Confidential Report

Transcript

REPORT TO FANNIE MAE REGARDING SHAREHOLDER COMPLAINTS BY MR. NYE LAVALLE OCJ CASE NO. 5595 BAKER & HOSTETLER LLP Mark A. Cymrot Ambika Biggs Washington Square, Suite 1100 1050 Connecticut Avenue, N.W. Washington, D.C. 20036 T 202.861.1500 F 202.861.1783 www.bakerlaw.com May 19,2006 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE Cincinnati Cleveland Columbus Costa Mesa Denver Houston Los Angeles New York Orlando Washington, DC TABLE OF CONTENTS Page I. EXECUTIVE SUMMARy ............................................................................................... 1 1. Foreclosure Policies and Procedures ......................................................... 4 Transparency .............................................................................................. 7 Protection of Promissory Notes ................................................................. 9 Predatory Servicing .................................................................................. 10 Fraud Detection and Reporting ................................................................ 12 2. 3. 4. 5. II. A. THE PROBLEM IN FORECLOSURES ......................................................................... 16 Mr. Lavalle's Assertions about Foreclosures ....................................................... 16 MERS Foreclosure Procedures ............................................................................ 18 MERS Florida Embarrassment ............................................................................ 20 False Statements May Be Occurring Elsewhere .................................................. 23 Servicers Standing to Foreclose ........................................................................... 26 Fannie Mae's Current Policy on Foreclosures ..................................................... 27 Fannie Mae's Oversight of Foreclosure Attorneys .............................................. 30 Proposal for Changes in Foreclosure Procedures ................................................ 33 Findings on Foreclosure Procedures .................................................................... 34 Mr. Lavalle's Plea for Transparency ................................................................... 35 Effects of Note Endorsed In Blank ...................................................................... 37 MERS Impact on Transparency ........................................................................... 39 Reasons for Endorsement and Recording Policies .............................................. 40 Disclosures to Borrowers ..................................................................................... 42 Findings Regarding Transparency ....................................................................... 43 Mr. Lavalle's Concerns ........................................................................................ 44 Borrower's Risk to a Holder in Due Course ........................................................ 46 Fannie Mae's Herndon Custody Facility ............................................................. 47 Other Certified Custodians .................................................................................. 50 -iCONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE B. C. D. E. F. G. H. I. III. TRANSPARENCY ISSUE .............................................................................................. 35 A. B. C. D. E. F. IV. PROMISSORY NOTE POLICIES .................................................................................. 44 A. B. C. D. TABLE OF CONTENTS (continued) Page VII. ACCOUNTING AND SECURITIES FRAUD ............................................................. 128 A. B. Fannie Mae's Financial Investigations and Reviews ......................................... 128 Mr. Lavalle's Accounting and Securities Concerns .......................................... 130 1. 2. 3. 4. Impact of Servicer Frauds ...................................................................... 130 Promissory Notes in MBS Pools ............................................................ 133 True Sale Opinions ................................................................................ 133 Impact of Holder Status During Foreclosures ....................................... 134 C. D. Servicer Reports of Financial Transactions ....................................................... 135 Under-Collateralization ofMBS Pools .............................................................. 135 1. 2. 3. Paid Off Promissory Notes .................................................................... 135 Duplicate Loans for Same Property ....................................................... 136 Inflated Property Appraisals .................................................................. 137 E. F. G. True Sale Opinions ............................................................................................ 138 Accounting for Holder Status in Foreclosure .................................................... 141 Findings Regarding Accounting and Securities Fraud ...................................... 142 -111- CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE I. EXECUTIVE SUMMARY The Office of Corporate Justice has retained Baker & Hostetler LLP to conduct an independent investigation of concerns expressed by Mr. Nye Lavalle, a Fannie Mae shareholder, about several Fannie Mae business practices in connection with single-family mortgages. 1 Mr. Lavalle accuses Fannie Mae of "aiding, abetting and sanctioning ... predatory lending and servicing schemes," as well as committing accounting and securities fraud, and racketeering violations. He views Fannie Mae as responsible for damage inflicted on single-family borrowers by unscrupulous lenders and servicers because Fannie Mae approves lenders and servicers, maintains servicer profiles and ratings, approves mortgage document terms and servicing requirements, and benefits from the income stream created by wrongdoing. He fears Fannie Mae's alleged failures could result in both civil and criminal liability that would affect shareholder value. Through a series of communications to members of the Board of Directors and others starting in December 2003, Mr. Lavalle called for an independent investigation of his allegations? The Board of Directors decided to conduct an internal review of these concerns. On September 12,2005, the Office of Corporate Justice retained Baker & Hostetler LLP. I Mr. Lavalle has informed us that he personally owns Fannie Mae stock, he is the beneficiary of the Pew Family Trust which owns Fannie Mae stock and debt, and he holds proxies from other Fannie Mae shareholders. See Email dated July 22, 2005, from Nye Lavalle to Deborah M. House, Vice President and Deputy General Counsel; Daniel H. Mudd, President and Chief Executive Officer; and Board of Director members Stephen Ashley, Ann Korologos, Frederic Malek, Donald Marron, Leslie Rahl, H. Patrick Swygert, and John Wulff; and others; E-mail dated Feb. 15,2006, from Mr. Lavalle to Mark Cyrnrot and Ambika Biggs. 2 See, i.e., E-mail dated Dec. 19,2003, from Nye Lavalle to then Fannie Mae Chairman and Chief Executive Officer Franklin Raines and other individuals; E-mail dated Jan. 8, 2004, from Nye Lavalle to Vice President and Deputy General Counsel Deborah M. House; E-mail dated June 4, 2004, fromNye Lavalle to Mr. Raines, Ms. House and other undisclosed recipients; E-mail datedJuly22.2005.fromNyeLavalletoMs.House.Mr. Mudd, and Board of Director members Stephen Ashley, Ann Korologos, Frederic Malek, Donald Marron, Leslie Rahl, H. Patrick Swygert, and John Wulff, and others; E-mail dated July 25, 2005, to the individuals referenced in July 22, 2005 email; E-mail dated July 26, 2005, from Nye Lavalle to the individuals referenced in the July 22, 2005, e-mail. CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE Mr. Lavalle began investigating the mortgage industry after his parents, Anthony and Matilde L. Pew, had a dispute with mortgage servicer EMC Mortgage Corporation ("EMC"), a subsidiary of Bear Stearns Companies ("Bear Stearns,,).3 EMC ultimately foreclosed on the Pews' property, even though, according to Mr. Lavalle, his family is wealthy and made repeated efforts to repay the loan. 4 The dispute motivated Mr. Lavalle to investigate and publicize his allegations that EMC engaged in predatory servicing practices, which has resulted in several lawsuits between Bear Stearns and Mr. Lavalle. 5 Mr. Lavalle then broadened his focus to include the single-family mortgage industry as a whole. Mr. Lavalle considers himself a gadfly of the mortgage industry. He claims to have been investigating, analyzing and exposing mortgage fraud, predatory lending and servicing, and securitization schemes since 1993. 6 He has a website that details his complaints, Mr. Lavalle has alleged that Bear Stearns Companies, its subsidiary EMC, and Savings of America committed predatory lending and servicing practices with regard to his parents' loan. Mr. Lavalle prepared a lengthy account of this dispute in a document he titled, Predatory Grizzly "Bear" Attacks Innocent, Elderly, Poor, Minorities, Disabled and Disadvantaged! 3 Mr. Lavalle alleges that the loan agent who originated the loan committed fraud, and either Fannie Mae, Freddie, EMC or EMC's predecessor, Savings of America, found the fraud. November 1,2005, conversation with Mr. Lavalle; e-mail dated July 22, 2005, from Nye Lavalle to Deborah M. House, Vice President and Deputy General Counsel; Daniel H. Mudd, President and Chief Executive Officer; and Board of Director members Stephen Ashley, Ann Korologos, Frederic Malek, Donald Marron, Leslie Rahl, H. Patrick Swygert and John Wulff; and others. 4 Nye Lavalle, Predatory Grizzly "Bear" Attacks Innocent, Elderly, Poor, Minorities, Disabled and Disadvantaged!, pp. 24-25, 102; see also Bear Stearns Companies v. Lavalle, No.3 :OO-CV -1900-D, 2000 WL 34339773, * I (N .D. Tex. Oct. 27, 2003). Mr. Lavalle created several websites that alleged that Bear Stearns engaged in abusive and illegal business practices. See Bear Stearns Companies v. Lavalle, Case No.3 :OO-CV -1900-D, 2000 WL 34339773 (N.D. Tex. Oct. 27, 2003)(in which the court enjoins Mr. Lavalle from using certain domain names and an e-mail address that incorporated Bear Stearns' name) and Bear Stearns Companies v. Lavalle, Case No. 3:00-CV-1900-D, 2002 WL 315757771 (N.D. Tex. Dec. 3, 2002). For further examples of the acrimony that exists between Mr. Lavalle and EMC and Bear Stearns, see Bear Stearns Companies v. Lavalle, Case No.3 :OO-CV -1900-D, 2002 WL 485697 (N.D.Tex. Mar. 29, 2002); Bear Stearns Companies v. Lavalle, Case No. 3:00-CV-1900-D, 2001 WL 406217 (N.D. Tex. Apr. 18,200 I); and Bear Stearns Companies v. Lavalle, Case No.3 :OO-CV -1900-D, 200 I U.S. Dist. Lexis 20633 (N.D. Tex. Dec. 11,2001). 6 5 June 04, 2004, e-mail attachment entitled Report on Predatory Lending & Servicing Practices & Their Effect on Corporate Compliance, Conduct, Ethics & Accounting II. E-mail dated July 22, 2005, from Nye Lavalle to Mr. Mudd, Ms. House, and various members of Fannie Mae's Board of Directors. 2 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE and has posted information on several other sites. 7 He claims to have spent more than 20,000 hours and nearly $500,000 investigating predatory lending and servicing. 8 He reports that he is a consultant to plaintiff lawyers who sue lenders and servicers and to homeowners. Mr. Lavalle's view is that since Fannie Mae is such an important force in the mortgage industry, it has both the responsibility and means to end abusive lending and servicing practices. Mr. Lavalle's view is that Fannie Mae directs the conduct of servicers from afar. In an e-mail ofFebruary21.2006.Mr. Lavalle expresses his frustration, saying: I hate to keep using the analogies that you don't like but it really is like a Mafia operation. The Godfather [Fannie Mae] says we got a problem, "take care of it" and the lieutenant ["the servicer"] orders the hit [foreclosure] and hires the hitman [the USFN or other lawyer to foreclose]. The hit man and lieutenant don't want the Godfather implicated so they create layers of deniability [a typical CIA, white house, legal and political maneuver] to conceal who the real parties in interest are and who had knowledge of and ordered the hit. While Mr. Lavalle is partial to extreme analogies that undermine his credibility, he has become knowledgeable about the mortgage industry. He has identified significant issues but, in our view, does not always analyze them correctly. In proposing solutions, he generally undervalues the benefits to homeowners of efficient mortgage markets operated at low costs and overstates the needs of borrowers to have information about the status of their loans in the secondary markets for mortgages. Fannie Mae has already identified and is addressing many of the same issues. This report details several areas where Fannie Mae faces legal and business issues that 7 See Mortgage Servicing Fraud.org, http://www.msfraud.org (last visited Mar. 16,2006). He also has posted information on EMC Sucks.org, http://www.emcsucks.org (last visited Mar. 16,2006); Websitetoolbox, http://www.websitetoolbox.com/tool/mb/ssgoldstar(lastvisitedMar.16.2006);andRip-OffReport.com. http://www.ripoffreport.com last visited Mar. 16,2006). 8 E-mail datedJuly22.2005.fromNyeLavalietoMr.Mudd.Ms. House, and various members of Fannie Mae's Board of Directors. 3 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE remain to be addressed. Mr. Lavalle also claims that as a result of this work, he and his family have been harassed. He expresses considerable anger when he attributes these attacks to Fannie Mae. An investigation of his personal retaliation claim is in progress; to date Mr. Lavalle has identified no direct conduct by Fannie Mae that he considers harassing. We have reviewed more than 1,500 pages of documents provided by Mr. Lavalle to Fannie Mae or us directly and had 17 conversations with him. We have identified six general areas of his concerns: (1) foreclosure policies and procedures, (2) transparency, (3) protection of promissory notes, (4) predatory servicing, (5) fraud detection and reporting, and (6) accounting and securities issues. Within each area, Mr. Lavalle identifies multiple issues that are detailed in this report. In investigating these concerns, we have collected documents from Mr. Lavalle, Fannie Mae and public sources, reviewed extensively eFannie.com, and interviewed at least 30 Fannie Mae employees. The company has fully cooperated in our investigation. In reviewing Mr. Lavalle's concerns as a shareholder, we have told Mr. Lavalle that the proper scope of our investigation is to determine whether he has identified wrongdoing hy Fannie Mae officials or financial risks of sufficient magnitude to affect materially Fannie Mae's financial statements. We cannot resolve every case of an alleged mishandled mortgage. 1. Foreclosure Policies and Procedures Mr. Lavalle asserts that Fannie Mae's mortgage servicers and the Mortgage Electronic Registry System, Inc. ("MERS") routinely make misrepresentations in foreclosure proceedings. He has identified two categories of alleged misrepresentations: that MERS or the servicers are the holders and owners of the defaulted promissory notes, and that promissory notes 4 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE are lost, stolen or destroyed. 9 He also questions whether foreclosures in the name of MERS or servicers satisfy state laws on standing to sue. Since Fannie Mae authorizes foreclosures, Mr. Lavalle argues that Fannie Mae could be liable for these misrepresentations, including for racketeering violations under federal and state laws, and could risk having foreclosure sales unwound by the courts. 10 We have found evidence that false statements by foreclosure attorneys are being routinely made in at least two counties in Florida and appear to be occurring elsewhere. Apparently due to Mr. Lavalle's ex parte communications, two Florida judges ordered hearings to examine MERS's role in foreclosures. During consolidated hearings that resulted in the judges dismissing 24 foreclosure actions, three judges (including one who took the time to observe and comment) criticized MERS for routinely filing "sham" pleadings and "false" affidavits regarding its interest in promissory notes and supposed lost promissory notes. I I One judge questioned whether large numbers of foreclosures would have to be reversed due to fraud on the court. MERS's counsel conceded false allegations are routinely made, and the practice should be "modified." He acknowledged that foreclosure counsel used the Florida Supreme Court's form pleading for foreclosures without critically analyzing the facts. The form contains an allegation that the plaintiff is the "owner and holder" of the promissory note. MERS is neither. 9 E-mail dated December 19,2003, from Mr. Lavalle to Mr. Raines and others. 10 E-mail datedJuly22.2005.fromNyeLavalletoMr.Mudd.Ms. House and various members of Fannie Mae's Board of Directors; Nye Lavalle, report on his allegations against Fannie Mae (Feb. 2, 2006) (unpublished report), sent as attachment to e-mail dated Feb. 2, 2006, to Mark Cymrot. 11 See Transcript of September 16, 2005, Hearing, MERS v. Cabrera, Case No. 05-02425 CA OS, pp. 15-23. 5 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE Courts in several other states also have rejected foreclosures based upon "discrepancies" between MERS' pleadings and supporting documents. Other court opinions or reports from borrowers - provided by Mr. Lavalle - suggest the same misrepresentations are made in other states. Our review of reported decisions and pleadings from Connecticut, Illinois, Louisiana, New York, Ohio, Kentucky, and Georgia appear to contain similar false statements. The Florida judges also criticized foreclosure counsel for routinely filing lost note affidavits and counts to reform promissory notes. Mr. Lavalle has identified cases in which the original promissory notes were produced once the court challenged the lost note affidavit. It appears the notes are not lost, and instead, false statements are being made in the pleadings and affidavits. Masked by the improper pleadings is a substantive legal issue of whether MERS or servicers have standing to foreclose. In the two Florida cases, the judges held that MERS did not have the right to bring the foreclosure actions and dismissed the actions. These opinions are on appeal. Fannie Mae's policy instructs servicers and MERS to commence foreclosure proceedings in their own names if permitted under state laws. While this policy is based upon reasonable legal arguments and policy considerations, the issue is not resolved in case law. It is axiomatic that the practice of submitting false pleadings and affidavits is unlawful. With his complaint, Mr. Lavalle has identified an issue that Fannie Mae needs to address promptly. For some time, the Legal Department has been working on a proposal for a new computer system to communicate better with and control attorneys working on Fannie Mae litigated matters. As a result of the Florida cases, the Legal Department is formulating a more immediate solution for the issues raised in those cases, including a directive to attorneys and servicers in Florida directing corrective action. 6 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE While these issues present reputational and litigation risks, Mr. Lavalle's assertion that Fannie Mae faces tens of billions of dollars of unenforceable mortgages and damages from class action lawsuits is overstated in our view. Even the Florida judges who were angered at MERS's misconduct dismissed the foreclosure actions without prejudice to the proper party bringing new actions. It appears unlikely that substantial numbers of borrowers who have defaulted on their mortgages could meet the heavy legal burden to avoid foreclosure. Borrowers seeking damages also would face a difficult burden to demonstrate that Fannie Mae is responsible for the attorneys' misconduct and the conduct was the proximate cause of damages. Prompt correct action, however, should be taken and would mitigate these risks. 