Sunday, August 2, 2015

Loan Originator Compensation - What to Avoid?

Prohibited Loan Originator Compensation Practices
-- Illegally Funded Employee Expense Accounts

            The CFPB’s Loan Originator Compensation Rule (“Rule”) prohibits compensation to loan originators based on the term of a loan transaction or terms of multiple transactions, but it permits compensation based on a fixed percentage of loan amount.  A compensation plan based on a fixed percentage (or basis points) of a certain loan amount may also be subject to a fixed floor or ceiling.  To attract talented loan originators or to increase production of existing originators, some mortgage lenders may attempt to introduce additional compensation mechanisms into their compensation scheme.  While some mechanisms designed to incentivize loan originators are legal, others, such as bonuses paid from individual employee expense accounts that are funded through loan-related profits resulting from origination charges or retained interest rebates, are illegal according to the CFPB.  Although the Rule does not expressly prohibit individual employee expense accounts, the CFPB has clearly shown that it believes some compensation or bonus mechanisms tied to individual employee expense accounts violate the Rule, and that they can create significant legal liability for mortgage lenders and their executives. 

1.         The CFPB’s Allegations  

In two recent enforcement actions against Franklin Loan Corporation (“Franklin”) and RPM Mortgage, Inc. (“RPM”), respectively, the CFPB targeted the lenders’ compensation plans, which allegedly contained the following features: (1) upfront commission based on a fixed percentage of the loan amount; and (2) additional compensation paid from individual employee expense accounts.  With respect to the employee expense accounts, the CFPB alleged that both Franklin and RPM: (1) established employee expense accounts for each loan originator; (2) deposited funds into the expense accounts only for closed loan with a profit; (3) the profit per loan is calculated by deducting the expenses from the revenue related to each loan; (4) the expenses related to each loan may include the loan originator’s upfront commission for the loan and/or other operating expenses allocated to the branch level; and (5) the revenue on each loan may include origination fees, net interest rebate, and other income tied to the interest rate.  The CFPB further alleged that Franklin paid quarterly bonuses to its loan originators that had positive balances in their individual employee expense accounts.  Regarding RPM, the CFPB claimed that RPM’s loan originators had open access to their individual expense accounts, and that they could use the funds to: (1) offset tolerance cures or other fee concessions to borrowers on future loans, and (2) provide periodic raises to themselves on future loans.          

2.         Civil Liability

            In the action against Franklin, the CFPB ordered Franklin to pay $730,000.00 in redress to borrowers for its alleged violation of the Rule.  Due to Franklin’s financial condition, the CFPB did not seek civil penalties against it. 

            With respect to RPM, the CFPB ordered RPM and its CEO to pay, jointly and severally, $18 million in civil damages; it also ordered RPM and its CEO to pay $1 million in civil penalties, respectively.
                                   
3.         Analysis

In both enforcement actions, the CFPB filed civil lawsuits against the defendants in federal courts in California.  The defendants in both cases chose to enter into a settlement agreement (Stipulated Final Judgment and Order) with the CFPB instead of trying the cases before the judge or a jury.  Therefore, concerned stakeholders in the mortgage industry will probably not know whether the CFPB’s allegations are facts or merely allegations.  While the results accomplished by the CFPB in these actions may demonstrate to the mortgage industry the enforcement power the CFPB wields, these cases lack the clarity and guidance that judicial decisions may otherwise provide.  Nonetheless, unless defendants in future enforcement actions are able to “fight” back, entering into settlement agreements and consent orders with the CFPB in enforcement actions will probably become the norm.   
     
            Assuming the CFPB’s allegations against Franklin and RPM were true, the “fatal” flaw in Franklin and RPM’s compensation plan was funding the employee expense accounts with revenue tied to the terms of loan transactions.  Terms under the Rule include fees, charges, interest rate, APR, collateral type, etc., related to covered mortgage loans.  By tying the employee expense accounts (e.g. source of additional compensation) to the revenue generated from each loan, Franklin and RPM’s compensation plans, arguably, incentivized loan originators to offer loan terms detrimental to consumers (higher rates and/or fees) in order to maximize the revenue on each loan so as to gain additional deposits into their expense accounts.  To be compliant, any compensation plan should not contain provisions that, directly or indirectly, purposefully or accidentally, link compensation to the terms of loan transactions.

            In zealously enforcing consumer finance protection laws, the CFPB has repeatedly demonstrated its willingness to hold mortgage company executives personally liable for civil penalties and damages.  Under the Consumer Financial Protection Act of 2010, a “related person” may be held jointly liable for a mortgage company’s violations, and the CFPB has actively relied on this legal tool to impose personal liability on executives for alleged violations that occurred on their watch.  Therefore, prudence dictates that mortgage company executives exercise due care and diligence in establishing and practicing a compliant lending culture that permeates all facets of a mortgage lender’s operations.    

4.         Conclusion

Creating a competitive and compliant loan origination compensation plan can be a challenging task.  On the one hand, the compensation plan must contain favorable terms to attract and maintain gifted loan originators in a highly competitive market place.  After all, the financial success of any mortgage lender largely depends on productive loan originators capable of originating high quality loans.  On the other hand, the Franklin and RPM enforcement actions serve as a stark reminder that a compensation plan incentivizing loan originators must comply with the Rule.  To accomplish these twin purposes in any compensation plan, mortgage lenders and their executives should carefully review their compensation plans for compliance with the Rule.  When necessary, they should engage legal counsel to see if their compensation plans contain any prohibited provisions.         

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