As we reported previously, in June 2018 Zillow Group (Zillow) announced that it is no longer under investigation by the CFPB for Real Estate Settlement Procedures Act (RESPA) and UDAAP compliance with regard to its co-marketing program. The CFPB investigation triggered a securities lawsuit filed in the United States District Court for the Western District of Washington (C17-1387-JCC). The plaintiffs alleged in a putative class action that they purchased Zillow shares at an inflated price and were damaged by alleged material misrepresentations by the defendants regarding the Zillow co-marketing program and CFPB investigation of the program. The court noted that there was a decline in the price of Zillow stock in the two days after Zillow provided an update in August 2017 regarding the status of the CFPB investigation. Underlying the plaintiffs’ claims were alleged violations of RESPA with regard to the co-marketing program, which are the focus of this blog post.

The court noted that because the plaintiffs alleged securities fraud under section 10(b) of the Securities Exchange Act of 1934 and section 10b-5 of Securities and Exchange Commission rules, in order to survive a motion to dismiss the complaint must satisfy the general standard of setting forth sufficient factual matter, accepted as true, to state a claim for relief that is plausible on its face, and meet additional standards. One additional standard is that that the complaint must state with particularity the circumstances constituting fraud or mistake.

With regard to RESPA, the plaintiffs asserted that the co-marketing program (1) acted as a vehicle to allow real estate agents to make illegal referrals to lenders in exchange for the lenders paying to Zillow a portion of the agents’ advertising costs, and (2) facilitated RESPA violations by allowing lenders to pay to Zillow a portion of their agents’ advertising costs that was in excess of the fair market value of the advertising services that the lenders received from Zillow. The court found that the plaintiffs failed to sufficiently plead either theory of RESPA liability.

In support of the theory that when lenders pay a portion of the real estate agent’s advertising costs to Zillow they are effectively paying to receive unlawful mortgage referrals from the agent, the plaintiffs cited the CFPB enforcement action against PHH Mortgage Corporation regarding mortgage reinsurance arrangements. We have extensively reported on the matter, in which the CFPB deviated from prior government interpretations of RESPA by effectively reading out of RESPA the section 8(c)(2) safe harbor that permits payments for goods and services between parties even when there are referrals of settlement services business between the parties. The U.S. Court of Appeals for the D.C. Circuit rejected the CFPB’s interpretation of RESPA. Summarizing the holding of the D.C. Circuit, the court in the Zillow case stated the “D.C. Circuit held that RESPA’s safe harbor allows mortgage lenders to make referrals to third parties on the condition that they purchase services from the lender’s affiliate, so long as the third party receives the services at a “reasonable market value.””

The court in the Zillow case determined the plaintiffs’ assertion that the co-marketing program violates RESPA because it allowed agents to make referrals in exchange for lenders paying a portion of their advertising costs “is neither factually nor legally viable.” The court first noted that the complaint does not contain particularized facts demonstrating that real estate agents participating in the co-marketing were actually providing unlawful referrals to lenders. The court then stated that, even if it “draws an inference that co-marketing agents were making mortgage referrals, such referrals would fall under the Section 8(c) safe harbor because lenders received advertising services in exchange for paying a portion of their agent’s advertising costs.”

Addressing the plaintiffs’ second theory of liability—that the co-marketing program facilitated RESPA violations by allowing lenders to pay more the than fair market value for advertising services they received from Zillow—the court states that the plaintiffs failed to provide particularized facts that demonstrate that the lenders actually paid more than the fair market value of the advertising services they received from Zillow.

While the mortgage industry will welcome the favorable decisions on the RESPA issues, industry members should be mindful that the context is a securities fraud case with specific pleading standards.

 

On January 31, 2018, the en banc D.C. Circuit handed down its opinion in the PHH v. CFPB case, which we’ve discussed at length. It held, 7 to 3, that the CFPB’s single-director-removable-only-for-cause structure is constitutional but that the CFPB’s interpretation of RESPA was wrong.

En Banc Court Reinstates Panel’s RESPA Ruling

The en banc Court reinstated the RESPA-related portions of the D.C. Circuit’s October 2016 panel decision. The panel had held that the plain language of RESPA permits captive mortgage re-insurance arrangements like the one at issue in the PHH case, if the mortgage re-insurers are paid no more than the reasonable value of the services they provide. This is consistent with HUD’s prior interpretation. For the first time in 2015, in prosecuting the case against PHH, the CFPB announced a new interpretation of RESPA under which captive mortgage reinsurance arrangements were prohibited. The panel rejected this on the ground that the statute unambiguously allows the kinds of payments that the CFPB’s 2015 interpretation prohibited.