2. Transparency One ofMr. Lavalle's principal themes is that the mortgage industry is not transparent to borrowers. The gulf between Fannie Mae's understanding of its role and Mr. Lavalle's contentions about its role is wide. Mr. Lavalle has a broader view of Fannie Mae's responsibilities than appears justified by its charter and the mortgage documents. On the issue of transparency, the mortgage industry has become more complex and more efficient as it has matured but with a loss of transparency to borrowers. Homeowners have benefited through lower interest rates and available mortgages. They remain entitled, as Mr. Lavalle points out, to assurances that their payments are properly credited, they have access to information concerning their mortgage balances, and they are not subject to improper charges or other harassing behavior. Fannie Mae's mortgage guidelines and servicer reviews already address these issues. Mr. Lavalle focuses on two structural developments in the mortgage markets that have decreased the transparency of transactions to borrowers: the requirement of having notes endorsed in blank and the creation ofMERS. Both developments were introduced to reduce 7 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE paperwork and the cost of transactions. They have, as Mr. Lavalle suggests, reduced somewhat the transparency from the borrowers' vantage. Mr. Lavalle proposes that Fannie Mae return to the days when each promissory note is endorsed and each note is returned stamped "paid in full." He wants an audit trail for mortgage servicing and ownership, and he proposes that borrowers be entitled to circumvent predatory servicers by dealing directly with their note owners. He also would give borrowers access to the MERS database - which contains considerable information regarding servicing histories - for a fee. These proposals are not practical, not legally required by the mortgage documents, and not necessary to meet borrowers' needs. Borrowers do not have a legal right or an identifiable interest in knowing the current owners of their mortgages or in the complex transactions that underlie the secondary mortgage markets. The Servicing Guide addresses borrower interests by placing disclosure obligations on the servicers. Servicing Guide III -104, for instance, provides that "The servicer also must provide a detailed analysis of all transactions relating to a borrower's payments or escrow deposit account whenever the borrower requests it." The Guide also requires servicers to disclose Fannie Mae's interest in the promissory note if a borrower asks.12 Mr. Lavalle's proposal that the owner or Fannie Mae, as trustee, should accept loan repayments or otherwise interact directly with borrowers is contrary to the concept of a secondary market. Ownership interests in mortgages are now fractured into a variety of income streams due to the advent of mortgage-backed securities ("MBS"). No single owner would have the means or authority to accept payments. It is also contrary to Fannie Mae's role, as stated in 12 Servicing Guide, 1-311. 8 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE its charter, of creating and operating within a secondary market. During years of lobbying, private financial institutions and their associations have urged Congress to limit the competition Fannie Mae provides private financial institutions. Fannie Mae officials uniformly express sensitivity to Fannie Mae's limitations with regard to direct consumer contacts; Fannie Mae's customers are lenders and servicers for whom homeowners are customers. Fannie Mae's approach appears sound and efficient, provided that servicers' disclosure obligations are enforced. As this report discusses, Fannie Mae has an extensive program for ensuring servicer compliance. 3. Protection of Promissory Notes In Mr. Lavalle's view, the numerous lost note affidavits filed in foreclosure proceedings support the notion that notes are regularly misplaced at a risk to both Fannie Mae and borrowers. He expresses fear that Fannie Mae does not have adequate procedures to protect the 15 million freely negotiable promissory notes in its portfolio. Mr. Lavalle has identified an important legal issue -lost notes threaten the enforceability of Fannie Mae's mortgages and expose borrowers to financial risks. Mr. Lavalle, however, has not provided support, and we have not found support, for the assertion that mortgage documents are regularly lost or stolen. Fannie Mae has extensive custodial procedures and certifies 58 private custodians, which must comply with its security procedures. Fannie Mae's in-house custodian reports minimal lost notes. Fannie Mae does not, however, have a centralized registry to identify notes lost by the other custodians or procedures for notifying or protecting borrowers. Fannie Mae's in-house custodian is subject to internal audit which is ongoing at the time of this report. It has recently instituted reviews of the certified custodians. The internal audits and external reviews should identify any issues regarding missing mortgage documents. The 2005 custodian 9 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE reviews did not find significant problems. The internal audits and external reviews do not currently specifically test security procedures for mortgage documents to ensure notes are not lost. We recommend this control be added to future reviews. 4. Predatory Servicing Mr. Lavalle alleges that Fannie Mae has been instrumental in creating a system in which predatory servicing flourishes. He perceives servicing problems within Fannie Mae's portfolio as more pervasive than Fannie Mae officials and suggests that Fannie Mae should do more to protect borrowers. In his opinion, Fannie Mae should mandate a set of "best practices" based on a 2003 consent decree that Fairbanks Capital Corporation agreed to with the United States. 13 Mr. Lavalle's proposals often go even further than the consent decree in imposing controls but also imposing costs on servicers. Fannie Mae has extensive procedures to review the conduct and efficiency of its servlcers. In recent years, it has become more conscious of concerns about predatory servicing, as have law enforcement and regulatory officials at the federal and state levels. Fannie Mae has responded by adding Servicing Guide requirements, conducting extensive statistical analyses of servicers' portfolios, and engaging in direct servicer reviews. Fannie Mae already has responded to the Fairbanks consent decree by augmenting its Servicing Guide in 2004, and adopting, in whole or in part, the Fairbanks requirements. Where Fannie Mae has not adopted the Fairbanks requirements completely, it believes the requirements are not appropriate for its universe of servicers, which generally do not operate in the subprime markets where most of the issues have See u.s. v. Fairbanks Capital Corp., No. 03-12219 (D. Mass. Oct. 6, 2003) (order preliminarily approving stipulated final judgment and order as to Fairbanks Capital Corp. and Fairbanks Capital Holding Corp.). In that case, the Federal Trade Commission ("FTC") and the Department of Housing and Urban Development ("HUD"), accused Fairbanks of violating the Federal Trade Commission Act, the Fair Debt Collection Practices Act, the Fair Credit Reporting Act and the Real Estate Settlement Procedures Act ("RESP A"). The case was settled by a consent decree that mandated certain business practices to correct the alleged abuses. 13 10 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE TABLE OF CONTENTS (continued) Page E. F. G. V. A. B. Fannie Mae's Internal Audits and Custodian Reviews ........................................ 53 Satisfactions and Lien Releases ........................................................................... 55 Findings Regarding Promissory Notes ................................................................ 55 Mr. Lavalle's Concerns ........................................................................................ 56 Current Servicer Rules and Procedures ............................................................... 59 Best Practices - Fairbanks Consent Decree ......................................................... 68 1. 2. 3. PREDATORY SERVICING ........................................................................................... 56 C. Crediting Payments .................................................................................. 70 Misrepresentations and Fee Disclosures .................................................. 73 Escrow Disbursements ............................................................................. 77 Force-Placed Insurance ............................................................................ 79 Consumer Services ................................................................................... 83 Consumer Credit Ratings ......................................................................... 86 Consumer Information ............................................................................. 89 Foreclosures ............................................................................................. 90 Late Charges ............................................................................................ 92 4. 5. 6. 7. 8. 9. D. E. F. VI. A. Mr. Lavalle's Problem Servicers ......................................................................... 95 Impact of Fannie Mae's Loan Repurchase Policy ............................................. 102 Findings Regarding Predatory Servicing ........................................................... 104 Mr. Lavalle's Concerns Regarding Fannie Mae's Fraud Procedures ................ 105 OFHEO's Mortgage Fraud Reporting Regulation ............................................. 106 Fannie Mae's Implementation of Fraud Detection and Reporting Measures .... 110 1. 2. FRAUD INVESTIGATIONS AND REPORTING ....................................................... 105 B. C. Internal Practices .................................................................................... 110 Reporting to OFHEO ............................................................................. 119 D. E. F. Lessons from the First Beneficial Case ............................................................. 123 The Olympia Fraud Response Model ................................................................ 126 Findings Regarding Fraud Procedures ............................................................... 127 -ii- CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE been found. The Fairbanks consent decree also was remedial of a serious problem; Fannie Mae believes it can safely give its servicers more discretion to deal with borrowers. These judgments appear to be reasonable. Mr. Lavalle asserts that Fannie Mae's loan repurchasing policies result in unqualified mortgages being labeled as "scratch and dent.,,14 These loans, he claims, are sold to "special servicers," which aggressively service the loans into foreclosure or bankruptcy. IS Mr. Lavalle refers to these special servicers as "the toxic waste dump.,,16 He asserts that these companies regularly defraud borrowers. Mr. Lavalle expresses particular concern about EMC Mortgage, Litton Loan Servicing, Ocwen Financial Corporation, and Select Portfolio Servicing ("SPS") (formerly Fairbanks Capital Corp). Mr. Lavalle proposes that Fannie Mae warn borrowers before transferring loans to special servicers. Fannie Mae must have the option of protecting its financial condition by setting enforceable parameters for the mortgages it purchases. Fannie Mae, like the rest of the mortgage industry, knows that loans that do not satisfy Fannie Mae, Freddie Mac or Ginnie Mae parameters tend to be less valuable. The industry - not Fannie Mae - created the term "scratch and dent." Fannie Mae's volume of repurchases is relatively small, about 10,000 from 2002 to 2004; it owned an average of 15.2 million loans during that period. We have reviewed Fannie Mae's oversight of the four servicers that are the target ofMr. Lavalle's strongest criticism. The four servicers are primary servicers for less than 1% of Fannie Mae's portfolio. Since the 2003 consent decree, Fairbanks has changed names to SPS, 14 Interview with Mr. Lavalle (Nov. 1,2005). 15 E-mail datedJuly22,2005,fromNye Lavalle to Mr. Mudd,Ms. House, and various members of Fannie Mae's Board of Directors; see also E-mail dated Oct. 7, 2005, from Nye Lavalle to Mark Cymrot. 16 E-mail datedJuly22,2005,fromNye LavalletoMr. Mudd,Ms. House, and various members of Fannie Mae's Board of Directors. 11 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE ownership to Credit Suisse First Boston, and its conduct. Fannie Mae no longer believes that SPS engages in pervasive predatory servicing practices, but it monitors the company closely. The other three servicers - EMC, Ocwen and Litton - are subject to regular reviews, including on-site visits from Fannie Mae's National Servicing Organization, which has not identified significant servicing problems. Their portfolios perform on a par with other servicers. The three main rating agencies also rate these servicers with their highest or second highest subprime ratings. Fannie Mae is aware that EMC currently is the subject of a Federal Trade Commission investigation, but at this stage, Fannie Mae - like the rating agencies - has not found reason to take action against the company. Mr. Lavalle appears to overstate the risk to borrowers of repurchases. He does not present any evidence that borrowers are regularly injured by servicers after repurchase transactions. While Fannie Mae polices its own servicers for predatory servicing practices, it is not in the position nor does it have the legal duty to police the entire industry. The general issue of predatory servicing is more appropriately the subject for state and federal regulations and enforcement. 5. Fraud Detection and Reporting Mr. Lavalle asserts that borrowers should be informed of mortgage fraud that Fannie Mae discovers in its due diligence and quality control processes. 17 Since the promulgation of fraud regulations by the Office of Federal Housing Enterprise Oversight ("OFHEO"), Fannie Mae has implemented extensive procedures to detect and investigate mortgage fraud. The effectiveness of these relatively new procedures will have to be monitored over time. As Mr. Lavalle suggests, Fannie Mae's procedures require fraud reports be made to 17 E-mail datedJuly22.2005.fromNyeLavalletoMr.Mudd.Ms. House, and various members of Fannie Mae's Board of Directors. 12 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE OFHEO but not to borrowers. The OFHEO regulation does not require Fannie Mae to report suspected cases of fraud to borrowers, but also does not relieve Fannie Mae from disclosing fraud to victims or law enforcement pursuant to undefined and largely non-existent "legal requirements." Fannie Mae must take legal or business action it may deem "appropriate." Fannie Mae's reluctance to contact borrowers arises from its lack of privity with borrowers as a secondary market company and its concern for its potential liability for the reports. The OFHEO regulation does not contain a safe harbor provision that would immunize Fannie Mae from tort suits - such as libel or interference with contract - arising from its reports. The regulation provides Fannie Mae with little guidance and requires the company to make very difficult judgments on incomplete information. Fannie Mae has faced financial exposure for its failure to report a fraud. In the case of a fraud by First Beneficial Mortgage Corp., Fannie Mae required the lender to repurchase the loans but did not report the fraud to law enforcement authorities. After the loans were sold to Ginnie Mae, Fannie Mae agreed to pay the government $7.5 million to settle a case in which the Justice Department alleged that Fannie Mae had accepted the proceeds of a fraud. In the case of a fraud by Olympia Mortgage Corporation ("Olympia"), however, Fannie Mae took extensive steps to ensure borrowers were made whole. In 2004, Fannie Mae discovered that a lender had not repaid prior loans after selling it refinancing loans. When Fannie Mae discovered the fraud, it reported its findings to law enforcement, transferred the portfolio to a sub-servicer with instructions to cure damage to borrowers (e.g., adjustment of balances and credit histories), and issued a press release to inform investors that Fannie Mae had purchased the loans out of the pool, which would cause a quick pay down on the loans instead of 13 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE a stream of monthly payments. Fannie Mae, however, does not have an institutional policy for reporting fraud to borrowers or other potential victims. Fannie Mae appears to be making decisions regarding the disclosure of fraud and misrepresentation findings on an ad hoc basis. In our view, Fannie Mae should create a corporate policy for determining when its findings of misrepresentations or fraud in mortgage lending or servicing should be reported to law enforcement, borrowers and potential victims. The policy should balance at least five interests: (1) Fannie Mae's public mission to expand homeownership; (2) potential liability for failure to inform potential victims; (3) lack of a direct relationship with borrowers; (4) law enforcement issues; and (5) risk of liability from libel and other claims brought by the alleged wrongdoers. 6. Accounting and Securities Issues Mr. Lavalle alleges that Fannie Mae has engaged in several forms of accounting and securities fraud. The company currently is undergoing an extensive accounting review and restatement of its financial statements. We, therefore, have not attempted to duplicate the ongoing work of independent accountants and lawyers. 18 We have limited our review to determining whether the issues raised by Mr. Lavalle are addressed through current tests and analyses designed to ensure the accuracy of financial reporting or are under review in the current review of accounting controls and restatement of financial statements. Mr. Lavalle has focused on the following four areas: (1) impact of servicer frauds on Fannie Mae's financial statements; (2) the alleged failure to remove paid-off promissory notes 18 See Report of Findings to Date, Special Examination of Fannie Mae, Office of Compliance, Office of Federal Housing Enterprise Oversight, September 17; A Report to the Special Review Committee of the Board of Directors of Fannie Mae, Paul, Weiss, Rifkind, Wharton & Garrison LLP. Fannie Mae is currently working to restate its financial statements from December 31, 2002 through June 30, 2004. It will submit its restated financial statements to its independent auditor, Deloitte & Touche LLP, so it can re-audit them. Federal National Mortgage Association, Notification of Late Filing (Form 12b-25), at 2-3 (Mar. 13,2006). 