mortgage banking alert - k&l gates · mortgage fraud held by the appraisal foundation, a...

March 2008 www.klgates.com

Authors:

Laurence E. Platt+1.202.778.9034 [email protected]

Lorna Neill+1.202.778.9216 [email protected]

K&L Gates comprises approximately 1,500 lawyers in 24 offices located in North America, Europe and Asia, and represents capital markets participants, entrepreneurs, growth and middle market companies, leading FORTUNE 100 and FTSE 100 global corporations and public sector entities. For more information, please visit www.klgates.com.

Mortgage Banking Alert

NYAG Leapfrogs Feds In Targeting Appraisals

Rather than waiting around for Congress or the Federal Reserve Board to complete their consideration of appraisal reform, New York Attorney General Andrew M. Cuomo announced on March 3, 2008 the execution of cooperation agreements (the “Cooperation Agreements” or “Agreements”) with Fannie Mae, Freddie Mac, and the Office of Federal Housing Enterprise Oversight (OFHEO) that will require significant changes in appraisals for residential mortgage loans on a nationwide basis.1

The Cooperation Agreements come in the wake of a sudden and steep decline in residential property values in many parts of the country that has resulted in many “underwater” subprime loans where the outstanding principal balance exceeds the value of the mortgaged property. Clearly, the underwater nature of many subprime borrowers has prevented them from escaping loans that are becoming unaffordable as the loans are adjusting to rising interest rates, leading to the current subprime mortgage crisis. While policymakers’ can discuss the combined effects of declining property values and rising interest rates, can they nonetheless attempt to pin the current crisis (with its resulting market correction of tightened underwriting guidelines, decreased consumer demand, and the general unavailability of residential credit) upon faulty appraisals at the time of origination?

Whatever the actual reasons may be, federal and state legislators and regulators have focused on an alleged lack of appraiser independence and standards as a contributing cause of the current mess. The New York Attorney General, however, has leapfrogged Congress and the Federal Reserve Board by “encouraging” the execution of the Cooperation Agreements, which address many of the same substantive issues. The result is the codification of an appraiser code of conduct by contract, if arguably under duress, rather than by law or regulation.

We have written three recent Client Alerts regarding other aspects of these mortgage reform proposals. The first Alert dealt with the ability to repay and net tangible benefit requirements contained in mortgage reform bills in Congress.1 The second Alert dealt with the imposition of duty of care requirements and anti-steering prohibitions upon mortgage originators.2 The third addressed the proposed remedies for a violation of the new mortgage reform proposals, and the extent parties (including the wrongdoer and those who committed no violation) would be legally responsible for those violations.3 This Alert discusses the proposed appraiser independence and standards of care in the New York Attorney General’s Agreements, the bills proposed in Congress, and the Federal Reserve Board’s recent proposed rule.

I. APPRAISER INDEPENDENCE – AN HISTORICAL PERSPECTIVE

The foundation of a sound residential mortgage loan is a valuation of the secured property that is as accurate as possible, and the integrity of an appraisal depends upon the objectivity of the appraiser. The appraiser must be free from improper or undue influence or pressure by parties with a direct financial interest in the loan transaction. Research shows that significant perceived pressure on appraisers has come from virtually all participants in the mortgage food chain – largely from mortgage brokers and real estate agents/brokers, but also from consumers, lenders, and appraisal management companies.2

March 2008 | 2


However, is all input from or exchange with interested parties improper? The appraisal process is certainly not a perfect science. Overly-conservative valuations can scuttle transactions that are beneficial to lenders and borrowers. Lenders review appraisals, and appropriately so, to ensure that appraisers have considered all relevant data, and may legitimately ask an appraiser to reconsider his or her valuation. Exchange of information between mortgage industry participants can be a healthy part of the appraisal process, actually leading to better appraisals with fewer errors, and a more vibrant and sturdy mortgage market.

While “undue” pressure is a bad thing, at what point is a claim of undue pressure a pretext to defend against lenders’ concerns of appraisal quality? How does one distinguish between proper and improper pressure on appraisers?

A. Federal Efforts to Ensure Appraiser Independence and Competence

Serious concerns about appraiser independence are not new. The issue attracted significant attention of policymakers during the fallout of the savings and loan crisis of the 1980s. In response to that crisis, Congress enacted the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA).3 FIRREA instituted a complex scheme of appraisal reforms designed to enhance the quality and integrity of appraisals for mortgage loans, including the establishment by the federal banking agencies of federal appraisal standards that meet the Uniform Standards of Professional Appraisal Practice (USPAP). Subsequent banking agency regulations and guidelines4 prescribed rules concerning the selection and monitoring of appraisers, market value approaches that an appraiser should use, when the lender may engage an appraiser to perform a limited as opposed to a complete appraisal, and which transactions do not require an appraisal, as such.5

Federal banking agency regulations under FIRREA attempted to address appraiser independence, but those regulations are broadly and simply worded. They require that appraisers be “independent,” and “have no direct or indirect interest” in the property, but generally give lenders latitude to determine how to comply.6 The agencies subsequently determined that the appraiser independence requirements should

be bolstered and issued additional guidance in 1994. The 1994 Interagency Appraisal and Evaluation Guidelines emphasized “non-preferential and unbiased” evaluations, by persons with the requisite education and expertise.7 This Interagency Guidance clarified that if a financial institution could not achieve “absolute lines of independence” between its appraisal function and loan production and collection functions, the institution “must be able to clearly demonstrate that it has prudent safeguards to isolate its collateral evaluation process from influence or interference from the loan production process,” or at least must prohibit any loan officer or director who performs a property appraisal evaluation from voting whether to approve or deny credit in the transaction.8

The 2003 efforts of the agencies once again to address defective property valuation concerns resulted in a joint statement on independent appraisal and evaluation functions,9 which warned that bank examiners will review financial institutions’ appraiser independence procedures, and that violators of the guidelines could be subject to enforcement actions.10 Finally, in 2005, the agencies jointly issued more guidance for selecting and ordering appraisals, accepting outside appraisals, reviewing appraisals, and selecting individuals to perform evaluations as opposed to appraisals.11

Additional measures to promote appraiser independence can be found in a number of other sources, including the guidelines of Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA).

Given all these rules and guidance, why have Attorney General Cuomo, Congress, and the Federal Reserve Board reached in to set new standards for appraisers? First, while the interrelationship of the various appraiser overseers is certainly complex, the states have not been vigorous in enforcing appraiser standards in response to complaints. According to the most recent Annual Report to Congress of the FIRREA-created Appraisal Subcommittee, at least 60 percent of the state appraiser regulatory agencies failed to uphold their 2006 enforcement responsibilities.12 At a symposium on mortgage fraud held by the Appraisal Foundation, a panelist from Fannie Mae stated that a third of the states respond well to cases alleging appraisal fraud, approximately one-third of them can take up to three years to respond to a referral, and another third do nothing.13 Inadequate resources and insufficient

March 2008 | 3


authority of the Appraisal Subcommittee over state appraisal boards are commonly considered key reasons for this enforcement shortfall.14 However, in the past several years a number of state legislatures have passed legislation prohibiting appraiser coercion,15 and many have considered or are considering similar measures.16 With Attorney General Cuomo’s setting an example, it is likely that states will be more empowered, and will have a greater mandate, to oversee appraiser problems.

Second, federal policymakers traditionally focused on appraisals in connection with commercial mortgage loans (which have a larger impact on their safety and soundness, and were considered important risk factors during the savings and loan crisis), and not appraisals for smaller, more highly regulated residential mortgage loans. Not until 2005 did the agencies expressly clarify in published FAQs that their appraisal guidance applies to both residential and commercial mortgage loans.17 Third, the federal banking agencies’ appraisal regulations apply only to depository institutions and their operating subsidiaries, and not to state chartered or regulated lenders. While the appraisal standards of Fannie Mae, Freddie Mac, and FHA may cover the activities of those lenders, not all states have sought to replicate the requirements imposed on federally chartered institutions, particularly in connection with the appraisers themselves.

II. APPRAISAL REFORM

In light of the belief that faulty appraisals are in part responsible for the large number of underwater borrowers during this mortgage credit crisis, and in response to the perceived void in appraiser controls, in the fall of 2007 both houses of Congress have proposed legislation amending the federal Truth in Lending Act (a law otherwise largely aimed at disclosing the cost of consumer credit) to impose appraiser independence requirements and standards of care. Around that time, Attorney General Cuomo was reportedly conducting investigations into a large real estate appraisal management company regarding pressured, collusive, and/or inflated appraisals, and filed suit against that company. Attorney General Cuomo then issued subpoenas to Fannie Mae and Freddie Mac and demanded an Independent Examiner to review all the appraisals for mortgages purchased by those entities from one of their largest customers.

