United States: FinCEN Issues New Rule For Non-Bank Residential Mortgage Lenders And Originators

On February 7, the US Financial Crimes Enforcement Network ("FinCEN") announced the release of its final rule¹ on Anti-Money Laundering Program and Suspicious Activity Report Filing Requirements for Residential Mortgage Lenders and Originators (the "AML Non-Bank Mortgage Lender Rule"), which would, for the first time, require residential mortgage lenders ("RM Lenders"),² and residential mortgage originators ("RM Originators"),³ to establish an anti-money laundering program ("AML Program"),⁴ and to file a suspicious activity report ("SAR")⁵ with FinCEN. The AML Non-Bank Mortgage Lender Rule identifies RM Lenders and RM Originators as a subgroup of loan or finance companies,⁶ and focuses on the activity of the entity rather than its geographic location, raising a question regarding whether the final rule is intended to include RM Lenders and RM Originators that are subsidiaries of non-US companies. RM Lenders and RM Originators that participate in foreclosure prevention programs and mortgage modification programs⁷ must comply with the final rule. However, FinCEN has indicated that it would not expect legitimate, non-profit organizations that limit their activities to assisting with the preparation of loan applications or referral of prospective borrowers to qualified lenders, for free or for a fee; that provide short-term, non-mortgage loans to qualified borrowers or homeowners; or that otherwise facilitate the extension of a residential mortgage loan (but do not make the loan or offer or negotiate the terms of the loan), to fall within the scope of the final rule.⁸

The AML Program Requirements

The AML Program must be approved by senior management and a copy of the AML Program must be made available to FinCEN or its designee upon request.⁹ At a minimum, the AML Program must incorporate policies, procedures, and internal controls based upon the assessment of the RM Lenders and the RM Originators money laundering and terrorist financing risks associated with its products and services;¹⁰ designate an AML Compliance Officer;¹¹ provide for ongoing AML training;¹² and provide for independent testing to monitor and maintain an adequate AML Program.¹³ If the RM Lender or the RM Originator has agents and brokers, the agents and brokers must be integrated into the AML Program, including by obtaining all relevant customer related information necessary for the AML Program to be effective. FinCEN has the authority to examine the RM Lender and the RM Originator for compliance with the AML Non-Bank Mortgage Lender Rule.¹⁴

The Reporting and Recordkeeping Requirements

Each RM Lender and RM Originator must file a SAR relevant to a possible violation of law or regulation and may file a report that it believes is relevant to the possible violation of law or regulation.¹⁵ Reporting is required where the transaction is "conducted or attempted by, at, or through" an RM Lender or RM Originator and the amount, singularly or in the aggregate, in funds or assets is at least $5,000 and the RM Lender or RM Originator "knows, suspects, or has reason to suspect" that the transaction (or a pattern of transactions of which the transaction is a part) is reportable.¹⁶ The SAR must be filed no later than 30 days¹⁷ after the date of the initial detection of facts that may form the basis for the SAR or up to 60 days¹⁸ to identify a suspect. Certain situations require immediate action (such as suspected terrorist financing and ongoing money laundering schemes), and transactions require an RM Lender and an RM Originator to immediately notify law enforcement by telephone as well as filing a SAR.¹⁹ The RM Lender and the RM Originator must maintain copies of all SARs filed and the original (or business record equivalent) of any supporting documents for five years from the date of the filing.²⁰

Limitations on the Disclosure of SARs; Limitation on Liability

SARs (including information that would reveal the existence of a SAR) are confidential, and may not be disclosed except in accordance with the Bank Secrecy Act and its implementing regulations.²¹ The prohibition on disclosure applies to each RM Lender and RM Originator and its officers, directors, employees and agents.²² An RM Lender and an RM Originator must refuse any request (other than as permitted or required by the Bank Secrecy Act and its implementing regulations), even if the request is in the form of a subpoena or other legal process, to disclose the SAR or information that would reveal the existence of the SAR and notify FinCEN.²³ Upon notification, FinCEN will provide instructions and will, if appropriate, go to court to seek to prevent the disclosure.²⁴ RM Lenders and RM Originators (and their officers, directors, employees and agents) are protected from liability with respect to the disclosure of information if a voluntary disclosure of any possible violation of law or regulation is made to a government agency or pursuant to the Bank Secrecy Act.²⁵

SNR Denton Observations

FinCEN requires certain financial institutions to maintain an AML Program and to file reports, including SARs. FinCEN originally exempted RM Lenders and RM Originators from the requirement to maintain an AML Program so that FinCEN could learn more about their operations, business products and services and their potential vulnerability to fraud, money laundering and other illegal activity. FinCEN concluded that mortgage fraud and other illegal activity made it necessary to require compliance with the Bank Secrecy Act. FinCEN decided that RM Lenders and RM Originators should have standards and requirements that are substantially identical to the AML and SAR requirements for banks and other financial institutions that offer retail consumer banking services and originate mortgage loans.

