Consumer Lending Industry Targeted by the Alabama Legislature

loan agreementLast month, a group of 45 members of Alabama’s House of Representatives introduced a proposed amendment to the Alabama Constitution that would cap the interest rate a lender may charge an individual on a “consumer loan, line of credit, or other financial product.” The proposed amendment, currently known as House Bill 321, is a direct attack on the Alabama Deferred Presentment Services Act and the Small Loan Act, and it contains a proposed interest rate cap of 36 percent per year for covered loans. This is the same cap proposed by the Consumer Financial Protection Bureau (CFPB) in its June 2016 proposed rulemaking on payday, vehicle title, and certain high-cost installment loans. House Bill 321 has now been referred to the Alabama House of Representatives’ Committee on Constitution, Campaigns and Elections.

On March 7, 2017, another far-reaching bill was introduced in the Alabama Senate. This bill, Senate Bill 284, also targets all lending institutions, including traditional banks. Under existing law, for a loan in which the principal amount is $2,000 or more, the parties may agree to any rate of interest so long as it is not “unconscionable.” Senate Bill 284, however, proposes a 60 percent annualized interest rate cap on loans greater than $2,000. Additionally, the bill would prohibit consumers from obtaining car title loans, which are currently governed by the Alabama Pawnshop Act. The bill would also establish a 30-day term on all payday loans and require an automatic three-month payment extension when a borrower is unable to meet his or her repayment obligations within the initial 30-day term. It would also cap the number of payday loan transactions that a borrower can enter into during a 12-month period. Senate Bill 284 has been referred to the Alabama Senate’s Committee on County and Municipal Government.

House Bill 321 and Senate Bill 284 follow numerous other bills that have been introduced in the Alabama Legislature over the past few years that seek lending reform. This trend toward legislation that is specifically aimed at the payday, title and other small-dollar consumer loan industry is likely to continue, both in Alabama and across the country.

For more details about these topics, please contact one of the authors of this post.

Student Loan Servicers Still Looking for Clarification on Reporting Obligations

Student Loan Servicers Still Looking for Clarification on Reporting ObligationsThere is surprisingly little guidance for student loan servicers when it comes to credit reporting. The only recent guidance directed at loan servicers came by way of an announcement from the U.S. Departments of Education and Treasury and the Consumer Financial Protection Bureau (CFPB) on April 28, 2016 (DoE Fact Sheet). The DoE Fact Sheet provides few specifics and, instead, lists broad concepts that the Department of Education desires to implement “as part of its new vision for serving student loans.”

The time frame for the initiative was “the coming months,” but no updated credit reporting system was released by the Obama administration. Student loan servicers face further uncertainty from the Trump administration, which has not yet released any information revealing its approach to federal student loan programs. Although the guidelines for student loan servicers remain obscured, CFPB enforcement is on the rise.

Per the CFPB’s February 2017 Monthly Complaint Report, “Student loan[s]” and “Credit reporting” are, respectively, the second and third most-complained about consumer financial products and services currently. In a year-to-year comparison examining the three-month time period of November to January, the CFPB noted that student loan complaints increased by 388 percent. Moreover, in January 2017, the CFPB announced a lawsuit against the nation’s largest servicer of both federal and private student loans. One specific allegation highlighted by the CFPB was Navient’s alleged “misreport[ing] to the credit reporting companies that borrowers who had their loans discharged under [the federal Total and Permanent Disability discharge] program had defaulted on their loans when they had not.”

Approximately 11.3 percent of federal borrowers who entered repayment in fiscal years 2012 or 2013 (Oct. 1, 2011 and Oct. 1, 2012) defaulted within three years. With 593,182 borrowers defaulting in that period alone, credit reporting of student loans is becoming an increasingly salient issue, and borrower-driven litigation may also increase under the Fair Credit Reporting Act (FCRA). To state a claim under FCRA, most federal circuits require a plaintiff to prove the following elements: 1) the reporting of an inaccuracy or misleading information by a furnisher of information to a consumer reporting agency (CRA); 2) that plaintiff disputed the inaccurate or misleading information to the CRA, who, in turn, alerted the furnisher of information; and 3) the furnisher of information failed to conduct a reasonable investigation into the plaintiff’s dispute. Although whether information is factually inaccurate is often the most important inquiry, allegations contending that reported information is misleading are much more fact-dependent and difficult to defend against. Depending on the judicial jurisdiction, vague and unclear guidance from the Department of Education and the CFPB could prove problematic if raised by borrowers in affirmative litigation.