While the U.S. House of Representatives has sent its appraiser reform bill (discussed below) to the Senate, and the Senate continues to consider its own reform bill, the Federal Reserve Board several weeks ago issued a proposed rule to amend its regulations under the Truth in Lending Act, including provisions on appraiser coercion. That rule is open for public comment until April 8, 2008, and after considering those comments, the Federal Reserve can finalize those provisions. However, Attorney General Cuomo decided not to wait for the outcome of those efforts, announcing last week that he had entered into Cooperation Agreements with Fannie Mae, Freddie Mac, and OFHEO, in which the entities agreed they will buy loans only from lenders that meet new standards designed to ensure independent and reliable appraisals.

The principal focus of all four appraisal reform proposals (the two bills in Congress, the Federal Reserve proposed rule, and the Cooperation Agreements) is to strengthen the independence of appraisers from any improper, coercive influences of loan transaction insiders. They also, at least to some degree, touch upon the perceived problems with federal appraisal policy discussed above – weak enforcement at a state level, lack of focus on residential mortgage loans, and lack of rules for non-depository, state chartered entities. Notably, however, none of the proposals conditions a violation on the production of an inaccurate appraisal (although as described below, one proposal contains fairly severe consequences to the loan holder for such inaccuracies).

In this Alert, we first examine the appraiser provisions of each proposal, and then review what each proposal would offer to enforce them.

A. Fannie Mae/Freddie Mac Cooperation Agreements

The Cooperation Agreements have two major components. First, Fannie Mae and Freddie Mac must implement a new Home Valuation Code of Conduct (the “Valuation Code” or “Code”),18 which articulates standards designed to ensure the independence of appraisers from undue influence by interested parties. With a few minor exceptions for select requirements, all lenders making loans to be purchased by Fannie Mae or Freddie Mac (and not just those lenders in New York, or loans to residents or secured by property in the state) must adhere to the Code in order for their loans (other

March 2008 | 4


than government-insured loans) to be eligible for sale to or securitization with Fannie Mae and Freddie Mac. The new rules are scheduled to take effect January 1, 2009, after a comment period for “market participants.” The Agreements commit Fannie Mae and Freddie Mac to a “good faith review” of comments submitted and to “consider any amendments to the Code necessary to avoid any unforeseen consequences.”

Unlike the other governmental proposals on appraisal reform discussed in this Alert, the proposed Valuation Code would proscribe not only certain types of conduct, but also certain relationships that the New York Attorney General has determined, rightly or wrongly, may give rise to undue influence on appraisers. These prohibited relationships would violate the proposed Code regardless of whether the relationships actually result in inappropriate pressure in a particular instance or in an inaccurate appraisal. For example, lenders would not be able to rely upon appraisers “selected, retained, or compensated in any manner” by mortgage brokers, real estate agents, or any other third party. Lenders also could not use appraisers employed by the lender or any of its affiliates or from an affiliated appraisal management company, even if the company merely retains appraisers under independent contracts (rather than under full employment. While not free from doubt, lenders apparently could use appraisals by contract appraisers retained by an unaffiliated appraisal management company, but not by appraisers employed by the company.

Second, Fannie Mae and Freddie Mac must fund a new Independent Valuation Protection Institute (the “Valuation Institute” or “Institute”), tasked with implementing, monitoring, and (as needed) proposing amendments to the Valuation Code. In addition, the Institute must establish a nationwide complaint hotline for consumers concerned that the appraisal in connection with their home mortgage loan suffered from a lack of independence. The Institute is authorized to mediate consumer and appraiser complaints, refer those complaints to federal or state regulators, or forward them to state or federal law enforcement agencies for possible investigation or prosecution. The Institute will be governed by an independent Board of Directors to be approved by the New York Attorney General’s Office and OFHEO.

1. Applicability

The Cooperation Agreements expressly apply to single-family mortgage loans intended for sale to Fannie Mae or Freddie Mac. In addition, the specific appraiser independence measures of the proposed Valuation Code would apply not only to lenders (with the exception of “small banks” under certain circumstances), but also to any “employee, director, officer, or agent of the lender, or any other third party acting as joint venture partner, independent contractor, appraisal management company, or partner on behalf of the lender.”19 As a result, the Agreements broaden the application of appraiser independence rules beyond commercial mortgage loans, and beyond federally chartered depository institutions and their operating subsidiaries.

2. Requirements and Prohibitions

The proposed Valuation Code would prohibit a broad range of actions that “influence the development, reporting, result, or review of an appraisal.”20 Thus prohibited conduct could include not only certain communications with appraisers, but any action that could be construed as an inappropriate attempt to influence appraisal results. Specifically, the Code provides as follows:

No employee, director, officer, or agent of the lender, or any other third party acting as joint venture partner, independent contractor, appraisal management company, or partner on behalf of the lender, shall influence or attempt to influence the development, reporting, result, or review of an appraisal through coercion, extortion, collusion, compensation, instruction, inducement, intimidation, bribery, or in any other manner.21

Of the terms used to describe prohibited conduct, “coerce,” “extort,” and “bribe” are recognizable legal terms commonly appearing in state and federal criminal codes. Thus, for example, California’s recently enacted appraiser independence provision is more limited, prohibiting “improperly influencing” an appraisal through “coercion, extortion, and bribery.”22 However, even those three terms in California and under the Code are vulnerable to intractable interpretative battles, and the other Code terms are as well. The prohibition on “instruction,” for instance, may be particularly

March 2008 | 5


worrisome. Lenders routinely review appraisals to ensure that they reflect all relevant data, and may ask an appraiser to reconsider the valuation. At what point would this type of legitimate and beneficial exchange constitute prohibited “instruction”?

The Code partially tempers those vagueness concerns with a lengthy list of examples of prohibited conduct, as follows:

• Withholding or threatening to withhold timely payment for an appraisal report or future business for an appraiser;

• Expressly or impliedly promising future business or increased compensation for an appraiser

• Demoting or terminating or threatening to demote or terminate an appraiser;

• Conditioning the ordering of an appraisal or the payment of a fee on the valuation to be reached;

• Requesting estimated, predetermined, or desired valuations prior to the appraiser’s completion of an appraisal report;

• Providing to an appraiser a desired value or a target amount to be loaned (although a copy of the sales contract may be provided, if applicable); (Under USPAP, an appraiser must ascertain a sale price.);27

• Providing to an appraiser or person related to the appraiser stock or other financial or nonfinancial benefits;

• Removing an appraiser from a qualified appraiser list without prior written notice, which notice must include written evidence of the appraiser’s illegal conduct, a violation of USPAP or state licensing standards, substandard performance, or otherwise improper or unprofessional behavior; (Does this mean that a lender cannot terminate a contract appraiser without cause?);

• Ordering, obtaining, using, or paying for a second or subsequent appraisal or automated valuation model in connection with a mortgage financing transaction, unless there is a reasonable basis to believe that the initial appraisal was flawed and that basis is noted

in the loan file, or unless the appraisal or automated valuation model is done pursuant to a bona fide pre- or post-funding appraisal review or quality control process; or

• Any other act or practice that impairs or attempts to impair an appraiser’s independence, objectivity, or impartiality.24

Also, the proposed Valuation Code specifies a few activities that would not be considered a violation, which could give lenders and others more comfort in taking at least these named actions:

• Requesting that an appraiser provide additional information or explanation about the basis for a valuation; or

• Requesting that an appraiser correct objective factual errors in an appraisal report.25

While those examples are an attempt to allow certain communications with appraisers, they are narrow, and it is unclear whether they would allow, for example, a lender to provide the appraiser with additional objective information important to the valuation conclusion.

3. Relationship Restrictions

Sure to be especially controversial are several provisions of the proposed Valuation Code that restrict lenders’ use of appraisals from certain sources. As mentioned above, lenders may not accept an appraisal report by an appraiser “selected, retained, or compensated in any manner” by any third party not “specifically authorized” by the lender – “including mortgage brokers and real estate agents.”26 This restriction has the potential to stymie mortgage brokers in some of their most basic functions. Mortgage brokers typically shop loans among a number of lenders. Prudent lenders generally cannot commit to making a brokered loan without an appraisal. Thus, brokers typically order an appraisal so that they can prepare the full loan packages they normally present to their various lenders. If the onus to undertake the appraisal is solely on the lender, the broker may be limited in its shopping efforts and thus limited in the options it can offer to potential borrowers. This restriction raises questions under the federal Real Estate Settlement Procedures Act (RESPA), as well, since that statute requires mortgage brokers to perform certain functions – such as “initiating/ordering appraisals” – to justify receiving compensation.27

March 2008 | 6


In addition, a lender also may not underwrite a loan using an appraisal report prepared by an appraiser employed by: (1) the lender, (2) an affiliate of the lender, (3) an entity owned wholly or partially by the lender, (4) an entity that wholly or partially owns the lender, (4) a “settlement services” provider (as defined under RESPA28), or (5) an entity owned wholly or partially by a “settlement services” provider.29 “Small banks” are not required to adhere to items (1)–(4), above, subject to Fannie Mae’s or Freddie Mac’s determination that “undue hardship” would result.30

The prohibition on appraisals by an appraiser “employed by” a “settlement services” provider sweeps in everyone involved in the process of originating a mortgage loan, including appraisal management companies (AMCs). In effect, lenders selling to Fannie Mae or Freddie Mac could not use appraisers employed by AMCs, whether or not affiliated with the lender.

