Consumer Financial Services Enforcement and Litigation Practice Update T his is the second issue of a periodic newsletter to our clients and friends designed to communicate the latest developments in the consumer financial services litigation, enforcement and compliance. We welcome your com- ments, feedback and suggestions for issues to address in our next newsletter. Recent enforcement efforts and court decisions in consumer financial services cases are highlighting a number of major developments with significant implications for the industry.
DOJ Small Business and Residential Redlining Settlement Agreement On May 19, 2004, the Civil Rights Division of the United States Department of Justice ("DOJ") and the United States Attorney 9s Office for the Eastern District of Michigan announced the settlement of a "redlining" investigation with the succes- sors in interest to Old Kent Bank ( cBank d). The investigation, which covered the years 1996-2000, led to allegations that the Bank did not make an adequate number of small business and residential-secured loans in the City of Detroit compared with the rest of the Detroit Metropolitan Statistical Area ("MSA"). Under the agreement, the Bank's successor in interest, Fifth Third Bank, which was not alleged to have violated the law, agreed to, among other things: ... more. less.
" Open three new branches in the City of Detroit during the three-year term of the agreement.<br><br> " Maintain at least three full-time small business lending positions, and relocate these lenders to the City of Detroit. " Fund $3 million in small business and residential loan subsidies over three years. " Fund $200,000 in small business and homebuyer education.<br><br> This agreement reflects the previously-announced priority of the new Assistant Attorney General for the Civil Rights Division, Alexander Acosta, who has stated publicly that he intends to renew the Division's focus on "redlining" in residential lending and to addi- tionally focus on small business lending. The Old Kent Bank agreement represents the first-ever DOJ settlement to focus primarily on small business lending. Acosta has stated in testimony before Congress in March 2004 that he has authorized another similar action and has "a number" of similar cases under preliminary investigation.<br><br> Editor's Note: Skadden represented Old Kent Bank in this matter. Inside DOJ Small Business and Residential Redlining Settlement Agreement........1 OTS Mortgage Servicing Supervisory Agreement.............................................2 New HMDAPrice Reporting Rules Will Spur Investigations, Enforcement Actions and Class Litigation...............................................3 Preemption Update: OCC Faces Congressional Criticism and Litigation.........................................3 OCC Consent Order and Advisory Guidance Regarding Credit Cards......4 Interagency Guidance on Unfair and Deceptive Trade Practices Marks Commitment by Bank Regulators to Attack cUnfair and Deceptive d Practices................................................4 GMAC Settles Tennessee Auto Finance Discrimination Case..............5 New Issues in Bank Regulatory Examinations........................................5 New CRAProposed Amendments Highlight Predatory Lending..............6 Outsourcing as a New Examination and Enforcement Issue.........................7 Federal Trade Commission Continues Focus on Predatory Lending...............7 Fannie Mae and Freddie Mac Reject Mandatory Arbitration Clauses on Non-Prime Loans.................................7 Fair Credit Reporting Act Amended...............................................8 HUD Creates New Systemic Enforcement Unit to Address Predatory and Discriminatory Lending.................8 Skadden Hosts 12th Annual Fair Lending Conference and Mortgage Loan Servicing Conferences...............8 * * * This Newsletter is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This newsletter may be consid- ered advertising under applicable state laws.<br><br> WWW . SKADDEN . COM Skadden Skadden, Arps, Slate, Meagher & Flom LLP & Affiliates Summer 2004 Skadden OTS Mortgage Servicing Supervisory Agreement In April, the Office of Thrift Supervision ("OTS") announced that it had entered into a Supervisory Agreement with Ocwen Federal Bank, FSB ("Ocwen"), relating to Ocwen's mort- gage loan servicing practices.