On July 23, 2013, the Consumer Financial Protection Bureau (“CFPB”) filed a complaint against Castle & Cooke Mortgage, LLC (the “Company”) alleging violations of the mortgage loan originator compensation rules. More specifically, the CFPB alleged that the Company paid quarterly bonuses to mortgage loan originators based on the interest rates on loans originated by each loan originator. According to the CFPB, the Company’s mortgage loan originators had an incentive to increase the interest rate on mortgage loans in order to receive a larger bonus; thus, steering borrowers into loans with higher interest rates. In its complaint, the CFPB alleged that the Company paid more than four million dollars in bonuses between July 8, 2011 and April 27, 2012.
The complaint goes on to address the Company’s written compensation policies and individual compensation agreements with loan originators. The CFPB claims that its review of the Company’s compensation practices did not reveal any written documentation of the bonus program or of the Company’s method for calculating bonuses.
In response to the complaint, the Company’s president noted that only 10% of their employees were eligible for bonuses in 2012 and five set criteria are used in making the determination of bonus eligibility. According to the Company’s president, in order to be eligible for a bonus, a mortgage loan originator must: (1) close nine or more loans per quarter; (2) meet certain quality-control standards; (3) meet or exceed a ratio of 70% of loans that are actually funded; (4) be a current employee of the Company; and (5) maintain a portfolio of performing loans without early payment default.
This recent complaint prompted us to reiterate some points from the CFPB’s final regulations issued on January 20, 2013, implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act provisions concerning loan originator compensation practices (the “Final Rule”). Regulation Z currently prohibits banks from compensating its mortgage loan originators on “any of the transaction’s terms or conditions,” such as the interest rate. The Final Rule also prohibits compensation based on any “proxy” of a term of a transaction. The Final Rule defines “a term of a transaction” as “any right or obligation of the parties to a credit transaction.” Compensation is defined in the Final Rule as “salaries, commissions, and any financial or similar incentive.” Therefore, a bonus payment is treated as compensation for purposes of the Final Rule.
As previously mentioned, the Company did not document its compensation practices in a policy or in individual compensation agreements with mortgage loan originators. Records “sufficient to evidence all compensation” paid to a mortgage loan originator must be retained for three years after compensation is paid. Sufficient records include those that demonstrate the type and amount of the payment; evidence that the payment was made and to whom; evidence that the payment was received and by whom; and when the payment was made and receipt of confirmation was obtained. The type of documentation necessary will depend on the type of compensation payments made.
The Final Rule prohibits the payment of compensation based on the profitability of a transaction or a pool of transactions or overall profitability of a department or organization that includes profits from covered mortgage loans. However, there is an exception for contributions to “designated tax –advantaged” plans such as 401(k)s, employee annuity plans, simple retirement accounts, simplified employee pension and eligible deferred compensation plans, all as defined in the Internal Revenue Code.
Bonuses paid based on the profitability of a transaction or pool of transactions can be made under certain non-deferred incentive plans only if the payment is not based on a term or transaction of the loan originator’s transactions and (1) the bonus does not exceed 10% of the total compensation received for that period (including the bonus payment) or (2) the individual was a loan originator for 10 or fewer transactions during the preceding 12 months.
The time period used for determining whether a payment will exceed the 10% cap is the time period during which the profits on which the bonus is based were earned. For example, if a loan originator will receive a bonus based on profits generated in 2012, then the calculation will include his 2012 compensation and the bonus payment even if the bonus will not be paid until January 2013. However, if the same loan originator will receive a bonus based on 2013 profits, but will be paid in early 2014, then the bonus payment paid in January 2013 (based on 2012 profits) should not be included in the 10% calculation for the bonus based on 2013 profits.
The 10% maximum compensation amount is only applicable to compensation based on profits generated from mortgage loans. A bonus or contribution made based on profits generated from any other bank activity is not subject to the 10% cap. If a bonus is paid based on profits from a specific area of the bank, such as an individual branch, then the bank will need to determine the percentage of profits earned from mortgage loan originations prior to determining the bonus amount if the total bonus to be paid would exceed the 10% cap. The bonus amount based on mortgage profits may not exceed 10% of the loan originator’s total compensation, but a bonus based on profits earned from other branch activities will have no cap.
That calculation can get complicated, depending on the situation. For example, if a bank wanted to pay a branch manager an annual bonus based on overall branch (or bank) profitability in an amount that would be more than 10% of the branch manager’s total compensation for the year, then the bank would need to make a determination of how much of that bonus was attributable to profits from covered mortgage loans if the branch manager originated more than 10 mortgage loans during the year. That determination is generally going to require some sort of calculation showing how the bonus pool was determined and may involve allocating overhead and expense between mortgage lending and other lines of business (deposits, other loans, etc.) so that the profitability of the mortgage lending business and, therefore, the portion of the bonus pool and individual branch manager’s share of the pool that comes from mortgage profits can be determined. As the CFPB enforcement action against Castle & Cooke demonstrates, documentation of that determination will be extremely important.