Thursday, March 31, 2011

The Judge Weighs In

Yesterday afternoon, after two days of waiting, our inboxes began to fill up with announcements that the federal judge reviewing the requests for an injunction to prevent implementation of the Fed Rule on loan originator compensation  had denied the requests filed by NAMB and NAIHP.  To most of us, I am sure that the judge's ruling was not a surprise.  Personally, I would have been shocked to see a ruling issuing a preliminary injunction.  But I was very interested to see why the judge ruled as she did.  A friend in Dallas emailed Judge Beryl Howell's opinion on the case and reading it this morning was very enlightening.  So today, I want to share the key points with all of you.

First, a little background.  Judge Howell is an Obama appointee who is likely to be sympathetic to one of the Administration's key pieces of legislation--the Dodd Frank bill.  So her political sympathies likely impacted her decision.  But her key points spelled out in the 46 page memorandum show that she has actually thought about the issue and they give us a good idea of where we as an industry stand now--one day prior to implementation of the Federal Reserve Rule.

NAMB and NAIHP filed suits asking for a preliminary injunction to keep the Fed Rule from being enacted tomorrow.  Judge Howell writes in her opinion that, in order for an injunction to be granted, four criteria must be met. "To warrant injunctive relief, the plaintiff 'must establish that he is likely to succeed on the merits, that he is likely to suffer irreparable harm in the absence of preliminary relief, that the balance of equities tips in his favor, and that an injunction is in the public interest'....The purpose of a preliminary injunction 'is merely to preserve the relative positions of the parties until a trial on the merits can be held.'..."Without a 'substantial indication' of the plaintiff's likelihood of success on the merits, 'there would be no justification for the court's intrusion into the ordinary processes of adminstration and judicial review.'"  This is key, because in each of the areas that NAMB and NAIHP were requesting relief, the judge found that the plaintiffs had very little likelihood of "success on the merits" and there was, therefore, no reason to grant the injunction.

Regarding the issue of whether the Federal Reserve Board has the authority to issue the loan originator compensation rule, Judge Howard found that they do.  "Based on the current record, the Court believes that proposed regulations are (e) rational and directed toward preventing unfair practices, within the meaning of that term in Section 5 of the FTC Act.  The Congress delegated the Board broad authority under TILA and HOEPA. As the Supreme Court noted, a Court that disregards the Board's views with regard to TILA 'embarks on a voyage without a compass' because proper regulation of the lending industry 'is an empirical process that entails investigation into consumer psychology and that presupposes broad experience with credit practices. Administrative agencies are simply better suited than courts to engage in such a process.'"

Most interesting of all was the court's assessment of the inevitable destruction of the small mortgage broker as a result of this rule.  "Regarding the Rule's likely adverse effect on small mortgage brokers, the Board concluded that 'the benefits of the prohibition to consumers outweigh the associated compliance costs....In reaching this conclusion, the Board considered studies about the benefits of independent mortgage brokers to consumer choice and costs, but found them 'not dispositive.' It also indicated its belief that the Rule would not 'require small brokerage firms to go out of business,' since creditors rely on them, and its optimistic view that 'new business models' will allow them to compete."  A major part of the request for an injunction centered around NAIHP's and NAMB's claims that the Rule will do "irreparable harm" to the small mortgage broker community.  In her opinion, Judge Howell defined the legal standards of irreparable harm.  She wrote that the D.C. circuit court has set a standard for irreparable harm that "must be both certain and great; it must be actual and not theoretical."  Irreparable harm may not be merely economic harm; to meet the legal definition the plaintiff must be able to prove that the harm is so great that it will actually cause the affected businesses to cease to exist. Merely losing money does not meet the standard. "Under this Circuit's irreparable harm standard, 'harm is that is 'merely economic' in character is not sufficiently grave'...Economic harm may qualify as irreparable, however, 'where a plaintiff's alleged damages are unrecoverable.'