First, though the final rule covers loan and finance companies, FinCEN decided only to cover RM Lenders and RM Originators, and reserved the right to include additional companies in the definition in the future. The basis for focusing on RM Lenders and RM Originators is that FinCEN concluded that they are "a significant subset of the 'loan or finance company' category, in terms of the number of businesses and the aggregate volume and value of transactions they facilitate." This likely means that RM Lenders and RM Originators will have to endure years of close AML scrutiny, which will require more staff, enhanced systems, more recordkeeping, more external advisors, more administrative costs, and in some cases, fines and penalties.

Second, FinCEN's focus on RM Lenders and RM Originators, especially with a focus on AML issues and mortgage fraud, means that RM Lenders and RM Originators may have to rethink the knowledge and experience of their staff. Traditional bank AML staff, for instance, are required to (1) have specialized training on state and federal AML and fraud laws; (2) identify AML-related "red flags;" (3) monitor document flows; (4) understand the business purpose of transactions; (5) understand how funds flow, including funds transfers; (6) understand how to develop customer profiles; (7) understand what information is useful to law enforcement; (8) understand what constitutes a reasonable suspicion; and (9) work as a team with the sales force, the operations staff, the audit function, the legal function, senior officials, and external advisors. RM Lenders and RM Originators may not have the option of assigning new responsibilities to existing staff. FinCEN, like the Federal banking agencies, may force RM Lenders and RM Originators to create a separate AML Department staffed with specialists as has been required as a part of other AML enforcement actions.

Third, FinCEN asserts in the final rule that "much of the effort necessary to meet these regulatory obligations...will be accomplished through business operations already undertaken." Yet, AML experts will quickly point out that AML due diligence, AML risk ratings, AML risk profiles and even the completion of SARs cannot be completed "through business operations already undertaken" because these tasks require, among other things, an analysis of the existing operations, an identification of the assumptions made about future activity, an analysis of the existing and projected customer base, an analysis of the source and nature of the funds, a review of publicly available databases, consultation with FinCEN and others, if deemed appropriate, the creation or revision of numerous policies and procedures and internal controls, and a methodology that explains the actions taken and decisions made.

Fourth, the ability of RM Lenders and RM Originators to maintain an effective AML Program has already been undermined by decisions made by FinCEN. For example, FinCEN does not require real estate agents, real estate brokers, title insurance companies, appraisers, escrow companies and others who may be a part of a residential mortgage transaction to provide information or otherwise cooperate with RM Lenders and RM Originators. This means that RM Lenders and RM Originators may not have access to the full range of information to make appropriate determinations, but will be held accountable if FinCEN subsequently concludes that the RM Lender or the RM Originator should have known about certain information or should have conducted due diligence that would have led to the discovery of certain information.

Fifth, RM Lenders and RM Originators may be at a competitive pricing disadvantage when their nonbank competitors also offer commercial mortgage products because depending on the mix of the products and services, the infrastructure and the staffing of the competitors, the competitors may be able to offer a discount on residential mortgage loans that an RM Lender or RM Originator may not be able to match.

Sixth, FinCEN intends the final rule to be broad in scope and cover most non-bank residential mortgage originators. This means the rule is likely to include RM Lenders and RM Originators (such as non-profit housing organizations that extend short term mortgage loans or offer or negotiate the terms of a residential mortgage loan) who may not know or believe they are required to comply with the final rule such as non-profit housing organizations that extend short term mortgage loans or offer or negotiate the terms of a residential mortgage loan. FinCEN makes it clear that it intends the final rule to cover "any business that, on behalf of one or more lenders, accepts a completed mortgage loan application, even if the business does not in any manner engage in negotiating the terms of a loan." Likewise, FinCEN intends the final rule to cover "businesses that offer or negotiate specific loan terms on behalf of either a lender or borrower, regardless of whether they also accept a mortgage loan application." In addition, FinCEN intends the final rule to include "residential mortgage originators, regardless of whether they receive compensation or gain for acting in that capacity." Finally, FinCEN makes it clear that it does not want to encourage reliance on other laws to determine whether a business is covered by the final rule. Indeed, FinCEN emphasizes that it made changes to the final rule to create "greater differences" and to "differentiate" the final rules from other rules.

Footnotes

1.31 C.F.R. 1010 and 31 C.F.R. 1029. The final rule is effective 60 days after publication in the Federal Register and those persons subject to the rule must be in compliance within 6 months of the date of the publication of the final rule in the Federal Register.

2.A residential mortgage lender is a person to whom the debt arising from a residential mortgage loan is initially payable on the face of the evidence of indebtedness or, if there is no such evidence of indebtedness, by agreement, or to whom the obligation is initially assigned at or immediately after settlement. The term does not include an individual who finances the sale of the individual's own dwelling or real property. 31 C.F.R. 1010.100.

3.A residential mortgage originator is a person who accepts a residential mortgage loan application or offers or negotiates terms of a residential mortgage loan. 31 C.F.R. 1010.100.