14 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE from MBS pools; (3) the question of whether terms ofMBS's comply with true sale accounting rules; and (4) whether the transfer of holder status to servicers during foreclosure proceedings are accounted for properly. Mr. Lavalle suspects that Fannie Mae does not have adequate procedures to monitor servicer reports on mortgages, particularly when servicers are caught committing predatory lending or servicing frauds. The principal balances and loan-to-value ratios on the loans need to be re-amortized and recalculated, but Mr. Lavalle questions whether they are. Inflated property appraisals also could lead to loans that are not adequately secured, thus resulting in inaccurate financial filings. Fannie Mae, however, does extensive modeling of its portfolio to identify anomalies in loan portfolios or particular loans. It, for instance, specifically checks for duplicate loans on the same property and has developed, and is improving, sampling techniques designed to identify appraisal errors or fraud. Mr. Lavalle's concern that paid-off promissory notes are not being removed from MBS pools is also addressed by current accounting controls. Mr. Lavalle claims to have been informed by mortgage industry executives that paid off promissory are still part of securitized pOOIS.19 He has not provided documentary evidence of these statements. Fannie Mae's accounting controls address these issues and their accuracy are currently under extensive review. With respect to paid-off loans, the pay down schedules are reconciled to the actual cash received to ensure that pay offs and other transactions are being properly accounted for. Id. In support of his allegations, Mr. Lavalle refers generally to Margery A. Colloff, "The Role of the Trustee in Mitigating Fraud in Structured Financings," J. of Structured Finance (Winter 2005). The article states "Government-reimbursed programs are at the top of the list [of hot spots for fraud]" because "[ c]ollateral may be overvalued, or non-existent, or pledged to more than one transaction. No one knows because the collateral is often in the custody of the servicer or another business party, not the trustee." Id. at 3. 19 15 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE Mr. Lavalle also claims that Fannie Mae's policy of removing certain loans from MBS pools raises questions as to whether the sale is a "true sale," which affects its accounting treatment. The Rudman Report discovered one true sale issue, which Fannie Mae is now taking steps to address. In addition, Fannie Mae did not obtain true sale legal opinions prior to the recent restatement. It now has two law firms reviewing true sale questions. Mr. Lavalle questions how promissory notes are accounted for on servicers' and Fannie Mae's accounting books when Fannie Mae transfers holder status to the servicer at the time of foreclosure. It appears that Mr. Lavalle has incorrectly analyzed the issue. Even when holder status changes, ownership does not change; thus, mortgages are properly maintained on Fannie Mae's books as assets. II. THE PROBLEM IN FORECLOSURES A. Mr. Lavalle's Assertions about Foreclosures Mr. Lavalle contends that MERS and servicers are routinely making false statements regarding their interest in promissory notes and routinely filing lost note affidavits. In support of his claim, Mr. Lavalle has provided court transcripts and opinions. In two Florida cases, judges dismissed 24 foreclosure actions in which MERS misrepresented it was the holder and owner of notes, when it is neither. 2o The courts found that MERS had submitted "sham" 1 · peadmgs. 21 20 In re Mortgage Electronic Registration Systems, Inc. (MERS), No. 05-001295CI-II et al. (Fla. Cir. Ct. Aug. 18, 2005) (order regarding standing ofMERS to foreclose on behalf of others); MERS v. Cabrera, No. 05-245 CA 05 et at. (Fla. Cir. Ct. Sept. 28, 2005) (order of dismissal on the corrected order to show cause). 21 Mortgage Electronic Registration Systems v. Cabrera, No. 05-245 CA 05 et at. (Fla. Cir. Ct. Sept. 28,2005) (order of dismissal on the corrected order to show cause). 16 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE He also provided us with opinions from Connecticut, New York, and Georgia, courts that have found discrepancies between a MERS affidavit and the exhibits. 22 The same allegations are referred to in a Kentucky case and in an email by an Ohio borrower. 23 The cases raise a substantive issue of whether MERS has standing to conduct foreclosures?4 MERS, Mr. Lavalle points out, has taken inconsistent positions in different cases. While MERS claims it can conduct foreclosures in its own name, MERS successfully defeated a borrower's effort to cancel a note, in part, by arguing that the borrower had failed to join an indispensable party, Fannie Mae. 25 With regard to lost note affidavits, Mr. Lavalle suggests Fannie Mae has a serious dilemma. If the notes are not, in fact, missing, Fannie Mae could be liable for the misrepresentations to the courts, he argues; while if the promissory notes actually cannot be produced, borrowers may be relieved of liability for the notes. 26 Mr. Lavalle alleges that MERS allows Fannie Mae to hide the fact that it is a real party in interest in foreclosure actions and avoid assignee liability issues?7 Mr. Lavalle has 22 See Mortgage Electronic Registration Systems v. Rees, No. 2003 Conn. Super. Lexis 2437 (Conn. Super. Ct. Sept. 4,2003) (unreported); Mortgage Electronic Registration Systems v. Burek, 798 N.Y.S.2d 346 (N.Y. Supp. 2004)(summary judgment motion denied based in part on an inconsistency between complaint and its reply affirmation); Taylor, Bean & Whitaker Mortgage Corp. v. Brown, 583 S.E.2d 844 (Ga. 2003) (reversed holding of trial court that cancelled note but remanded for determination whether MERS as nominee of the lender had the power to foreclose). 23 See Waggoner v. Mortgage Electronic Registration Systems, No. 2003-CS-002666-MR, slip op. (Ky. Ct. App. Sept. 5,2005) (affirming summary judgment for MERS in a foreclosure action). 24 Mortgage Electronic Registration Systems v. Thompson, No. 2002 Conn. Super. Lexis 828 (Conn, Super. Ct. Mar. 14,2002) (unreported); Mortgage Electronic Registration Systems v. Pressman, No. 2005 Conn. Super. Lexis 82 (Conn. Super. Ct. Jan. 7,2005) (unreported). 25 Taylor, Bean & Whitaker Mortgage Corp. v. Brown, 583 S.E.2d 844 (Ga. 2003). Fannie Mae involuntarily terminated Taylor, Bean & Whitaker Mortgage Corp. as a servicer in 2002. March 3, 2006, e-mail attachment of a chart of all terminations in 2002, from Marianne Sullivan, Senior Vice President, Credit Loss Management. 26 E-mail dated Dec. 19,2003, from Nye Lavalle to then-Fannie Mae Chairman and Chief Executive Officer Franklin Raines and other Fannie Mae employees, as well as other individuals. 27 E-mail datedJuly22,2005,fromNye LavalletoMr. Mudd, Ms. House, and various members of Fannie Mae's Board of Directors. 17 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE communicated with MERS General Counsel, Sharon Horstkamp, regarding his concerns that MERS is committing fraud on the courts.z s Mr. Lavalle states that his communications with Fannie Mae and MERS, as well as the court opinions, put Fannie Mae on notice of the fraudulent conduct of MERS and the servicers, which Mr. Lavalle considers to be agents of Fannie Mae. 29 These practices not only expose Fannie Mae to liability, he asserts, but also may result in foreclosures being unwound. Mr. Lavalle claims that the alleged fraud regarding ownership of the notes and lost note affidavits violates federal and state Racketeer Influenced and Corrupt Organizations ("RICO") acts and parties engaging in the fraud face both civil and criminalliability?O He states that the number of civil conspiracy claims against these Fannie Mae, MERS, and servicers will increase. 3l He claims to be consulting with the counsel for a class action brought by victims who were foreclosed upon illegally.32 If counsel for the class action seeks to void all prior foreclosures in Florida, Fannie Mae shareholders, as well as servicers, investors, and MERS shareholders, could potentially lose tens of billions of dollars, Mr. Lavalle asserts. 33 This large figure results from the compensation that the victims would be due, as well as the compensation due to new homeowners whose title to the property may be clouded due to the fraud, he claims. 34 28 See Letter from Nye Lavalle to Sharon Horstkamp, MERS General Counsel, informing her of his allegations of MERS committing fraud (September 15, 2005). 29 Telephone interview with Nye Lavalle (November 1,2005). E-mail dated Feb. 15,2006, from Mr. Lavalle to Mark Cymrot and Ambika Biggs. I d. Id. 30 31 32 33 34 Id. Id. 18 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE He asserts that he has spoken with hundreds of victims and read their postings on his website and forum. 35 Some of the victims have lost everything due to the fraud, Mr. Lavalle claims, and some have committed suicide or are suicidal. 36 In addition, he believes that a "troubled and victimized borrower" may one day kill a major Wall Street executive or mortgage servicer as a result of the fraud?7 B. MERS Foreclosure Procedures MERS regularly brings foreclosure actions on behalf of parties that own a beneficial interest in mortgages registered on its system. MERS was conceived as a registry for mortgages; the original concept did not include the idea that MERS would conduct foreclosures in its own name. 38 Fannie Mae, Freddie Mac, Ginnie Mae, the Mortgage Bankers Association of America, HUD and VA created MERS to simplify the process of transferring interests in mortgages. 39 Fannie Mae is a MERS shareholder, as well as one of 15 charter members. 4o Fannie Mae also has a permanent seat on MERS' Board of Directors. 41 MERS reduces the need for paper mortgage assignments and the payment of recordation fees when mortgage rights are transferred. 42 Documents from MERS' creation show 35 36 Jd. Jd. 37 38 I d. E-mail dated Nov. 7,2005, from Daniel C. Smith, Deputy General Counsel, Legal Department, to Mark Cymrot. MERS is a Reality!, an undated document created by MERS announcing that MERS has been formally launched [hereinafter MERS is a Reality!]. Fannie Mae. Freddie Mac, Ginnie Mae and MBA published the Whole Loan Book Entry White Paper in October 1993, and MERS was incorporated on October 16,1995. Jd. According to Fannie Mae's August 18, 1997, Announcement, "Fannie Mae [was] an active supporter ofMERS since the concept of electronic tracking was first discussed in 1993, contributing substantial resources and effort to help the concept come to fruition." 39 40 MERS Overview; MERS: About Us: Shareholders, available at http://www.mersinc.org/about/shareholders.aspx; MERS State by State MERS Recommended Foreclosure Procedures. Telephone interview with Robert Engelstad, Vice President for Policy and Standards (February 21,2006). MERS is a Reality!, pp. I, 10. 41 42 19 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE that the creators contemplated MERS assigning mortgages out of its system in the case of foreclosures, and having this assignment recorded in the land records. 43 We have not been able to determine when or why MERS began bringing foreclosure actions in its name; the Fannie Mae employees involved have since left the company. Presumably, it began offering this service because it adds efficiency by eliminating the need for a mortgage assignment from MERS to the foreclosing servicer. MERS, however, has not instituted controls over the servicers who conduct foreclosures or their attorneys. MERS has the servicer retain counsel. MERS has authorized an employee of the servicer to act as an officer of MERS for the purpose of approving pleadings. MERS' Recommended Foreclosure Procedures state that employees of the servicers will be MERS certifying officers. 44 A MERS corporate resolution gives these certifying agents the power to sign any necessary documents as a MERS officer. 45 This practice enables in-house transfer of possession of the note from the servicer to MERS, in cases in which the foreclosing party has to be the note holder. 46 C. MERS Florida Embarrassment Two Florida trial courts recently have criticized MERS for false pleadings in foreclosure proceedings. Mr. Lavalle apparently approached judges in two Florida counties with sufficient information to prompt the judges to call extraordinary hearings. See Mortgage Electronic Registration System, Legal Issues Work Team, Mortgage Bankers Association of America, August 25, 1994, p. 9. See also MERS Kick Off Meeting Minutes, p. 10, stating "Either the clearinghouse as the mortgagee of record will have to handle foreclosures and execute and record releases or a procedure will have to be developed for another party - the servicer or custodian - to handle one or both of these matters through an assignment or a power of attorney." 43 44 45 46 See State-by-State MERS Recommended Foreclosure Procedure. Id. See, e.g., MERS Recommended Foreclosure Procedure for Connecticut. 20 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE In MERS v. Cabrera, the judge started an extraordinary show cause hearing regarding nine foreclosure cases by reading portions of inquiries from Mr. Lavalle and his mother, Ms. Pew. 47 MERS counsel was forced to concede that the complaints contained inaccurate allegations regarding its interests in promissory notes. 48 The complaints allege that MERS is the "holder and owner" of promissory notes when neither is true. This allegation hides the relationships of the parties who will benefit from the foreclosure and masks a serious legal issue. The judge was troubled that MERS changed its stance after filing "thousands and thousands of cases" stating that it owns the note. 49 A second judge (who took the time to observe the hearing) criticized MERS for routinely filing lost note affidavits and counts to reform the promissory notes. It appears the notes are not lost but lawyers or servicers find it easier and quicker to claim the notes cannot be found. The judge pointed out the inconsistency of the affidavit to the MERS complaint, asking: Where is it at the time it is lost in all of these myriad hundreds of cases which alleged that it's in our possession at the time it was lost or destroyed?5o The judge accused MERS of filing "false affidavits" and questioned whether foreclosures should be allowed to go forward. 51 MERS' attorney made the concession that "My understanding is lost note affidavits and lost note counts are routinely filed by mortgagees and note holders ... ,,52 He acknowledged the practice should be "modified.,,53 See Transcript of September 16,2005 Hearing at 15-23, MERS v. Cabrera, No. 05-245 CA 05 et al. (Fla. Cir. Ct. 47 Sept. 16, 2005). 48 I d. at 25. 49 I d. at 58-59. SOld. at 49. 51 [d. at 52. I d. 52 53Id. at 54. 21 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE In an order of dismissal dated September 28,2005, the court dismissed four foreclosures as a "sham and/or frivolous pleading," but dismissed them without prejudice so that the true owners and holders of the notes could file their own foreclosure actions. 54 The court also criticized MERS' practice of certifying servicers' employees as certifying officers, saying: "[t]he use of designating employees of the servicer as officers of MERS in order to circumvent the 'technical' requirement of law is transparent.,,55 He called the practice a "charade.,,56 A judge in the Pinellas County, Florida, circuit court issued an order dismissing 20 MERS foreclosures for essentially the same reasons. Judge Logan noted the false allegations, stating: "The standard allegation in the Complaint alleged that ... 'Plaintiff now owns and holds a mortgage note and mortgage ... ' The Court never found that allegation which is contained in all of the MERS Complaints to be supported by a review of the documents within the Court file. ,,57 Fannie Mae does not authorize attorneys to represent that MERS holds or owns promissory notes. The Servicing Guide states "MERS will have no beneficial interest in the mortgage, even if it is named as the nominee for the beneficiary in the security instrument. ,,58 54 MERS v. Cabrera, No. 05-245 CA 05 et at. at 5, (Fla. Cir. Ct. Sept. 28, 2005) (order of dismissal on the corrected order to show cause). The court held a show cause hearing for nine consolidated actions on September 16,2005, but five of the cases were voluntarily dismissed before the issuance of the Corrected Order to Show Cause. Id. at 2. 55 56 I d. at 13. I d. at 42. 57 En re Mortgage Electronic Registration Systems, Inc. (MERS), at 2, No. 05-00 1295CI-II et al. (Fla. Cir. Ct. Aug. 18, 2005) (order regarding standing of MERS to foreclose on behalf of others). 58 Servicing Guide, 1-407. See also Selling Guide, IV-I03 ("Even when MERS is named as the nominee for the beneficiary in the security instrument, it will have no beneficial interest in the mortgage."). 22 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE MERS is appealing Judge Logan's ruling on standing, but has ceased all foreclosure actions brought in the name of MERS in Florida in the meantime. 59 In addition, MERS revoked the authority of MERS certifying officers to bring foreclosure actions in Florida. 6o Fannie Mae has joined in filing an amicus brief with Freddie Mac, the Mortgage Bankers Association, Chase Home Finance LLC, and Countrywide Home Loans, Inc., in which they argue that affirming the circuit court's decision on standing would result in higher credit costs, reduced efficiency in the mortgage industry, and impair federal housing policy.61 To our knowledge, however, MERS has not addressed the issue of its counsels' repeated false statements to the courts. Mr. Lavalle claims that he is preparing a detailed ex parte report that he will submit to Judges Logan and Gordon in which he will offer all of his tapes, e-mail, reports; and other information that show Fannie Mae, MERS, EMC, BankOne, Merrill Lynch and United States Foreclosure Network ("USFN") attorneys have been on notice of this issue. 62 He has not shared this report with us. He is also reviewing pleadings in other counties and claims to have found similar false statements in those counties. 59 MERS September 23,2005, press release entitled "MERS Suspends Foreclosures In Florida," available at http://www .mersinc.org/newsroom/press_ details.aspx?id= 178. See Proposed Changes to Rule 8 (stating "In the state of Florida, the power to conduct foreclosures in the MERS granted to a Member's Certifying Officers under Paragraph 3 ofthe Member's MERS Corporate Resolution is revoked. Effective January 19, 2006, the Member shall be sanctioned $10,000.00 per violation for commencing a foreclosure in Florida in the name of MERS.") See E-mail fromAdamL.BendettofReiner.Reiner & Bendett, PC to Daniel Gray, Associate General Counsel, stating the proposed changes to the rule will go into effect on January 19,2006 (December 12,2005). 60 61 See Consolidated Joint Amicus Brief, Mortgage Electronic Registration Systems v. Azize, No. 2D05-4544 (Fla. Dist. Ct. App. Jan. 27, 2006). Azize was one of the cases dismissed in the August 18,2005 order. E-mail dated Feb. 15,2006, from Mr. Lavalle to Mark Cymrot and Ambika Biggs. 62 23 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE D. False Statements May Be Occurring Elsewhere MERS' concession that false statements are routine does not appear to be isolated to Florida. Other courts have questioned the accuracy of MERS' pleadings. A review of reported cases and pleadings reveal that MERS counsel are misrepresenting to courts that MERS is the owner or holder of defaulted promissory notes in at least 7 states. While these reported cases are small in number, the law firms undoubtedly are making the same representations in other foreclosures, and given the experience in Florida, these cases could be indicative of a broader problem within these states. While Fannie Mae officials do not have a single opinion, some officials believe foreclosure counsel are sacrificing accuracy for speed. Connecticut, New York, and Georgia courts have found "discrepancies" in MERS' pleadings. In Mortgage Electronic Registration Systems v. Thompson, a trial court dismissed a foreclosure action brought by MERS after it had ruled in MERS' favor and title to the property had passed. 63 In that case, the homeowner of the foreclosed property moved to reopen the judgment, arguing that MERS did not have standing to bring the foreclosure action because it did not own the mortgage at the time it initiated the action, and the court agreed. 