The proposed Valuation Code treats contract appraisers differently from employee appraisers. First, the Code expressly disallows using any appraisal report obtained by or through an affiliated AMC, regardless of whether the appraiser is an employee or an independent contractor.31 This restriction applies unless the lender’s ownership percentage in the AMC is under 20 percent, the lender has no involvement in the AMC’s day-to-day business operations, the AMC is operated independently, and the lender has no involvement in selecting individual appraisers or panel of approved appraisers used by the AMC.32 Second, at first glance it appears that lenders would be permitted to use appraisals by appraisers “retained” (presumably as independent contractors) by unaffiliated AMCs.33 Undermining this conclusion, however, is the outright prohibition on a lender accepting an appraisal report completed by an appraiser retained by any third party not “specifically authorized by the lender.”34 What is required to “specifically authorize[]” a third party? Given this lack of clarity, it is possible that this provision could in practice prohibit the use of AMCs.

While in-house staff appraisers cannot perform appraisals for the lender, they can order appraisals, review appraisals (pre-funding or post-funding), develop or use internal automated valuation models, or prepare appraisals in connection with transactions other than mortgage origination transactions (e.g., loan workouts).35

With all these restrictions on the relationship between a lender and an appraiser, it’s difficult to see who is left to perform the work. The industry likely will give Fannie Mae and Freddie Mac an earful on these provisions during the proposed comment period.

Neither the Attorney General’s press release announcing the Cooperation Agreements nor the Agreements themselves provides any meaningful support for the position that the performance of appraisals by or through employees of the lender or any affiliated AMC materially increases the likelihood of faulty appraisals in any systematic or material way. Indeed, federal appraisal regulations have not opposed such arrangements in the past, instead focusing on the clear separation of the production side of the business from the valuation side. Proposed federal regulations would trigger the notice and comment requirements of the Administrative Procedures Act to provide public debate of the merits of the proposed action. Proposed federal law likely would be accompanied by Congressional hearings and the opportunities for meetings with Congressional staffers to test the premise. The execution of a cooperation agreement in lieu of publicly reported threats of a lawsuit provides no meaningful opportunity to challenge the underlying premise.

4. Likely Impact of Cooperation Agreements

Several aspects of the Cooperation Agreements are unclear, including how long members of the Institute’s Board of Directors will serve and how the Institute will be funded after the first five years of Fannie Mae/Freddie Mac start-up contributions. In addition, most of the requirements of the Agreements (all except those related to the Institute, such as the five-year funding obligation) are set to terminate 28 months from the date of the Agreements (i.e., by July 2010). Thus, while Fannie Mae and Freddie Mac will have amended their guidelines to reflect the Code and using the eligibility requirements in purchasing loans since January 1, 2009, they will apparently be able to reverse those guidelines and purchase restrictions after essentially a year-and-a-half.

In essence, the Cooperation Agreements represent a decisive repudiation of the effectiveness of current federal appraisal rules and Fannie/Freddie appraisal guidelines to stem the alleged tide of inflated appraisals. Nonetheless, the new Valuation Code likely

March 2008 | 7


will not supplant the USPAP, which provides detailed guidelines on how appraisals must be conducted and is primarily directed to appraisers. Similarly, it is doubtful the new Institute will supplant the appraisal bodies established in connection with FIRREA (the Appraisal Foundation, Appraisal Standard Board, and the Appraisal Subcommittee of the Federal Financial Institutions Examination Council), although their roles will certainly change. Overall, the significance of the Cooperation Agreements and the companion Valuation Code cannot be understated, given that Fannie Mae and Freddie Mac purchase a substantial number of home loans originated in the United States (and their market share may increase, at least temporarily, with the significant raise in their loan limits under the recent economic stimulus package).36

B. The Frank Bill

Congress is not likely to discontinue its appraisal reform efforts as a result of the New York Attorney General’s initiative with Fannie Mae and Freddie Mac. One of the proposals that has progressed the farthest is part of the Mortgage Reform and Anti-Predatory Lending Act (H.R. 3915), which was sponsored by Rep. Brad Miller and co-sponsored by Rep. Barney Frank, Chairman of the House Committee on Banking, Housing, and Urban Affairs) (the “Frank Bill”). The Frank Bill has passed the House of Representatives and is under consideration in the Senate.

1. Applicability

Like the Cooperation Agreements, the Frank Bill’s appraisal requirements expressly apply to residential mortgage loans (specifically, to consumer creditor transactions secured by the consumer’s principal dwelling), although several of the Bill’s appraisal-related provisions apply only to high-cost loans subject to the federal Home Ownership and Equity Protection Act (HOEPA). Another appraiser independence measure in the Bill, which appears intended to be free-standing and not necessarily part of the Truth in Lending Act, apply even more broadly, to any “real estate transaction involving an appraisal.”37 In addition, the Frank Bill requires the federal banking agencies to reevaluate their threshold level ($250,000) for transactions requiring appraisals and to determine “in writing that the threshold level provides reasonable protection for consumers who purchase 1-4 unit single-family residences.”38 This could result in more

residential loan transactions being subject to a full appraisal rather than a less rigorous “evaluation.”39

Also like the Cooperation Agreements, the Frank Bill broadens the application of its appraiser independence rules beyond federally chartered depository institutions and their operating subsidiaries. In this regard, the Frank Bill is the most expansive of the four proposals, applying strictures against appraiser coercion to “mortgage lenders, mortgage brokers, mortgage bankers, real estate brokers, appraisal management companies, employees of appraisal management companies, and any other person with an interest in a real estate transaction.”40


The Frank Bill’s appraiser independence language is similar to that of the proposed Valuation Code for Fannie Mae and Freddie Mac in content and breadth. For loans secured by the borrower’s principal dwelling, the Frank Bill defines the following as “unfair and deceptive practices” by one of the persons identified above:

Any appraisal of a property offered as security for repayment of the consumer credit transaction [] in which a person with an interest in the underlying transaction [indicated above] compensates, coerces, extorts, colludes, instructs, induces, bribes, or intimidates a person conducting or involved in an appraisal, or attempts to compensate, coerce, extort, collude, instruct, induce, bribe, or intimidate such a person, for the purpose of causing the appraised value assigned, under the appraisal, to the property to be based on any factor other than the independent judgment of the appraiser.41

Similarly, for any “real estate transaction” generally, no person listed above may do the following:

[I]mproperly influence, or attempt to improperly influence, through coercion, extortion, collusion, compensation, instruction, inducement, intimidation, non-payment for services rendered, or bribery, the development, reporting, result, or review of a real estate appraisal sought in connection with a mortgage loan.42

Like the proposed Valuation Code, the Frank Bill provides three specific prohibited actions to the general

March 2008 | 8


“catch-all” provision, applicable to transactions secured by a borrower’s principal dwelling:

• M i s c h a r a c t e r i z i n g o r s u b o r n i n g a mischaracterization of the appraised value of the securing property;

• Seeking to influence the appraiser or otherwise to encourage a targeted value to facilitate the making or pricing of the transaction; and

• Failing to timely compensate an appraiser for a completed appraisal regardless of whether the transaction closes.43

Second, the Frank Bill, like the proposed Valuation Code, lists actions that would not constitute a violation, namely, asking an appraiser to provide one or more of the following services:

• Consider additional, appropriate property information, including the consideration of additional comparable properties to make or support an appraisal;

• Provide further detail, substantiation, or explanation for the appraiser’s value conclusions; or

• Correct errors on the appraisal report.44

3. Likely Impact of the Frank Bill’s Appraiser Requirements

As described above in connection with the proposed Valuation Code language, the Frank Bill’s appraiser independence language is expansive. Could a lender’s request that the appraiser consider additional data be considered an attempt to make the appraiser base the appraised value on “any factor other than [the appraiser’s] independent judgment”? Indeed, what if the independent judgment is simply and objectively wrong – what course of action is available to the lender?