Although the Department of Education proclaimed a need for standardized credit reporting across borrowers, the DoE Fact Sheet references a few potential ways that credit reporting of student loans could vary based on the originating program and whether the loan is tracking towards a forgiveness program. The Department of Education also noted its preference for student loan servicers to report borrowers who invoke their right to a forbearance period unrelated to financial hardship distinctly from borrowers experiencing financial distress—an apparent effort to distinguish the reporting of student loans from other credit services such as mortgages. A FCRA plaintiff could argue that these differences, if not incorporated into a student loan servicer’s internal reporting guidelines, make existing reporting “misleading.” By issuing a statement emphasizing the need for loan servicers to incorporate student loan specific information into the otherwise standardized process of credit reporting, the Department of Education has invited confusion and error.

Student loan servicers are in dire need of clarification about their specific obligations. Until the current administration takes further action, there is little student loan servicers can do but monitor their practices and procedures to ensure they have a comprehensive plan to handle student loan servicing credit disputes. Student loan servicers should take into account the CFPB’s recent Supervisory Highlights Consumer Reporting Special Edition, which identifies common weaknesses in the policies and procedures of furnishers of information generally. More importantly, student loan servicers should train their staff to understand the specific product serviced. By training employees in the specificities of student loans, as well as in responding to disputes, communicating with borrowers, and recordkeeping in general, student loan servicers will be better able to recognize potential inaccuracies in information reported and respond to disputes before borrowers or the CFPB take action.

CFPB Solicits Comments for its 2017 Credit Card Market Report

Stacked credit cardsOn Friday, the Consumer Financial Protection Bureau (CFPB) published a request for information about the credit card market. The CFPB uses responses to those requests, in conjunction with other data and research, to publish the biennial consumer Credit Card Market Report  required by the Credit Card Accountability Responsibility and Disclosure Act (CARD). The CFPB issued its first Credit Card Market Report in October  2013 and its second report in December 2015. The 2015 report focused on costs and availability of card credit, issuer practices, product innovation, deferred interest cards, rewards programs, and debt collection efforts.

The CFPB has specifically requested information relating to the following areas:

  • Terms of Credit Card Agreements and Issuer Practices – Substantive changes to the terms and conditions of credit card agreements, including the ways in which issuers have changed their pricing, marketing, underwriting, or other practices;
  • Effectiveness of Disclosures – The effectiveness of current disclosures regarding rates, fees, and other costs and terms of credit card accounts, methods to improve those disclosures, and the costs associated with improvements;
  • Adequacy of UDAAP Protections – The existence and frequency of unfair, deceptive, or abusive acts and practices, or unlawful discrimination and methods to reduce these practices;
  • Cost and Availability of Consumer Credit Cards – Changes in the cost and availability of consumer credit cards and the factors that have driven any changes;
  • Deferred Interest Products – Market trends regarding deferred interest products and methods to address risks associated with deferred interest products;
  • Subprime Specialist Products – The differences in consumer experience when using a subprime specialist product rather than a mass market credit card;
  • Third-Party Comparison Sites – The degree to which consumers understand the risks and benefits of third-party comparison sites and the degree to which current standards protect consumers from unfair, deceptive, or abusive acts and practices;
  • Innovation – The impact of advances in payment security technology and new consumer lending models on consumers;
  • Secured Credit Cards – The current state of the secured credit card market and potential risks that consumers should consider when choosing secured cards;
  • Online and Mobile Account Servicing – Information about the degree to which a shift towards electronic billing decreases the likelihood that consumers will actually see required disclosures and the obstacles, including regulatory obstacles, that inhibit innovation in mobile and online account servicing;
  • Rewards Products – Information regarding market trends and potential risks to consumers associated with rewards programs;
  • Variable Interest Rates – The extent to which consumers are aware that interest rate increases could increase borrowing costs for funds borrowed prior to the increase and the practices issuers use to inform consumers of rate increases; and
  • Debt Collection – Changes in policies and practices of credit card issuers’ collection and debt sale practices.

