Yesterday (7/23/13), the CFPB filed its first action based on violations of “Compensation Rule” under Regulation Z, 12 C.F.R. § 1026.36(d)(1)(i), and the Consumer Financial Protection Act, 12 U.S.C. § 5536(a)(1)(A), (CFPA). The complaint alleges that Castle & Cooke Mortgage LLC, and two of its officers, “recklessly or knowingly paid quarterly bonuses” to loan officers “who steered consumers into mortgages with higher interest rates” in violation of the Compensation Rule. The Compensation Rule prohibits the payment of any type of compensation “based on any of the transaction’s terms or conditions.” The CFPB claims that the defendants had an unwritten policy of paying quarterly bonuses to loan officers based on an unwritten formula that rewarded the origination of loans with high interest rates. The CFPB believes that more than 1,100 bonuses were paid to originators under this system, which could result in civil penalties ranging from $5,000 per violation, up to $25,000 for reckless violations, and up to $1,000,000 for knowing violations. In addition to be being the CFPB’s first action over alleged violations of the Compensation Rule, the action is significant for two other reasons, which should be of concern to financial institutions.

First, the CFPB’s complaint is based not only on the alleged illegal payments, but the company’s failure to “retain evidence of compliance with the Compensation Rule” in violation of Regulation Z. The CFPB acknowledges that the company kept records of the quarterly bonuses, but violated Regulation Z and the CFPA by failing to: (i) “record what portion of a loan officer’s quarterly bonus is attributable to a given loan;” (ii) “maintain a written policy explaining the method … used to calculate the amount of the loan officers’ quarterly bonuses;” and (iii) “maintain compensation agreements” that “identify, explain, or refer to the existence of the Company’s quarterly bonus program.” This complaint should serve as notice to financial institutions that the failure to maintain adequate records for any reasons is considered actionable by the CFPB.

This complaint is also significant because it highlights the increased cooperation between state regulators and the CFPB. The alleged violations in this case were not discovered by the CFPB, but by the Utah Department of Commerce, Division of Real Estate who referred the case to the CFPB.