C. THE DODD BILL

The Senate also is considering its own appraiser independence requirements and standards, in connection with its Homeownership Preservation and Protection Act (S.B. 2452, introduced and sponsored by Sen. Christopher Dodd, Chairman of the Senate Committee on Banking, Housing, and Urban Affairs) (the “Dodd Bill”). The appraiser independence provisions of the Dodd Bill share certain characteristics

of the Cooperation Agreements and the accompanying proposed Valuation Code, as well as the Frank Bill.

1. Applicability

Like the other provisions discussed above, the Dodd Bill’s appraisal provisions would expressly apply to a “home mortgage loan,” defined as “a credit transaction secured by a home, used or intended to be used as a principal dwelling, regardless of whether it is real or personal property, or whether the loan is used to purchase the home.”45 The Dodd Bill would similarly broaden the application of appraiser independence rules beyond federally chartered depository institutions and their operating subsidiaries. However, the Dodd Bill is markedly less inclusive than any of the other three proposals we address in this Alert. The Dodd Bill applies appraiser coercion prohibitions only to “lenders and loan servicers,”46 neither of which the Bill defines.


In general, the Dodd Bill would give lenders and others somewhat more latitude in communicating with appraisers than does the proposed Valuation Code or the Frank Bill. As noted above, the Dodd Bill’s appraiser independence provisions would apply only to “lenders and loan servicers.” It is unclear why the Dodd Bill addresses “loan servicers,” as they are not typically among those involved in the appraisal process. At the same time, the Dodd Bill does not address certain persons identified in some studies as greater sources of appraiser pressure – mortgage brokers, real estate agents, and consumers.

In addition, the Dodd Bill would actually prohibit comparatively little conduct. Specifically, the Dodd Bill provides that no lender or loan servicer may, with respect to a home mortgage loan, in any way:

• Seek to influence an appraiser or otherwise encourage a targeted value to facilitate the making or pricing of a home mortgage loan; or

• Select an appraiser on the basis of an expectation that the appraiser will provide a targeted value to facilitate the making or pricing of the home mortgage loan.47

The Dodd Bill focuses on conduct directed at achieving a “targeted value” for the securing property. While the prohibition on seeking to “influence” or “otherwise

March 2008 | 9


encourage” a targeted value is prohibited under the Frank Bill, the Dodd Bill’s second prohibition expressly addresses a separate issue (also addressed under the proposed Valuation Code) – the selection of an appraiser based on an expectation that the appraiser will arrive at a desired value for the home.

The Dodd Bill does not specify permitted actions as do the Valuation Code and the Frank Bill (as well as the FRB Proposed Rule, discussed below). The sponsors or drafters may not have deemed this necessary given the limited scope of the Bill’s appraiser independence provisions.

Finally, at odds with the goal of favoring open communication between appraisers and others, the Dodd Bill would prohibit including the requested loan amount, “or any estimate of value for the property [], express or implied,” in an appraisal order.48 As discussed above, that provision would reverse the longstanding recognition that the contract price can be an important and legitimate consideration in valuing property, including the policies of USPAP.

D. The FRB Proposed Rule

Clearly under pressure from Congress and others for not doing enough to forestall or correct the mortgage crisis, the Board of Governors of the Federal Reserve published in January a proposed rule offering amendments to the regulations under the Truth in Lending Act (the “FRB Proposed Rule”).49 The FRB Proposed Rule could be viewed as articulating a middle ground between the breadth and vagueness of the proposed Valuation Code and the appraiser independence language in the Frank Bill on the one hand, and the Dodd Bill’s minimalist approach to appraiser regulation on the other.

1. Applicability

In line with all the other proposals, the FRB Proposed Rule applies to residential mortgage loans – specifically, all “consumer credit transactions secured by the consumer’s principal dwelling.”50 Likewise, the FRB Proposed Rule broadens the application of appraiser independence rules beyond federally chartered depository institutions and their operating subsidiaries. Here, the FRB Proposed Rule is more inclusive than the Dodd Bill, but less so than the proposed Cooperation Agreement or Frank Bill. The FRB would apply its appraiser independence provisions to any “creditor or mortgage broker” or its affiliates.51 Interestingly,

while the FRB Proposed Rule would expressly address mortgage brokers, it would not reach real estate agents, appraisal management companies, consumers, or other potentially interested parties.

The FRB Proposed Rule’s list of expressly proscribed conduct is not as long as that of the Frank Bill, but more inclusive than that of the Dodd Bill. Specifically, a creditor or mortgage broker, or an affiliate of a creditor or mortgage broker, would be prohibited from directly or indirectly coercing, influencing, or otherwise encouraging an appraiser to misstate or misrepresent the value of the dwelling.52

The prohibited activities listed in the FRB’s proposed appraiser independence provisions are broad, encompassing any action to “directly or indirectly coerce, influence, or otherwise encourage an appraiser” to misrepresent a property value. Unlike the proposed Valuation Code or Frank Bill, however, the FRB Proposed Rule (and the Dodd Bill) would more narrowly apply to appraisers’ conduct, rather than lenders’ (or servicers’).53 However, the Frank Bill would prohibit a wider range of enumerated conduct toward, applicable not only to a person “conducting” an appraisal, but anyone “involved in an appraisal.”

The FRB Proposed Rule follows other proposals by providing specific examples of prohibited conduct. The FRB presents “examples” of violations, as follows:

• Implying to an appraiser that retention of the appraiser depends on the amount at which the appraiser values the consumer’s home;

• Failing to compensate an appraiser or to retain the appraiser in the future because the appraiser does not value a consumer’s principal dwelling; or

• Conditioning an appraiser’s compensation on loan consummation.

Finally, the FRB Proposed Rule includes examples of actions that are not violations of the anti-coercion provision. Those examples are much more comprehensive than those in the Frank Bill (though not as extensive as in the proposed Valuation Code), potentially giving lenders and brokers more leeway in their conduct with appraisers. FRB examples of actions that do not violate the above provision include:

March 2008 | 10


• Asking an appraiser to consider additional information about a consumer’s principal dwelling or about comparable properties;

• Requesting that an appraiser provide additional information about the basis for a valuation;

• Requesting that an appraiser correct factual errors in a valuation;

• Obtaining multiple appraisals of a consumer’s principal dwelling, so long as the creditor adheres to a policy of selecting the most reliable appraisal, rather than the appraisal that states the highest value;

• Withholding compensation from an appraiser for breach of contract or substandard performance of services as provided by contract;

Terminating a relationship with an appraiser for violations of applicable federal or state law or breaches of ethical or professional standards; or

Taking action permitted or required by applicable federal or state statute, regulation, or agency guidance.60

III. Enforcement

All four proposals addressed in this Client Alert would strengthen the enforcement of appraiser independence by expressly prohibiting coercive communications with and treatment of appraisers, and by including additional the enforcement measures, described below.

A. Fannie Mae/Freddie Mac Cooperation Agreements and Proposed Valuation Code

The Cooperation Agreements are obviously not designed to provide consumers with a private right of action against any party to the transaction. Instead, the principal enforcement measures of the Cooperation Agreements relate to the new Valuation Institute’s powers. The Institute is charged with, among other responsibilities, establishing and maintaining a nationwide “complaint hotline” for consumers with appraisal concerns, and serving as a contact point for appraisers with concerns that “their independence has been threatened in some way, including by undue pressure.”54 As mentioned above, the Institute may mediate consumer and appraiser complaints itself, refer them to federal or state regulators, or forward them to

state or federal law enforcement agencies for possible investigation or prosecution.55

In addition, lenders selling to Fannie Mae or Freddie Mac must establish telephone hotlines and email addresses to receive complaints from appraisers, borrowers, and other persons or entities about improper influence of appraisers.56 Lenders must disclose to appraisers and borrowers the existence and purpose of the complaint telephone lines and email addresses, and must comply with deadlines to begin investigating the complaint reporting improper conduct to the Valuation Institute and “any other relevant regulatory bodies.”57 Finally, lenders with reasons to believe an appraiser is violating applicable laws or engaging in other unethical conduct must promptly report it to the Valuation Institute and the applicable state appraiser certifying and licensing agency.58 Of course, it is not clear whether either entity will be more responsive to the complaints than in the past, although perhaps attention to the current crisis will increase scrutiny on follow-up and enforcement.