64 See also Mortgage Electronic Registration Systems v. Rees, No. 2003 Conn. Super. Lexis 2437 (Conn. Super. Ct. Sept. 4, 2003) (unreported) (motion for summary judgment denied because of a discrepancy between an affidavit and the promissory note); Mortgage Electronic Registration Systems v. Pressman, No. 2005 Conn. Super. Lexis 82 (Conn. Super. Ct. Jan. 7, 2005)(unreported)(motion to strike special defenses denied including one that alleged that MERS did not have standing to enforce the indebtedness); Mortgage Electronic Registration Systems v. 63 Mortgage Electronic Registration Systems v. Thompson, No. 2002 Conn. Super. Lexis 828, at *2 (Conn, Super. Ct. Mar. 14,2002) (unreported). ld. at *2. 64 24 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE Burek, 798 N.Y.S.2d 346 (N.Y. Supp. 2004)(summary judgment motion denied based in part on an inconsistency between complaint and its reply affirmation); Taylor, Bean & Whitaker Mortgage Corp. v. Brown, 583 S.E.2d 844 (Ga. 2003)(reversed holding of trial court that cancelled note but remanded for determination of whether MERS as nominee of the lender had the power to foreclose). Mr. Lavalle provided us with other examples in which MERS claimed to be the owner or holder of the note, or used a lost note affidavit. See Waggoner v. Mortgage Electronic Registration Systems, No. 2003-CS-002666-MR, slip op. (Ky. Ct. App. Sept. 5, 2005)(affirming summary judgment for MERS in a foreclosure action); and Mortgage Electronic Registration Systems v. Andrews, No. 05-CA-007881, Lost Instrument Aff. (Fla. Cir. Ct. Nov. 10, 1005). Our research also revealed other cases in Illinois, Ohio, Louisiana and Connecticut in which MERS claimed to hold or own the promissory notes. See Freedom Mortgage Corp. v. Burnham Mortgage, No. 03 C 6508 2006 U.S. Dist. LEXIS 10538, *46 n.14 (N.D. Ill. Mar. 13, 2006)(stating that the verified complaints in foreclosure actions stated MERS was the owner and legal holder of the note, mortgage and indebtedness); Mortgage Electronic Registration Systems v. Akpele, C.A. No. 21822, 2004 Ohio App. LEXIS 3052, *7 n. 2, * 13 (Ohio Ct. App. June 30, 2004)(stating that MERS' affidavit asserted that MERS was the holder of the note and mortgage and holding that MERS was the holder, but reversing the lower court's grant of summary judgment for other reasons); Mortgage Electronic Registration Systems v. Barclay, No. 05AP-58, 2005 Ohio App. LEXIS 3375 (Ohio Ct. App. July 21, 2005)(stating that MERS' complaint asserted that it was the owner and holder of the note and mortgage and affirming the trial court's denial of relief to the appellant from a default judgment in a foreclosure action); Mortgage Electronic Registration Systems v. Richard, 889 So. 2d 1126, 1126 25 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE (La. Ct. App. 2004) (stating that MERS alleged in a petition for executory process that it was the holder of the mortgage); Mortgage Electronic Registration Systems v. Dorcely, CV020187258NS, 2002 Conn. Super. LEXIS 3086, *1, *7-8 (Conn. Super. Ct. Sept. 18, 2002)(unreported)(stating that MERS alleged it was the holder of the note and mortgage and denying MERS' motion to strike the defendants' special defenses because it had not recorded an assignment of the mortgage); Mortgage Electronic Registration Systems v. Leslie, CV044001051, 2005 Conn. Super. LEXIS 1360, *5 (Conn. Super. Ct. May 25, 2005)(unreported)(denying the defendants' motion to strike and holding that MERS had standing to bring a foreclosure action because it alleged in its complaint that it was the mortgagee and holder of the note and mortgage); Mortgage Electronic Registration Systems v. Serencsics, CV000339985S, 2000 Conn. Super. LEXIS 3028, *2, *4 (Conn. Super. Ct. Nov. 16, 2000)(unreported)(stating that MERS filed and served an affidavit stating that it was the holder of the mortgage and note and granting MERS summary judgment on the issues of default and the right to foreclose); and Mortgage Electronic Registration Systems v. Socci, CV020 190866S, 2003 Conn. Super. LEXIS 1490, * 1, *3 (Conn. Super. Ct. May 16,2003) (unreported) (stating that MERS' s affidavit showed that was the owner of the note and mortgage and granting MERS' motion for summary judgment as to liability). MERS recently amended its Rules of Membership to prevent servicers from pleading that MERS owns the note and to require MERS certifying agents to have possession of the note before conducting foreclosures in MERS' name. 65 65 Proposed Changes to Rule 8, Foreclosure, Section 2. See E-mail from AdamL. BendettofReiner,Reiner & Bendett, PC to Daniel Gray, Associate General Counsel, stating the proposed changes to the rule will go into effect on January 19,2006 (December 12,2005). 26 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE E. Servicers Standing to Foreclose While MERS took the brunt of the public criticism for false affidavits, servicers' counsel were the ones representing MERS and filing the false statements. There is no reason to believe they are acting any differently when representing servicers directly.66 The legal standing to sue based on the trustee's delegation of authority over the mortgage). Bankruptcy court precedents also support the servicer. (In re Raymond C. Q.K. T.N W Tainan, 48 B.R. 250 (Bankr. E.D. Pa. 1985) (servicer in its capacity as representative for collection purposes of Fannie Mae was a real party in interest); Greer v. O'Dell, 305 F.3d 1297 (l1th Cir. 2002) (credit card servicer was a real party in interest). Mr. Lavalle, nonetheless, suggests that foreclosures could still be unwound because an indispensable party, the owner of the promissory note, was not a party to the action. Three cases from lower courts do not resolve the issue, and therefore the accuracy of pleadings is particularly important to avoid misleading borrowers and the courts. Fannie Mae is entitled to take the legal position that MERS or servicers have standing to sue, provided the pleadings clearly set forth the facts. F. Fannie Mae's Current Policy on Foreclosures Fannie Mae's Servicing Guide states that routine legal proceedings generally should not be initiated in Fannie Mae's name, even though it would clearly satisfy the standing requirements in all states as the owner and holder of the promissory note. 69 Foreclosures are conducted in Fannie Mae's name only when it is the mortgagee of record, which generally means it is an older loan, or if a filing in MERS or the servicer's name would require the imposition of a transfer tax. 70 The Servicing Guidelines express a preference for naming MERS as plaintiff. 71 69 70 Servicing Guide, VIII-J02. Servicing Guide, VIII-105. 71 ld. It states: "In either situation, the attorney (or trustee) should subsequently have title vested in our name in a manner that will not result in the imposition of a transfer tax. Examples of ways to accomplish this include the assignment of the foreclosure bid or judgment to us, inclusion of appropriate language in the judgment that directs the sheriff or clerk to issue a deed in our name, recordation of an assignment of the mortgage or deed of trust to us immediately before the foreclosure sale, recordation of a grant deed to us immediately following the foreclosure sale, etc. The servicer and its selected foreclosure attorney (or trustee) must determine the most appropriate method to use in each jurisdiction .... " 28 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE Fannie Mae's guidelines do not provide specific pleading guidelines. Servicers and their attorneys are required to comply with the applicable state laws. 72 Although foreclosure actions generally are not to be initiated in Fannie's name, the Guide states that if the borrower asks who owns the note, the servicer is to inform them that Fannie Mae owns it. 73 Fannie Mae's position is that by having the servicer foreclose, the borrower continues to deal with the company with whom it already has a relationship. The servicer is in the best position to make adjustments to loan records and has the most detailed information about the loans. In addition, if the borrower has complaints, it is likely against the servicer, and they can be litigated during the foreclosure. On the issue of producing the promissory note during the foreclosure, the Servicing Guide states that most servicers have a copy of the note and can begin foreclosure proceedings with copies in jurisdictions that allow it. 74 For jurisdictions that require the original note, the servicer can request it from Fannie Mae. 75 For jurisdictions that allow only the "holder" of the note to conduct a foreclosure, Fannie Mae transfers possession of the note to the servicer temporarily in accordance with a statement in its Servicing Guide, which says: In some jurisdictions, only the "holder" of the note may conduct a foreclosure. In any jurisdiction in which our servicer must be the holder of the note in order to conduct the foreclosure, we Servicing Guide, 1-306. Servicing Guide, 1-311. 72 73 74 Servicing Guide, VIII-I02. It states: "In most cases, a servicer will have a copy of the mortgage note that it can use to begin the foreclosure process. However, some jurisdictions require that the servicer produce the original note before or shortly after initiating foreclosure proceedings. If our possession of the note is direct because the custody documents are at our document delivery facility, to obtain the note and any other custody documents that are needed, the servicer should submit a request to our Custody Department through the Loan Document Request System (LDRS) on our Web site (www.efanniemae.com). Ifwe possess the note through a document custodian that has custody of those documents for us, to obtain the note and any other custody documents that are needed, the servicer should submit a Request for Release/Return of Documents (Form 2009) to our custodian. In either case, the servicer should specify whether the original note is required or whether the request is for a copy." 75 1d. 29 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE temporarily transfer our possession of the note to our servicer, effective automatically and immediately before commencement of the foreclosure proceedings. When we transfer our possession, our servicer becomes the holder of the note during the foreclosure proceedings. 76 In Fannie Mae's view, no documents need be exchanged or physical possession of the note passed to signify a change in holder status. The Guide states: The transfer of our possession, and any reversion of possession to us, are evidenced and memorialized by our publication of this paragraph. This Guide provision may be relied upon by a court to establish that the servicer conducting the foreclosure proceeding has possession, and is the holder, of the note during the foreclosure proceeding, unless the court is otherwise notified by Fannie Mae. 77 Possession of the note automatically reverts to Fannie Mae if the borrower reinstates the loan or the servicer stops servicing the loan for Fannie Mae. 78 Fannie Mae's position has a reasonable legal basis, but the courts mayor may not accept it. The issue is whether stating that holder status is transferred without a physical transfer of the note is enough to make the servicer the holder. The V.C.C. defines a "holder" as: "(A) the person in possession of a negotiable instrument that is payable either to bearer or to an identified person that is the person in possession .... ,,79 In order to be a holder, the servicer must be in possession of the promissory note that was endorsed in blank to Fannie Mae. 76Id. For instance, a Connecticut appellate court has held that an entity must be a holder of a promissory note in order to initiate foreclosures. See Fleet National Bank v. Nazareth, 818 A.2d 69, 72 (Conn. App. 2003) (holding that a Connecticut statute allows a holder of a note who has not had the mortgage assigned to him to foreclose, but that an assignee of the mortgage who does not hold the note cannot foreclose). 77 Id. 78 [d. It states: "If the borrower reinstates the loan or the servicer ceases to service the loan for Fannie Mae for any reason, then possession of the note at that time automatically reverts to Fannie Mae and the note must be returned to the document custodian. At that time, Fannie Mae also resumes being the holder, just as it was before the foreclosure proceedings." 79 U.C.C. § 1-201(21). 30 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE In MERS v. Cabrera,80 the trial court held that MERS did not have physical possession of the promissory notes, as it alleged, and thus it did not "hold" the notes. It stated when a note is in the hands of an agent, the principal can have constructive possession of the note. 8l However, the converse was not true. 82 As MERS was an agent of the servicer or the owner of the note, it could not have constructive possession based on the servicer's possession of the note, the court held. 83 This decision is now on appeal and Fannie Mae has supported its position with authorities in an amicus brief. 84 G. Fannie Mae's Oversight of Foreclosure Attorneys Most foreclosures are conducted by servicers (even where MERS or Fannie Mae are the named plaintiff), and the servicers are responsible for choosing counsel. Fannie Mae, through its National Servicing Organization ("NSO"), has established a Retained Attorney Management Network ("RAMN"), which acts as a listing of preferred counsel. 85 Servicers can 80 MERS v. Cabrera, No. 05-245 CA 05 et at. (Fla. Cir. Ct. Sept. 28, 2005)(order of dismissal on the corrected order to show cause). The court used a slightly different definition of "holder." Florida Statute § 671.201(20) defines holder as: "'Holder,' with respect to a negotiable instrument, means the person in possession if the instrument is payable to bearer or, in the case of an instrument payable to an identified person, if the identified person is in possession. 'Holder,' with respect to a document of title, means the person in possession if the goods are deliverable to bearer or to order of the person in possession." 81 Id. at 13. Id. 82 83 84 Id. at 13. The trial court's view, however, has support. Gilmore's treatise on Security Interests in Personal Property takes the position that a written declaration is insufficient to "give him the right to collect the instrument from the obligor." See Investment Service Co. v. Martin Bros. Contained & Timber Products, 465 P.2d 868 (Or. 1970), quoting I Grant Gilmore, Security Interests in Personal Property § 1.2, 11 (1965). The Supreme Court of Oregon has stated that "it is questioned under the U.C.C. whether constructive possession is sufficient [for recovery on a negotiable instrument]." Id. Cf In re Big Squaw Mountain Corp. v. Big Squaw Mountain Corp., 122 B.R. 831, (Bankr. Me. 1990) (stating "Certainly, were we considering an attempted transfer for security of a negotiable instrument by a separate writing, unaccompanied by delivery of the instrument itself, the opportunity for mischief would exist, and the transfer would not be effective against third parties."). 85 Servicing Guide, VIII-l 04.02; e-mail from Adam Womack, Servicing Process Manager, Quality Assurance (December 19,2005) .. 31 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE choose to retain a RAMN counselor operate outside of Fannie Mae's network. 86 Fannie Mae has a retainer agreement with RAMN counsel. 87 Fannie Mae's Servicing Guide contains time guidelines for the efficient handling of defaults and foreclosures. 88 Servicers who retain RAMN counsel are relieved of penalties for delays.89 About 21 percent of foreclosure actions are RAMN network cases. 90 If the servicer chooses not to work within the RAMN network, it can retain counsel of its own choosing. Fannie does not have a retainer agreement with non-network counsel. In those cases, the attorney-client relationship appears to be between the servicer and the attorney. The Servicing Guide Art VIII, 104.01 imposes upon servicers the responsibility for monitoring all aspects of the performance of any foreclosure attorney or trustee it retains, Fannie current servicer oversight does not review attorney pleadings or litigation conduct. Servicing specialists, who are a part of the NSO's Centralized Servicing Operations Division,91 are responsible for attorney supervision, as well as loss mitigation, loan administration, and default management (which includes foreclosures and bankruptcy).92 Loan administration includes reviewing loan level delays in foreclosures and bankruptcies to determine whether to assess penalties against servicers and reviewing reports of delinquent loans 86 Servicing Guide, VIII-l 04. In many cases, servicers will conduct a foreclosure out of the network, even though the attorney they select is part of RAMN. Telephone interview with Debbie Kehr, Director of Centralized Servicing Operations (Dec. 19, 2005). 87 88 Telephone interview of Robin Gillespie, Vice President and Deputy General Counsel (Mar. 17,2006). See, e.g., Servicing Guide, VIII, Ch 1, Exhibit 4, and Servicing Guide, VIJ-602. 89 Servicing Guide, VIII-1D4.02. 90 91 92 Telephone interview with Debbie Kehr, Director of Centralized Servicing Operations (Dec. 19,2005). Id. I d. 32 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE to determine if they were accurately reported. 93 Fannie Mae's NSO does not perform quality assurance of attorney conduct or the legal positions taken in pleadings. Fannie Mae views foreclosure counsel as the attorney of the servicer. The Legal Department has had a view that it can insulate Fannie Mae from responsibility for servicer and attorney misconduct if they are independent contractors and not under Fannie Mae's direct supervision. 94 This approach is under review. 95 Legal positions taken by counsel can have state-wide or national impact, like the standing issue that is currently being litigated in Florida. Since Fannie Mae authorizes servicers to execute legal documents on its behalf% and receives the benefit from foreclosures, some plaintiffs may argue that servicers and their counsel are not independent contractors, and therefore may not be insulated from liability for misconduct by servicers or their attorneys. Fannie Mae believes that lost note affidavits are the servicer's responsibility and can not be effectively reviewed under the current system. Fannie Mae has delegated the execution oflost note affidavits to servicers. 97 It does not believe that it is in a position to make a subjective call as to whether a servicer has lost a note. 98 The party executing the affidavit makes a sworn statement under penalty of perjury as to whether the note is lost, and an attorney advises the executing party regarding the legality of the affidavit. 99 The servicer must comply with all applicable law related to foreclosures. loo The use of a lost note affidavit also is not 93 Attachments to e-mail from Debbie Kehr, Director of Centralized Servicing Operations (Dec. 19,2005). Interview of Daniel C. Smith, Deputy General Counsel of the Legal Department (Oct. 14,2005). Telephone interview of Robin Gillespie, Vice President and Deputy General Counsel (Feb. 1,2006). Servicing Guide 1-202.05: Execution of Legal Documents. E-mail from Adam Womack, Servicing Process Manager, Quality Assurance (Dec. 19,2005). ld. I d. 94 95 96 97 98 99 100 Servicing Guide, 1-306. It states: "We require each Fannie Mae-approved servicer (and any subservicer or thirdparty originator it uses) to be aware of, and in full compliance with, all federal, state, and local laws (including statutes, regulations, ordinances, administrative rules and orders that have the effect of law, and judicial rulings and 33 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE captured as computer data, so reviewing lost note affidavit usage would be manual. 101 Fannie Mae's servicing consultants also do not investigate whether notes are really lost when servicers use lost note affidavits. 