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.
