Loan Originator and Other Compensation Rules
By: Laura Pringle
March 18, 2013
The Consumer Financial Protection Bureau’s (“CFPB”) Final Rule on Loan Originator Compensation Requirements Under the Truth in Lending Act (Regulation Z) has effective dates of June 1, 2013, for two of the provisions and January 10, 2014, for all other provisions in this rule. http://www.gpo.gov/fdsys/pkg/FR-2013-02-15/pdf/2013-01503.pdf. The final rule implements requirements and restrictions imposed by the Dodd-Frank Act concerning loan originator compensation; qualifications of, and registration or licensing of loan originators; compliance procedures for depository institutions; mandatory arbitration; and the financing of single- premium credit insurance. The final rule revises and provides additional commentary on Regulation Z’s restrictions on loan originator compensation, including application of these restrictions to prohibitions on dual compensation and compensation based on a term of a transaction or a proxy for a term of a transaction, and to recordkeeping requirements. This final rule also establishes tests for when loan originators can be compensated through certain profits-based compensation arrangements.
This final rule implements Dodd-Frank Act provisions which prohibit certain arbitration agreements and the financing of certain credit insurance in connection with a mortgage loan. These are the two provisions which are effective June 1, 2013. In a separate article Jeanne Erickson covers the arbitration and single premium insurance portions of this final rule.
This article will focus on the provisions which are effective on January 10, 2014, i.e., the loan originator compensation requirements of this final rule including this final rule’s (1) prohibition against compensation based on a term of a transaction or proxy for a term of a transaction, (2) prohibition against dual compensation, (3) no prohibition on consumer payment of upfront points and fees, and (4) provisions regarding loan originator qualifications and identifier requirements. Reminders are also included in this article about the proposed incentive compensation rule and current safety and soundness rules on compensation.
Prohibitions Against Compensation Based on a Term of a Transaction of Proxy for a Term of a Transaction
This final rule places prohibitions against compensation based on a term of a transaction or proxy for a term of a transaction by defining “a term of a transaction” as “any right or obligation of the parties to a credit transaction.” For example, a mortgage broker cannot receive compensation based on the interest rate of a loan or on the fact that the loan officer steered a consumer to purchase required title insurance from an affiliate of the broker, since the consumer is obligated to pay the interest and the required title insurance in connection with the loan. This final rule also prohibits compensation based on a “proxy” for a term of a transaction. This rule clarifies the definition of a proxy to focus on whether: (1) The factor consistently varies with a transaction term over a significant number of transactions; and (2) the loan originator has the ability, directly or indirectly, to add, drop, or change the factor in originating the transaction. To prevent evasion, this final rule generally prohibits loan originator compensation from being reduced to offset the cost of a change in transaction terms (often called a ‘‘pricing concession’’). However, the final rule allows loan originators to reduce their compensation to defray certain unexpected increases in estimated settlement costs. To prevent incentives to ‘‘up- charge’’ consumers on their loans, the final rule generally prohibits loan originator compensation based upon the profitability of a transaction or a pool of transactions. However, subject to certain restrictions, the final rule permits certain bonuses and retirement and profit-sharing plans to be based on the terms of multiple loan originators’ transactions. Specifically, mortgage-related profits can be used for: (1) contributions to or benefits under certain designated tax- advantaged retirement plans, such as 401(k) plans and certain pension plans; (2) bonuses and other types of non-deferred profits-based compensation if the individual loan originator originated ten or fewer mortgage transactions during the preceding 12 months; and (3) bonuses and other types of non-deferred profits-based compensation that does not exceed 10 percent of the individual loan originator’s total compensation. The final rule generally reaffirms the existing rule insofar as it does not permit, under non-deferred profit-based compensation plans and designated defined contribution plans, individual loan originators to be compensated based on the terms of their individual transactions.
Prohibition Against Dual Compensation
This final rule also provides prohibitions against dual compensation. Regulation Z already provides that where a loan originator receives compensation directly from a consumer in connection with a mortgage loan, no loan originator may receive compensation from another person in connection with the same transaction. The Dodd-Frank Act codifies this prohibition, which was designed to address consumer confusion over mortgage broker loyalties where the brokers were receiving payments both from the consumer and the creditor. The final rule implements this restriction but provides an exception to allow mortgage brokers to pay their employees or contractors commissions, although the commissions cannot be based on the terms of the loans that they originate.