102 Fannie Mae views such an investigation as unnecessary because document custodians are responsible for retaining mortgage documents and must bear an expense if they are unable to locate mortgage documents. 103 For these reasons, Fannie Mae believes that servicers are not likely to state that the notes are lost, stolen or missing if they in fact are not. 104 Some in the Legal Department, however, suspect foreclosure attorneys may be taking short cuts by misrepresenting that the notes are lost. H. Proposal for Changes in Foreclosure Procedures The Legal Department is formulating a proposal for a new computer system that would permit better communication with foreclosure attorneys and capture information about their conduct. lOS The department recognizes the need for greater communication with attorneys representing Fannie Mae's interests in foreclosures and other proceedings. 106 The new system would permit direct interaction between Fannie Mae attorneys and counsel handling specific cases. 107 Legal positions with broad impact could be coordinated. lOS Lost note affidavits and opinions) that apply to any of its origination, selling or servicing practices or other business practices (including the use oftechnology) that may have a material effect on us ..... " 101 102 103 E-mail from Adam Womack, Servicing Process Manager, Quality Assurance (Dec. 19,2005). Telephone interview with Sheila Green, Director of Servicer Management (Dec. 16, 2005). Jd. Jd. Telephone Interview with Robin Gillespie, Vice President and Deputy General Counsel (Feb. 1,2006). 104 105 106 Jd. Jd. Jd. 107 108 34 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE other conduct could be better monitored. ID9 The creation and installation of the computer system is a long-term goal, and the system will not be operational in the near future. IID The Legal Department also plans to recommend amendments to the Servicing Guide to address the issues raised in the Florida cases, but that too is a long-term project. 111 In the meantime, the Legal Department is working on an interim solution to instruct its RAMN attorneys and large servicers as to how to avoid the issues. 112 It also plans to review samplings of pleadings its attorneys and servicers file to ensure they are complying with Fannie Mae's instructions. I 13 I. Findings on Foreclosure Procedures We conclude that foreclosure attorneys in Florida are routinely filing false pleadings and affidavits regarding the plaintiffs - MERS or servicers - interest in the proceedings and regarding lost, missing or destroyed promissory notes. The practice could be occurring elsewhere. It is axiomatic that the practice is improper and should be stopped. Fannie Mae has not authorized this unlawful conduct. As a result of the MERS hearings in Florida, Fannie Mae recognizes the issue and is taking action to correct it. Mr. Lavalle's claim that large numbers of foreclosures - tens of billions of dollars worth - could be unwound as a result of this misconduct likely overstates the risk to Fannie Mae. Courts are unlikely to unwind foreclosures unless borrowers can demonstrate that the foreclosure would not have gone forward with the correct pleadings, which is a difficult burden for most borrowers to meet. Even the Florida judges who were very angry about the false pleadings \09 110 1II 112 Id. Telephone Interview with Robin Gillespie, Vice President and Deputy General Counsel (Mar. 17,2006). Id. Jd. Jd. \\3 35 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE ordered that the foreclosures could go forward with correct pleadings and the proper plaintiff. Civil lawsuits would have a similar burden; the plaintiffs would have to demonstrate damages arising from the false statements. Mr. Lavalle has not presented evidence that the borrowers were improperly placed in default. Nevertheless, the issues Mr. Lavalle raises should be addressed promptly in order to mitigate the risk of exposure to lawsuits and some degree of liability. III. TRANSPARENCY ISSUE A. Mr. Lavalle's Plea for Transparency A principal source of Mr. Lavalle's concerns is his perception that the mortgage industry is not transparent to homeowners and courts. As the industry has matured, it has become highly complex. Fannie Mae has instituted policies that have made transactions more efficient and less costly but have resulted in borrowers having less access to information about their mortgages. In Mr. Lavalle's view, this development allows Fannie Mae and others in the mortgage industry to hide transactions that should be transparent to borrowers, has contributed to predatory servicing, and has made Fannie Mae's financial statements unreliable. For instance, Fannie Mae's policy of having promissory notes endorsed in blank, undated and without recourse 114 was intended to reduce significant administrative costs. When notes are endorsed in blank and mortgage assignments are not recorded in land records, however, borrowers cannot identify the chain of owners and servicers. This procedure, Mr. Lavalle contends, hinders borrowers from auditing the trail of charges and payments in order to correct 114 Selling Guide, IV-204. 36 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE errors. 115 Victims of predatory servicing, Mr. Lavalle also contends, should be entitled to circumvent unscrupulous servicers to pay off their loans directly to the owners. I 16 Mr. Lavalle contends that by creating MERS and United States Foreclosure Network, Fannie Mae has "helped shaped [sic], guide, direct, govern and implement such [predatory or aggressive servicing] practices for a variety of motives.,,117 MERS is another innovation designed to add efficiency to the system. It eliminates the need for paper mortgage assignments and the payment of recordation fees when mortgages are transferred. 118 Mr. Lavalle claims, however, that MERS has further hidden the chain of servicers and owners. Mr. Lavalle proposes that Fannie Mae instruct MERS to open its records for a fee to the public so that borrowers can ascertain who are the servicers, trustees, investors and custodians of their mortgages. I 19 He also claims to be obtaining proxies from friends who have substantial shares in Fannie Mae so that they can seek approval from the Board of Directors or shareholders for various corporate resolutions, including one for an investigation of Fannie Mae's relationship with MERS and USFN. 120 115 116 Telephone interview with Nye Lavalle (Feb. 6, 2006). Telephone interviews with Nye Lavalle (Nov. 1,2005 and Feb. 6, 2006). 117 E-mail datedJuly22.2005.fromNyeLavalletoMr.Mudd.Ms. House, and various members of Fannie Mae's Board of Directors. 118 Fannie Mae Announcement 97-0;, MERS is a Reality!, pp. 1, 10. 119 E-mail dated June 4, 2004, from Nye Lavalle to Mr. Raines, Ms. House, and other undisclosed recipients; E-mail dated July 22,2005, from Nye Lavalle to Mr. Mudd, Ms. House, and various members of Fannie Mae's Board of Directors; E-mail dated Oct. 14,2005, from Nye Lavalle to Mark Cymrot. 120 E-mail dated Feb. 15,2006, from Mr. Lavalle to Mark Cymrot and Ambika Biggs. 37 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE B. Effects of Note Endorsed In Blank When Fannie Mae purchases mortgages,121 Fannie Mae requires the lender to endorse the promissory notes "in blank" and without recourse. 122 Promissory notes in this form are bearer instruments that can be negotiated without endorsement. 123 Promissory notes, which establish the obligation to repay the loan, are governed by Article 3 ofthe Uniform Commercial Code ("UCC"). The sale of promissory notes is also now covered under Revised UCC Article 9. 124 As a result of Fannie Mae's policy of requiring lenders to endorse notes in blank, notes do not contain a series of endorsements that would permit the borrower to identify the chain of ownership. Secondary market transactions, however, do not affect a borrower's payments or other obligations under the mortgage. They also do not necessarily affect the servicer with whom the borrower interacts. Mortgages are treated differently from promissory notes under the law. Mortgages, which establish the security interest in the home, are governed by UCC Article 9, and the obligation to record the mortgage is governed by state laws that vary from state to state. The purpose of land record laws is to give public notice of liens on real property. These laws do not 121 Fannie's Selling Guide defines "Mortgage" as: "Collectively, the security instrument, the note, the title evidence, and all other documents and papers that evidence the debt (including the chattel mortgage, security agreement, and financing statement for a cooperative share loan); an individual secured loan that is sold to us for retention in our portfolio or for inclusion in a pool of mortgages that backs a Fannie Mae-guaranteed mortgage security. The term includes a participation interest where context requires." Selling Guide, Part XIII, Glossary. 122 Selling Guide, IV -204. 123 U.C.C. Revised § 3-205(b). It states: "(b) When indorsed in blank, an instrument becomes payable to bearer and may be negotiated by transfer of possession alone until specially indorsed." U.C.C. Revised § 3-205(a) defines a special indorsement as one that "identifies a person to whom it makes the instrument payable." 124 Revised § 9-109. It states: "this article applies to ... a sale of accounts, chattel paper, payment tangibles, or promissory notes." § 9-109(a)(3). Former Article 9 did not apply to the sale of promissory notes. "Subsection (a)(3) expands the scope ofthis Article by including the sale of ... a 'promissory note. '" Revised § 9-\ 09, Official Comment 4. 38 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE require and do not provide a mechanism for recording promissory notes. 125 When a lender sells to Fannie Mae a mortgage that is not registered with MERS, the lender or the servicer must prepare a mortgage assignment. 126 If the lender is not the servicer, the lender must assign the mortgage to the servicer and record the assignment in the land records. 127 Fannie Mae's position is that it does not need to appear in the land records in order to have the benefit of the security provided by the mortgage. 128 UCC§ 9-203(g) and its accompanying comment state that the transfer of an obligation secured by a security interest also transfers the security interest. 129 Thus, the transfer of the promissory note, which is the obligation, also transfers the mortgage, which is the security interest. Once the note is sold to Fannie Mae, the mortgage also transfers, despite the fact that the servicer, lender or MERS' name appears in the land records. Borrowers thus cannot determine the chain of owners from public records. Under the Servicing Guide, however, borrowers should be able to determine whether Fannie Mae is the beneficial owner of their loan. The Servicing Guide states that the "servicer should freely 125 See Asset Based Financing: A Transactional Guide, at §9.04[2] (Howard Ruda ed., LexisNexis, Vol. 1 2005), which states: "Typically, [recording] acts require that the mortgage or deed of trust be recorded in the district or county where the property is located"); see also Black's Law Dictionary 1301 (8th ed. 2004), which defines "recording act" as a "law that establishes the requirements for recording a deed or other property interest and the standards for determining priorities between persons claiming interest in the same property," and defines "recordation" as the "act or process of recording an instrument, such as a deed or mortgage, in a public registry." 126 Selling Guide, IV -402 states: "For any mortgage that is not registered with MERS, we require the lender to prepare an assignment of the mortgage to Fannie Mae, although the assignment should not be recorded. If the mortgage seller is not going to service the mortgage, the unrecorded assignment to Fannie Mae must be executed by the mortgage servicer." 127 Selling Guide, IV-403. It states: "When the mortgage seller and the mortgage servicer are not the same entity, we require a recorded intervening assignment from the seller to the servicer-and then an assignment from the servicer to us (or MERS)." 128 Interview with Daniel C. Smith, Deputy General Counsel (Oct. 14,2005). 129 U.C.C. Revised § 9-203(g) states: "The attachment of a security interest in a right to payment or performance secured by a security interest or other lien on personal or real property is also attachment of a security interest in the security interest, mortgage or other lien." The Official Comment states that subsection (g) "codifies the commonlaw rule that a transfer of an obligation secured by a security interest or other lien on personal or real property also transfers the security interest or lien." 39 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE disclose Fannie Mae's interest in the mortgage in response to a borrower's inquiry (including the name, address, and telephone number of our applicable regional office if the borrower requests this type of information).,,13o Borrowers may not always be able to determine who owns their mortgage, but they should be able to determine if Fannie Mae owns it, if that information is important to them. C. MERS Impact on Transparency Prior to the creation of MERS, the borrower could look to the land records to follow the chain of servicers. If a mortgage is registered with MERS, however, MERS is the mortgagee of record. Fannie Mae does not require lenders to register mortgages they sell or service for Fannie Mae with MERS.l3I If a lender registers a mortgage with MERS, it can do so in one of two ways. First, it can originate the mortgage with MERS appearing in the security instrument as the nominee for the beneficiary and its successors and assigns.132 This is known as MOM, or MERS as Original Mortgagee. 133 Originating the mortgage with MERS as nominee "eliminate [s] the need for a subsequent assignment of the security instrument should the lender sell (or transfer servicing of) the mortgage to another lender that is a member of MERS. 134 130 Servicing Guide, 1-311. 131 Fannie Mae Announcement 97-08, p.1, stating: "Although we will not require lenders to register their Fannie Mae-owned or securitized mortgages with MERS, we expect that many lenders will want to register all of their mortgages with MERS. We encourage all lenders to look into the benefits that MERS offers." 132 133 134 MERS Recommended Foreclosure Procedures, First Edition, p. 4. MERS Recommended Foreclosure Procedures, First Edition, p. 4. Selling Guide, IV-103. It states that when a mortgage is originated with MERS as nominee: "the applicable security instrument must be appropriately modified to show MERS as the nominee for the lender, to define and name the originating lender, and to obtain the borrower's acknowledgment ofMERS' role in the mortgage transaction ... The lender will be responsible for the accurate and timely preparation and recordation of the security instrument (and must take all reasonable steps to ensure that the information on MERS is updated and accurate at all times)." 40 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE Second, if the mortgage already has been originated, the lender can record an assignment of the mortgage to MERS, making MERS the mortgagee of record. 135 In either case, MERS becomes the mortgagee of record in the county land records. 136 All subsequent transfers of ownership or servicing rights among MERS members are recorded electronically. 137 As long as the loan is sold and transferred to a MERS member, the identity of the record mortgagee never changes during the life of the loan even though the owner and servicer might. 138 If a borrower has not kept historical records of payments, the land records no longer will provide a chain of servicers for the borrower to use to trace problems. A study of foreclosures in the Chicago, Illinois area found that in 2003, MERS was the most active foreclosing institution in that area. 139 That year MERS started 14.7 percent of all foreclosures.1 4o The study found that MERS made it difficult for borrowers to track who owned properties that were foreclosed upon, as well as those entities that may have used abusive practices, by hiding the identities oflenders, servicers or trustees. 141 D. Reasons for Endorsement and Recording Policies The purpose of both developments was to reduce paperwork and lower the costs of mortgage administration, which should have the effect of lowering interest rates. If notes MERS Recommended Foreclosure Procedures, First Edition, pp. 4-5. \35 136 I d. at 5. Lenders who sell loans to Fannie Mae mayor may not have to assign the mortgage to Fannie Mae depending on whether the mortgage is registered with MERS. See, Selling Guide IV, Chapter 4: Assignment of Mortgages. \37 MERS Recommended Foreclosure Procedures, First Edition, p. 5. 138 I d. at 5. See also MERS is a Reality!, p. 2, stating: "Because the mortgagee of record (MERS) [does] not change while the loan is current, there [is] no necessity either to execute or record in the public land records any assignments to reflect the ... sale of the mortgage to an investor, or the transfer of servicing rights." \39 Nati.onal Training and Information Center, October 8, 2004, "Preying on Neighborhoods II: Community Partners Tum the Tide Against Predatory Lending," p. 25. The study analyzed foreclosures in Cook, DuPage, Kane, Lake, McHenry and Will counties. Id. at 11. 140 I d. at 25. 141Id. 41 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE were endorsed (as they once were), Fannie Mae would incur the considerable administrative cost of endorsements for millions of transactions. 142 MERS was created, in part, to eliminate the need to record mortgage assignments in state land records when servicing rights were transferred. These developments, however, had the secondary effect of making the mortgage markets less transparent for borrowers. Fannie Mae's policy of having the servicer, lender, or MERS act as the mortgagee of record serves two other purposes. The servicer's duties include protecting Fannie Mae's interest in the mortgaged property. 143 The servicer can better perform when legal notices that may affect Fannie Mae's lien on the property come directly to it. 144 If Fannie Mae were the mortgagee of record, it would have to forward these notices to the servicer, just as MERS must do when it is the mortgagee of record. 145 Having MERS or the servicer named in the land records also tends to direct complaints to the servicer whose conduct is generally the one being questioned. Borrowers rarely, if ever, need to know the current owner, or chain of owners, oftheir mortgage. Income streams from mortgages have been fractured and sold as MBS' s. In many cases, none of the numerous owners would have the legal right to resolve issues with a servicer. Mr. Lavalle's proposal to allow borrowers to avoid an unscrupulous servicer by paying the owners or trustee is 142 See U.C.C. Revised § 3-201(b), which states " ... ifan instrument is payable to an identified person, negotiation requires transfer of possession of the instrument and its indorsement by the holder. Ifan instrument is payable to bearer, it may be negotiated by transfer of possession alone." U.C.C. Revised § 3-201(a) states: '''Negotiation' means a transfer of possession, whether voluntary or involuntary, of an instrument by a person other than the issuer to a person who thereby becomes its holder." 143 Servicing Guide, 1-202. 144Id. It states: "To facilitate performance of the servicer's contractual responsibilities to Fannie Mae and the borrower, the servicer ordinarily appears in the land records as the mortgagee. For example, this ensures that the servicer receives legal notices that may impact our lien, such as notices of foreclosure of tax and other liens." 