The CFPB identified the role of subprime specialists, deferred interest products, and variable interest rates as areas of consumer concern in the 2015 Credit Card Market Report. Therefore, responses in these areas may be especially likely to influence future rulemaking and/or regulatory enforcement action. Additionally, the specific solicitation regarding information related to third-party comparison sites could signal that the CFPB plans to enhance its focus on the relationships between issuers and these sites.

Interested parties must submit comments prior to June 8, 2017. If you have any questions about the comment process, please contact the authors of this article for further information.

Is There a Statute of Limitations on Disgorgement?

Is There a Statute of Limitations on Disgorgement? How long does the Securities and Exchange Commission (SEC) have to bring a lawsuit asking for disgorgement of unlawful gains? The United States Supreme Court will decide that issue this term in Kokesh v. Securities and Exchange Commission.

Under federal law, no “action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise” can be brought more than five years after the claim first accrued. Kokesh will decide whether the five-year statute of limitations in § 2462 applies to SEC actions seeking disgorgement. The federal courts of appeals are split on the issue: The Eleventh Circuit decided last year that disgorgement was a “penalty or forfeiture” subject to § 2462, but the First Circuit, the D.C. Circuit, and most recently the Tenth Circuit in Kokesh decided the question the other way.

The case is likely to turn on how the Supreme Court views the nature of the disgorgement remedy.  Is disgorgement meant to punish illegal acts? The SEC frequently seeks disgorgement in its enforcement actions, and its use of the remedy has resulted in large collections — $3 billion in disgorgement collections in 2015 alone – that surely feel like punishments to defendants. Or is disgorgement meant to prevent wrongdoers from benefiting from breaking the law? The SEC argues – and the First, D.C. and Tenth Circuits agree – that disgorgement puts the defendant back in the position he would have occupied if he had never broken the law, and therefore it is not a “penalty” under § 2462. Or is “disgorgement” really a synonym for “forfeiture,” as the Eleventh Circuit concluded (see SEC v. Graham)? In practice, both remedies seem to involve not being able to keep money as a result of breaking the law.

It may depend on what definition of “forfeiture” the Supreme Court thinks Congress had in mind when drafting § 2462.  Historically, “forfeiture” meant the remedy allowing the seizure of property used in illegal activity, regardless of the property owner’s innocence or guilt. Other definitions, such as those in the Oxford English Dictionary or Black’s Law Dictionary, suggest that both “disgorgement” and “forfeiture” mean turning over ill-gotten property, without much to distinguish the two terms. Kokesh points out that even the Supreme Court has used the terms virtually interchangeably to explain that forfeitures “are designed primarily to confiscate property used in violation of the law, and to require disgorgement of the fruits of illegal conduct” (see United States v. Ursery). The decision in Kokesh should resolve the ambiguity.

If Kokesh prevails, and the five-year statute of limitations in § 2462 applies to SEC actions for disgorgement, a potent enforcement tool now available everywhere but in the Eleventh Circuit will be blunted. The SEC will still be able to seek disgorgement, but will be unable to collect amounts received more than five years before the claim accrued. If the SEC prevails, however, and the Supreme Court rules that § 2462 does not apply to disgorgement actions, wrongdoers on the losing end of an SEC enforcement action will continue to have to disgorge ill-gotten profits going back well beyond the five-year limit.

The case is set for oral argument on April 18, 2017.

Bradley Launches New Broker-Dealer and Investment Advisor Blog Series

Bradley Launches New Broker Dealer and Investment Advisor Blog SeriesBradley’s Banking & Financial Services Team is pleased to announce a new blog series led by its Broker-Dealer and Investment Advisor Team. The series will focus on issues critical to assisting financial institutions and service providers in maintaining compliance, protecting their operations and developing their businesses while minimizing risk.

