It did not take long after the Silicon Valley Bank failure for politicians in Washington to rush to the next available microphone and lament the “loosening of bank regulations”. Instinctively the finger pointing began, and in many quarters ended up in the direction of the prior administration’s policy to generally roll back stringent business regulations and allow free market decisions to govern various industries. Chief among the complainants (no pun intended) was Sen Elizabeth Warren, who emerged out of the 2008 crisis as an architect and advocate for the Wall Street Reform Act and the creation of the vaunted Consumer Financial Protection Bureau ( CFPB), which she briefly directed. Just yesterday in DC’s The Hill publication, Sen Warren was reported as blaming the the collapse of Silicon Valley Bank on Republicans in Congress, which in 2018 helped pass a law to ease bank regulations put in place following the 2008 financial crisis. “No one should be mistaken about what unfolded over the past few days in the U.S. banking system: These recent bank failures are the direct result of leaders in Washington weakening the financial rules,” Warren is quoted as saying. According to The Hill piece, Warren, who voted against the 2018 bank deregulation bill, said that the crises would have been avoided if the banks were required to hold more liquid assets because the bill exempted banks with less than $250 billion in assets from rigorous Fed stress tests. Warren and other Democrats say the old rules could have caught the issues at SVB sooner. Given that politicians generally “never let a crisis go to waste,” many now suspect that the banking industry is about to be slammed with heightened regulatory scrutiny, tighter operational rules, more audits and exams, and larger and very public fines, penalties and consent orders. What does this mean for independent mortgage bankers (IMBs)? It means that they have to get back to the compliance mindset they were frightened into adopting between 2008 and 2018, and before the bottoming out of interest rates led everyone to believe that easy money was here to stay and that self-regulation meant hiring more loan officers. Keep those risk management officers and compliance directors close by folks, we are all in for a bumpy ride on the regulatory

For years real estate closing work has been the “bread and butter” of many small law practices.  Representing buyers and sellers in sales and mortgage closing transactions can be a lucrative practice area, and because there are no significant rules and training or practice barriers as for example complex criminal defense or tax work, it has helped many an attorney pay off their law school loans.  That perception may be changing with the advent of the Consumer Financial Protection Bureau, established under The Dodd–Frank Wall Street Reform and Consumer Protection Act (Pub.L. 111–203, H.R. 4173); commonly referred to as “Dodd-Frank.”

The Dawn Of A New Regulator Has Brought Changes

The CFPB, which has been granted super-regulatory powers answerable only to the Federal Reserve and not Congress has been making headlines for the past few years with its plethora of new financial industry rules designed to prevent another mortgage and banking industry collapse while protecting consumers from financial harm and abusive practices.  Last year, the CFPB issued a bulletin in April 2012 (CFPB Bulletin 2012-3, or Bulletin) without much fanfare.  This Bulletin, which was the precursor for final rules that went into effect in January 2014 require all non-bank entities (read mortgage lenders and brokers) to “manage third party service provider relationships.”  This Bulletin has already had an impact on how real estate closing attorneys are conducting business and will only have a greater impact after the new year.

In relevant part, Bulletin 2012-3 states: “The CFPB recognizes that the use of service providers is often an appropriate business decision for supervised banks and nonbanks. Supervised banks and nonbanks may outsource certain functions to service providers due to resource constraints, use service providers to develop and market additional products or services, or rely on expertise from service providers that would not otherwise be available without significant investment….However, the mere fact that a supervised bank or nonbank enters into a business relationship with a service provider does not absolve the supervised bank or nonbank of responsibility for complying with federal consumer financial law to avoid consumer harm…The CFPB expects supervised banks and nonbanks to have an effective process for managing the risks of service provider relationships. The CFPB will apply these expectations consistently, regardless of whether it is a supervised bank or nonbank that has the relationship with a service provider.”

            What this has meant in the real estate closing industry, for title agents, escrow firms, lawyers and even notaries, is that all banks who are in the business of making mortgage loans must develop and implement a program to manage the risk of harm, to them and to consumers, by closing professionals.  This includes attorneys who handle the funds and documents at a residential real estate closing.

Resistance To These Changes Has Not Been Successful

When the Bulletin first came to light and the realization set in that a previously unsupervised profession would now be subject to intense scrutiny there was understandable push-back, mainly by professional associations such as the American Land Title Association, the Independent Escrow Association and the National Association of Independent Land Title Agents.  These organizations stepped up to give cover to their members and make the case that vetting closing professionals was unnecessary for reasons of economic, privacy and competitive disadvantage issues.  Their complaints fell largely on deaf ears as the statistics reflected in FBI reports on mortgage industry fraud showed that escrow and title defalcations were a growing segment of white collar criminal activity.  The FBI estimated that 15% of the $13 billion in mortgage fraud claims in 2012, or nearly $2 billion, were directly attributable to the bad acts of closing professionals (FBI Annual Mortgage Fraud Report, www.fbi.gov/stats-services ).  The potential for losses is much bigger.  In 2012, banks funded 8.4 million residential mortgage transactions, wiring more than $1.4 trillion into the trust accounts of more than 100,000 closing professionals (entities and individuals) nationwide (www.MortgageBankers.org; www.corelogic.com, www.realtor.org).

