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   ARTICLE   |   From Scotsman Guide Residential Edition   |   October 2009

When State Regulators Come Knocking

Brokers should understand what to do before and after enforcement actions

The financial industry is in a state of turmoil. Daily headlines resound with the closing of more financial institutions and new bankruptcies — and questions. Amid theories of what caused this, elected officials and the public blame financial-industry professionals as a whole.r_2009-10_Bley_Marquez-Garrett_spot

As a result, state regulators are cracking down on mortgage companies and pursuing financial institutions more aggressively than ever.

For mortgage brokers, this means a higher likelihood of regulatory examinations. Such investigations could result from the introduction of new regulations, which bring the potential for new mistakes. It is therefore critical that industry professionals ensure compliance; update procedure manuals; bolster internal audit and compliance procedures; and properly train their employees.

Knowing what to expect and how to respond when state regulators approach your business is the key to survival in today's regulatory environment.

Basic compliance

A certain amount of paperwork comes with any profession that requires licensing. Submitting this paperwork — which includes everything from routine licensing and renewal documents to annual reports — is the most frequent interaction companies have with state regulators. But when companies do not follow the rules properly, routine interactions can pave the way for steep regulatory backlash.

Most, if not all, of the requisite forms and rules can be found on states' regulatory Web sites. If forms are returned incomplete or if a company attempts to shut down without following the appropriate procedures, state regulators often will first informally request immediate compliance. These requests should not be ignored, as an inadequate response or none at all may lead to later and stricter regulatory action.

Such action likely will come with fees and fines, the purpose of which is to compensate the regulator for time spent and to deter future noncompliance. As violation fees accrue, a small fine can snowball into thousands of dollars.

From a cost-benefit standpoint, brokers often can handle many basic compliance and maintenance issues without an attorney's help. Nonetheless, they require careful attention, thorough research, documentation, and sometimes an experienced attorney's assistance or oversight.


Regulatory examinations generally are initiated in one of two ways:

  1. Many regulators conduct routine examinations as a means of monitoring industry compliance across the board. These examinations aren't brought on by any action on the part of the examinee; they are simply part of the regulatory process.
  2. Examinations can be triggered by consumer or competitor complaints filed with the regulatory authority. Although one complaint likely will not prompt a full-scale examination, frequent and founded complaints may.

Brokers should pay attention to customers who complain and, to the extent practical, deal with their concerns proactively.

When a regulator's attention is the result of a complaint, companies can expect requests for documents or information as an initial response. Regulators have broad authority to make such requests, including of out-of-state companies conducting business with in-state residents. Such requests enable the regulator to determine whether the complaint is well-founded and provide an opportunity to resolve potential concerns or violations before turning to the costlier and more time-consuming examination process.

An examination involves not only much-broader requests for documents and information but also thorough investigation. Examiners will request as many records as they believe necessary to conduct an adequate examination. This examination may occur on-site, off-site or both.

Following an examination, regulators should provide companies with reports of their findings and an opportunity to address the issues at hand. Unfortunately, this is not always the case. An enforcement action is the next step in the process and can occur when a regulator determines that compliance is lacking and that the company is unwilling or unable to bring its operations into full compliance, or both.

The initiation of an enforcement action is not a death knell. Indeed, even companies with the best intentions and strictest monitoring procedures have difficulty maintaining strict compliance with ever-changing state and federal regulations. Depending upon the seriousness and frequency of the alleged violations, such actions may be resolvable.

Before an examination, take steps to ensure you're doing everything right. This includes reviewing regulations thoroughly and frequently; keeping pace with changes in existing rules; and maintaining an adequate system of employee training, internal audits and quality control. Attorneys and other third-party consultants can help perform internal spot-check audits and review and update internal procedures and guidelines.

Common violations

If a regulator receives a complaint, brokers likely will receive a request for more information. In some cases, an honest response is enough. If the complaint is founded, however, brokers should address restitution or other steps to resolve regulator concerns. Unresolved complaints can open the door to additional questions and investigation.

In the case of routine examinations, companies can expect to receive a notice of examination. Again, these notices don't mean that a company did anything wrong. Regulators often perform routine exams of licensed companies as a means of checking overall industry compliance. Even the most-compliant brokerage companies can expect regulatory examination at some point.

