by Timothy Raty – DocuTech, Regulatory Compliance Specialist
On August 26, 2009, the Federal Reserve Board proposed a new rule to be included in Regulation Z (12 CFR §§226 et seq.) that eliminates dual compensation paid to loan originators and prohibits the practice of “steering” consumers into making loans that were not “in their interest because the loans would result in greater compensation for the loan originator” (Federal Register, Vol. 75, No. 185, p. 58509). According to the Board, they did this under authority granted to them under 12 U.S.C.A. §1639(l)(2)(A) & (B).
Under the new rule, loan originators can only be compensated either by the borrower (and seller) or by the lender (and other third-party financial institutions) and such compensation cannot be based upon the terms of the loan (such as a yield spread premium, unless used as a credit to the borrower) or any proxies for terms. Also, originators are prohibited from “steering” consumers into making loans wherein the originator will receive more compensation from the lender than other loans, unless the originator offered the consumer a range of loan programs and features to choose from.
Due to the intricacies of this rule, mortgage brokerage firms cannot pay their mortgage brokers any type of compensation directly arising from the loans the firm originates. Rather than being paid by, for example, commission therefore, originators in these firms will have to be paid by yearly salary or hourly wages, which practically decreases the earnings of such originators and leads to less productivity.
When proposed, this rule remained open to public comment until December 24, 2009. During this period, over 6,000 comments were received from mortgage brokers, trade associations, consumer groups, Federal agencies, state regulators, state attorney generals, individual consumers, and members of Congress.
Six month’s later, on July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was executed into law. This act amended the Truth-in-Lending Act (15 USC §§1601 et seq.) and imposed restrictions on loan originator compensation and “steering.” Although the Board’s proposed changes to Regulation Z implement most of these restrictions, it does not do so entirely and further rules will need to be implemented by the new Consumer Financial Protection Agency to properly execute the Dodd-Frank Act.
Nevertheless, the Board finalized their loan originator compensation rules on September 24, 2010 and loan originators were expected to comply with these rules by April 1, 2011.
However, the National Association of Independent Housing Professionals and the National Association of Mortgage Brokers filed suits against the Board of Governors of the Federal Reserve Board in the United States District Court for the District of Columbia on March 7 and March 10, 2011, respectively. Both claimed that the Board does not have authority, under the Truth-in-Lending Act, to implement their final rule. They further requested that the District Court grant a temporary and preliminary injunction that would prevent the implementation of the Board’s rule until the District Court could determine its legality.
A temporary and preliminary injunction can be granted by a court in order to prevent an action from causing irreparable harm before the legality of the action is determined. The basis for the plaintiff’s request was that this rule would cause irreparable harm to small business mortgage brokers, their loan officer’s, and their entire staff. Such harm would include depressing mortgage broker compensation to the point where brokers will leave the industry to find better paying jobs, thus, in effect, suffocating the broker industry by squeezing out competent originators and replacing them with less skilled originators.
The Board filed a motion to consolidate both cases with the District Court, which granted the motion on March 11th. The Board further rebuked the claim for injunctive relief, stating that not only would the injunction not prevent irreparable harm, but that the injunction would, in itself, cause harm to consumers who would be obliged to pay dual compensation.
In a decision rendered on March 30th Judge Beryl A. Howell dismissed the plaintiff’s request, stating that “although NAMB’s demonstration that its members face substantial irreparable harm is compelling, the Court must consider the plaintiff’s harm against both the public interest furthered through the Rule, and the fact that the plaintiffs have not demonstrated a likelihood of success on the merits.” (see National Ass’n of Mortg. Brokers v. Board of Governors of the Federal Reserve System, et al., 2011 WL 1158432, 24 [D.D.C., 2011])
The plaintiff’s filed for an appeal to the United States Court of Appeals which, late on March 31st, granted a temporary stay of the rule until they provided further orders. The Appeals Court, though granting the stay, was quick to state that this stay was granted for the Court to be given sufficient time to review the merits of the injunction, but that such a stay was not, in itself, a ruling on those merits. Both parties were given, at various times, deadlines for filing briefs and replies until April 5th.
On April 5th, the Appeals Court not only lifted the stay, but also ordered that the motions for emergency relief be denied, because, according to the Court, the plaintiffs “have not satisfied the stringent standards required for a stay pending appeal.”
At the current moment, the rule, which is primarily codified as 12 CFR §226.36(e), is in full effect. However, litigation continues over whether the Board had the authority, under the Truth-in-Lending Act and the Dodd-Frank Act, to implement this rule. The Court of Appeals has set deadlines for both parties’ various papers and motions to be filed throughout May, with any Dispositive Motions to be filed by May 20, 2011. It is suspected that it may take at least another two months for the Court’s ruling on this matter.