B. The Frank Bill

The Frank Bill also includes a number of administrative reforms aimed principally at tightening enforcement of federal appraisal rules and guidelines, and increasing resources available to fund enforcement.59 It appears that violations of the appraiser independence requirements could subject creditors to private rights of action by consumers for actual and statutory damages with the standard civil liability section of the TILA.60 In addition, for a first violation of those provisions (in a dwelling-secured transaction), a person would be subject to a civil penalty of $10,000 for each day the violation continues. For any subsequent violations, a person would be subject to a civil penalty of $20,000 each day the violation continues.61 Administrative enforcement is also authorized.62

The Frank Bill requires any person with an interest in any real estate-secured mortgage transaction to report suspicious appraisal activity to the appropriate state regulator.63 Finally, federal regulators must issue regulations necessary to carry out the anti-coercion and mandatory reporting provisions.64

C. The Dodd Bill

The Dodd Bill’s enforcement-related provisions are much more limited, although they would impose a unique provision requiring a holder to modify a loan

March 2008 | 11


that was over-valued, as explained below. Otherwise, the Dodd Bill imposes civil damages, but only on appraisers. This effectively means that the Bill would authorize no civil damages for those who are found to have coerced appraisers. Specifically, appraisers who violate any appraisal-related provisions of the Dodd Bill could be liable to consumers for actual damages, an amount of “not less than $5,000,” or costs of the action and attorneys’ fees.65 (One can guess the “or” in that provision may have been intended as an “and.”)

Private plaintiffs and state attorneys general are expressly authorized to bring an action under the Dodd Bill.66 Indeed, they may have grounds to do so fairly easily, as the terms “influence” and “encourage” under the Bill (and under other proposals) are sufficiently broad terms to support a range of allegations. Plaintiffs could, however, have a difficult time prevailing, as they would have to show not only evidence that the prohibited “influence,” “encourag[ment]” (or appraiser “select[ion]”) occurred, but also that a specific targeted value motivated the conduct. In addition, what specific consequences violators might face is unclear – the Dodd Bill does not provide for any specific civil or criminal penalties against “lenders or loan servicers” for violations of the appraiser independence provisions.

As mentioned above, a highly controversial measure in the Dodd Bill requires holders of a loan to modify and recast the loan – to retroactively lower the loan amount – when a retrospective appraisal shows inaccuracies above a certain tolerance (set at 10 percent, which tolerance level may be adjusted at regulator discretion), without regard to whether the lender or holder in any way acted inappropriately or illegally.67 The Bill does not indicate when retrospective appraisals might be required or appropriate, but the responsibility for loan recasting and modification would fall to holders and their loan servicers. The holder must recast the loan from the beginning to a loan amount that is the same loan-to-value ratio that the original loan purported to be, and to apply all payments made prior to the recasting to the reduced loan amount. In practice, this provision – effectively a loan forgiveness, regardless of who was at fault – might influence holders to avoid retrospective appraisals wherever possible, thus weakening a tool for appraiser accountability.

Another measure in the Dodd Bill raising concerns among appraisers is a requirement that appraisers post a bond that could be used to compensate borrowers and lenders for faulty appraisals.68 Appraisers fear

that this “qualifying bond” would be overly expensive and burdensome, forcing appraisers to pass the expense on to consumers, or under a worst-case scenario, to be driven out of business entirely. Further, the provision in fact does not propose a mechanism for collecting or administering these bonds, or assign to any regulatory agency the responsibility of implementing this requirement.


In keeping with TILA69 enforcement provisions, the FRB Proposed Rule would permit public and private civil actions for violations of the appraiser independence provisions, but only against creditors (and, for HOEPA loans, their assignees).70 Consumers bringing actions against creditors may be eligible for: (1) actual damages; (2) statutory damages in an individual action of up to $2,000, or, in a class action, total statutory damages of up to $500,000 or one percent of the creditor’s net worth, whichever is less; (3) special statutory damages up to the sum of all finance charges and fees paid by the consumer; and (4) court costs and attorneys’ fees.71

IV. Duty of Care

The question of whether an appraiser (or a lender employing or retaining an appraiser) owes a duty of care to the borrower, and thus could be held liable to the borrower for a faulty appraisal, remains unresolved by the courts. Unfortunately, the current federal appraisal reform proposals we discuss in this Alert, including the Fannie Mae and Freddie Mac Cooperation Agreements, do not answer the question, and in fact send a mixed message. The lack of legal clarity on this point could lead to exponentially greater litigation costs for the industry, as that question becomes central to the growing number of appraisal fraud cases.

The appraisal has historically been intended for use by the lender in determining whether to extend credit and how much to extend. Accordingly, the appraiser’s legal duty of care has most often been construed by courts and federal regulators as being to the lender, not to the borrower/purchaser.72 A minority of courts, however, have held that the appraiser has a duty to the borrower and thus can be held liable to the borrower for a bad appraisal. Those courts have based their decisions on determinations that borrower reliance on the appraisal was foreseeable and/or that the borrower in fact relied

March 2008 | 12


on the appraisal, as well as interpretations of state and federal appraisal laws.73

Regardless of whether the current proposals expressly define an appraiser’s (or lender’s) duty of care, measures that permit consumers to collect money damages could effectively make defining the duty of care less relevant. As explained above, the Cooperation Agreements and the proposed Valuation Code do not (and by their legal nature could not) authorize consumers to bring suits for money damages against alleged violators of the Code. The Frank Bill, on the other hand, enables consumers to sue violators of the appraisal independence provisions for money damages.74 Empowering consumers in that way indicates that those involved in the appraisal process are answerable to consumers.

The Dodd Bill, which states broadly that appraisers must “act with reasonable skill, care, diligence, and in accordance with the highest standards,” and that they must “act in good faith and fair dealing in any transaction,” does not expressly provide to whom they owe those duties. However, the Dodd Bill allows consumers to collect money damages against appraisers for violations of the appraisal provisions, and no other parties.75 This too points to a de facto duty of appraisers to consumers. Finally, the FRB Proposed Rule does not explicitly impose on appraisers a duty of care to consumers, but it provides that consumers may enforce violations by claims for money damages under the general civil liability provisions of TILA.76

Below, we address appraiser duties under the four proposals in detail.

A. Fannie Mae/Freddie Mac Cooperation Agreements and Proposed Valuation Code

Neither the Cooperation Agreements nor the companion Valuation Code expressly states that an appraiser or lender has a duty of care to the consumer in the appraisal process. However, the dominant tenor of the Agreement and Code is clearly one of consumer protection: “[The New York Attorney General’s Office] believes reforms are necessary . . . to protect consumers. . . .”77 More to the point, another express basis of the Cooperation Agreements is the assertion that, “The appraisal [] provides important information for consumers to consider in determining their best financial interest.”78 This statement directly counters

traditional views that the appraisal is strictly for the lender’s benefit.

In effect, all of the requirements in the Valuation Code can be read as intended to further consumer protection goals. However, of those expressly relating to consumers, worth mentioning again is the requirement that the lender must establish a complaint hotline for borrowers and must investigate and address these complaints within specified time periods.79 In addition, the lender must provide a copy of the appraisal to the borrower “immediately upon completion” and at least 3 days prior to closing the loan transaction.80 This appraisal disclosure requirement could diminish both appraiser and lender reliance on the defense that he or she could not have foreseen that the consumer would rely on or be harmed by the appraisal.

The Equal Credit Opportunity Act81 (ECOA) already requires the creditor to give the borrower either a copy of the appraisal or notice of his or her right to receive a copy of the appraisal.82 However, under ECOA the creditor has the option of requiring the borrower to request the appraisal in writing up to 90 days after receiving notice of the creditor’s credit decision. After receiving the borrower’s written request, the creditor then has 30 days to provide the appraisal – which could be well after the loan transaction occurs.83 In short, borrower reliance on the appraisal is less foreseeable under ECOA than under the Valuation Code.

B. The Frank Bill

The Frank Bill does not explicitly provide that an appraiser has a duty to the consumer, although it allows consumers to collect money damages against violators of the appraiser independence provisions. It also redefines the FIRREA/FFIEC Appraisal Subcommittee’s “mission” to include not only guarding the safety and soundness of financial institutions, but also “protect[ing] the consumer from improper appraiser practices and the predations of unlicensed appraisers.”84

In addition, the Frank Bill requires creditors to “provide” or “make available” a copy of the appraisal to the consumer at least three days before closing.85 As discussed above, the Frank Bill’s appraisal disclosure requirement could diminish appraiser and lender reliance on the defense that he or she could not have foreseen that the consumer would rely on or be harmed by the appraisal.

March 2008 | 13


On the other hand, however, the Frank Bill cuts against expanding appraiser liability to consumers by including a requirement that for HOEPA loans, lenders give consumers notice that the appraisal is expressly for the lender, but that the consumer may obtain an appraisal on her own if she wishes.86 To fend off consumer claims based on a faulty appraisal, lenders and appraisers could point to this disclosure. Still, courts could look past this disclosure if, for example, the facts of a given case indicate that consumer reliance on the lender-ordered appraisal was reasonable.

C. The Dodd Bill

Aside from allowing consumers to collect money damages against appraisers, the Dodd Bill sheds little light on the scope of an appraiser’s duty of care. The Bill includes language defining an appraiser’s “standard of care” and “duties,”87 as mentioned above, but it does not define the various broad terminology used to explain those duties, nor does it specify to whom those duties are owed.