No Prohibition on Consumer Payment of Upfront Points and Fees
This final rule provides no prohibition on consumer payment of upfront points and fees. Section 1403 of the Dodd-Frank Act contains a section that would generally have prohibited consumers from paying upfront points or fees on transactions in which the loan originator compensation is paid by a person other than the consumer (either to the creditor’s own employee or to a mortgage broker). However, the Dodd-Frank Act also authorizes the CFPB to waive or create exemptions from the prohibition on upfront points and fees if the CFPB determines that doing so would be in the interest of consumers and in the public interest. The CFPB had proposed to waive the ban so that creditors could charge upfront points and fees in connection with a mortgage loan, so long as they made available to consumers an alternative loan that did not include upfront points and fees. The proposal was designed to facilitate consumer shopping, enhance consumer decision- making, and preserve consumer choice and access to credit. The CFPB stated in its publication ofthis final rule that the CFPB decided not to finalize this part of the proposal at this time, however, because of concerns that it would have created consumer confusion and other negative outcomes. The CFPB stated that instead complete exemption to the prohibition on upfront points and fees will be issued pursuant to the CFPB’s exemption authority under section 1403 and other authority while the CFPB scrutinizes several issues relating to the proposal’s design, operation, and possible effects in a mortgage market undergoing regulatory overhaul. The CFPB stated that consumer testing and other research to understand how new Dodd-Frank Act requirements affect consumers’ understanding of and choices with respect to points and fees is to be conducted, so that the CFPB can determine whether further regulation is appropriate to facilitate consumer shopping and enhanced decision-making while protecting access to credit.
The CFPB stated that it intends to conduct research on these issues over the next five years as required by the Dodd-Frank Act. The CFPB also stated that this five-year review period will allow the CFPB, as part of its research on points and fees, to assess effects on the mortgage market arising from the new disclosures for the TILA–RESPA Integration, the ATR Final Rule, the HOEPA Final Rule, and other relevant Title XIV rulemakings. The CFPB reasoned that these Title XIV rulemakings are likely to have a significant impact on how points and fees are structured in the mortgage market. The CFPB stated that if it determines over this period that additional requirements are needed, the CFPB would issue a new proposal for public notice and comment.
Loan Originator Qualifications and Identifier Requirements
Because the Dodd- Frank Act imposes a duty on individual loan officers, mortgage brokers, and creditors to be ‘‘qualified’’ and, when applicable, registered or licensed to the extent required under State and Federal law this final rule also provides for loan originator qualifications and identifier requirements. The final rule imposes duties on loan originator organizations to ensure that their individual loan originators are licensed or registered as applicable under the Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (SAFE Act) and other applicable law. For loan originator employers whose employees are not required to be licensed, including depository institutions and bona fide nonprofits, the rule requires them to: (1) ensure that their loan originator employees meet character, fitness, and criminal background standards similar to existing SAFE Act licensing standards; and (2) provide training to their loan originator employees that is appropriate and consistent with those loan originators’ origination activities. The final rule contains special provisions with respect to criminal background checks and the circumstances in which a criminal conviction is disqualifying, and with respect to situations in which a review of consumer reports on a loan originator is required. The final rule also implements a Dodd-Frank Act requirement that loan originators provide their unique identifiers under the Nationwide Mortgage Licensing System and Registry (NMLSR) on loan documents; i.e., mortgage brokers, creditors, and individual loan originators which are primarily responsible for a particular origination will be required to list on enumerated loan documents their NMLSR unique identifiers (NMLSR IDs), if any, along with their names.
The final rule also extends existing recordkeeping requirements concerning loan originator compensation so that these requirements apply to both creditors and mortgage brokers for three years. The rule also clarifies the definition of ‘‘loan originator’’ for purposes of the compensation and qualification rules, including exclusions for certain employees of manufactured home retailers, servicers, seller financers, and real estate brokers; management, clerical, and administrative staff; and loan processors, underwriters, and closers.