When you become the subject of a regulatory exam, do everything possible to comply. Unfortunately, there is no exact formula with respect to the examination process. The best thing to do is monitor exam issues and, to the extent practical, keep examiners fully informed.

Common violations committed by mortgage brokers include:

  • Failure to disclose yield-spread premiums properly;
  • Failure to provide timely good-faith estimates (GFEs) or Truth in Lending Act disclosures;
  • Failure to provide accurate or properly completed disclosures;
  • Failure to notify borrowers promptly of adverse actions; and
  • Failure to disclose trade names properly on loan documents.

For instance, brokers sometimes use lines 801 and 802 of the GFE to display fees payable to the mortgage broker although regulations require that such fees be stated in lines 808 through 811. As long as the fees were stated accurately, this type of violation results in no actual harm to consumers. Nonetheless, regulators may demand restitution to consumers, as well as fines and the costs of investigation if the above violations occurred.

On the other hand, if these are the only violations and if the examinee gets a report of examination before enforcement action is taken, good communication with the enforcement agency can go a long way toward preventing a statement of charges. Often, such violations are considered technical in nature and are almost always caused by oversight or inadvertence. Recognizing the errors and providing assurances that the company will be brought into immediate compliance can help resolve the concerns without formal proceedings and steep penalties.

More-serious violations include:

  • The collection of unearned or unlawful fees;
  • Trust-account violations or improper accounting;
  • Failure to disclose subsequent rate increases;
  • Violation of advertising regulations;
  • Failure to ensure that loan originators are licensed; and
  • Conducting business from unlicensed locations.

These types of violations aren't considered technical in nature and often will result in enforcement action or, at the least, considerable oversight and regulator involvement moving forward. If an enforcement action is filed, it almost certainly will include a demand for restitution to individual consumers as well as fines.

There also is a category of violations that state regulators consider the most serious. These violations involve fraud or other misconduct on the part of loan originators and include:

  • Stated-income fraud;
  • Occupancy falsification; and
  • Document falsification.

These types of violations are particularly problematic for principals and designated brokers in larger companies as they may face individual liability despite a lack of knowledge or involvement in individual originators' misconduct. Moreover, such violations will more likely lead to enforcement actions and bans from future industry participation. Often, examiners will raise these issues during the examination process, at which point there will be immediate investigation into the individual and whether fraud occurred.

Punishment and settlement

If examiners find violations, whether substantive or technical, they have a wide range of discretion with respect to how to proceed. Unfortunately, because examiners and state agencies differ, there's no way to predict the next steps. Post-audit responses typically range from providing an opportunity to cure deficiencies to initiating administrative proceedings.

In the event that a regulator doesn't follow up after an examination, don't assume everything is fine. The onus is on brokers to ensure everything has been resolved to the satisfaction of the state agency.

Examination findings may lead to enforcement actions. If an enforcement action is based on a field examination, an examination report more than likely has been produced. Due process should, but doesn't always, require the production of the report and an opportunity for the licensee to respond to the findings.

Regulators are authorized to revoke and suspend companies' and individuals' licenses. They also can impose investigative and examination costs; restitution they believe is due consumers; and fines to deter future misconduct. Enforcement related to the most-serious violations almost always will include the following:

  • License revocation
  • Prohibition from future industry participation
  • Imposition of a fine
  • Restitution to consumers
  • Collection of investigation fees

Once an enforcement action is initiated, pay close attention to deadlines. In Washington state, for example, brokers have 20 days from receipt of a statement of charges to request an administrative hearing. Deadlines are critical and often provide a small window of time to find a qualified attorney.

The next step includes determining the strength of the regulator's allegations, which will inform a settlement position. Having a qualified attorney is indispensible at this point as determinations must be made as to the facts and law.

The most efficient and only way to resolve regulator enforcement actions is frequently through settlement. Settlements with state regulators vary greatly depending on the case and the nature and number of allegations. In some cases, however, there may be a basis for challenging either factual allegations or the regulator's conclusions of law, in which case an administrative hearing could make sense.

•  •  •

Simply closing your doors won't make the problem go away, and inadequate responses can result in steep liability. Knowing the facts and applying the law should go a long way in achieving a satisfactory settlement. Moreover, understanding how to deal with examinations from their outset can help brokers avoid enforcement altogether.


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