<br><br> The Supervisory Agreement does not allege any wrongdoing on the part of Ocwen, nor does it require Ocwen to make any restitution or other monetary payment. Under the Supervisory Agreement Ocwen agreed to implement or continue the following servic- ing "best practices": 2 Consumer Ombudsman: Ocwen agreed to maintain and continue to develop its Office of Consumer Ombudsman and ensure access to the ombudsman through a toll-free number or a dedicated email address. " Borrower-Oriented Practices: Ocwen agreed to implement a "borrower-oriented customer service plan," in consultation with consumer interest groups.<br><br> The plan, which would include a semi-annual customer satisfaction survey, the results of which would be used to further refine Ocwen's practices and policies. " Consumer Dispute Resolution Initiative: Ocwen agreed to implement a "Dispute Resolution Initiative Plan," under which it would respond to borrower complaints at least as promptly as required under the Real Estate Settlement Procedures Act ("RESPA"). " Force-Placed Hazard Insurance Practices: Ocwen agreed not to force place hazard insur- ance without first taking a number of prescribed steps, including placing a telephone call to the borrower's previous insurer and sending three notices, the second of which would be sent via certified mail.<br><br> " Default Notice Fees: Ocwen agreed to continue not to charge borrowers for notice of default letters. " Forbearance Agreement Practices: Ocwen agreed not to charge borrowers a fee for enter- ing into forbearance agreements. " Payoff Quotation Practices: Ocwen agreed to utilize best efforts to provide payoff quota- tions within five business days of the receipt of a payoff request.<br><br> In addition, Ocwen agreed to itemize in detail all payoff quotations and reinstatement quotations, and to con- spicuously notify borrowers that they may contact the Customer Ombudsman if they dipute any of the charges. In addition to the foregoing, Ocwen also agreed to form a compliance committee comprised pri- marily of outside directors. Finally, the OTS emphasized that the requirements of the Supervisory Agreement apply equally with respect to any functions that Ocwen might choose to outsource to other service providers.<br><br> 2 3 Skadden New HMDA Price Reporting Rules Will Spur Investigations, Enforcement Actions and Class Litigation Lenders are currently working to comply with new Home Mortgage Disclosure Act ( cHMDA d) report- ing rules that will require public disclosure of pricing data. The 2004 data is expected to be publicly available by mid-2005. Specifically, under these rules, lenders are, for the first time, required to report: " Rate spreads (the difference between the loan's APR and the comparable Treasury rate) for all first liens where the rate spread is at least 3 percentage points and second liens where the rate spread is at least 5 percentage points.<br><br> " Whether loans are "high cost" loans, subject to the Home Ownership and Equity Protection Act ("HOEPA"). Although these reporting requirements are most likely to fall on non-prime lenders, certain "prime" loans may also trigger HMDAreporting, particularly where the loans have high loan-to-value ratios or where loan officers or brokers are empowered to charge overages. The disclosure of this pricing data publicly will likely prompt a new wave of government enforcement and class action litigation alleging pricing disparities based on race or ethnicity.<br><br> As discussed in the enclosed article, lenders are well advised to evaluate their situation and take appropriate steps to mitigate any risks. Preemption Update: OCC Faces Congressional Criticism and Litigation On January 7, 2004, the Office of Comptroller of the Currency ( cOCC d) issued two final rules clarifying the types of state laws that are preempted by federal law as applied to national banks and their operating subsidiaries. The first regulation asserts that the OCC's visitorial powers to examine and supervise national banks are exclusive and not shared by the states.<br><br> Thus, the OCC has preempted all state predatory lending laws which seek to control the deposit-taking and lend- ing activities of national banks and their operating subsidiaries. The second regulation concerns the types of state laws that apply to the lending and deposit-tak- ing activities of national banks. This final rule adopts two new substantive anti-predatory lending standards to apply to the lending activities of national banks.<br><br> The first new anti-predatory lend- ing standard prohibits a national bank and its operating subsidiary from making any consumer loan without regard to the borrower's ability to repay the loan. The second anti-predatory lending standard prohibits national banks and their operating subsidiaries from committing unfair and deceptive practices in violation of the Federal Trade Commission Act ( cFTC Act d). The OCC 9s preemption of all state predatory lending laws has met intense opposition from state attorneys general, state banking agencies, and consumer groups.