Impact of this Final Rule on Small Entities
In this final rule the CFPB considered the benefits, costs, and impacts of the following major provisions on small entities. (1) Upfront Points and Fees. The Dodd-Frank Act prohibits consumer payment of upfront points and fees in all residential mortgage loan transactions except those where no one other than the consumer pays a loan originator compensation tied to the transaction (e.g., a commission) and provides the CFPB authority to waive or create exemptions from this prohibition if doing so is in the interest of consumer and in the public interest. The CFPB adopted in this final rule a complete exemption to the statutory ban on upfront points and fees. (2) Compensation Based on Transaction Terms. This final rule clarifies and revises restrictions on profits-based compensation from mortgage-related business profits for loan originators based on the analysis of the potential incentives that loan originators have to steer consumers to different transaction terms in a variety of contexts. Section 1026.3(d)(1)(iii) permits creditors or loan originators organizations to make contributions from mortgage-related profits to “designated tax-advantaged plans” as listed in that paragraph. Section 1026.36(d)(1)(iii) permits creditors or loan originator organizations to make contributions from mortgage-related profits to 401(k) plans, and other “designated tax- advantaged plans,” such as Simplified Employee Pensions (SEPs) and savings incentive match plans for employees (SIMPLE plans), provided the contributions are not based on the terms of the individual loan originator’s transactions. Section 1026.36(d)(1)(iv) permits creditors or loan originator organizations to pay compensation under non-deferred profits-based compensation plans from mortgage- related business profits if: (i) The individual loan originator is the loan originator for ten or fewer mortgage transactions during the preceding 12 months (a de minimis number of originations); or (ii) the percentage of an individual loan originator’s compensation under a non-deferred profits-based compensation plan is equal to or less than 10 percent of that individual loan originator’s total compensation. While such contributions and bonuses can be funded from general mortgage profits, the amounts paid to individual loan originators cannot be based on the terms of the transactions that the individual had originated. (3) Loan Originator Qualification Requirements. This final rule implements a Dodd- Frank Act provision requiring both individual loan originators and loan originator organizations to be “qualified” and to include their license or registration numbers on loan documents. Loan originator organizations are required to ensure that individual loan originators who work for them are licensed or registered under the SAFE Act where applicable. Loan originator organizations and the individual loan originators that are primarily responsible for a particular transaction are required to list their license or registration numbers on key loan documents along with their names. Loan originator organizations are required to ensure that their loan originator employees meet applicable character, fitness, and criminal background check requirements.
Incentive Based Compensation Proposal and Current Safety and Soundness Standards
Incentive-based compensation arrangements are also addressed in Section 956 of the Dodd-Frank Act and in the rule proposed pursuant to those provisions by the OCC, Federal Reserve, FDIC, NCUA and other federal regulatory agencies on April 14, 2011. http://www.gpo.gov/fdsys/pkg/FR-2011-04-14/pdf/2011-7937.pdf. That proposed rule is expected to be finalized in the near future with a mandatory compliance date expected to be 6 months from the publication date; thus, perhaps these provisions will be in effect before or on approximately the same effective date as the provisions restricting loan originator compensation in January 2014. However, unlike these loan originator compensation restrictions, generally the incentive-based compensation rule, as proposed, applies to financial institutions with total consolidated assets of $1 Billion or more.
Importantly, the compensation requirements in the Safety and Soundness Standards required by Federal law continue to be applicable regardless of the size of a financial institution. 12 USC 1831p-1g. Those provisions prohibit “excessive compensation” or compensation that can lead to “material financial loss,” require safeguards to be established, and can lead to prompt corrective action by the financial institution’s primary federal regulator.
Loan originator compensation rules require action to be prepared to fully comply with new requirements affecting all sizes of financial institutions. Large financial institutions should also prepare for compliance with proposed incentive-based compensation requirements and these proposed rules provide helpful guidance for all financial institutions. These new provisions build upon the current and important safety and soundness standards which prohibit excessive compensation or compensation which could lead to “material financial loss” to a financial institution. The review of these issues in budgeting and planning for 2013 and 2014 is an important part of strategic planning and examination preparation.
This Article was also published at Wolters Kluwer’s Compliance Headquarters™ website: www.complianceheadquarters.com.