Similar to the Valuation Code and Frank Bill, the Dodd Bill requires the “lender or loan servicer” in dwelling-secured loans to provide a copy of the appraisal to the applicant of a home mortgage loan, whether credit is granted, denied, or the application was withdrawn. The Bill does not specify timing for providing the appraisal copy, however, weakening arguments that this requirement could render a borrower’s reliance on the appraisal foreseeable.


The FRB Proposed Rule does not explicitly impose a duty of care on appraisers to consumers, but again, it does allow consumers to enforce violations by claims for money damages under the general civil liability provisions of TILA. It also prohibits a creditor from extending credit if the creditor “knows or has reason to know” at or before closing of a violation of the above provision in connection with the transaction.88 However, the creditor may extend credit on the original terms if it exercises “reasonable diligence” to confirm that the tainted appraisal was in fact accurate.96 The proposed Commentary clarifies that “reasonable diligence” means that the creditor must obtain a new appraisal. Thus, a lender may not be permitted to consummate a transaction but it does not have any specifically articulated duty of care to consumers.

* * * * *

Establishing a uniform standard for appraiser independence could reduce or eliminate the burden of complying with multiple state law independence standards, as well as give greater legal clarity to appraisers, other mortgage industry insiders, and consumers. However, the proposals do not provide for federal preemption of state law appraiser standards, to the extent they exist or to the extent they are enacted in the future.

One major challenge in establishing a uniform appraiser independence rule, however, is striking a balance between outlawing clearly harmful conduct on the one hand, while leaving room for the healthy communications between appraisers and lenders (and other interested parties) that can lead to better appraisals for a stronger mortgage credit market. Notably, none of the key appraisal proposals contain a “no harm/no foul” rule excluding liability where it ultimately is determined that an appraisal by an allegedly “coerced” appraiser in fact was materially correct. For all of the hullabaloo about undue pressure on appraisers, most large lenders have detailed appraisal review procedures to reduce the risk that an appraisal will be materially inaccurate – regardless of the circumstances under which the appraiser produced the appraisal. There might be lots of anecdotal information about allegedly undue appraisal pressure, but that is a far cry from establishing that the appraisals in fact were inaccurate.

Appraiser independence clearly is a “hot button” topic these days as part of the larger debate to understand what led to the subprime crisis and what should be changed to avoid future problems. Notwithstanding Fannie Mae’s and Freddie Mac’s heightened attention to appraisal fraud, it is not at all clear that undue pressure on appraisers or the routine production of materially inaccurate appraisals is systemic – particularly in connection with “prime” mortgage loans. What seems clear, however, is that many states have been unable to develop effective mechanisms to resolve complaints concerning appraisals within their state. Rather than deal with the specific state issues that may exist, the Cooperation Agreements try to develop a national solution, but without involving the states (other than New Y ork) in the process. For their part, the Frank Bill, Dodd Bill and FRB Proposed Rule demonstrate ways in which the federal government is trying to fill the state void.

March 2008 | 14


The coming months will be critical for establishing new appraisal rules that could impact the mortgage industry for decades to come. Comments on the Valuation Code will be fielded by Fannie Mae, Freddie Mac, and OFHEO. Congress will continue to negotiate and modify current legislative measures. The FRB comment period on the FRB Proposed Rule is still open (until April 8, 2008).

While these three proposals in final form may conform closely to the Code, the fear of lenders is that the government effectively will empower each of the appraisers to cry “wolf” every time a lender questions the quality of their work and consumers to sue lenders every time an appraisal proves to be inaccurate. Will a scheme designed to promote quality institutionalize mediocrity instead? Will lenders become guarantors of the value and condition of homes selected for purchase by consumers? Time will tell, but, ironically, under the Code and the federal proposals, the ultimate accuracy of the appraisal is irrelevant in determining the occurrence of a violation.

If you would like to weigh in on shaping new appraisal policies, K&L Gates can assist you. Please contact Larry Platt (202-778-9304; [email protected]) or Lorna Neill (202-778-0217; [email protected]).

1 See Home Value Protection Program and Cooperation Agreements among the New York Attorney General’s Office, Fannie Mae & Freddie Mac (respectively), and OFHEO, March 3, 2008 (together, the “Cooperation Agreements”), including the proposed Home Valuation Code of Conduct (the “Valuation Code” or “Code”) available on the Internet at http://www.fanniemae.com/newsreleases/2008/4291.jhtml?p=Media&s=News+Releases

Kris D. Kully & Laurence E. Platt, Regulating Wrongful Lending: Protecting Borrowers from Themselves, Mortgage Banking and Consumer Credit Alert, January 23, 2008. http://www.klgates.com/newsstand/Detail.aspx?publication=4242

3 Laurence E. Platt, R. Bruce Allensworth, Phoebe S. Winder, Andrew C. Glass, David D. Christensen, Consumers Clog Courts with Codified Care Claims, Mortgage Banking and Consumer Credit Alert, January 30, 2008. http://www.klgates.com/newsstand/Detail.aspx?publication=4260

4 Laurence E. Platt, Kristie D. Kully, Kerri M. Smith, Was Chicken Little Right?, Mortgage Banking and Consumer Credit Alert, February 15, 2008. http://www.klgates.com/newsstand/Detail.aspx?publication=4319

5 See Statement of Alan Hummel, Chair, Government

Relations, Appraisal Institute, “Ending Mortgage Abuse: Safeguarding Homebuyers,” Hearing before the Subcomm. on Banking, Hous., and Comm’y Dev. of the S. Comm. on Banking, Hous. and Urban Affairs, 110th Cong. 4 (June 26, 2007) (citing the October Research Corporation’s 2007 National Appraisal Survey).

6 Pub. L. No. 101-73, 103 Stat. 183 (1989).

7 See, e.g., 12 C.F.R. Part 34, subpart C; 12 C.F.R. § 208.18, Part 225, subpart G; 12 C.F.R. Part 323; 12 C.F.R. Part 564; OCC, FRB, FDIC, OTS, Interagency Appraisal and Evaluation Guidelines (Oct. 27, 1994); OCC, FRB, FDIC, OTS, NCUA, “Frequently Asked Questions on the Appraisal Regulations and the Interagency Statement on Independent Appraisal and Evaluation Functions” (March 22, 2005).

8 “Appraisal” is defined as “a written statement independently and impartially prepared by a qualified appraiser setting forth an opinion as to the market value of an adequately described property as of a specific date(s), supported by the presentation and analysis of relevant market information.” 12 C.F.R. §§ 225.62(a), 323.2(a), 34.42(a), 564.2(a). Appraisals of regulated institutions must meet certain minimum standards. See 12 C.F.R. §§ 225.64, 323.4, 34.44, 564.4. However, for certain transactions, the federal banking agencies have determined that “[a] formal opinion of market value prepared by a State licensed or certified appraiser is not always necessary.” See, e.g., 12 C.F.R. §§ 225.63(b), 323.3(b), 34.43(b), 564.3(b); see also Interagency Appraisal and Evaluation Guidelines (Oct. 27, 1994) (Anyone with “real estate-related training or experience and knowledge of the market relevant to the subject property” can perform an “evaluation” and the financial institution is permitted to determine in advance how comprehensive it wishes the evaluation to be).

9 See 12 C.F.R. §§ 225.65, 323.5, 34.45, 564.5.

10 OCC, FRB, FDIC, OTS, Interagency Appraisal and Evaluation Guidelines (Oct. 27, 1994).

11 Id.

12 See OCC, FRB, FDIC, OTS, NCUA, “Interagency Statement on Independent Appraisal and Evaluation Functions” (Oct. 28, 2003).

13 See id.

14 See OCC, FRB, FDIC, OTS, NCUA, “Frequently Asked Questions on the Appraisal Regulations and the Interagency Statement of Independent Appraisal and Evaluation Functions” (March 22, 2005).

15 See Appraisal Subcommittee, Federal Financial Institutions Examination Council, Annual Report 2006 (delivered to Congress on March 23, 2007), p. 7. Based on 23 on-site state reviews, the Appraisal Subcommittee found that 14 states “did not resolve complaints expeditiously or did not adequately document enforcement files”; two states did not forward disciplinary actions to the Appraisal Subcommittee

March 2008 | 15


as the law requires; one state sanctioned appraisers on an inconsistent basis; and one state failed to take appropriate action on a complaint involving a person with a state agency position.

16 See Lew Sichelman, “Most Fraud Charges Not Investigated,” Realty Times (summarizing comments by Mark Simpson, Director of Property Standards, Fannie Mae) (Oct. 18, 2006). Of 860 cases that Fannie Mae reported to state regulators during an 18-month period between 2001 and 2002, 469 cases had not been addressed as of October 2006.

