For default servicing, all eyes rest on Colorado
The time for the industry to act is now
It’s been poorly reported by much of the trade press (perhaps because at least one trade media outlet owns their own attorney guild), but you may have noticed recently at HousingWire that we’ve been highlighting coverage of an ongoing legal fracas involving the Colorado state Attorney General and nearly all of the major creditor’s rights firms in that state. The case centers on expenses charged in connection with foreclosure actions.
As the facts continue to come out, and evidence is made public by court order, let’s just say the facts in the Colorado case increasingly don’t look very positive for the law firms involved — or by extension for the mortgage industry in general.
While the case has become water-cooler chat fodder for most default executives, few yet realize that while the facts of the Colorado case may be unique, what’s taking place in Colorado right now is far from it.
According to sources I’ve spoken with, similar investigations into foreclosure billing practices are already active in key states on the Eastern seaboard, too, even if the subpoenas haven’t been made public.
The heart of the matter
At the core of the investigations, sources tell me, is how foreclosure law firms billed for allowable “costs” in conjunction with the foreclosure – with the lever being loans insured or guaranteed by Fannie Mae, Freddie Mac or the Federal Housing Administration.
While the GSEs set a public and fixed-fee schedule for foreclosures, they also allow law firms to bill for variable, additional reimbursable costs — typically things like process of service or posting and publication of notices, as well as filing fees with the courts. These pass-through costs are typically borne by the law firms and then billed back to their clients as an allowable cost; and in some cases, like filing fees, the fees are set by the court.
But in other cases, the fee structure is much more flexible. And it’s in these reimbursable costs that serious questions are starting to be asked by both Federal and state officials.
Here’s why: it turns out that many of the major law firms responsible for managing foreclosures for the GSEs also have a controlling interest in the ancillary service firms that generate the variable fees that appear as “costs” on the lawyer’s bill. Many law firms either outright own, or their partners have a significant interest in, the company that is posting and publishing notices; or they may own or have an interest in the company that manages process of service, as well.
Arrangements like this aren’t illegal per se.
But it doesn’t take an MBA to understand that close vertical integration between law firms and their service providers creates a strong potential conflict of interest, not to mention strong incentives for collusion and price fixing — and investigators are now looking to see if any evidence of “fee padding” actually exists in these ancillary services.
The case in Colorado centers on these issues, but state officials there aren’t the only ones looking into this.
A Federal matter, not just for states
Last week, as covered here at HW (and also conveniently ignored amongst most other trade press), was the fact that the banking unit at MetLife, Inc. (MET) was subject to a CID — that’s Civil Investigative Demand — from the Department of Justice, as disclosed in the insurance giant’s most recent quarterly filing with the Securities and Exchange Commission.
Here’s the relevant part of what was disclosed in the MetLife filing:
In May 2013, MetLife Bank received a subpoena from the U.S. Department of Justice requiring production of documents relating to MetLife Bank’s payment of certain foreclosure-related expenses to law firms and business entities affiliated with law firms and relating to MetLife Bank’s supervision of such payments, including expenses submitted to the Federal National Mortgage Association, the Federal Home Loan Mortgage Corp. and the U.S. Department of Housing and Urban Development (“HUD”) for reimbursement.
Read that again, and understand the Feds are investigating precisely the same issues that have the state AG in Colorado up in arms. Precisely. Also understand that MetLife wasn’t alone — PNC Financial Services Group, Inc. (PNC) disclosed the very same investigation in its own most recent 10-Q filed with the SEC, too.
But in the case of PNC, it’s the U.S. Attorney’s Office that is now involved in investigating precisely the same thing, not the DOJ. From PNC’s SEC filing:
PNC has received a subpoena from the U.S. Attorney’s Office for the Southern District of New York seeking information regarding claims for foreclosure expenses that are incurred in connection with the foreclosure of loans insured or guaranteed by FHA, Fannie Mae or Freddie Mac. This inquiry is in its early stage, and PNC is cooperating with the investigation.
Take a minute and put two and two together. Still think this is a one-off thing, limited to just Colorado? Still think the Colorado AG, the DOJ and the U.S. Attorney’s office just happen to be conducting their own completely separate and wholly uncoordinated investigations into exactly the same thing?
If so, it’s time to get that head out of the sand.
Frankly, based on what’s being found in the Colorado investigation thus far, I think it’s high time the mortgage industry understand that these investigations are more likely than not only going to gain steam. And depending on the facts that get uncovered, these investigations have the potential to become the next “big thing” affecting the mortgage industry.
How big? Potentially an even bigger black eye than robosigning — which offended our sensibilities about what is just and fair, but in the end likely harmed very few. In this case, however, if there is actual evidence uncovered of “fee padding,” there is a smoking gun where the shots fired from it harmed defaulted homeowners, taxpayers and investors alike.
Add up the volume of foreclosures at Fannie Mae and Freddie Mac alone in the past four years, and you’ve got a problem of epic proportions. And let’s go one step further, since the Feds are already digging in at some servicing shops: what if those investigations uncover evidence of servicer negligence, too?
You do the math, but there are a lot of zeroes potentially involved here depending on where this goes next.
It’s hard to say if what we’re seeing now in Colorado and elsewhere is the early stages of the next major industry crisis, or if this will blow over. But the threat to the structure of the industry, and the trust so many consumers place in it, is massive. It’s also clear that playing defense — or worse, doing nothing and hoping this too shall pass — isn’t a strategy that has worked very well for our industry thus far.
The mortgage industry has endured more than its fair share of body blows and black eyes in the past few years, and the MBA along with other trade orgs have said they are committed fully to restoring consumer trust in our industry. To doing whatever it takes to get there.
If so, now is the time to test that commitment. Our industry needs to step up.
Servicers need to work now to start addressing these issues head-on, and should be digging in long before the Feds come knocking — because they will. Get an auditing committee to look at historical foreclosure billings. Review internal procedures used to manage cost reimbursements. Find areas of weakness and address them. Find problems, and proactively tackle them. Fire those involved, or those negligent, if need be.
Any creditor’s rights law firm that owns ancillary legal businesses, especially in high-volume foreclosure states, is likely going to see some combination of the DOJ, the US Attorney, and/or their state AG come knocking — if they haven’t already done so. These firms should proactively be working with their clients on this issue, and directly, too.
Do it now. Not later. Show the public that this industry is being proactive in addressing what could be a potentially very, very large problem.
The best-case scenario is that current investigations don't find evidence of wrongdoing, and in the meantime the industry will have strengthened its controls and procedures. But if there has been wrongdoing — if some law firms crossed the line and improperly padded their costs, or if some servicers were negligent and lacked appropriate controls, or both — there will be a price to pay, regardless.
That price, however, need not take an entire industry’s reputation along with it.