<br><br> A particular focus of criticism has been that the OCC will be unable or unwilling to aggressively enforce state anti-predatory lending laws which protect consumers from abusive and deceptive practices. The opposition to preemption has taken the form of lawsuits and Congressional action. In January 2004, New York Attorney General Eliot Spitzer challenged the new OCC rules by filing a lawsuit against an oper- ating subsidiary of a national bank, First Horizon Home Loan Corporation, for engaging in an alleged illegal foreclosure action.<br><br> In April 2004, Senator John Edwards (D-NC) and Representative Luis Gutierrez (D-IL) each introduced resolutions of disapproval seeking to recall the OCC 9s final rules. 4 Skadden Since announcing its preemption rules, the OCC has issued two advisory letters of interest to the consumer financial services industry. First, in February 2004, the OCC issued an advisory letter to national banks outlining procedures for referral of consumer complaints from state officials.<br><br> In con- nection with consumer complaints, the OCC suggests that national banks notify the OCC if a state official attempts to examine or supervise the activities of a national bank or contacts them with questions regarding the application of state law to national banks. The letter, however, directs national banks to work diligently to resolve all consumer complaints, regardless of whether it was referred from a state official. The OCC seems to be demanding that national banks implement a consumer complaint and compliance management program which monitors consumer complaints, the sources of the complaints, and refers complaint information to the overseeing supervisor.<br><br> Second, the OCC recently announced a notice of proposed rulemaking seeking to require nation- al banks to provide the name, location and contact information of their operating subsidiaries so as to assist consumers with identifying national bank operating subsidiaries. The OCC would place this information on its website so that consumers know which operating subsidiaries are subject to OCC supervision. OCC Consent Order and Advisory Guidance Regarding Credit Cards In May 2004, the OCC entered into a consent order with First National Bank of Marin, regard- ing the bank's credit card program.<br><br> The order required the bank to fund at least $10 million in restitution to customers whom the OCC claimed had been charged interest on a $200 "security deposit" that they had been encour- aged to charge to their credit cards. The OCC alleged that by encouraging customers to charge the $200 deposit to their credit cards, the bank had artificially inflated credit balances. The OCC alleged that this so-called "charge the deposit" feature was an unfair and deceptive trade practice, in violation of the Federal Trade Commission Act.<br><br> This OCC action followed a 2001 OCC con- sent order in which the bank had agreed to fund $4 million in restitution in connection with allegedly misleading statements to consumers relating to its credit card program. The OCC consent order followed closely an April 28, 2004, OCC advisory letter in which the OCC warned of numerous risks associated with secured credit card lending. In its advisory letter, the OCC instructed national banks not to issue secured cards in which the security deposit or fees are charged to the cards and not to offer unsecured credit cards in which the amount of fees charged to the card upon issuance "substantially reduces the amount of initial available credit and card utility." Interagency Guidance on Unfair and Deceptive Trade Practices Marks Commitment by Bank Regulators to Attack cUnfair and Deceptive d Practices On March 11, 2004, the Federal Reserve Board and the Federal Deposit Insurance Corporation issued Interagency Guidance for state-chartered banks to ensure that they do not engage in unfair or deceptive acts or practices.<br><br> The issuance of this guidance sends a clear signal that the bank regulators plan to devote additional resources to enforcing Section 5 of the FTC Act, which pro- hibits unfair or deceptive acts or practices, with a particular focus on alleged "predatory" lending conduct related to loan origination and servicing. 