145 Servicing Guide, III, Chapter 5. When the notices provide enough information for MERS to determine the servicer of the mortgage, MERS forwards the notice to the servicer. When not enough information is available to identify the servicer, MERS electronically notifies all MERS members about the unidentified notice. 42 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE unworkable. The owners are too numerous and Fannie Mae does not have facilities to deal directly with the pUblic. In a recent conversation, Mr. Lavalle acknowledged that strict enforcement of servicer obligations would be a better approach to the issue. E. Disclosures to Borrowers Fannie Mae has chosen, consistent with its charter, to require servicers to provide information to and assist borrowers with problems rather than interact with borrowers directly. The Servicing Guide III-l 04 requires servicers to provide borrowers with an annual statement of activity in their account. Servicers also: ... must provide a detailed analysis of all transactions relating to a borrower's payments or escrow deposit account whenever the . b orrower requests It. 146 Servicers also must "provide borrowers with assistance when it is requested" and "have effective processes to promptly address borrower inquiries (relating to both current and delinquent loans) and provide timely payoff quotes.,,]47 The Guide also instructs servicers to inform borrowers that Fannie Mae is the owner of their notes if they ask.148 When servicing rights are transferred, Fannie Mae requires the servicers to notify and provide information to borrowers about the transfer. 149 RESP A also requires servicers of "federally related mortgage loans" to inform borrowers of any assignment, sale or transfer of the .. servIcmg 0 f a Ioan. 150 146 1d. 147 Servicing Guide, 1-202. It states: "As a general matter, servicers should have sufficient properly trained staff, and adequate controls and quality assurance procedures in place, to carry out all aspects of their servicing duties; to protect against fraud, misrepresentation, or negligence by any parties involved in the mortgage servicing processes; to protect our investment in the security properties .... " 148 Servicing Guide 1-311. 149 Servicing Guide, 1-205.04. 15°12 U.S.C § 2605. 43 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE Although Fannie ordinarily does not have direct contact with borrowers, it has established channels for borrowers to report suspected cases of mortgage fraud. 151 Borrowers can contact Fannie Mae via a toll-free telephone number or bOy e-mail. 152 Fannie Mae's procedures for investigating these tips are detailed in the section on fraud investigations and reporting. F. Findings Regarding Transparency Mr. Lavalle's complaint about transparency is the natural consequence of mortgage markets becoming more complex and fractured. The requirement to have notes endorsed in blank and the creation of MERS are designed to add efficiency to the mortgage markets and reduce costs, which should benefit homeowners with lower interest rates and more choices. These developments, however, have made the system less transparent. Mr. Lavalle complains that a lack of transparency has made it easier for predatory servicers to flourish. Fannie Mae has addressed this issue by requiring servicers to disclose information to borrowers and through other enforcement efforts detailed in the predatory servicing section. These disclosures respond to Mr. Lavalle's proposal that borrowers have access to the MERS' database for a fee; they should be able to get relevant information from the servicers. The borrowers should have ready access to information about their payments, escrows, fees and other relevant information concerning their mortgages. Mr. Lavalle's proposed solution that borrowers be given the option to conduct transactions directly with note owners or Fannie Mae is impractical and not consistent with Fannie Mae's mission. Ownership interests in mortgage income streams have been fractured due 151 Fannie Mae Response to OFHEO Mortgage Fraud Reporting Rule; Single-Family Anti-Fraud Protocols and Procedures, p. 6. 152 I d. 44 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE to the advent ofMBS's. No single owner would have authority to bind others, and no mechanism exists for owners to resolve servicing disputes. Fannie Mae, as owner or trustee for MBS's is not intended to, and not capable of, interacting directly with borrowers; it operates in a secondary market in which its customers are lenders and servicers. Mr. Lavalle has provided examples of situations in which borrowers have had difficulty obtaining information, even in litigation. We have not been able to examine the full context of these problems. As discussed below, Fannie Mae reviews certain servicer conduct and has taken steps to prevent or uncover predatory servicing practices. As Mr. Lavalle recently acknowledged, the better approach is for Fannie Mae to mandate that servicers be transparent with borrowers - which it already does - and to enforce these requirements and those prohibiting predatory lending and servicing practices - which it also appears to do. IV. PROMISSORY NOTE POLICIES A. Mr. Lavalle's Concerns Mr. Lavalle expresses concern about two Fannie Mae policies regarding the handling of promissory notes: (1) notes are required to be endorsed in blank, undated and without recourse,153 and (2) original notes are not consistently returned to the borrower stamped "cancelled" and "paid in full." I 54 Mr. Lavalle questions whether Fannie Mae has adequate procedures in place to keep track of 15 million promissory notes that it has in its possession or is held for its account. 155 Mr. Lavalle claims that the endorsement-in-blank policy leads to trillions 153 E-mail dated Dec. 19, 2003 from Nye Lavalle to then-Fannie Chairman and Chief Executive Officer Franklin Raines and other individuals. 154 E-mail datedJuly22,2005,fromNye Lavalle to Ms. House, Mr. Mudd, and Board of Director members Stephen Ashley, Ann Korologos, Frederic Malek, Donald Marron, Leslie Rahl, H. Patrick Swygert, and John Wulff, and others. 155 E-mail dated Dec. 19,2003, from Nye Lavalle to then-Fannie Mae Chairman and Chief Executive Officer Franklin Raines and other individuals; E-mail dated July 22, 2005, fromNye Lavalle to Ms. House,Mr. Mudd, and 45 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE of dollars of missing or lost negotiable paper. 156 Mr. Lavalle bases his claim that the problem is widespread by extrapolating from routine filing of lost note affidavits in Florida foreclosure proceedings. 157 He acknowledges that every entity operating in the secondary mortgage market has the same policy.158 According to his calculations, about $6 trillion worth of bearer paper exists due to this practice. 159 Since these notes are negotiable instruments, Mr. Lavalle contends borrowers face dire consequences from their mishandling. 160 A holder in due course, for instance, can recover even when the maker has defenses or has paid the note in full. 161 Mr. Lavalle also criticizes Fannie Mae's policies regarding the return of original notes upon payoff. Fannie Mae's policies allegedly are having an adverse impact on borrowers and on the value of Fannie Mae's mortgages and mortgage-backed securities. Original promissory notes are not routinely returned to borrowers stamped "cancelled" and "paid in full" when they payoff their loans. He feels that satisfactions or lien releases, which are now permitted under state laws, do not adequately protect borrowers should their original promissory notes end up in the wrong hands. 162 Mr. Lavalle claims this practice leaves borrowers at risk for years after they have paid off the note. 163 Mr. Lavalle has supplied us with cases of borrowers Board of Director members Stephen Ashley, Ann Korologos, Frederic Malek, Donald Marron, Leslie Rahl, H. Patrick Swygert, and John Wulff, and others. 156 157 158 Telephone interview with Mr. Lavalle (Nov. 1,2005). Telephone Interview with Mr. Lavalle (Nov. 23, 2005). Telephone interview with Mr. Lavalle (Nov. 1,2005). 159 ld. 16°1d. See also Benny L. Kass, Lost Mortgage Documents May Cause Future Problems, Realty Times, Sept. 13, 2004, available at http://realtytimes.com/rtcpages/20040913_lostdocs.htm. 161 162 u.c.e. Revised §§ 3-305(b) and 3-601. Telephone interview with Mr. Lavalle (Nov. 1,2005). 163 ld. 46 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE subjected to claims by multiple lenders alleging ownership of the same notes. 164 Mr. Lavalle proposes that lenders be required to return the original promissory notes stamped "paid in full" with each payoff. Mr. Lavalle fears that if the notes are mishandled, borrowers could bring class action lawsuits, exposing Fannie Mae to great liability. B. Borrower's Risk to a Holder in Due Course The risk Mr. Lavalle perceives from lost or mishandled notes arises from the rights given a holder in due course by the uee. A borrower can be required to pay a note twice - even one that is lost or stolen - if the note comes into the hands of a holder in due course. Under uee Article III, a maker of a note (i. e., the borrower) is "discharged" of liability under the note once payment has been made in accordance with the note. 165 If, however, the party who comes to possess the note is a holder in due course without notice of the discharge, the discharge is not effective against that party. 166 Generally speaking, a holder in due course is a good faith purchaser of a note for value. 167 An individual who finds or even steals a promissory note endorsed in blank can become a person entitled to enforce the promissory note. 168 Against a person entitled to enforce, the borrower can assert defenses, such as the note has already been 164 See First Union Nat 'I Bank v. Hufford, 767 N.E.2d 1206(Ohio Ct. App. 2001); E-mail from Nye Lavalle to Mark Cymrot and Ambika Biggs, containing po stings by individuals claiming there were multiple foreclosures on the same property (Nov. 29, 2005). See also E-mail attachments from Carl Erickson, which include an allegedly fraudulent promissory note (Nov. 30,2005). Mr. Erickson claims that two different companies - Freddie Mac and the Charles F. Curry Company - claimed to be the owner of the note at the same time. Mr. Erickson has communicated with Mr. Lavalle, as is evidenced in the e-mail. 165 U.e.e. Revised § 3-602(a). It states: "an instrument is paid to the extent payment is made by or on behalf of a party obliged to pay the instrument, and to a person entitled to enforce the instrument. To the extent of the payment, the obligation of the party obliged to pay the instrument is discharged ... " 166 U.C.C. Revised § 3-601(b). It states: "Discharge of the obligation ofa party is not effective against a person acquiring rights of a holder in due course of the instrument without notice of the discharge." 167 168 U.C.e. Revised §§ 3-302. U.C.C. Revised § 3-205, Comment 2; U.C.C. Revised § 3-301, Comment. 47 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE paid. 169 If, however, the lost or stolen note is transferred to a holder in due course, the note can be enforced without regard to many of the borrower's defenses, including discharge. 170 The borrower is, thus, at risk to paying twice if the original promissory note is not properly protected. 171 The borrower would have the expensive and unenviable task of trying to collect from the custodian that was negligent in losing the note, from the servicer that accepted payments, or from others responsible for the predicament. C. Fannie Mae's Herndon Custody Facility Fannie Mae's mortgage documents - including promissory notes - are stored in one of three places: Fannie Mae's document delivery facility in Herndon, Virginia; in the possession of an independent custody agent; or in the possession of the servicer, acting as a custody agent. I72 The party responsible for physical possession of the mortgage documents, called custody documents,173 may vary depending on whether Fannie Mae purchases the 169 See U.C.C. Revised § 3-302, Comment 3, which states: "Discharge is effective against anybody except a person having rights of a holder in due course who took the instrument without notice of the discharge." Section 3-305(a) provides other defenses. U.C.c. Revised § 3-601(b). It states: "Discharge of the obligation ofa party is not effective against a person acquiring rights ofa holder in due course of the instrument without notice of the discharge." In cases involving lost note affidavits, courts have addressed Mr. Lavalle's concern that a subsequent holder will seek to recover against a borrower. See McKay v. Capital Resources Co., 940 S.W.2d 869, 871 (Ark. 1997)(reversing a foreclosure decree in which the foreclosing party only produced a photocopy of the promissory note because the borrower may have been subjected to double liability if the holder of the original note brought a claim); Shores v. First Florida Resource Corp., 267 So. 2d 696 (Fla. Dist. Ct. App. 1972) (in an action for reestablishment of a lost note, the court held that evidence that the note and mortgage had not been assigned was inadequate because the borrowers were entitled to assurance that future holders would not sue them on the instruments); Resolution Trust Corp. v. First Federal Savings Banks of Diamondsville, 36 F.3d 972 (lOth Cir. 1994) (holding that the debtor was adequately protected by the foreclosing party's agreement to indemnify the debtor for any liability arising from a claim by a person who may become a holder of the lost note). 170 171 Notice of discharge does not prevent holder in due course status. See Official Comment to U.C.C. § 3-60 I, stating: "Notice of discharge is not treated as notice of a defense that prevents holder in due course status." However, if the holder in due course had notice of discharge when holder in due course status was established, discharge is effective against the holder in due course. Jd. 172 Interview with Debra Thompson, Director, Asset Acquisitions and Custody (Nov. 8, 2005). See also Selling Guide, 1-403. 173 Generally speaking, for portfolio mortgages, these custody documents "consist of the original mortgage notes" and other important mortgage documents. Selling Guide, 1-403. 48 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE mortgage for its portfolio or is a trustee for an MBS pool. Fannie Mae's document delivery facility generally maintains custody of the mortgage documents for its portfolio mortgages, certifying and holding 67 percent of all Fannie Mae portfolios loans certified in 2005.175 A lender-designated document custodian, which can be the lender, a third-party document custodian, or Fannie Mae's document delivery facility, generally maintains control over MBS custody documents. 176 Fannie Mae certified and held about 6.3 percent of Fannie Mae MBS loans that were certified in 2005. 177 Of the approximately 15 million Fannie Mae loans (portfolio and MBS), the Herndon facility maintains custody over approximately 2 million, or 13 percent. 178 Each month, Fannie Mae receives and releases the mortgage documents for about 40,000 mortgages, although the numbers can vary considerably. 179 When a mortgage arrives at Fannie Mae's document custody facility for purchase, the custody documents undergo a certification process, during which Fannie Mae employees ensure that the mortgage documents are legally enforceable and that the information the lender submitted regarding the mortgage corresponds with the information recorded on the promissory note. 180 lfthe mortgage is certified, the promissory note 174 174 Selling Guide, 1-403. It states: "The only exceptions to this involve some mortgages we agree to purchase under the terms of a negotiated contract that permits the lender to designate another document custodian and participation pool mortgages we purchased under commitments executed prior to 10/31191, wh ich permitted the mortgage servicer or the participating lender to retain the custody documents." 175 See Certification chart, included in Letter from Debra Thompson, Director, Asset Acquisitions & Custody, to Mark Cymrot (Jan. 26, 2006). 176 See Selling Guide, 1-403. It states: "The only exception to this involves some participation interests in MBS pools that were issued under contracts executed prior to 10/31191 ... " 177 See Certification chart, included in Letter from Debra Thompson, Director, Asset Acquisitions & Custody, to Mark Cymrot (Jan. 26, 2006). 178 See Vault Percentage chart, included in Letter from Debra Thompson, Director, Asset Acquisitions & Custody, to Mark Cymrot (Jan. 26, 2006). 179 Interview of Debra Thompson, Director, Asset Acquisitions and Custody (Nov. 8,2005). 180 During the certification process, Fannie Mae employees ensure that there are no breaks in the chain of endorsement from the originating lender to Fannie Mae, that the seller was a holder in due course of the promissory 49 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE and other mortgage documents are placed in a vault and remain there until either: (l) the lender requests Fannie Mae to return the promissory note; (2) the lender reports the note as liquidated;181 or (3) the lender wants the documents to be transferred to another document custodian, which can occur when servicing rights are transferred. 182 Thirteen jurisdictions require an individual to have possession of the original promissory note in order to take certain legal actions, including foreclosure. 183 Fannie Mae returns the notes to lenders in these jurisdictions, referred to as the Original Notes States. Fannie Mae also returns notes to lenders that have informed Fannie Mae that they always want the notes returned after pay off. 184 Fannie Mae does not mark notes "cancelled" when it returns them to servicers.185 In addition, if a lender wants Fannie Mae to return a note because it is initiating foreclosure actions, the lender can request it from Fannie Mae through the Loan Document Request System ("LDRS"), which is an electronic system through which lenders request and Fannie Mae sends documents. 186 If a note is not from an Original Notes State and the lender does not request its return, Fannie Mae destroys the note after the servicer informs it that the loan has been note, and that the promissory note is endorsed in blank. In addition, employees review certain information, such as the interest rate, property address, original note rate, first payment due date, principal and interest constant, and unpaid principal balance, to ensure that the information submitted by the lender corresponds to the information recorded on the promissory notes. 181 Payoffs, repurchases, assignments, deeds-in-lieu, and foreclosures are categorized as liquidation transactions. Servicing Guide, X-601. 182 Interview of Debra Thompson, Director, Asset Acquisitions and Custody (Nov. 8,2005). 183 The jurisdictions are: California, Connecticut, Colorado, Florida, Massachusetts, Michigan, New Jersey, New York, Pennsylvania, Texas, Virginia, Washington, and Puerto Rico. 184 These lenders are: Sky Financial, Bank of America, First Merit, and Whatcom Educational Credit Union. Telephone Interview with Debra Thompson, Director, Asset Acquisitions and Custody (March 3, 2006). Servicing Guide, VIII- 102. IllS 186 50 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE liquidated. 187 Lenders report account activity for the mortgages monthly through an electronic system called LASER I88 Fannie Mae examines these reports and determines which loans have been liquidated. 189 In order to provide for mistakes in reporting, Fannie Mae leaves a lag time between when lenders indicate that a loan has been liquidated and when the promissory note is shredded. 190 Fannie Mae employees pull the promissory notes from the vaults 90 days after lenders report the loan liquidated. The note is stored for 30 days before it is sent to the contractor for shredding. 191 Approximately 60 percent of the mortgage documents are returned to lenders and 40 percent are destroyed. 