision in in Starbucks Corp. v. Mckinney, Regional Director of Region 15 of the NLRB, No. 23-367, was a highly anticipated opinion by parties on both sides of the labor aisle, unions, employers and the NLRB. The U.S. Supreme Court found that the United States District Court, District of Western Tennessee and the Sixth Circuit Court of Appeals improperly applied a two-factor “reasonable cause” test, instead of the traditional four-factor test articulated in Winter v. Natural Resources Defense Council, Inc, 555 U.S. 7 (2008), when granting and upholding the issuance of a §10(j) injunction against Starbucks. In so ruling, the U.S. Supreme Court resolve the circuit split as to the test to be applied when evaluating NLRB requests for §10(j) injunctions.

By way of background, this matter arose after several Starbucks employees announced plans to unionize and invited a news crew from a local television station to visit the store after hours to promote their unionizing efforts. Starbucks fired the employees for violating company policy. The NLRB filed an administrative complaint against Starbucks for engaging in unfair labor practices. Thereafter, the NLRB filed a petition pursuant to §10(j) of the NLRA seeking a preliminary injunction that would require Starbucks to reinstate the employees during the determination of the administrative complaint.

The District Court of Western Tennessee utilized the two-factor “reasonable cause” test, followed by the Third, Fifth, Sixth, Tenth, and Eleventh Circuits, in issuing the injunction. Notably, the two-factor test imposes a low burden upon the NLRB when seeking §10(j) injunctions, only requiring a court to determine whether “there is reasonable cause to believe that unfair labor practices have occurred,” and whether injunctive relief is “just and proper.” McKinney v. Ozburn-Hessey Logistics, LLC 875 F. 3d 333, 339. This standard requires courts to adopt the Board’s preliminary view of the facts, law, and equities – thereby giving the NLRB an advantage over its employer-adversaries. Given the minimal thresholds set forth in the two-factor test, the District Court granted, and the Sixth Circuit affirmed, the NLRB’s request for injunctive relief. 2022 WL 5434206, at *12 (WD Tenn., Aug. 18, 2022); 77 F. 4^4th391, 400-401 (2023).

Starbucks petitioned for a Writ of Certiorari from the U.S. Supreme Court following the Sixth Circuit’s decision, arguing that the four-part standard for preliminary injunctions articulated in Winter v. Natural Resources Defense Council, Inc, 555 U.S. 7 (2008) is the proper standard for §10(j) injunctions – not the two-factor “reasonable cause” criteria. The Winter test requires a plaintiff to make a clear showing that “he is likely to succeed on the merits, that he is likely to suffer irreparable harm in the absence of preliminary relief, that the balance of equities tips in his favor, and that an injunction is in the public interest.” Winter, 555 U.S. at 20, 22. The First, Second, Fourth, Seventh, Eighth, and Ninth Circuits already use the Winters factors in §10(j) proceedings.

The U.S. Supreme Court agreed with Starbucks that the four-factor Winters test sets the correct legal standard for 10(j) proceedings and vacated the Sixth Circuit’s decision. The U.S. Supreme Court reasoned that without a clear command from Congress, courts must adhere to the traditional four-factor test prescribed by Winter because, “[n]othing in §10(j)’s test overcomes the presumption that the four traditional criteria govern a preliminary-injunction request by the Board.” Starbucks Corp., 23-367 at *6. The U.S. Supreme Court further found that by using the two-factor reasonable cause standard, “it is hard to imagine how the Board could lose [ . . .].”

This decision is a win for employers with employees in the Third, Fifth, Sixth, Tenth, and Eleventh Circuits, as the NLRB is now tasked with meeting the more burdensome Winters factors when seeking §10(j) injunctions in those jurisdictions.

Ballard Spahr’s Labor and Employment Group routinely represents employers before the NLRB and in connection with opposing 10(j) injunctions. Please reach out with any questions.

Michele Solari & Meredith S. Dante

Looking Ahead

By Passing Buck to Second Circuit, U.S. Supreme Court Leaves National Bank Preemption in Limbo

A Ballard Spahr Webinar | July 11, 2024, 12:00 PM – 1:00 PM ET

Moderator: Alan S. Kaplinsky; Joseph Schuster

MBA Human Resources Symposium 2024

September 18-19, 2024 | MBA Headquarters, Washington, D.C.

Agenda

Fair Labor Standards Act and 2024: New Rules, New Headaches

September 18, 2024 – 9:15 AM ET

Speaker: Meredith S. Dante

The Loan Originator Compensation and Other Regulatory and Legal Developments

September 18, 2024 – 1:00 PM ET

Speaker: Richard J. Andreano, Jr.

Subscribe to Ballard Spahr Mailing Lists

Get the latest significant legal alerts, news, webinars, and insights that affect your industry.

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, including electronic, mechanical, photocopying, recording, or otherwise, without prior written permission of the author and publisher.

This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.

Mortgage Banking Update - June 27, 2024

Share

Subscribe to Ballard Spahr Mailing Lists

Related Areas