The CFPB Bulletin should not have been a surprise to anyone.  In fact when the author of this article met with the CFPB in 2012, just after the Bulletin was released, he was told that regulators were merely extending to non-bank lenders (not just those federally regulated) the same rules that had been in place for a decade under the OCC for supervised entities, albeit not often enforced.  Indeed, the OCC (and others) had adopted aggressive vendor management rules as far back as 2001 (OCC-2001-47, November 2001; see also Fannie Mae Customer Education Group, Report of December 2005, NCUA Guidance Letter 07-CU-13, December 2007), requiring closing professionals to be vetted.  In response, warehouse banks and some large retail lenders had adopted a modicum of pre-funding vetting requirements that included asking attorneys and other settlement agents to produce proof of insurance and evidence of a trust account, but the implementation was not uniform and neither was the result.  Indeed, the period 2007-2011 saw dozens of defalcations involving attorneys who stole mortgage proceeds or conspired with others to commit other forms of mortgage fraud.

Banks Must Comply or Face Stiff Penalties

The issuance of CFPB Bulletin 2012-3 essentially inaugurated a new era in third party service provider management to the extent that the federal government, through the CFPB, HUD, OCC, FDIC and others agencies, now has an enforceable expectation that attorneys and other settlement agents must be (a) vetted for risk, (b) monitored for changes in risk, (c) verified to be in compliance with consumer protection statutes, and (d) maintained in a database for examination in the event of an audit.  Failure to comply can result in fines, penalties and even injunctive action against banks.

But it is not just the CFPB Bulletin that is making banks nervous about their settlement agents: It is also the realization that the Graham-Leach-Bliley Act (Pub.L. 106–102, 113 Stat. 1338), which addresses the need to manage access to consumers private information, is also looming over their heads because the CFPB is now in charge of enforcing that law as well.  Lawyers who handle real estate closings may have access to a borrower’s complete personal and financial history, usually contained in the closing documents, especially the RESPA Form 1003 mortgage application.  The 1003 sets forth a consumer’s identity information (including SSN), address, workplace history, bank, and asset information.  Other closing documents may detail family relationships, marriage and divorce information, and similar personal data.

It is indisputable that attorneys, more than any other discipline that makes up the closing professional industry (the others being title agents, notaries, escrow firm and sometimes realtors), are generally the most educated, most trained, and most supervised group. However, even the state bar associations and the supervising disciplinary committees are largely reactionary to attorney malpractice and criminal behavior.  They simply do not have the technology, labor force and resources to engage in the type of ongoing risk evaluation and reporting that the government expects to ensure proper consumer protection.

Vetting Is Nothing More Than A Vendor Management Process

In an effort to fill the void, vendor management companies are thriving.  These entities specialize in conducting background checks, verifying credentials and experience, reviewing insurance and bond coverage, and generally assisting lenders in meeting these new regulatory requirements.  For years they have established the bar for many vendors to access business at large national and international corporations (the author’s company recently entered the second month of a grueling vendor approval process for a national bank). Lawyers who have previously never even thought about “vetting” are suddenly being told that they cannot handle a banks funds or documents unless they submit their own business and personal information to be screened and verified.  Some are complying, some are complaining and many have yet to experience this new process.  And while there are legitimate concerns about vetting firms, such as data security and privacy, fairness in risk evaluation, and expectations about what is required to be “approved,” the issue is not going away.

With the recent rise in interest rates, the mortgage industry saw a steep drop off in rate and term refinance transactions that have largely fueled the mortgage lending market in the past three years.  It seems no one is left to refinance.  Now new home purchases are back in the unending cycle of the economy and that means one thing to regulators and lenders alike: higher risk. The national Mortgage Bankers Association opined recently that “At the end of 2013, we will see higher home prices, higher mortgage rates, and more existing home sales….”(Remarks of Hon. David Stevens, President MBA, MBA National Fraud Issues Conference, Ft Lauderdale, FL, April 2013). Mortgage financing for purchases is estimated to be 7-10 times riskier than refinances.  Why? Because most mortgage fraud schemes involve the transfer of funds and titles to real estate.

What About The CPL?

Historically those suffering losses from closing professional fraud have mainly relied upon the title industry’s “closing protection letter” also know in some states as an “insured closing letter.”  This form of warranty, which is not an insurance product, has been source of conflict with lenders and consumers for years because of its limits and the high costs frequently incurred to litigate coverage and claims issues.  Today the National Association of Insurance Commissioners, in conjunction with the title industry and banks, is seeking a better way to cover losses.  Vetting and vendor management just may be the type of underwriting foundation that could encourage property and casualty insurers to come up with a better product.  That may mean lower E&O and bond costs for attorneys         and better protections for consumers too.

What You Can Expect

There is no question that the CFPB Bulletin 2012-3 covers attorneys who handle mortgage proceeds and closing documents in connection with residential real estate transactions.  There is no exemption for lawyers performing these functions nor does state bar licensing requirements satisfy the CFPB mandate for banks.  Lenders must comply with these vendor management rules or face unacceptable risks.  Accordingly as the January 2014 final rule deadline approaches for CFPB regulations, more and more banks will be requesting that attorneys submit to vendor management or “vetting” processes to meet regulatory expectations.  These processes may be internal to the bank, or they may be outsourced to third party vendor management firms such as the one we operate.

Vendor risk management programs will likely require attorneys to submit information sufficient to verify (a) individual identity, (b) corporate or business status, (c) criminal and civil litigation history, (d) licensing and licensing disciplinary history, (e) internal operating controls regarding data privacy and security and consumer protection, (f) compliance with trust account rules, and (g) insurance and bond coverage (as applicable by state requirement or lender requirement).  Typically lenders require attorneys to demonstrate between $500,000 and $1 million in appropriate errors and omissions insurance coverage. This information will be evaluated for risk (i.e. derogatory findings) and are subject to ongoing monitoring requirements.

In the end, the old way of doing business as a real estate closing attorney is changing and changing fast.  There are good reasons for these changes, and attorneys are encouraged to study the applicable regulations and statutes so that they can better understand why they may be asked to become “vetted” before they close their next residential real estate transaction.