5 Skadden It is particularly significant that Section 5 of the FTC Act reaches beyond traditional bank con- sumer protection statutes and regulations. The Interagency Guidance specifically noted that "there may be circumstances in which an act or practice violates" the unfair or deceptive provi- sions of the FTC Act "even though the institution is in technical compliance with other applica- ble laws, such as consumer protection and fair lending laws." The Interagency Guidance offered a number of recommendations for managing risks relating to unfair or deceptive acts of prac- tices, including establishing procedures for monitoring and addressing consumer complaints and monitoring activities performed by third parties on behalf of lenders.<br><br> GMAC Settles Tennessee Auto Finance Discrimination Case In February 2004, the United States District Court for the Middle District of Tennessee approved the settlement of a nationwide class action alleging discrimination in the pricing of auto financing. The settlement, in Coleman v. GMAC , No.<br><br> 3-98-0211 (M. D. Tenn.), follows the settlement last year of a case involving Nissan's financing arm.<br><br> In both cases, the plaintiffs alleged that minority customers paid higher interest rates in the form of dealer "markups," and that the finance companies were legally responsible because they permitted such markups. Under the settlement, which involved a nationwide class of Black and Hispanic borrowers, GMAC agreed to: = Cap the finance charge markup at 2.50 percent above the buy rate on all auto finance contracts other than extended term contracts (more than 60 months), which it agreed to cap at 2 percent. " Include the following disclosure prominently on all contracts that it supplies to dealers: "The Annual Percentage Rate may be negotiable with the Seller.<br><br> The Seller may assign this contract and retain its right to receive a part of the Finance Charge." " Fund a "Diversity Marketing Initiative," under which 1.25 million Black and Hispanic consumers will receive preapproved firm offers of credit at GMAC's buy rate (i.e., with zero "markup"). " Contribute $1.6 million to nonprofit organizations to improve minority outreach, education, and assistance with credit financing. " Pay $9 million in attorneys' fees and approximately $600,000 in litigation expenses to plaintiffs' counsel.<br><br> Litigation in federal court in Nashville and elsewhere based on the same legal theory continues against several other banks and auto finance companies. New Issues in Bank Regulatory Examinations Bank regulators are focusing on a number of new issues in examinations that deserve careful attention by lenders. Joint Applicants Lenders 9treatment of joint applicants who are not married to each other, particularly in the indirect auto lending context, has arisen as an issue in examinations and in class action litigation.<br><br> Many banks, either in policy or in practice, have distinguished in underwriting or in pricing between a loan application from two individuals who are not married to each other and a loan to a married couple. The former typ- 6 Skadden ically involves a parent or other relative acting, in effect, as a guarantor or a co-signer for a young adult with no credit, little credit, or poor credit. For this reason, these loans are perceived to present a greater risk than a loan from a married couple with roughly equivalent credit.<br><br> The Federal Reserve, however, recently amended Regulation B to state that "in evaluating joint applicants, a creditor shall not treat applicants differently based on the existence, absence, or likelihood of a marital relationship between the parties." 12 C.F.R. § 202.6(b)(8). Although it is unclear whether the Equal Credit Opportunity Act actually prohibits differentiating consumers on the basis of their marital relationship to each other - as opposed to differentiating on the basis of marital status, which clearly is prohibited - given the regula- tors' apparent stance in this matter, lenders should scrutinize their policies and practices for underwrit- ing and pricing loan applications from joint or co-applicants.<br><br> Lending On Indian Reservations Another issue that has arisen in some examinations is lenders 9 policies or practices with regard to real estate lending on Indian reservations. Because the Indian tribe typically owns the land on which houses sit in reservations, it is often difficult to obtain title insurance for properties located on reservations. As a result, some lenders may have blanket prohibitions on lending for proper- ties located in Indian reservations.