4.At a minimum, loan or finance companies (e.g., RM Lenders and RM Originators) shall develop and implement a written AML Program that is reasonably designed to prevent the loan or finance company from being used to facilitate money laundering or the financing of terrorist activities, which means it must have internal policies, procedures and controls; an AML Compliance Officer; an ongoing employee training program; and an independent audit function to test the AML Program. 31 C.F.R. 1029.210(a).

5.31 C.F.R. 1029.320(a).

6.A loan or finance company means a person engaged in activities that take place wholly or in substantial part within the US as a RM Lender, an RM Originator or both, whether on a regular basis or as an organized business concern, including as a sole proprietor acting as a loan or finance company, but not as a bank or certain functionally regulated or examined entities. 31 C.F.R. 1010.100(kkk). The final rule does not apply to government sponsored enterprises ("GSEs") regulated by the Federal Housing Finance Agency, but there is another rule that requires the GSEs to have an AML Program and file SARs. Traditional mortgage servicers (i.e., those servicers who do not offer residential mortgage loans or originate residential mortgage loans or do not otherwise provide products that would bring them into the final rule) do not come within the final rule. FinCEN views servicers as businesses that support post-origination principal and interest collection and taxation. FinCEN agrees that the typical activities of mortgage servicing companies do not fall within the definition of residential mortgage originator in the final rule. Other mortgage servicers (i.e., those who offer residential mortgage loans or originate residential mortgage loans) are likely to be included. A strict reading of the language in the final rule suggests that RM Lenders and RM Originators that are subsidiaries of non-US companies are covered by the final rule.

7.This includes the Making Home Affordable Program, the Home Affordable Modification Program, the Hardest Hit Funds Program and the Federal Housing Administration Refinance Program to the extent any transactions conducted by the RM Lender and the RM Originator could reasonably be considered to be extending a residential mortgage loan or offering or negotiating the terms of a residential mortgage loan, within the meaning of the definitions of "residential mortgage lender" and "residential mortgage originator" in the final rule.

8.The final rule does not apply to the federal or state housing authorities and agencies administering the programs.

9 31 C.F.R. 1029.210(a).

10.31 C.F.R. 1029.210(b (1).

11.31 C.F.R. 1029.210(b) (2). The AML Compliance Officer must ensure that the AML Program is implemented effectively, updated as necessary and appropriate persons are properly trained. Id.

12.31 C.F.R. 1029.210(b) (3). An RM Lender or an RM Originator may satisfy the training requirement by providing the training directly or by verifying that such persons have received training by a competent third party. Id.

13.31 C.F.R. 1029.210(b) (4). The independent testing must also cover any agents and brokers. The scope and frequency of the testing must be commensurate with the risks posed by the products and services of the RM Lender or the RM Originator. The testing may be conducted in-house by an independent party or by a third party. Id.

14.FinCEN also has the authority to delegate the examination, and, in other contexts, such as with insurance companies and money service businesses, the Internal Revenue Service, rather than FinCEN, conducts examinations of nonbank financial companies that are subject to the AML Program requirements.

15.31 C.F.R. 1029.320(a) (1). The SAR must be filed with FinCEN, and, as a courtesy the RM Lender and the RM Originator should file a courtesy copy with its federal regulator, if it has authority under the Bank Secrecy Act. Similarly, many states that require a similar filing will accept the filing with FinCEN (if a copy is provided to the state authority) as compliance with state law. In addition, some states have criminal money laundering laws that may necessitate action with local law enforcement.

16.A transaction is reportable if it (i) involves funds derived from illegal activity or is intended or conducted in order to hide or disguise funds or assets derived from illegal activity (including, without limitation, the ownership, nature, source, location, or control of such funds or assets) as part of a plan to violate or evade any Federal law or regulation or to avoid any transaction reporting requirement under Federal law or regulation; (ii) is designed, whether through structuring or other means, to evade any requirements of the Bank Secrecy Act; (iii) has no business or apparent lawful purpose or is not the sort in which the particular customer would normally be expected to engage, and the loan or finance company knows of no reasonable explanation for the transaction after examining the available facts, including the background and possible purpose of the transaction; or (iv) involves use of the loan or finance company to facilitate criminal activity. 31 C.F.R. 1029.320(a).

17. 31 C.F.R. 1029.320(b) (3).

18. Id.

19.31 C.F.R. 1029.320(b) (4).

20.31 C.F.R. 1029.320(c). Supporting documents must be made available to FinCEN or any federal, state or local law enforcement agency or federal regulatory authority that examines the RM Lender or the RM Originator for compliance with the Bank Secrecy Act and its implementing regulations or the state agency with such authority.

21.31 C.F.R. 1029.320(d).

22.31 C.F.R. 1029.320(d) (1).

23.Id.

24.See http://www.fincen.gov/news_room/rp/legal_decision.html for three cases addressing SAR disclosures.

25.31 C.F.R. 1029.320(e).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.