192 D. Other Certified Custodians Other than its own facilities, Fannie Mae certifies 58 active document custodians. 193 Fannie Mae has additional inactive custodians that hold mortgage documents for Fannie Mae, but they no longer certify documents for new loans. 194 Document custodians must comply with Fannie Mae's procedures. 195 In order to be a document custodian, the custodial institution must be a regulated financial institution or a subsidiary and meet certain eligibility 187 Telephone Interview with Debra Thompson, Director, Asset Acquisitions and Custody (March 3, 2006). Servicing Guide, 1-403.03, however, states: "The document delivery facility will automatically return to the servicer any custody documents it is holding for a portfolio mortgage and MBS pool within 60 to 90 days after the servicer reports a mortgage payoff or repurchase, the acceptance of a deed-in-Jieu, or the completion of foreclosure proceedings to us through LASER." This procedure has since been updated, but the change is not reflected in the Servicing Guide. 188 189 190 191 192 See Servicing Guide, X: LASER Reporting System. Interview of Debra Thompson, Director, Asset Acquisitions and Custody (Nov. 8,2005). I d. Id. I d. 193 194 Telephone interview with Debra Thompson, Director, Asset Acquisitions and Custody (Mar. 3, 2006). [d. 195 Guidelines for Document Custodians, Introduction (stating "Fannie Mae requires that certain documents relating to mortgages in MBS pools be held by custodial institutions (called document custodians) that meet the eligibility criteria set out in the Selling and Servicing Guides."). 51 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE criteria that are set forth in the Selling and Servicing Guides and the Guidelines for Document Custodians. 196 These criteria include having the capabilities to track the receipt and release of documents and the physical location of documents, and maintaining secure storage facilities that have controls to ensure the security of custody documents. 197 The custodian also must install the MORNET Custodian Certification System, an electronic service that enables it to transmit MBS pool certifications. Each document custodian must subscribe to Fannie Mae's Selling, Servicing, and Forms Guides to ensure that all are aware of Fannie Mae's latest policies and procedures.,,198 Lenders must have a Custodial Agreement with one of the certified custodians for all MBS pools they deliver to Fannie. 199 The promissory note is one of the custody documents the custodian holds?OO When the document custodian receives documents from the lender, it must review and certify them in the same manner as Fannie Mae's Herndon facility.201 The lender electronically submits to the custodian a Schedule of Mortgages, which includes data about the individual mortgages in each MBS pool for which the custodian will maintain documents. 202 The custodian must compare the information recorded in the Schedule of Mortgages to the information contained on the related notes to ensure it is the same. 203 If the document custodian 196 See id.; Guidelines for Document Custodians, Eligibility Criteria for Third-Party Document Custodian; Guidelines for Document Custodians, Eligibility Criteria for Lending [sic] Acting as Own Document Custodian. 197 198 Guidelines for Document Custodians, Eligibility Criteria for Third-Party Document Custodian. Guidelines for Document Custodians, Introduction. 199Id. 200 Guidelines for Document Custodians, Custody Documents. See also SeIling Guide, VI-302.0l, for a similar list of items that a lender that creates an MBS pool must send to the document custodian for each mortgage in the pool. 201 202 Guidelines for Document Custodians, Introduction. Guidelines for Document Custodians, Documentation Review, and Certification, Schedule of Mortgages (Form 2005). 203 Id. 52 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE receives all the required documents and determines that they contain the correct information and are consistent with Fannie Mae's requirements, it sends an electronic certification of the MBS pool to Fannie Mae. 204 After the custodian has certified the MBS pool, it "must exercise control over all documents that are retained in its custody.,,205 If a lender transfers documents to a different custodian, the new custodian must recertify the MBS pool, by indicating that it has received all required documents and that any new documents required in connection with the transfer satisfy Fannie Mae's requirements.z° 6 The Guidelines for Document Custodians also state that "[0 ]nce the documents related to an MBS pool are delivered to the document custodian, the note and, if applicable, the assignment of the mortgage to Fannie Mae must remain in the custodian's possession at all times, unless the lender needs to obtain documents to perform a specific servicing function (such as the initiation of foreclosure proceedings or satisfaction of a mortgage that has been paid-infull). ,,207 The lender must submit a Request for Release/Return of Documents form to obtain the documents from the custodian,208 and if the documents are released on a temporary basis, the lender must return the documents as soon as it no longer needs them.209 When an MBS pool has been liquidated, meaning that all the individual mortgages in the pool have been liquidated, the 204 Guidelines for Document Custodians, Documentation Review, and Certification, Document Custodian's Certification. This electronic certification is sent via the MORNET Custodian Certification System. 205 Guidelines for Document Custodians, Introduction. I d. 206 207 Guidelines for Document Custodians, Request for Release/Return of Documents (Form 2009). I d. 208Id. 209 53 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE lender should send a written request within 30 days of liquidation of the MBS pool to the document custodian to return any remaining documents to the lender. 2lO The current Custodian Guidelines, however, do not have any provision for centralized reporting of lost notes, or a procedure for requiring the custodian or the servicer to report the missing note to the borrower. E. Fannie Mae's Internal Audits and Custodian Reviews Fannie Mae's own document custodian facility undergoes periodic internal audits by Fannie Mae's Audit Department to ensure compliance with these procedures. In the past, internal auditors had not focused specifically on the document custodian facility, but had reviewed it while auditing other areas of Fannie Mae. 211 Currently, a more vigorous internal audit is in progress.z 12 Internal auditors are reviewing Fannie Mae's procedures regarding certification, access to the vault, and inventory control, which includes note retention, return, and destruction processes. 213 So far, they have found that Fannie Mae management already had identified and taken steps to correct most of the issues they discovered during the audit. 214 They anticipate completing the audit by mid-March 2006. 215 Fannie Mae recently instituted reviews of the 58 certified custodians. 216 Fannie Mae employees conducted walk-throughs at document custodians' facilities to examine their Guidelines for Document Custodians, Liquidated MBS Pools. It further states: "For the most part, the custodian will already have released the documents based on receipt of a Request for Release/Return of Documents (Form 2009). The custodian does not need to request submission of a Form 2009 for any remaining documents - the lender's written request will be sufficient justification for the document custodian to close out its records for the pool." 210 211 Telephone interview with Curtis Doss, Audit Director for the Guarantee Fee Division (Mar. 3, 2006). 1d 212 213 214 215 216 Id Id Id. Interview with Debra Thompson, Director, Asset Acquisitions and Custody (Nov. 8,2005). 54 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE procedures and processes. They also selected pools and loans to review to determine if there are any errors in their certification procedures. Fannie Mae conducted reviews of six custodian facilities in 2005, and plans to visit all 58 during 2006. 217 The 2005 reviews found generally good compliance with the required custodial procedures. Fannie Mae is in the process of developing guidelines to standardize the certification process. Fannie Mae's custodian reviews focus principally on the certification process, which tests the information about mortgages in Fannie Mae's computer system. The reviews do not specifically test whether the custodian is maintaining proper control over promissory notes. We have not found evidence that Fannie Mae's custodial procedures are inadequate or that notes are regularly being lost or stolen. Other than pointing to the filing of numerous lost note affidavits, which appear to be indicative of improper pleading rather than actual lost notes, Mr. Lavalle has not presented evidence that notes are regularly being mishandled. Fannie Mae's document custodian prepared lost note affidavits as follows: 2003 2004 2005 97 183 108. 218 Fannie Mae's original promissory notes do not appear to be regularly lost or stolen in a volume that would present a serious financial problem for Fannie Mae. Every lost note obviously is important because it puts a borrower at risk. We have found no evidence, however, that any lost notes have been misused to the detriment of a borrower. 217 Interviews with Debra Thompson, Director, Asset Acquisitions, and Custody (Nov. 8,2005, and Feb. 17,2006); and interview with John Gang, Vice President, Asset Acquisitions, and Custody (Dec. 8,2005). 218 E-mail from Debra Thompson, Director, Asset Acquisitions, and Custody to Mark Cymrot (Feb. 21, 2006); Letter from Ms. Thompson to Mr. Cyrnrot (Jan. 30,2006). 55 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE F. Satisfactions and Lien Releases Mr. Lavalle would like every original promissory note returned to the borrower once it is discharged in order to mitigate the risk that it could get into the wrong hands. Fannie Mae's policy is to require servicers to satisfy a mortgage and release the lien in a timely manner and in accordance with the applicable state law. 219 The servicers also must return the cancelled note to borrowers if required by state law or the borrower specifically requests the note?20 In other cases, the servicer either can return the documents to the borrower or retain them?21 In our view, Fannie Mae can rely upon the dictates of state law. State legislators presumably evaluated the risks Mr. Lavalle has expressed and determined that loan satisfactions and lien releases are adequate to protect borrowers and a reasonable trade off for the added efficiencies to the mortgage system. G. Findings Regarding Promissory Notes While Mr. Lavalle's concern has a theoretical legal basis, we have not found evidence that large volumes of promissory notes are being mishandled. He bases his assertion on the routine filing of lost note affidavits. The affidavits, however, appear to be inaccurate, rather than the notes lost. Fannie Mae has policies for its own in-house custodian and the 58 custodians 219 Servicing Guide, VI-I03. It states: "We expect a servicer to take all actions necessary to satisfy a mortgage and release the lien in a timely manner .... Procedures for satisfying the mortgage will vary depending on whether or not we are the owner of record for the mortgage; the party holding the custody documents; and whether the mortgage is a portfolio mortgage or an MBS pool mortgage. Regardless of the procedure used, the servicer has the ultimate responsibility for having the lien released in a timely manner." If Fannie Mae is the owner of record, it must execute any required release or satisfaction documents, unless it has granted a limited power of attorney to the servicer. Servicing Guide, VI -103.0 l. If Fannie Mae is not the owner of record, the servicer must execute the release or satisfactions documents in its or MERS' name. Servicing Guide, VI-103.02. The servicer also must submit forms to either Fannie Mae or the document custodian requesting the custody documents. See Servicing Guide, VI-I03.01 and VI-103.02. 220 1d. It states: "Once the required release or satisfaction documents are executed and the mortgage note is canceled, the servicer must immediately send the canceled documents to the borrower if state law requires such action or the borrower specifically requests the return of the documents." 221 ld. (stating "In other instances [when state law does not require the return of the documents and the borrower has not requested them], the servicer may either return the documents to the borrower or retain them (as long as they are not destroyed until after the retention period required by applicable law).") 56 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE it has certified that they seek to protect the mortgage documents. We have found no evidence suggesting that these procedures are ineffective. With respect to the return of original promissory notes, Fannie Mae is following state law. In the jurisdictions in which original notes must be returned, they are. Fannie Mae also responds to requests from lenders and borrowers to return original notes. If borrowers want their original notes, they can ask for them. In our view, Fannie Mae can reasonably rely upon state law. The risk that Mr. Lavalle identifies has been evaluated by state legislatures which have established rules for mortgages within their states. V. PREDATORY SERVICING A. Mr. Lavalle's Concerns Mr. Lavalle alleges that Fannie Mae has been instrumental in creating a system in which predatory servicing flourishes. He claims to have coined the term "predatory servicing,,222 to describe practices and schemes that mortgage servicers use to defraud borrowers?23 Mr. Lavalle perceives servicing problems as more pervasive than Fannie Mae officials and suggests that Fannie Mae should do more to protect borrowers, including having direct interaction with borrowers when problems arise. He objects to a perceived lack of oversight of servicers by Fannie Mae and to Fannie Mae's role in creating and operating MERS. Mr. Lavalle believes that Fannie Mae and Freddie Mac "are responsible for the activities of sellers and more importantly, servicers" and views Fannie Mae as a quasi- 222 E-mail dated Oct. 2, 2005, fromNye Lavalle to MarkCymrot. Mr. Lavalle claims to have coined the phrase in the late 1990s. 223 See, e.g., report by Nye Lavalle entitled "Predatory Grizzly 'Bear' Attacks Innocent, Elderly, Poor, Minorities, Disabled & Disadvantaged!", pp. 4-11. 57 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE regulator. 224 He claims a seller or servicer is practically required to be Fannie Mae-approved in order to do business?25 Fannie Mae also establishes how the servicers conduct their businesses, and Fannie Mae places employees in servicers' offices to oversee their servicing operations?26 He also claims that servicers are Fannie Mae's agents, and therefore, Fannie Mae can be held liable for its servicers' inappropriate actions. Fannie Mae's employees make the decision or authorize the servicers' recommendation "to make the hit" - that is, deciding whether to foreclose?27 Since Fannie Mae plays such a central role in the mortgage industry, it can and should take the lead in ending predatory servicing practices, he argues?28 In Mr. Lavalle's opinion, Fannie Mae should institute good servicing guidelines because the mortgage industry follows Fannie Mae and Freddie Mac's lead "as a matter of course in doing business.,,229 For instance, he has proposed ajoint effort to review servicer performance, and he wants Fannie Mae to mandate a set of "best practices" based on a set of practices that Fairbanks Capital Corp. agreed to in its 2003 consent order with the United States?30 224 225 E-mail dated Oct. 14,2005, trom Nye Lavalle to Mark Cymrot. Id. 226 Telephone interview with Mr. Lavalle (Nov. 1,2005). See "Current Issues: Overview of Credit Risk Management at Fannie Mae, June 19, 2002, available at www.fanniemae.com. stating: "Fannie Mae employs 44 servicing consultants," who work as on-site consultants at our largest loan servicers, helping them manage problem loans on a case-by-case basis with judgment and speed. Working with our mortgage servicers, Fannie Mae has redefined the traditional collection rules to focus lender resources and attention on those loans most at risk." 227 Telephone interview with Mr. Lavalle (Nov. 1,2005). E-mail dated Oct. 14,2005, from Nye Lavalle to Mark Cymrot. 228 229 E-mail datedJune4,2004tromMr. LavalletoMr. Raines, Ms. House, and other undisclosed recipients requesting Fannie Mae establish a National Compliance Center and institute mortgage servicing best practices standards that he recommended. He also requested that Fannie Mae not conduct any business with any companies found to be using predatory servicing practices. E-mail dated Oct. 14,2005, from Nye Lavalle to Mark Cymrot. u.s. v. Fairbanks Capital Corp., No. 03-12219 (D. Mass. Oct. 6, 2003) (order preliminarily approving stipulated final judgment and order as to Fairbanks Capital Corp. and Fairbanks Capital Holding Corp.)In that case, the Federal Trade Commission ("FTC") and the Department of Housing and Urban Development ("HUD"), accused Fairbanks of violating the Federal Trade Commission Act, the Fair Debt Collection Practices Act, the Fair Credit Reporting 230 58 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE He also asserts that borrowers are not informed of fraud by loan originators and servicers that Fannie Mae discovers in its due diligence and quality control processes. 231 Fannie Mae may report its findings to MARl, an industry database, but borrowers are not told?32 Mr. Lavalle believes that Fannie Mae has an ethical obligation to inform borrowers when it uncovers fraud. 233 Mr. Lavalle asserts that Fannie Mae has a policy of labeling mortgages that are unsellable as "scratch and dent" after rejecting them for purchase. 234 The loans are then sold to "special servicers," such as EMC Mortgage, Litton Loan Servicing, Ocwen, and Select Portfolio Servicing ("SPS")(formerly Fairbanks Capital Corp.), which aggressively service the loans into foreclosure or bankruptcy, he claims.235 Mr. Lavalle alleges that in the foreclosure process, Fannie Mae transfers servicing rights to aggressive servicers?36 Mr. Lavalle refers to these special servicers as "the toxic waste dump.,,237 He asserts that these companies defraud borrowers, by such schemes as not crediting a borrower for payments, misapplying payments, and placing unnecessary force-placed insurance on borrowers' accounts and others. 238 When borrowers complain about these practices, which the mortgage Act, and the Real Estate Settlement Procedures Act ("RESP A"). The case was settled by a consent decree that mandated certain business practices to correct the alleged abuses. 23l E-mail dated June 22, 2005 fromNye Lavalle to Mr. Mudd, Ms. House, and various members of Fannie Mae's Board of Directors. ld. ld. Telephone interview with Mr. Lavalle (Nov. 1,2005). 232 233 234 235 E-mail fromNye Lavalle to Mr. Mudd, Ms. House, and various members of Fannie Mae's Board of Directors (July 22, 2005); see also E-mail from Nye Lavalle to Mark Cymrot (Oct. 7,2005). 236 Telephone interview with Nye Lavalle (Dec. 14,2005). 237 July 22, 2005, e-mail fromNyeLavalietoMr.Mudd.Ms. House, and various members of Fannie Mae's Board of Directors 238 See. e.g., report by Nye Lavalle entitled "Predatory Grizzly 'Bear' Attacks Innocent, Elderly, Poor, Minorities, Disabled & Disadvantaged!", pp. 4-11. 59 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE servicers claim are just mistakes, their mortgages are not reamortized to adjust payments and interest assessments, he claims. 