<br><br> Such a blanket prohibition may be problematic, and lenders need to work with title companies to ensure that insurance is available for collateral located in an Indian reservation. Ability to Pay Calculation Finally, some examinations have raised issues relating to how a lender treats certain income, such as social security, child support, and public assistance income. In determining a borrower's ability to repay his or her obligation, lenders need to ensure that they are consistently considering such income if there is a basis for believing that the income will be available to the borrower for some time.<br><br> In addition, to the extent that such income is not subject to tax, lenders should "gross up" the income to account for its actual purchasing power. Afailure to consider such income appropriately may be viewed by regulators as evidence of discrimination on the basis of age or marital status. New CRA Proposed Amendments Highlight Predatory Lending On February 6, 2004, the federal bank regulatory agencies issued a notice of proposed rule mak- ing to amend the Community Reinvestment Act ("CRA") regulations in a variety of ways.<br><br> One of the most significant involves the decision to seek to use CRA ratings as a way of policing allegations of predatory lending. The proposed regulations makes three significant additions to the CRA regulations. First, the agencies plan to specify certain violations of law related to predatory lending that will adversely effect an institution's CRA rating.<br><br> Second, the agencies specifically define cequity stripping d as a predatory lending activity that could result in a reduced CRA rating. Finally, the amended CRA regulations will continue to per- mit institutions to include loans by any affiliate in their CRA reporting, however, such affiliates' conduct then would be subject to the analysis for predatory lending issues and potentially have an adverse affect on the institution's CRA rating. This expansion of CRA into a tool to police alleged predatory lending marks a dramatic expan- sion of the bank regulators 9 role and the impact of CRA.<br><br> It further highlights the necessity to address concerns regarding predatory lending as the effects of an adverse CRA rating are very substantial for an institution. 7 Skadden Outsourcing as a New Examination and Enforcement Issue According to a study by A.T. Kearney, financial service firms plan to relocate more than 500,000 jobs offshore in the next five years.<br><br> This growth in outsourcing in mortgage loan origination and servicing undoubtedly will be accompanied by intensified regulatory scrutiny. Outsourcing is becoming a significant issue in the 2004 Presidential race. The presumptive Democratic nominee, Senator John F.<br><br> Kerry (D-MA), has spoken out against outsourcing as have other prominent elected officials. Further, it was recently reported that Senator Diane Feinstein (D-CA) wrote to the OCC expressing concern about overseas compliance with finan- cial privacy laws. Senator Feinstein also reportedly requested that the OCC provide information about the number of contractors it had audited and how many examiners are assigned to monitor overseas operations.<br><br> Compliance with the panoply of laws and regulations relating to consumer protection, privacy, credit reporting and money laundering are complicated by foreign outsourcing. Firms which out- source significant loan origination or servicing activities - particularly those which outsource overseas - need to ensure that their business partners are fully compliant with applicable laws. Federal Trade Commission Continues Focus on Predatory Lending Earlier this year, Howard Beales, Director of the Bureau of Consumer Protection of the Federal Trade Commission ("FTC"), testified before the Senate Special Committee on Aging on the FTC's recent efforts to eliminate unfair and deceptive lending practices in the nonprime lending industry.<br><br> Beales reiterated the FTC's authority to regulate lending institutions, specifically non- bank subsidiaries not monitored by federal banking agencies, through enforcement of the Truth in Lending Act ("TILA"), HOEPA, the Real Estate Settlement Procedures Act ("RESPA"), and Section 5 of the FTC Act, which provides the FTC with jurisdiction to enforce unfair and decep- tive acts or practices affecting consumers. Beales explained that since 1998, the FTC has reached 18 settlement agreements with non-prime lenders who allegedly committed unfair and deceptive acts or practices, particularly misrepresenting key loan terms and costs to consumers. Beales focused on the FTC's efforts to protect senior citizens, frequent targets of "equity stripping" predatory practices.