17 See Statement of Alan Hummel, Chair, Government Relations, Appraisal Institute, “Ending Mortgage Abuse: Safeguarding Homebuyers,” Hearing before the Subcomm. on Banking, Hous., and Comm’y Dev. of the S. Comm. on Banking, Hous. & Urban Affairs, 110th Cong. 4 (June 26, 2007).

18 See, e.g., Ark. Code Ann. § 23-39-513; Cal. Civ. Code § 1090.5; Colo. Rev. Stat. §§ 6-7-717, 12-61-910.2; Iowa Code § 543D.18A; Mich. Comp. Laws § 445.1634; Minn. Stat. § 609.822; N.C. Gen. Stat. § 53-243.11; Ohio Rev. Code §§ 1322.07, 1345.031, 4763.12; Tenn. Code Ann. § 45-13-108; W.Va. Code § 31-17-8; Wy. Stat. § 40-23-117.

19 Additional states that have considered or are considering appraiser independence measures include, among others, Delaware, Georgia, Illinois, Missouri, New Hampshire, and New York.

20 Even before yesterday’s announcement of the Cooperation Agreements, attorneys general in Ohio and New York had gained recent attention for pursuing actions against alleged appraisal quality issues, although questions remain regarding the substance of the allegations. See, e.g., Ohio Office of Attorney General Marc Dann, 2007 Press Releases, “Dann Targets Brokers and lenders for undue influence” (June 7, 2007), http://www.ag.state.oh.us/press/07/06/pr070607.asp (visited Feb. 24, 2008); Office of the New York State Attorney General Andrew M. Cuomo, 2007 Press Releases, “NY Attorney General Sues First American and Its Subsidiary for Conspiring with Washington Mutual to Inflate Real Estate Appraisals” (Nov. 1, 2007), http://www.oag.state.ny.us/press/2007/nov/nov1a_07.html (visited Feb. 24, 2008). Perhaps the most influential state enforcement action prior to the Cooperation Agreements was the Ameriquest Settlement Agreement of 2006. This Agreement between Ameriquest Mortgage Company (and related affiliates) and state attorneys general and financial regulators contained numerous provisions on appraiser independence. See Settlement Agreement between ACC Capital Holdings Corporation et al. and State Attorneys General, State Financial Regulators and California District Attorneys (Jan. 23, 2006), pp. 22-29; see also “Visions of Mortgage Reform Underlie Multi-State Attorneys General Settlement”, Mortgage Banking/Consumer Finance Alert, by Ronald W. Stevens, Laurence E. Platt, Erin E.

Murphy (February 2006). http://www.klgates.com/files/Publication/ba3e8cdf-bac7-4d84-8fcf-258043d76714/Presentation/PublicationAttachment/abf01d6e-b78e-4560-ad47-0cebc940ab2c/MBC0206.pdf

21 See OCC, FRB, FDIC, OTS, NCUA, “Frequently Asked Questions on the Appraisal Regulations and the Interagency Statement of Independent Appraisal and Evaluation Functions” (March 22, 2005), Question #1.

22 See supra note 1.

23 Valuation Code, Part I.

24 Id.

25 Id. (emphasis added).

26 See Cal. S.B. 223 (codified at Cal. Civ. Code § 1090.5) (eff. Oct. 5, 2007).

27 USPAP Advisory Opinion 19 (AO-19: Unacceptable Assignment Conditions in Real Property Appraisal Assignments (Sept. 15, 1999) (emphasis added).

29 Valuation Code, Part I.

30 See id.

31 Id. Part III.

32 HUD Statements of Policy 1999-1 and 2001-1.

33 RESPA defines “settlement services” as

[A]ny service provided in connection with a real estate settlement including, but not limited to, the following: title searches, title examinations, the provision of title certificates, title insurance, services rendered by an attorney, the preparation of documents, property surveys, the rendering of credit reports or appraisals, pest and fungus inspections, services rendered by a real estate agent or broker, the origination of a federally related mortgage loan (including, but not limited to, the taking of loan applications, loan processing, and the underwriting and funding of loans), and the handling of the processing, and closing or settlement.

12 U.S.C. § 2602 (emphasis added).

Regulation X, implementing RESPA, defines “settlement services” as

[A]ny service provided in connection with a prospective or actual settlement, including, but not limited to, any one or more of the following:

(1) Origination of a federally related mortgage loan (including, but not limited to, the taking of loan applications, loan processing, and the underwriting and funding of such loans);

(2) Rendering of services by a mortgage broker (including counseling, taking of applications, obtaining verifications

March 2008 | 16


and appraisals, and other loan processing and origination services, and communicating with the borrower and lender);

(3) Provision of any services related to the origination, processing or funding of a federally related mortgage loan;

(4) Provision of title services, including title searches, title examinations, abstract preparation, insurability determinations, and the issuance of title commitments and title insurance policies;

(5) Rendering of services by an attorney;

(6) Preparation of documents, including notarization, delivery, and recordation;

(7) Rendering of credit reports and appraisals;

(8) Rendering of inspections, including inspections required by applicable law or any inspections required by the sales contract or mortgage documents prior to transfer of title;

(9) Conducting of settlement by a settlement agent and any related services;

(10) Provision of services involving mortgage insurance;

(11) Provision of services involving hazard, flood, or other casualty insurance or homeowner’s warranties;

(12) Provision of services involving mortgage life, disability, or similar insurance designed to pay a mortgage loan upon disability or death of a borrower, but only if such insurance is required by the lender as a condition of the loan;

(13) Provision of services involving real property taxes or any other assessments or charges on the real property;

(14) Rendering of services by a real estate agent or real estate broker; and

(15) Provision of any other services for which a settlement service provider requires a borrower or seller to pay.

24 C.F.R. § 3500.2 (emphasis added).

34 Valuation Code Part VI.

35 See Cooperation Agreements, Part I.1.

36 See Valuation Code, Part VI.

37 See id.

38 See id. Parts III and V.

39 Id. Part III.

40 See id. Part VI.

41 See Economic Stimulus Act of 2008, H.R. 5140 (enacted Feb. 7, 2008).

42 See H.R. 3915, § 703(m).

43 See id. § 703.

44 See supra note 8.

45 H.R. 3915, §§ 702, 703(m) (emphasis added).

46 H.R. 3915, § 702 (emphasis added). A “qualified appraiser” is defined as a state certified or state licensed appraiser who performs appraisals in conformity with USPAP and Title XI of FIRREA. See id. § 701.

47 Id. § 703(m) (emphasis added).

48 Id. § 702 The Bill also instructs federal agencies (the FRB, OTS, OCC, FDIC, NCUA, and FTC) to issue regulations that further specify “unfair and deceptive practices.” See H.R. 3915, § 702.

49 See id. §§ 702, 703(m).

50 S.B. 2452, § 401.

51 Id.

52 Id. § 401 (emphasis added).

53 Id.

54 73 Fed. Reg. 1672-1735 (Jan. 9, 2008).

55 Id. at 1701, 1726.

56 Id. For purposes only of the FRB’s proposed appraisal measures, “mortgage broker” is defined as a person who “for compensation or other monetary gain arranges, negotiates, or otherwise obtains an extension of consumer credit, but is not an employee of a creditor,” and expressly includes any person meeting this definition who “makes use of ‘table funding.’” Id. at 1726, 1734.

57 Id. at 1726 (emphasis added).

58 “Appraiser” is defined as “a person who engages in the business of providing assessments of the value of the dwellings” and includes persons that employ, refer, or manage appraisers and their affiliates. See id. at 1701, 1726.

59 Id.

60 Id.

61 Cooperation Agreements, Part II.5.

62 Id.

63 See Valuation Code, Part VII.

64 Id.

65 Id. Part IX.

66 See H.R. 3915, §§ 703-704. These include, among others, broadening the enforcement mandate of the Appraisal Subcommittee to include protecting consumers from improper appraisal practices; requiring the Appraisal Subcommittee to detail its audits of, and actions against, state appraisal agencies; increasing enforcement resources

March 2008 | 17


by raising the annual appraiser national registry fee; and requiring federal regulators to undertake a study of how to improve appraisal rule compliance and enforcement. See id.

67 See id. § 702.

68 See id.; see also id. § 701 (creditors who “willfully” fail to obtain an appraisal for a HOEPA loan in accordance with the requirements of Section 701 are liable to the consumer for $2,000).

69 See id. §§ 702 (for dwelling-secured mortgage loans in particular) and 703(m) (for real estate mortgage loans in general).