Bradley’s Broker-Dealer & Investment Advisor Team is led by Dylan Black, Jeffrey Blackwood and Brian O’Neill and is comprised of team members with extensive experience assisting financial institutions with issues involving litigation, regulatory compliance and enforcement, including matters involving the SEC, FINRA, and DOJ. In addition, a number of Team members have experience working within the SEC, FINRA, DOJ, and with various exchanges, in addition to experience as in-house counsel for major financial institutions.

“We are pleased to offer this resource to our clients as part of our interdisciplinary, client-focused approach to navigating the ever-changing regulatory environment,” said Mr. Black. “Our seasoned team of attorneys has a deep understanding of the complex, high-stakes securities industry, which we look forward to sharing with our clients through this new initiative.”

Bradley’s Broker-Dealer and Investment Adviser Team counsels broker-dealers, investment advisers, market-making firms, proprietary trading firms, exchanges, hedge funds, banks and asset managers at some of the largest financial institutions in the country. Services include:

  • Legal and regulatory interpretation related to mergers and acquisitions, joint ventures, debt financing, fund formation, and other specialized transactions for compliance with securities rules and regulations
  • Compliance programs, including designing, reviewing, and monitoring policies and procedures for compliance with exchange trading rules, federal rules, and other regulatory rules, and conducting mock audits and gap analysis
  • Inquiries and investigations to resolve and limit financial, operational and reputational damage, as well as defending clients against civil and criminal claims related to fraud, suitability, negligence, trading errors, selling away, breach of contract, trade secrets, sales practice violations, accounting irregularities, money laundering, insider trading, FCPA violations, and corporate raiding

Visit Bradley’s Broker-Dealer and Investment Adviser page at bradley.com.

Navigating Through the Hazy Intersection of Financial Services and the Legal Marijuana Industry

Navigating Through the Hazy Intersection of Financial Services and the Legal Marijuana IndustryAs more states legalize marijuana use, financial institutions face increased uncertainty about how to handle accounts opened by marijuana-related businesses (MRBs) in light of regulatory difficulties stemming from the obvious tension between state and federal law. Although the marijuana industry continues to rapidly grow, financial institutions have largely been sidelined by federal laws prohibiting the use of the financial system to violate the law. While federal regulators have issued regulatory guidance designed to encourage financial institutions wishing to provide services to MRBs, the guidance merely provided financial institutions that were willing to violate federal law a roadmap for reducing the regulatory risk. As such, in light of the mixed messages from federal regulators, there is little doubt that financial institutions choosing to provide services to MRBs do so at the risk of going up in smoke.

Tension Between Federal and State Law

Notwithstanding the increasing number of states that have decriminalized various forms of marijuana use, the use, cultivation, and distribution of marijuana remains illegal under the Controlled Substances Act, 21 U.S.C. § 801, et seq. (CSA). Significantly, federal law also prohibits aiding and abetting or conspiring with a person to use, cultivate, and distribute marijuana. Therefore, financial institutions may be subject to criminal liability for opening accounts for or giving loans to known MRBs. Even more, due to the CSA’s prohibition on marijuana, financial institutions doing business with MRBs also risk running afoul of federal anti-money laundering statutes, the unlicensed money-remitter statute, and the BSA. These statutes can impose criminal liability for engaging in certain financial and monetary transactions with the proceeds of a “specified unlawful activity” and for failing to identify or report financial transactions that involve the proceeds of marijuana-related violations of the CSA. Accordingly, unless and until there are significant changes to federal law, the risks associated with doing business directly with MRBs is likely more than most financial institutions can bear.

Federal Regulatory Guidance

On February 14, 2014, the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued guidance clarifying regulatory expectations under the BSA for financial institutions seeking to provide services to MRBs. FinCEN’s guidance was issued in conjunction with related guidance issued by the Department of Justice (DOJ) regarding marijuana-related enforcement priorities.

The DOJ guidance directs federal prosecutors to consider the following priority factors to identify the “most significant” marijuana cases for prosecution:

  • preventing the distribution of marijuana to minors;
  • preventing revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels;
  • preventing the diversion of marijuana from states where it is legal under state law to other states where it is not;
  • preventing state-authorized marijuana activity from being used as a cover or pretext for trafficking of other illegal drugs or illegal activity;
  • preventing violence and the use of firearms in the cultivation and distribution of marijuana;
  • preventing drugged driving and exacerbation of other adverse public health consequences associated with marijuana use;
  • preventing the growing of marijuana on public lands and the attendant public safety and environmental dangers posed by marijuana production on public lands; and
  • preventing marijuana possession or use on federal property.