Both NAIHP and NAMB argued that the rule would do irreparable harm.  Judge Howell ruled that NAIHP did not sufficiently make their case for irreparable harm  or show that the harm they were attempting to prove was "actual and not theoretical."  However, she found that the NAMB attorneys did meet the standard for irreparable harm.  NAMB provided attestations from five small business owners who testified that the new loan originator compensation rules and the prohibitions on commission-based compensation will cause them to have to lay off their loan originators and originate as one-man shops, which in turn will not allow them to generate enough income to cover their overhead.  Thousands of small brokerages will be forced to close nationwide because of the new rules, and thousands of people working in support positions for these companies will find themselves unemployed.  In response to the testimony and the attestations presented, Judge Howard wrote the following:  "NAMB has sufficiently demonstrated that its members will likely be irreparably harmed by the implementation of the Board's Rule prohibiting dual compensation for loan originators who are paid directly by the consumer. Although NAMB members face purely economic injury, they sufficiently assert that this injury will 'result in the complete destruction of their businesses' which certainly constitutes irreparable harm." 

But even though NAMB attorneys presented enough evidence to show that irreparable harm is being done, Judge Howell denied the injunction.  Why?  Because the public good being done by the rule outweighs the harm done to the small business owners in the industry. Judge Howell agrees with the FRB that the current manner of compensation to loan originators is unfair to consumers. "Under the FTC Act, a practice is unfair if it 'causes or is likely to cause substantial injury to consumers which is not reasonably unavoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition.' An injury may be considered substantial even if it 'causes a small amount of harm to a large number of people.'"  Of course, this interpretation of fairness completely obscures the fact that consumers are likelier to get a better deal when they have many options to choose from.  Rather than permitting practices which might cause "a small amount of harm to a large number of people," the judge is siding with the FRB to support a ruling which will cause a large amount of harm to a small number of people (us). "The Board has admitted in the Rule's supplementary comments that small independent brokerages and loan originators across the country will be substantially affected by the Rule and its prohibitions on certain compensation practices....Plaintiff NAMB has demonstrated that its members face irreparable harm absent an injunction enjoining the Final Rule...Although NAMB's demonstration that its members face substantial irreparable harm is compelling, the Court must consider the plaintiff's harm against both the public interest furthered by the Rule and the fact that the plaintiffs have not demonstrated a likelihood of success on the merits.  That said, the Board has reasonably concluded that the Rule will further public policy interests, a position that is further supported by the Dodd Frank Act....Based upon the record, despite the harm plaintiffs' members may face, the Court must deny the plaintiffs' motions for injunctive relief."

And that is the crux of the matter.  Yes, the mortgage brokers are going out of business; yes all of the small business owners who invested our lives, our time and our money in building our businesses are going to lose everything we have worked for.  But in the end, our demise is in the public interest, because we don't deserve to be saved.  The world is better off without us. 

Maybe the question we need to be asking is what gives a government bureaucracy or a federal judge the right to determine whether our industry has the right to exist.  Why is their definition of "public interest" more important than our survival?

Unfortunately, this case could go to 1000 judges who would probably all say the same thing.  This is not a battle which can be won in court--it has to be won in the court of public opinion which can lead to changes to the legislation behind the Fed Rule. But at least now, we know where we stand with the judge.

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  1. It is sad to see politics, not principle, dictate the rule of law.

    Judge Howell's ruling (paraphrased): ‘This compensation rule is going to happen under Dodd-Frank thus eliminating Plaintiff’s chance of success. Therefore, motions to stop the rule are denied.’

    Judge Howell… which is it? Existing TILA law or Dodd-Frank amended TILA law?

    If Dodd-Frank… how do the plaintiffs sue based on a rule that doesn’t exist? Oh, I see, they can’t.

    If existing law… why do you reference Dodd-Frank in your ruling?

    The plaintiffs didn’t have the blind lady of justice at all. They had the legal ‘gerrymandering’ of a very political Judge.

    Don’t even get me started on the RFA, APA, and SBREFA concerning the admitted destruction of small business.

    I thought we had 3 Branches of Government for this very reason.

    Sadly, it appears we have only 2… Democrat and Republican.

  2. This ruling is a terrible blow to small business as a whole and sets a very bad precedent for government interference in private enterprise. Hopefully the appellate court will feel differently.