<br><br> Beales 9 testimony reinforces the FTC's commitment to an active enforcement program against non-prime lenders to address predatory lending activities. Fannie Mae and Freddie Mac Reject Mandatory Arbitration Clauses on Non-Prime Loans Federal National Mortgage Association ( cFannie Mae d) and Federal Home Loan Mortgage Corp. ( cFreddie Mac d) recently announced that they will cease buying non-prime mortgage asset- backed securities containing mandatory arbitration clauses.<br><br> Previously, Fannie Mae and Freddie Mac typically did not accept mandatory arbitration clauses on prime loans they purchased, but allowed them on riskier non-prime loans. Arbitration provisions have been a significant protec- tion against frivolous class action litigation while providing both consumers and lenders with an expeditious and efficient manner to resolve disputes. The likely impact of the decisions of Fannie Mae and Freddie Mac, which buy 50% of all non-prime loans, is an increased amount of class action lawsuits because lenders will not include arbitration clauses in loan contracts.<br><br> In addition, Freddie Mac and Fannie Mae 9s actions will likely strengthen challenges to the use of mandatory arbitration clauses by lenders even on loans Freddie Mac and Fannie Mae do not purchase. 8 Skadden Fair Credit Reporting Act Amended The Fair and Accurate Credit Transactions Act (the "FACT Act"), signed into law on December 4, 2003, amends the Fair Credit Reporting Act ("FCRA"), 15 U.S.C. § 1681 et seq.<br><br> , in several signifi- cant areas. The new law includes provisions to improve the accuracy of credit reports, restrict the sharing of credit reports among affiliated entities, prevent identity theft, guarantee consumers one free credit report per year, and make permanent FCRA's provisions preempting state laws in areas specifically regulated by the federal statute. As required under the FACT Act, the FTC and Federal Reserve Board recently issued joint regulations establishing effective dates for FACT Act provi- sions that do not themselves specify an effective date.<br><br> HUD Creates New Systemic Enforcement Unit to Address Predatory and Discriminatory Lending The Department of Housing and Urban Development ("HUD") will consolidate all investigations of predatory and discriminatory lending in the newly created Systemic Investigations Office within HUD 9s Office of Fair Housing and Equal Opportunity. Rather than simply investigate individual com- plaints and agency referrals, as HUD has done in the past, the Systemic Investigations Office will be charged with initiating investigations and conducting systemic investigations concerning predatory and discriminatory lending issues. HUD also is continuing to work with fair housing advocacy groups to address predatory lending issues.<br><br> Skadden Hosts 12 th Annual Fair Lending Conference and Mortgage Loan Servicing Conferences On April 26, 2004, the Consumer Financial Services Enforcement and Litigation Practice Group hosted its 12th Annual Fair Lending Conference in the Washington, D.C. office. The conference covered recent developments in fair lending enforcement and litigation, including recent HMDA and CRA changes, servicing and collections enforcement and compliance issues, and other issues related to predatory lending.<br><br> On January 12 and February 25, 2004, the Consumer Financial Services Enforcement and Litigation Practice Group held seminars regarding mortgage loan servicing in Washington, D.C. and Orange County, California, respectively. The conferences focused on recent enforcement actions, litigation due diligence and best practices in mortgage loan servicing, including the Fairbanks settlement and its implications.<br><br> The materials provided at the conferences included articles and publications authored by Skadden attorneys regarding risk analysis and due diligence in the mortgage loan servicing context, recent enforcement and regulation settlements, and other fair lending information. The Fair Lending con- ference materials are available on CD-ROM and the conference was videotaped. Please feel free to contact us for a copy of the seminar materials.<br><br> Contact Information Please feel free to contact William J. Sweet, Jr. at 202.371.7030 (firstname.lastname@example.org), Andrew L.<br><br> Sandler at 202.371.7400 (email@example.com), Stacie E. McGinn at 202.371.7905 (smcginn@skad- den.com), Benjamin B. Klubes at 202.371.7508 (firstname.lastname@example.org), Anand S.<br><br> Raman at 202.371.7019 (email@example.com) and Joseph L. Barloon at 202.371.7322 (firstname.lastname@example.org) about these or any other consumer financial services issues. <br><br>