70 See id. § 703(m).

71 See id.

72 See S.B. 2452, § 401.

73 See id.

74 See id. If a retrospective appraisal shows that the original appraisal exceeded the true market value of the home by 10 percent or more, the holder of the loan must recast the loan to a loan amount that is at the same loan-to-value which the original loan would have been. The holder must apply any excess payments made prior to the recasting to the reduced loan amount. See id. The “regulatory agency which oversees appraisers in the jurisdiction in which the collateral is located” may issue rules permitting the 10 percent tolerance level to deviate by 2 percent “where local conditions warrant.” Id.

75 See id. Under the Dodd Bill, no appraiser could charge, seek, or receive compensation for an appraisal unless the appraisal is covered by a “qualifying bond” of not less than one percent of the aggregate value of all homes appraised by the appraiser for home mortgage loans in the calendar year preceding the date of the transaction. See id.

76 See 15 U.S.C. §§ 1601 et seq.

77 See 73 Fed. Reg. 1672-1735, 1716-1717 (citing 15 U.S.C. §§ 1639, 1640).

78 See id.

79 See, e.g., U.S. v. Neustadt, 366 U.S. 697 (1961).

80 See, e.g., Larsen v. United Fed. Sav. & Loan Ass’n of Des Moines, 300 N.W.2d 281, 283-284 (Iowa 1981); Costa v. Neimon, 366 N.W.2d 896, 900 (Wis. App. 1985); Rubin v. Century 21 Peterman Real Estate, Inc., 857 P.2d 1059, 1061-1062 (Wash. App. 1993)

81 See H.R. 3915, § 702; see also id. § 701 (creditors who “willfully” fail to obtain an appraisal for a HOEPA loan in accordance with the requirements of Section 701 are liable to the consumer for $2,000).

82 See S.B. 2452, § 401.

83 See 73 Fed. Reg. 1672-1735, 1716-1717 (citing 15 U.S.C. §§ 1639, 1640).

84 Cooperation Agreements, “Whereas” clauses (emphasis added).

85 Id.

86 See Valuation Code, Part VII.

87 Id. Part II.

88 See 15 U.S.C. §§ 1691 et seq. (implemented by Regulation B, 12 C.F.R. Part 202).

89 See 12 C.F.R. § 202.14.

90 See id.

91 See H.R. 3915, § 703(a).

92 For HOEPA loans, the Frank Bill requires creditors to give consumers one free copy of the appraisal at least “3 days” before closing. Id. § 701. For any other extension of credit secured by an interest in real estate (presumably including all other residential mortgage loans), the Frank Bill requires the creditor or “other mortgage originator” to “make available” to the applicant a copy of all appraisal valuation reports no later than “3 business days” prior to closing. Id. § 705.

93 See H.R. 3915, § 701. At the time of the initial mortgage application, creditors must provide consumers a notice that “any appraisal prepared for the mortgage is for the sole use of the creditor,” and that the consumer may choose to have a separate appraisal conducted at the consumer’s own expense. Id.

94 S.B. 2452, § 401. The Dodd Bill defines the appraiser “Standard of Care” as follows:

• For each home mortgage loan transaction, each appraiser must act with reasonable skill, care, diligence, and in accordance with the highest standards.

• Each appraiser must act in good faith and with fair dealing in any transaction, practice, or course of business associated with the transaction.

Id.

Appraiser “Duties” are identified as follows:

• All home mortgage loan appraisals must be accurate and reasonable.

• An appraiser cannot have any direct or indirect interest in the property to be appraised, the real estate transaction prompting the appraisal, or the home loan involved in the transaction.

Id.

95 73 Fed. Reg. 1672-1735, 1726.

96 Id.

March 2008 | 18


K&L Gates’ Mortgage Banking & Consumer Finance practice provides a comprehensive range of transactional, regulatory compliance, enforcement and litigation services to the lending and settlement service industry. Our focus includes first- and subordinate-lien, open- and closed-end residential mortgage loans, as well as multi-family and commercial mortgage loans. We also advise clients on direct and indirect automobile, and manufactured housing finance relationships. In addition, we handle unsecured consumer and commercial lending. In all areas, our practice includes traditional and e-commerce applications of current law governing the fields of mortgage banking and consumer finance.

For more information, please contact one of the professionals listed below.

LAWYERS

Boston R. Bruce Allensworth [email protected] +1.617.261.3119 Irene C. Freidel [email protected] +1.617.951.9154 Stephen E. Moore [email protected] +1.617.951.9191 Stanley V. Ragalevsky [email protected] +1.617.951.9203 Nadya N. Fitisenko [email protected] +1.617.261.3173 Brian M. Forbes [email protected] +1.617.261.3152 Andrew Glass [email protected] +1.617.261.3107 Phoebe Winder [email protected] +1.617.261.3196Los Angeles Thomas J. Poletti [email protected] +1.310.552.5045Miami Paul F. Hancock [email protected] +1.305.539.3378 Melissa Sanchez [email protected] +1.305.539.3373 New York Elwood F. Collins [email protected] +1.212.536.4005 Steve H. Epstein [email protected] +1.212.536.4830 Drew A. Malakoff [email protected] +1.216.536.4034San Francisco Jonathan Jaffe [email protected] +1.415.249.1023 Erin Murphy [email protected] +1.415.249.1038Seattle Holly K. Towle [email protected] +1.206.370.8334Washington, D.C. Costas A. Avrakotos [email protected] +1.202.778.9075 Melanie Hibbs Brody [email protected] +1.202.778.9203 Eric J. Edwardson [email protected] +1.202.778.9387 Steven M. Kaplan [email protected] +1.202.778.9204 Phillip John Kardis II [email protected] +1.202.778.9401 Rebecca H. Laird [email protected] +1.202.778.9038 Laurence E. Platt [email protected] +1.202.778.9034 Phillip L. Schulman [email protected] +1.202.778.9027 H. John Steele [email protected] +1.202.778.9489 Ira L. Tannenbaum [email protected] +1.202.778.9350 Nanci L. Weissgold [email protected] +1.202.778.9314 Anthony C. Green [email protected] +1.202.778.9893 Kris D. Kully [email protected] +1.202.778.9301

March 2008 | 19


K&L Gates comprises multiple affiliated partnerships: a limited liability partnership with the full name Kirkpatrick & Lockhart Preston Gates Ellis LLP qualified in Delaware and maintaining offices throughout the U.S., in Berlin, and in Beijing (Kirkpatrick & Lockhart Preston Gates Ellis LLP Beijing Representative Office); a limited liability partnership (also named Kirkpatrick & Lockhart Preston Gates Ellis LLP) incorporated in England and maintaining our London office; a Taiwan general partnership (Kirkpatrick & Lockhart Preston Gates Ellis) which practices from our Taipei office; and a Hong Kong general partnership (Kirkpatrick & Lockhart Preston Gates Ellis, Solicitors) which practices from our Hong Kong office. K&L Gates maintains appropriate registrations in the jurisdictions in which its offices are located. A list of the partners in each entity is available for inspection at any K&L Gates office.

This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.

Data Protection Act 1998—We may contact you from time to time with information on Kirkpatrick & Lockhart Preston Gates Ellis LLP seminars and with our regular newsletters, which may be of interest to you. We will not provide your details to any third parties. Please e-mail [email protected] if you would prefer not to receive this information.

©1996–2008 Kirkpatrick & Lockhart Preston Gates Ellis LLP. All Rights Reserved.

David L. Beam [email protected] +1.202.778.9026 Emily J. Booth [email protected] +1.202.778.9112 Krista Cooley [email protected] +1.202.778.9257 David G. McDonough, Jr. [email protected] +1.202.778.9207 Lorna M. Neill [email protected] +1.202.778.9216 Staci P. Newman [email protected] +1.202.778.9452 Stephanie C. Robinson [email protected] +1.202.778.9856 Kerri M. Smith [email protected] +1.202.778.9445 Holly M. Spencer [email protected] +1.202.778.9853 Morey E. Barnes [email protected] +1.202.778.9215 Elena Grigera [email protected] +1.202.778.9039

DIRECtoR oF LICEnSIng

Washington, D.C. Stacey L. Riggin [email protected] +1.202.778.9202

REguLAtoRY ComPLIAnCE AnALYStS

Washington, D.C. Dameian L. Buncum [email protected] +1.202.778.9093 Nancy J. Butler [email protected] +1.202.778.9374 Teresa Diaz [email protected] +1.202.778.9852 Jennifer Early [email protected] +1.202.778.9291 Marguerite T. Frampton [email protected] +1.202.778.9253 Robin L. Gieseke [email protected] +1.202.778.9481 Joann Kim [email protected] +1.202.778.9421 Brenda R. Kittrell [email protected] +1.202.778.9049 Dana L. Lopez [email protected] +1.202.778.9383 Jeffrey Prost [email protected] +1.202.778.9364

mortgage banking alert - k&l gates · mortgage fraud held by the appraisal foundation, a...

Documents