The Trouble with Mortgages: The CFPB Regulations Arrive

“Man is the only animal that laughs and has a state legislature.”  Samuel Butler (1835-1902)

I may have used the quote above before, but it is such an appropriate statement, it is hard to wear it out.  By the time you read this, the New Mexico Legislature will probably be in session for the so-called “short session”.  We will be in touch on that. 

In the meantime, it may be helpful to deal with other pressing matters and not-so-pressing matters which you may nevertheless want to think about.

The Consumer Financial Protection Agency (“CFPB”) continues to churn out regulations.  On January 10, 2014 most—if not all— of the CFPB’s mortgage rules became effective. Knowledgeable legal counsel from Wall Street has predicted that the mortgage rules will tend to force lenders to focus on “plain vanilla” mortgages that fall within the “qualified mortgage” guidelines.  A hidden risk in this trend is the potential for running afoul of other regulatory traps.  For example there is no safe harbor in the CFPB’s mortgage rules for allegations that lending practices promoting qualified mortgages have a disproportionate impact on minority borrowers—exposing lenders to Equal Credit Opportunity Act or Fair Housing Act charges.  Although the CFPB has made statements that lenders “should not worry” so long as they meet the needs of low-income lenders, such statements provide no real comfort.  Some commentators wonder if the CFPB rules will effectively drive community banks out of the mortgage business. 

CFPB has published a Dodd-Frank Mortgage Rules Readiness Guide on its website.  I expect most mortgage lenders have downloaded the Guide and spent countless hours cross referencing the Guide to the many references to the amended regulations on qualified mortgages, escrow requirements, home ownership counseling, mortgage servicing, appraisal requirements and the scary loan originator compensation requirements (which were effective earlier this year).  I recommend that bank management consult the “Readiness Questionnaire” which is part of the Guide and insure (if not done before) that their institution is on track.  No matter how sophisticated a bank’s consumer mortgage department is, remember that  the CFPB rules were written by government personnel with little realization of the burdens caused by the new rules.  For example, one Wall Street lawyer has stated that the mortgage servicing rules are so onerous that many banks will cease servicing and cede the market to specialty loan servicing companies that are not subject to regulatory capitol requirements.

I will now repeat matters dear to my heart but I think important to bankers.

First, why not use Deeds of Trust in commercial transactions?  Although the current version of the Deed of Trust Act has flaws because the Deeds of Trust cannot be used in consumer transactions (due to another statute), there is really no downside in using a Deed of Trust.  Most lawyers who question the use of Deeds of Trust voice concern that there has been no court challenge to the procedure.  What if such a challenge happens?  Worst case, the court forces you to treat the Deed of Trust as a mortgage and engage in judicial foreclosure.  What is the benefit: “time is money”.  Mike Altum, one of the most skilled workout artists in New Mexico estimates the time for a foreclosure with any opposition to be 12 months to possession in our courts.  In surrounding states with Deed of Trust procedures, he estimates the time to closure and possession averages about 6 months—and he has worked in Arizona and Colorado.  Like all estimates, the time may vary by the facts of the property and financing but there is no question that New Mexico banks in commercial transactions should use Deeds of Trust.  After the first challenge, I predict the Deed of Trust will be the common land security instrument.

Second, all bank management should look at carefully at cyber insurance coverage in addition to the usual several other forms of liability and D&O coverage.  In the wake of the Target and Neiman Marcus hacker invasions, it becomes clear that an epidemic of hacking is taking place.   In Target’s and Neiman’s cases, class action lawsuits will follow by the usual class action attorneys. Cyber Insurance is becoming more necessary.   Legal counsel should work with management on the coverage limits and cost.  In many cases, there are no actual invasions of customer data but rather an exposure of the data.  In such cases, normal damages from litigation may not occur but the bank will have to enter into remedial action.  The cost of remedial action may or may not be recoverable by insurance and the difficulty of calculating such costs are great. 

Beware bankers; you may find a union banner in front of your branch or main office.  Most people in Santa Fe and Albuquerque are used to seeing a gaggle of somewhat unkempt males standing behind a large banner which proclaims, “Shame of __{name of business}____for engaging in unfair labor practices….” or stating that the business has done something equally offensive to the working class.  Who is doing this: the Carpenters Union (not a local union, but one run out of Los Angeles).   For the first time the Carpenters have attacked a local financial service business.  During the week of January 14, the Carpenters posted banners claiming that NM Educators Federal Credit Union was engaged in shameful anti-union practices.  The Carpenters banner was posted in front of the credit union’s Paseo del Norte branch.  Robert Tinnin, the dean of New Mexico’s labor and employment bar, explained to me that the Carpenter’s bannering activity does not violate the secondary boycott restrictions of the National Labor Relations Act.  The activity is not picketing and that is apparently why the guardians of the banner stand mutely behind it.   The bannering is permitted under a “publicity proviso” to the Act’s restrictions on secondary boycotts.  The Carpenters have carried out their bannering against restaurants, grocery stores, apartment buildings and a prominent church.  It is important to note that there is no evidence of any union organizational activity in any of these cases.  Advice: if the Carpenters show up ignore them.  They appear to have had little impact on the business of those “bannered”.