In remanding the case to the CFPB for further proceedings, the panel had admonished the CFPB by alternatively holding that—even assuming that the CFPB’s interpretation was permitted under any reading of RESPA—the CFPB’s attempt to retroactively apply its 2015 interpretation, which departed from HUD’s prior interpretation, violated due process. It held that “the CFPB violated due process by retroactively applying that new interpretation to PHH’s conduct that occurred before the date of the CFPB’s new interpretation.” The en banc Court cited the panel’s due process analysis with approval.

The panel’s RESPA decision remanded the case to the CFPB to determine whether PHH violated RESPA under the longstanding interpretation previously articulated by HUD. The en banc Court’s reinstatement of that aspect of the panel decision led it to order that the case be remanded to the CFPB for further proceedings.

Statute of Limitations Continues to Apply to RESPA Cases Before CFPB

At the administrative stage of the case, the CFPB argued that no statute of limitations applies to any CFPB administrative action. The panel soundly rejected that argument, holding that RESPA’s three-year statute of limitations applies to any RESPA claims that the CFPB brings, whether administratively or otherwise. That aspect of the panel decision, because it pertains to RESPA, is also reinstated by the en banc Court’s ruling.

CFPB’s Structure Deemed Constitutional

The panel of the D.C. Circuit had also held that the CFPB’s structure was unconstitutional because it improperly prevented the President from “tak[ing] Care that the Laws be faithfully executed.” Rejecting this holding, the en banc Court held that “[w]ide margins separate the validity of an independent CFPB from any unconstitutional effort to attenuate presidential control over core executive functions.” In other words, the en banc Court found (wrongly, in our view) that it wasn’t even a close call.

In reaching this conclusion, the en banc Court considered two questions: First, it asked whether the “means” that Congress employed to make the CFPB independent was permissible? That is, were the independence-creating tools used ones that the Supreme Court approved of, such as for-cause removal or budgetary independence? The en banc Court found that the Supreme Court approved each of the “means” Congress used to achieve CFPB “independence” individually. It reasoned then, that those “means” could all be combined in a single agency without running afoul of the U.C. Constitution.

Second, the en banc Court asked whether “the nature of the function that Congress vested in the agency calls for that means of independence?” In answer to the second question, the en banc Court found it was consistent with historical practice to grant financial regulators like the CFPB such independence.

The en banc Court went further, however, and dismissed the panel’s other constitutional concerns under the heading “Broader Theories of Unconstitutionality.” For example, it rejected the panel’s concern that having a powerful unaccountable CFPB Director was a threat to individual liberty. It suggested that such an argument “elevat[ed] regulated entities’ liberty over those of the rest of the public.” “It remains unexplained why we would assess the challenged removal restriction with reference to the liberty of financial services providers, and not more broadly to the liberty of the individuals and families who are their customers,” it said. In doing so, it seems to have forgotten that Dodd-Frank gives the CFPB Director broad powers to go after individuals, “mom and pop” businesses, and large “regulated entities.”

Lucia Issue Regarding ALJ Appointment Not Addressed

Notably, the en banc Court in PHH specifically “decline[d]to reach the separate question whether the ALJ who initially considered this case was appointed consistently with the Appointments Clause.” That was the issue in Lucia, which we have blogged about extensively. In that case, Raymond J. Lucia challenged the manner in which the SEC appointed administrative law judges (“ALJs”), arguing that ALJs are “inferior officers” who must be appointed by the president, a department head, or the courts under the Appointments Clause of the U.S. Constitution.  The Supreme Court recently agreed to hear Lucia.

The Supreme Court is considering a cert petition requesting that it hear the Lucia case, which we have blogged about extensively due to its potential impact on the outcome of the PHH case. Significantly, the DOJ recently filed a brief in the case siding against the SEC and with Lucia, who is challenging the constitutionality of how the SEC’s Administrative Law Judges (“ALJs”) are appointed.

Under the Appointments Clause of Article II of the U.S. Constitution, an “inferior officer” must be appointed by the President, a court, or the head of a “department.” Lucia argues that  because the SEC’s ALJs are hired by the SEC’s Office of Administrative Law Judges and not appointed by an SEC commissioner, their appointments would be unconstitutional if they are “inferior officers. ”

In its brief, the DOJ acknowledged the course change on this issue, stating that, “In prior stages of this case, the government argued that the Commission’s ALJs are mere employees rather than ‘Officers’ within the meaning of the Appointments Clause. Upon further consideration, and in light of the implications for the exercise of executive power under Article II, the government is now of the view that such ALJs are officers because they exercise ‘significant authority pursuant to the laws of the United States.'”

Needless to say, it is extremely unusual for the DOJ to take up arms against another government agency like this. How it impacts the outcome of the Lucia case is yet to be seen. As we’ve explained in prior posts, the CFPB uses SEC ALJs to hear its administrative cases. So, if the Supreme Court hears the Lucia case and determines that ALJs are inferior officers, it will call into question every SEC and CFPB case that an ALJ decided. It may also impact how the en banc D.C. Circuit decides the PHH case.

We will continue to follow the issues and keep you posted.