While the DOJ guidance instructs federal prosecutors to weigh these enforcement priorities when determining whether to charge a financial institution in connection with marijuana-related violations of the CSA, it explicitly states that the guidance “does not alter in any way the Department’s authority to enforce federal law” and does not provide a legal defense to any civil or criminal violations of federal law.

The FinCEN guidance clarifies financial institutions’ due diligence and reporting obligations under the BSA in light of the enforcement priorities set forth in the DOJ’s guidance. The guidance sets forth enhanced due diligence and monitoring requirements for financial institutions doing business with MRBs. The guidance emphasizes that financial institutions must first evaluate the risks associated with offering certain products or services to an MRB. In assessing these risks, financial institutions should conduct customer due diligence that includes:

  • verifying with the appropriate state authorities whether the business is duly licensed and registered;
  • reviewing the license application (and related documentation) submitted by the business for obtaining a state license to operate its MRB;
  • requesting available information about the business and related parties from state licensing and enforcement authorities;
  • developing an understanding of the normal and expected activity for the business, including the types of products to be sold and the type of customers to be served;
  • ongoing monitoring for suspicious activity, including for any of the red flags described in the guidance; and
  • updating information obtained as part of customer due diligence on a periodic basis and commensurate with the risk.

The FinCEN guidance also identifies a number of red flags that indicated that an MRB may be engaged in activity that implicates one of the DOJ priority factors or violates state law.

The FinCEN guidance also confirms that financial institutions choosing to do business with MRBs are required to file suspicious activity reports (SARs), due to the fact that services provided to MRBs almost certainly involve funds derived from activity that is illegal under federal law. The FinCEN guidance includes, however, the following special provisions for SARs filed in connection with MRBs:

  • “Marijuana Limited” SARs should be filed when an institution reasonably believes, based on its due diligence, that the MRB does not implicate one of the DOJ priority factors or violate state law;
  • “Marijuana Priority” SARs should be filed when an institution reasonably believes, based on its due diligence, that the MRB implicates one or more of the DOJ priority factors or violates state law; and
  • “Marijuana Termination” SARs should be filed if an institution deems it necessary to terminate a relationship with an MRB in order to maintain an effective anti-money laundering compliance program.

While the DOJ and FinCEN guidance was designed to encourage financial institutions to provide services to MRBs, it has done little to alleviate the fears many financial institutions have about doing business with MRBs. Practically speaking, the federal guidance requires the implementation of burdensome and costly compliance measures that many financial institutions are simply unwilling to undertake. Even more, financial institutions find little comfort in the DOJ and FinCEN guidance, because it simply does not have the force of law and is subject to change at any time.

As the Trump administration begins to formulate enforcement priorities, financial institutions have no guarantee that the DOJ and FinCEN guidance won’t be summarily replaced. While President Trump has publicly expressed support for legalization of marijuana at the state level, Attorney General Jeff Sessions has a long history of opposing legalization. During his confirmation hearing earlier this year, Attorney General Sessions, in response to a question regarding the tension between state and federal marijuana laws, explained that he would not commit to not enforcing federal law. To be sure, it remains unclear whether the Trump administration’s DOJ will continue to follow the enforcement priorities outlined in the DOJ guidance or undertake strict enforcement of federal marijuana laws. In sum, unless and until federal law changes, guidance alone is not enough to alleviate the concerns financial institutions have regarding the increased scrutiny and risk involved in providing services to MRBs.

As industry and government stakeholders continue to push for reforms aimed at providing MRBs increased access to financial services, the stage appears to be set for significant changes to the uncertain regulatory environment.

Trump’s New FCC Chairman Ajit Pai May Drain the TCPA Swamp

How Will the FCC’s TCPA Declaratory Ruling and Order Affect Your Business?In one of his first official actions, newly elected President Donald Trump tapped Ajit Pai as the new chairman of the Federal Communications Commission (FCC), replacing outgoing chairman Tom Wheeler. Pai is a sharp critic of the Telephone Consumer Protection Act (TCPA) as it is currently being applied, meaning the FCC’s regulatory approach to the TCPA is likely to shift under his leadership.