Do good.

MARSHALL G MARTIN

 505 228 8506

The Legislature, Bitcoins and Other

December 7, 2013.  “Old soldiers never die, just the young ones.”  (Anon). 

Seventy two years ago today the Japanese Empire attacked the U.S. fleet at Pearl Harbor in a surprise attack.  The world changed thereafter.  How many of our children remember the event or the great and small persons who survived that attack, the battles and the war?  Patton, Wainwright, Bataan, Bradley, MacArthur,  Hurtgen Forest, Guadacanal, Code Talkers?

Manny is back, sort of.   Former New Mexico Senator Manny Aragon has been released from federal prison to a half-way house after about four years incarceration for his conviction on kick-backs from an Albuquerque court house construction project.  At one time Manny virtually controlled the New Mexico Senate and much of state government.  Although Manny will likely not be there, we are within about six weeks of the start of the “short” session of the N.M. Legislature.  Despite the N.M. Constitutional restrictions on the matters that can be considered—budget, vetoed bills and matters on the Governor’s call—most of the legislation which should be of concern to the financial services industry seems to come back year after year.  I think this year will not be unique.  As we approach the Session, I will review the proposed legislation as it appears.

Social Media and electronic communication continue to cause problems to business and government.  Winston Brooks, Superintendent of the Albuquerque Public Schools, is an opponent of the Martinez’ administrations’ education reforms that involve testing which may impact teacher evaluations.  Apparently, after having been told by e-mail or a “tweet” that the Martinez’ education chief, Ms. Skandera, was to appear at a rural location, Brooks made inappropriate and allegedly sexist comments about her on his Tweeter account.  Mr. Brook’s was suspended for three days and his future contract with the school system was not extended.  His future is uncertain.

Although one may question the judgment of Mr. Brook’s posting anything on an obviously public site, any business operating in 2013 should be aware that all managements’ company e-mails are subject to discovery in litigation, if not publicly available.  Depending on the case, an officer’s social media may be discovered in litigation.  The solution is neither easy nor fool proof—education and the threat of inappropriate behavior being made public may be the only preventive measure.

            Bitcoins are in the news and being studied by the regulators.  Bitcoins are a product of the Internet age. A programmer or group of programmers invented Bitcoins in 2009.  The Bitcoin “currency” is a rigid system of virtual supply and demand functions, monitored by a peer group called “miners”.  Please don’t expect me to explain this, except that the total Bitcoin supply is limited in its founding program.  No more than 21 million Bitcoins will ever be issued and by 2013 about half that number had been issued.  Exchanges that trade Bitcoins for hard currency are limited—they have a short life and two of the most prominent are Japanese and Chinese.  A small number of companies accept them as a matter of routine commerce.  Two of the Facebook veterans have announced a purchase of 1% of the Bitcoins in existence, and are preparing a filing of a Bitcoin ETF. 

            Why all the fuss about Bitcoin?  Until 2013 the Bitcoin market was fairly stable and unknown to most people.  However, in October 2013, the F.B.I. arrested the mastermind of the “Silk Road” drug empire, which operated in the so-called “Dark Web” (an invention of U.S. security and law enforcement agencies formed for clandestine activities—but downloadable by anyone).  Silk Road was an Internet market place in which transactions in drugs and I.D. theft occurred, masked by the “Dark Web” promise of anonymity.  All transactions were in Bitcoin.  “Silk Road” operated with impunity until its mastermind felt aggrieved by some employees or business associates and let out contracts to kill.  In the process he let his real Internet identity slip, and he was caught. 

            Almost immediately, the Bitcoin value dropped to less than $2.00 and then in the wake of the “Silk Road” story, the Bitcoin value climbed to $1000 per Bitcoin.  In testimony before Congress the regulators voiced concern about the lack of regulation of the Bitcoin market, but generally stated that such virtual currency had a place in the market.  Ben Bernanke voiced support for the concept of virtual currencies.  But, like a wet blanket, on December 4, former Federal Reserve Chairman Alan Greenspan termed Bitcoin “not a currency” and predicted a “bubble” in Bitcoins. 

            On November 8, 2013, the CFPB released its “tool” to assist lenders in complying with the Dodd-Frank Act that requires that consumers be furnished a means to find housing counselors before entering into housing and mortgage transactions.  The deadline is near, February 2014. The regulations appear at 12 CFR Part 1024.  Although the regulations do not appear all that burdensome (although detailed), one wonders if New Mexico consumers will ever use a housing counselor.   How many housing counselor meeting HUD requirements are there in rural areas of New Mexico.  The regulations require a list of ten and some proximity by zip code.  Sounds simple.  Is it?

I will be in touch, as we know more about the legislature.

Do good.