Pai was initially nominated by President Barack Obama for a Republican Party position on the FCC and was confirmed by the Senate in 2012. Pai previously served as associate general counsel with Verizon Communications Inc. and has also worked as a staffer at the U.S. Senate, the Justice Department, and the FCC.

Currently, Republicans hold a 2-1 majority on the five-member FCC, pending the appointment of two additional members. The President appoints the FCC commissioners with Senate confirmation, though only three commissioners may be members of the same political party. Accordingly, Republicans are likely to maintain a majority on the FCC under the new presidential administration.

Among its other duties, the FCC holds regulatory authority of the TCPA. On July 10, 2015, the FCC issued its TCPA Declaratory Ruling and Order, which we discussed in a previous post. Pai, who was a commissioner on the FCC at that time, voted against the 2015 Declaratory Ruling and Order (the “order”) and strongly criticized the ruling in a dissenting statement.

Pai specifically criticized two of the more controversial aspects of the order in his dissenting statement, both of which—as Pai pointed out—pose regulatory nightmares and increase the potential for abusive litigation.

First, Pai noted that the order “dramatically expands the TCPA’s reach” by expanding the TCPA’s definition of an automatic telephone dialing system (ATDS) to include the equipment’s potential capabilities, rather than its present capabilities. As Pai explained, this expanded definition turns virtually any communication device—save rotary phones—into an ATDS, opening their users to potential liability under the TCPA. Ultimately, Pai suggests in his dissenting statement that the expanded definition of an ATDS is “sure to spark endless litigation, to the detriment of consumers and the legitimate businesses that want to communicate with them.”

Pai also took aim at the order’s application of the TCPA’s strict liability to calls to reassigned phone numbers. Specifically, the FCC found that “the TCPA requires the consent not of the intended recipient of the call, but of the current subscriber,” meaning liability can be imposed under the TCPA for calls to reassigned numbers in certain circumstances. Pai pointed out that this rule “creates a trap for law-abiding companies by giving litigious individuals a reason not to inform callers about a wrong number” and called it a “veritable quagmire of self-contradiction and misplaced incentives.” Instead, Pai supported the “expected-recipient approach,” which would shield good actors from liability so long as they stop calling as soon as they learn that a number is wrong.

“The common thread here is that in practice the TCPA has strayed far from its original purpose,” Pai wrote in his dissenting statement, “[a]nd the FCC has the power to fix that.” With Pai as the new chairman and a Republican majority on the FCC, Pai may just have the opportunity to make those fixes. A decision by the D.C. Circuit Court of Appeals is currently pending in ACA International v. Federal Communications Commission, the consolidated appeal challenging the FCC’s order. Should the D.C. Circuit vacate portions of the order, it would provide Pai a chance to reform the FCC’s interpretation and application of the TCPA.

Additionally, Congress is currently considering reforms to the Federal Communications Act and may consider amending the TCPA in the process. Before joining the FCC, Pai served as chief counsel to the Senate Judiciary Subcommittee on the Constitution, Civil Rights, and Property Rights under Sen. Sam Brownback (R-KS) and as deputy chief counsel to the Senate Judiciary Subcommittee on Administrative Oversight and the Courts under Sen. Jeff Sessions (R-AL). Thus, Pai’s views and voice on the TCPA will be very persuasive in any reform efforts as both the current FCC chairman and a former Capitol Hill staffer.

Ultimately, the future for the TCPA is unclear, but the potential for reform–whether it’s administrative or legislative–is looking much brighter under FCC Chairman Pai.

Appellate Court Reverses Course on Lis Pendens Effect on Post Judgment Liens

House underwater foreclosureUPDATE: On rehearing, the appellate court held that all liens placed on property between a final judgment of foreclosure and judicial sale are discharged by Florida statute. Specifically, the court recognized that the sale discharges all liens, whether recorded before final judgment or after, if the lienor does not intervene in the action within 30 days after the recording of the lis pendens.

For more information on the Florida Appellate Court ruling, please see our Financial Services Perspectives blog post from August 2016: Florida Appellate Court Rules Lis Pendens Does Not Bar Post Judgment Liens.

The Looming Student Debt Crackdown: Compliance and Enforcement Lessons from the Foreclosure Crisis

Compliance chartGiven the parallels between the current student loan debt crisis (including the CFPB, Illinois and Washington’s recent lawsuits against Navient) and the foreclosure crisis of 2010-14, now is a good time to reflect on the lessons learned from past experience. From our experience negotiating comprehensive deals with regulators, advising companies on how to comply in an ever-shifting regulatory landscape, and litigating cases in front of judges and juries suspicious of members of our industry and tired of the ensuing volume of litigation that resulted from the crisis, four lessons stand out:

  1. Technical compliance is not enough. For years, companies operating in highly regulated industries believed that so long as their conduct was not in direct breach of a law or express regulation, they would not be punished by a regulator. That seemed like a pretty safe assumption in an environment operating under the rule of law. However, it quickly proved to be dangerously untrue during the foreclosure crisis. Both courts and enforcement agencies had little patience with large companies that, at least in their minds, were exploiting “loopholes” or engaging in bad (or at least sloppy) business practices to the detriment of their customers and the public, regardless of whether it was in actual violation of an express law. Instead, the industry was urged to adopt a broader culture of compliance – with threats of enforcement actions under amorphous laws like UDAAP or similarly hazy common law causes of action to encourage that compliance. Student lenders would be wise to recognize that historical practices of complying with actual stated laws and policies may not be enough to keep them out of trouble.
  2. Regulators care about borrower complaints. In the mortgage servicing world, servicers long viewed the entities paying them to service or sub-service the loans as their customers. While it might have been a best practice to offer effective responses and solutions for complaints from borrowers, that appeared to be a lower priority than responding to issues arising with the investors, who could make life very difficult with an ill-timed repurchase demand or by insisting that the servicer eat the loss on a non-performing loan. But in the foreclosure crisis, regulators flipped that relationship. Reasoning that borrowers had no choice in who serviced their loans—and thus lacked the free market threat of moving their business elsewhere if they received lousy service from the loan servicer—regulators paid close attention to consumer complaints and even shaped regulatory agendas and priorities around them. Student loan servicers should realize that the perception of working hard to do what’s best for borrowers (and not necessarily lenders) is what regulators are looking for.
  3. Federal regulators believe that disclosure is the best remedy for everything. During the foreclosure crisis, federal regulators such as the CFPB and DOJ appear to have taken to heart the famous quote from Justice Louis Brandeis: Sunshine really is the best disinfectant. Regulators wanted to see mortgage lenders and servicers disclosing everything—every possible fact that could conceivably affect a borrower’s decisions about taking out a loan and repaying it, and especially the facts that might work to bolster a lender or servicer’s bottom line. The common wisdom is that if a mortgage loan servicer is in the slightest doubt about whether a practice is in the borrower’s best interest, then it should be disclosed, and done so in a text and format that is understandable to an unsophisticated borrower. While that requirement may seem aspirational, the same regulators are almost certain to look at student lending practices the same way.
  4. Regulators may follow the crowd, but lenders and servicers should not. Finally, the foreclosure crisis taught us that while regulators may tend to follow the crowd and “piggyback” in their regulatory and enforcement actions, lenders and servicers should resist the natural inclination to reflexively adopt industry-wide practices. As evident from the National Mortgage Settlement, as well as the numerous examinations and lawsuits that preceded and followed it, both state and federal regulators have proven to be more than happy to let another entity take the lead on conducting an investigation, only to swoop in when it’s time to negotiate a settlement. But in those negotiations, it was no excuse for companies to claim that their purportedly bad or sloppy practices were standard in the industry at the time. Indeed, the mere fact that 49 states and the federal government agreed to a national settlement requiring payment of billions of dollars with all of the largest mortgage servicers indicates that following the crowd was more of a liability than a defense. Lenders and servicers of student loans should expect similar coordinated investigations, enforcement actions, and lawsuits, as well as a similar lack of sympathy for claims that the targets were merely employing practices that were standard or typical in the industry at the time.