MARSHALL G MARTIN

Mobile:  505-228-8506

Office:  505-982-4611

Crowdfunding, SEC Rules

ATTORNEY: The youngest son, the 20-year-old, how old is he?
       WITNESS: He's 20, much like your IQ.  (Courtesy Lowell Hare)

“I have no idea what Gluten is, either, but I’m avoiding it just to be safe.” (Anon)

“Crowdfunding” as a way of raising capital for small businesses has been in the news since Congress passed the Jobs Act in 2012. Although the role of bankers in the Crowdfunding process may evolve, there is a role—how big may depend on the success of the concept. 

As presented in the media and in Congress, Crowdfunding was presented as a way to raise capital through the internet in a less rigid format than the usual U.S. Securities Act exemptions.  Ideally, small business issuers would present their start-up companies to a “crowd” of investors who would buy shares in the start-up for relatively small amounts. In the absence of explicit amendments to the Securities Act of 1933, Crowdfunding would not be a legal way to raise capital.  Small businesses would have to follow the very rigid exempt transaction rules of the Act with sales only to “accredited investors” or , limited Regulation A offerings or  “go public”.   Congress added the  Crowdfunding sections to the securities laws as a way to promote capital raises for small or start-up companies.

The SEC’s release of the proposed Crowdfunding rules on October 23, 2013 is more than 585 pages long and poses more than 250 questions for comment. The full release can be retrieved from the SEC EDGAR site.   The Crowdfunding  rules are not likely to become final for some time.  The rules are open for a 90 day comment period and then the Commission has to adopt the final rules, and then there is statutory 60 day wait for the rules be effective.  Most experts expect that no   Crowdfunding issues will occur before Summer 2014.  Some important highlights of the SEC’s proposed rules follow:

            1.  The maximum annual limit for a Crowdfund issue is $1 million, with rather stringent requirements concerning financial and other information about the issuer.  Lower Crowdfund limits of $500,000 and $100,000 have much less rigid or burdensome requirements for the issuer.  Given the expected legal and other costs of a Crowdfund issue it is not likely that many $100,000 issues will be done.

            2.  Significantly, the SEC’s proposed rules do not aggregate Crowdfund issues with other exempt issues (as is often the case in the SEC rules).  For example, the issuer could do a Crowdfund issue and, when successful, follow it with a much larger Regulation D exempt offering or vice-versa. 

            3. If the annual income or net worth of an investor is less than $100,000 (net worth does not include a principal residence), the investor may not contribute more than $2,000 or 5% of annual income or net worth, whichever is larger. If the investor’s income or net worth exceeds $100,000 the limit is 10% of net income or net worth.  Under the current proposal no laborious due diligence is required of the internet portal or broker-dealer (called collectively “intermediaries”)  to confirm the investor’s financial status.  One expert said that the investor would merely “check a box” and the intermediaries could rely on that, given good faith belief.  We will see if that survives the comment period. 

            4.  Although the Crowdfunding security issue can be done through a broker-dealer, it is difficult to imagine Raymond James or even small broker-dealers’ undertaking a $1 million Crowdfunding offering.  Most issues will probably take place through “funding portals” which, while not broker-dealers, will have to register with the SEC and follow a fairly rigid set of rules.  One of which, of interest to bankers, is the explicit requirement that all funds collected during the offering by the funding portal be deposited in an escrow type account with a bank.   The funding portals also have to be a member of a national exchange.  The SEC has designated FINRA to serve as the funding portal exchange.  FINRA is drafting rules for the funding portals. 

            5.  What about fraud?  Many pundits have predicted widespread fraud by the unscrupulous scam artists.  Obviously, there is no guarantee  that fraud can be prevented, rules or no rules.  However, the funding portals have a duty under the proposed rules to do background checks and pursue other means to determine if the issuers are real.  The issuers must give the “crowd” a fairly detailed disclosure statement, which when the lawyers get involved will look like a full blown prospectus.  In the $1 million offerings, detailed financials and business plans are required. I think the most likely ground for fraud may lie in funding portals.    Despite the requirement that funds be deposited in banks one knows that such requirements are easily dodged.  The Act and rules contain provisions for legal recoveries for fraudulent conduct similar to the Securities Act’s anti-fraud provisions.

            6.  The investors in a Crowdfunding venture are subject to restrictions on resale of their stock.  They must hold the stock for one year, except  for sales to an accredited investor, to the issuer or to family. 

Crowdfunding, as presented by the SEC proposed rules, is not simple or cheap.  One expert has predicted that the legal and  business cost of raising capital under the Crowdfunding concept may amount to 20-25% of the amount raised.  I think this is possible, but not after funding portals become more common and expert in their work. The accounting requirements for issuers for the $1 million issue will be expensive and the issuer will also have to do what amounts to  SEC style MD&A (management discussion and analysis) for  issuer. 

Sorry to take up so much space but Crowdfunding may be a significant way to raise capital for small business.  Bankers may get involved in escrowing funding portal’s issuer funds or  evaluating the chances of success for an existing customer.  Among other things, it will be a faster way to raise capital from the public than existing stock raises.  Until it gets going it is difficult to determine if it will be a success. 

Do Good,

Marshall Martin

(505)228 8506

(505)982 4611