Given the current state of the student loan market and the regulatory framework governing it, student loan lenders and servicers would be well advised to consider the lessons learned during and after the foreclosure crisis. Student loan servicers should not wait for broad servicing standards to be promulgated before considering whether they might need to make compliance adjustments to their business. Considerable efforts should be spent analyzing and responding to consumer complaints, and ensuring that disclosures are clear, conspicuous, and truthful should be a top priority. Finally, student loan lenders and servicers should keep their ear to the ground and track practices that are deemed to be problematic by regulators through supervisory or enforcement actions. Just because everyone does something the same way in no way guarantees that it won’t cause you problems down the road.

The Super-Priority Saga Continues – Nevada Supreme Court Holds That NRS 116’s Notice Provisions Are Constitutional

The Super-Priority Saga Continues – Nevada Supreme Court Holds That NRS 116’s Notice Provisions Are ConstitutionalThe Ninth Circuit sent shockwaves through the mortgage industry when it held that NRS 116—the statute allowing an HOA to impose a nominal super-priority lien that can extinguish a senior deed of trust when foreclosed—was facially unconstitutional under the Due Process Clause in Bourne Valley  Court Trust v. Wells Fargo Bank, N.A. In Bourne Valley (see our previous blog posts on this decision here and here), the Ninth Circuit held that NRS 116’s notice scheme did not mandate that mortgagees receive actual notice of these HOA super-priority lien foreclosures, but instead required that mortgagees request such notice from the HOA in advance of the HOA’s foreclosure sale. The Ninth Circuit determined this “opt-in” notice scheme violated the Due Process Clause’s requirement that statutes authorizing the extinguishment of junior liens mandate that junior lienholders receive actual notice of the foreclosure sales that can extinguish their liens.

Importantly, the Ninth Circuit held that an HOA’s foreclosure under NRS 116 constituted state action, a threshold determination in Due Process Clause challenges, as the Due Process Clause only applies to state actions. Specifically, the Ninth Circuit held that NRS 116 foreclosures constitute state action because HOA liens are purely statutory, rather than contractual, like deeds of trust. Because an HOA could not impose and foreclose on its super-priority lien absent the statutory authority granted to it through NRS 116, an HOA’s super-priority lien foreclosure constitutes state action under Bourne Valley.

Today, the Nevada Supreme Court disagreed with the Ninth Circuit’s interpretation of the United States Constitution’s state-action requirement. In Saticoy Bay LLC Series 350 Durango 104 v. Wells Fargo Home Mortgage, the Nevada Supreme Court held the Due Process Clause does not apply to NRS 116 foreclosures because such foreclosures are not state action. The Nevada Supreme Court analogized NRS 116 foreclosures to deed of trust foreclosures, citing to a Ninth Circuit decision holding that deed of trust foreclosures do not constitute state action, Charmicor, Inc. v. Deaner. The Nevada Supreme Court did not address the distinguishing characteristic between deed of trust and NRS 116 foreclosures—that the former is authorized by private contract, while the latter is authorized solely by a state statute. Bluntly, the Nevada Supreme Court determined the Ninth Circuit misinterpreted Ninth Circuit precedent when it held that NRS 116 foreclosures met the federal constitution’s state-action requirement.

Significantly, the Nevada Supreme Court’s holding in Saticoy Bay is based on federal law. The Ninth Circuit owes no deference to the Nevada Supreme Court on questions of federal law, meaning Bourne Valley will presumably remain binding in Nevada’s federal courts. In state courts bound by Saticoy Bay, however, the quiet-title actions pitting HOA-sale purchasers against senior mortgagees over title to properties purchased at HOA foreclosure sales will likely turn on factual issues like the HOA’s compliance with NRS 116, whether the mortgagee tendered the super-priority amount before the HOA’s foreclosure, and the commercial reasonableness of the foreclosure sale itself.

So, practically speaking, the Saticoy Bay decision indicates there will be an ongoing split between federal and state courts on whether NRS 116.3116 is constitutional. State and federal trial courts will be bound by their respective superior courts. Thus, the forum for each quiet-title action regarding a NRS 116 foreclosure may be outcome determinative—unless the United States Supreme Court resolves the conflict.

 

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