239 Mr. Lavalle suggests that Fannie Mae has an obligation to inform the borrowers their loans are going to be subject to aggressive servicers. As a Fannie Mae shareholder, Mr. Lavalle is concerned about criminal and civil liability that Fannie Mae could face for its servicers' misconduct. 240 B. Current Servicer Rules and Procedures Fannie Mae has contracts with about 1,500 active servicers, either original lenders or independent servicers. 241 A servicer must first be approved before servicing Fannie Mae loans. If a servicer assigns its responsibility to service a loan to another servicer, it must first get approval from Fannie Mae?42 For a traditional servicer to be approved, the servicer must meet minimum eligibility and capability requirements. 243 For instance, it must have experience in selling and servicing mortgages, have knowledge of Fannie Mae's policies and practices, and have postclosing quality control methods in place?44 In addition, Fannie Mae conducts a MARl check on the sellerlservicer and LexisNexis background checks on the sellerlservicer's principals?45 239 240 E-mail dated Oct. 7, 2005, from Nye Lavalle to Mark Cymrot. E-mail dated July 22, 2005, from Nye Lavalle to Ms. House, Fannie Mae President, and CEO Daniel Mudd, and Board of Director members Stephen Ashley, Ann Korologos, Frederic Malek, Donald Marron, Leslie Rahl, H. Patrick Swygert, and John Wulff, and others. 241 E-mail dated Mar. 1,2006 with attachment of a chart of the Servicer Counts for Year-Ends 2002-2004, from Marianne Sullivan, Senior Vice President, Credit Loss Management. There was an average of 1,532 servicers at year-end in 2002, 2003, and 2004. 242 243 Mortgage Selling and Servicing Contract, VII; see also Servicing Guide, 1-205. Interview with Robert Sanborn, Vice President, National Servicing Organization (Nov. 15,2005). Jd. 244 245 Interview with Mercy Jimenez, Senior Vice President of the National Business Center (Nov. 7,2005). 60 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE MARl, Mortgage Asset Research Institute, Inc., provides information services for the mortgage and financial services industries. 246 Approved processors of less traditional loans, referred to as non-traditional servicers, are subjected to a more rigorous approval process. 247 Fannie Mae employees visit the servicers' facility and observe its selling and servicing practices to determine if they comply with Fannie Mae's.248 Fannie Mae has approved only 46 non-traditional servicers, but 13 of those do not service any Fannie Mae loans?49 Non-traditional servicing is not synonymous with subprime servicing, and non-traditional servicers do not necessarily service loans with a higher risk of default than most loans. 25o For instance, reverse mortgages and eChannelloans, which allow borrowers with good credit ratings to streamline the home buying process, are considered non·. 1 trad11l0na,251 Nine large servicers service 70 percent of Fannie Mae's loan assets, and 40 servicers service 85 percent of Fannie Mae's loan assets. 252 Mr. Lavalle has specifically complained about the practices of four servicers - EMC Mortgage, Litton Loan Servicing, Ocwen Financial Corporation, and Select Portfolio Servicing ("SPS"), formerly Fairbanks Capital Corp. From 2002 through 2004, these entities combined serviced less than one percent 246 247 MARl Overview, available at http://www.mari-inc.com/about.html. Interview with Robert Sanborn, Vice President, National Servicing Organization (Nov. 15, 2005). 2481d. 249 Telephone Interview, Rick Bauerband, Director of Non-Traditional Servicing (Mar. 14,2006). These approved servicers may originate loans and then transfer them to other servicers, but they are approved to service Fannie Mae loans. 250 251 ld. Id. 252 Interview with Robert Sanborn, Vice President, National Servicing Organization (Nov. 15, 2005). 61 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE of all the loans Fannie Mae owned. 253 They also serviced less than one percent of the unpaid principal balances for loans Fannie Mae owned. 254 After approval, all servicers must sign Fannie Mae's Mortgage Selling and Servicing Contract that establishes the basic legal relationship?55 Fannie Mae also publishes a Selling Guide and a Servicing Guide to keep lenders informed of its policies. Under the contract, the mortgages must be sold and serviced in accordance with the Guides. 256 The Servicing Guide allows for variants which are subject to negotiation between Fannie Mae and the servicer. 257 The Servicing Guide provides "broad parameters" for servicers. 258 Fannie Mae takes the position that servicers are independent contractors, and not agents, assignees or representatives of Fannie Mae. 259 The Servicing Guide thus gives servicers considerable discretion about how to conduct their businesses. The Guide states: ... most of the policies and standards described in this Guide are intended to set forth the broad parameters under which lenders should exercise their sound professional judgment as mortgage servicers in the performance of their duties. As a result, in most instances we have not set forth absolute requirements because we believe that servicers need to maintain the discretion to apply appropriate judgment in dealing with borrowers and loans on a case-by-case basis, consistent with our servicing policies?60 Fannie Mae generally will not object to the practices a servicer regularly applies so long as they are carried out in accordance with established written procedures that are consistent with Fannie 253 All Active Single-Family Loans chart from Marianne Sullivan, Senior Vice President, Credit Loss Management. Id. 254 255 Mortgage Selling and Servicing Contract, I-A. 256 See Mortgage Selling and Servicing Contract, l-C ("Whenever there is a reference to the Guides in this Contract, it means the Guides as they exist now and as they may be amended or supplemented in writing."). 257 258 Interview with Daniel C. Smith, Deputy General Counsel, Legal Department (Oct. 14,2005). Servicing Guide, 1-202. ld. 259 260!d. The Selling Guide contains similar language. Selling Guide, 1-201.01. 62 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE . . Mae ' s servlcmg pO 1"lCles. 261 The Servicing Guide also "require[s] each Fannie Mae-approved servicer (and any subservicer or third-party originator it uses) to be aware of, and in full compliance with, all federal, state, and local laws (including statutes, regulations, ordinances, administrative rules and orders that have the effect oflaw, and judicial rulings and opinions) that apply to any of its origination, selling or servicing practices or other business practices (including the use of technology) that may have a material effect on [Fannie Mae].262 The Servicing Guide requires servicers to have trained staff and adequate procedures to conduct their duties and ... to protect against fraud, misrepresentation, or negligence by any parties involved in the mortgage servicing processes; to protect our investment in the security properties; and to provide borrowers with assistance when it is requested. Servicers should have effective processes to promptly address borrower inquiries (relating to both current and delinquent loans) and provide timely payoff quotes and refunds of escrow deposits after payoff. 263 The guidelines encourage servicers to adopt servicing practices that allow for an appropriate level of discretion to take into account the facts of a particular loan and the circumstances of the borrower. 264 Servicing Guide, 1-202. 261 262 Servicing Guide, 1-306. It further states: "Among other things, this means that the servicer must comply with any applicable law that addresses fair housing, equal credit opportunity, truth-in-lending, wrongful discrimination, real estate settlement procedures, borrower privacy, escrow account administration, mortgage insurance cancellation, debt collection, credit reporting, electronic signatures or transactions, predatory lending, terrorist activity, or the enforcement of any of the terms of the mortgage. Since applicable law can change quickly, sometimes without widespread notice, it is imperative that a servicer monitor federal requirements and the requirements of each state or locality in which it does business and take appropriate action to comply with any changes. If a change to applicable local or state law represents a potential conflict with our requirements, the servicer should advise its lead Fannie Mae regional office. When we consider it appropriate, we may request a servicer to provide evidence of its compliance with any given jurisdictional requirement or applicable law." 263 264 Servicing Guide, 1-202. ld. 63 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE Fannie Mae conducts performance monitoring on the status of the lender and also audits servicer records related to Fannie Mae mortgages. 265 Fannie Mae uses an array of analytical tools to track the performance of servicers. Fannie Mae monitors its servicers' performance by validating that the loan activity data reported to Fannie Mae is accurate; by checking if servicers are servicing Fannie Mae's loans in compliance with Fannie Mae's guidelines; by checking whether servicers are following the timelines Fannie Mae has established for foreclosure and bankruptcy actions; and by auditing servicers' records?66 Servicers provide Fannie Mae with information on a monthly basis about loan activity for the loans that they are servicing. 267 Servicers report "loan level" activity for all the loans that they service, whether they are held in Fannie Mae's portfolio or back MBS?68 This information includes the last paid installment, the unpaid principal balance, principal, interest, actions taken on the loans, and fees collected. 269 Servicers also report "pool level" activity for loans that back MBS, which includes the outstanding security balance for fixed rate pools, and the security balance and aggregate pass through rate of the underlying adjustable loans for adjustable rate pools.270 Fannie Mae validates the loan activity information the servicers provide by comparing it with Fannie Mae's expectations on how the loans and pools of loans will 265 266 The Selling Guide 1-104. Interview of Dror Oppenheimer, Vice President for Asset Development and Management (Dec. 7,2005); interview with Robert Sanborn, Vice President of the National Servicing Organization (Dec. 16,2005); interview with Debbie Kehr, Director of Centralized Servicing Operations (Dec. 19,2005); and Selling Guide, 1-404. 267 Interview ofDror Oppenheimer, Vice President for Asset Development and Management (Dec. 7,2005) 268 I d. This information is reported to a mortgage accounting system named LASER. Servicers report loan activity to Fannie Mae through the SURF or MORNET systems, or via a direct line to Fannie Mae. 269 I d. 270 I d. This information is reported to a computer system named MAST. 64 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE perform. 271 Fannie Mae's primary tasks are ensuring that servicers remit all the funds that Fannie Mae is due and ensuring that the appropriate funds are being passed on to investors?72 In these reviews, Fannie Mae does not have a mechanism to ensure that the fees servicers are charging borrowers are appropriate?73 Unusual activity - such as high default rates or other indications that loans are not performing as expected - would prompt Fannie Mae to conduct further reviews of a servicer. 274 The statistics are now being analyzed to assist in detecting lender or servicer fraud in the origination or servicing of loans. 275 Fannie Mae employs servicing "consultants" who train servicers on how to comply with Fannie Mae's guidelines, as well as provide on-going consultation?76 They also regularly review servicers' compliance with Fannie Mae's guidelines?77 They monitor the servicers' performance by looking at factors such as the delinquency and loan level delays, which include servicers' delays in collecting on the loans and delays during foreclosure?78 Consultants determine why the delays occurred and whether they are acceptable or not. 279 Servicers often ask on-site consultants for advice if they have difficulty interpreting Fannie Mae's guidelines or if they want to know if they are in compliance with Fannie Mae's standards. 28o Some servicing consultants are responsible for dozens of small servicers, while 271 Id. 272 Id. 273 Id. 274 Id. 275 Id. 276 Id. 277 Id. 278 Id. 279Id. 280 1d. 65 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE others may be responsible for managing one large servicer. 281 The consultants are decentralized an d report to POrtIO l' managers. 282 10 Consultants are responsible for ensuring that servicers are pursuing alternatives to foreclosures when borrowers are delinquent on their payments. 283 Mr. Lavalle has pointed to language contained on Fannie Mae's website as evidence that Fannie Mae is responsible for making the decision whether to foreclose and argues that Fannie Mae "order[s] the hit." The website states that Fannie Mae "employs 44 servicing consultants, who work as on-site consultants at [its] largest loan servicers, helping them manage problem loans on a case-by-case basis with judgment and speed.,,284 Fannie Mae's policy is that if a loan goes into foreclosure, consultants work with the servicer, but consultants do not make the decision of whether to foreclose. 285 Servicing specialists are part of the Centralized Servicing Operations Group, a division of the NSO. 286 Specialists are responsible for loss mitigation, loan administration, default management (which includes foreclosures and bankruptcy), and attorney supervision. 287 Loan administration includes reviewing loan level delays in foreclosures and bankruptcies to determine whether to assess a penalty against the servicer and reviewing reports of delinquent loans to determine if they were accurately reported as falling outside of Fannie Mae's guidelines 28\ 282 283 Id. Id. Id. 284 Current Issues: Overview of Credit Risk Management at Fannie Mae, June 19,2002, available at www.fanniemae.com. 285 286 287 Interview with Robert Sanborn, Vice President of the National Servicing Organization (Dec. 16,2005). Interview with Debbie Kehr, Director of Centralized Servicing Operations (Dec. 19,2005). Id. 66 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE ("exception review,,).288 Specialists audit the servicing records to ensure that penalties have been properly assessed and to conduct a review for loan level delays relating to title issues, servicing issues, litigation, bankruptcy and foreclosure?89 In essence, servicing specialists focus on whether servicers are acting in a timely manner to protect Fannie Mae's interest. They are not responsible for determining whether servicers are engaging in predatory servicing. Servicing specialists also conduct a review of Fannie Mae-retained attorneys through the RAMN (Retained Attorney Management Network) system. Servicers must permit Fannie Mae to examine certain records relating to mortgages they services for Fannie Mae?90 The Selling Guide states that servicers must maintain their records in such a manner that would enable Fannie Mae to examine and audit them at any time. Mortgage files and records include the individual mortgage files, permanent mortgage account records, and accounting system reports. The accounting records relating to mortgages serviced for Fannie Mae must be maintained in accordance with sound and generally accepted accounting principles and in such a manner as will permit its representatives to examine · . an d au dIt such record s at any tIme. 291 Fannie Mae reserves the right in its Mortgage Selling and Servicing Contracts to terminate a servicer with or without cause. 292 Grounds for terminating with cause include knowingly selling Fannie Mae a mortgage that has untrue mortgage warranties; failing to comply Attachments to e-mail from Debbie Kehr, Director of Centralized Servicing Operations (Dec. 19,2005). ld.; e-mail from Adam Womack, Servicing Process Manager, Quality Assurance (Dec. 19,2005). 288 289 290 291 292 Mortgage Selling and Servicing Contract, II-D. Selling Guide, 1-404. Mortgage Selling and Servicing Contract, IX-C: "We may terminate servicing for any reason, by giving the Lender notice of the termination. Ifwe do so, the provisions of this Contract covering the servicing of the affected mortgages will automatically terminate on the thirtieth day following the day our notice is given .... " See also Servicing Guide, 1-201.08. See also Selling Guide, 1-201.07, which Fannie revised on January 31, 2006, and which contains similar language. 67 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE with the Fannie Mae Selling and Servicing Contract and Selling and Servicing Guides, by failing to keep accurate accounting and mortgage servicing records, or other non-performance; and failing to properly foreclose on a property when a borrower is in default. It also is a breach of the Mortgage Selling and Servicing Contract and grounds for termination if a court of competent jurisdiction finds that the Lender or any of its principal officers has committed an act of civil fraud; or the Lender or any of its principal officers is convicted of any criminal act related to the Lender's lending or mortgage selling or servicing activities or that, in [Fannie Mae's] opinion, adversely affects the Lender's reputation or [Fannie Mae's] reputation or interests?93 One of three business centers, the Eastern Business Center, Western Business Center, or National Business Center, is responsible for the relationship with each servicer, The business center responsible for a particular servicer works with the National Servicing Organization to determine whether to terminate that servicer.294 The business center's Vice President of Operations, the Vice President in charge of the National Servicing Organization, and the Servicing Director must consent to the termination. 295 Fannie Mae rarely has cause to terminate a servicer involuntarily. For the past three years the terminations have been: 2003 2004 2005 5 2 1296 Fannie Mae has a preference for trying to reform servicers with problems. In its view, an involuntary termination does not help anyone - it severely harms the servicer, who is no longer 293 294 295 Mortgage Selling and Servicing Contract, VIII-A. E-mail from Mercy Jimenez, Senior Vice President, National Business Center (Apr. 13,2006). Id. 296 E-mail attachment ofa chart of all terminations, from Marianne Sullivan, Senior Vice President, Credit Loss Management (Mar. 3,2006). 68 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE Fannie Mae approved, and it harms borrowers whose loans are serviced by that servicer because it is no longer overseen by Fannie Mae?97 Fannie Mae tries to reform a nonperforming servicer's behavior. 298 Fannie Mae believes that ifit terminated the servicers, they might not ever change their poor practices. 299 C. Best Practices - Fairbanks Consent Decree Mr. Lavalle has requested Fannie Mae mandate a set of "best practices" that all of its servicers must follow. 300 These "best practices" would be based upon the practices Fairbanks Capital Corp. ("Fairbanks") and its parent Fairbanks Capital Holding Corp., agreed to implement in the 2003 consent order they entered into with FTC and HUD. 301 FTC and HUD accused Fairbanks of violating the Federal Trade Commission Act ("FTCA"), Fair Debt Collection Practices Act ("FDCP A"), Fair Credit Reporting Act ("FCRA") and Real Estate Settlement Procedures Act ("RESPA"). In settling the matter, Fairbanks and its parent agreed to refrain from engaging in certain predatory servicing practices and to provide borrowers with certain information pertaining to their loans. 302 The settlement, which was coordinated with a settlement in a class action lawsuit, also required the companies to pay the FTC $40 million to compensate 297 March 3, 2006, interview with Marianne Sullivan, Senior Vice President, Credit Loss Management (Mar. 3, 2006). 298 299 1d. 1d. E-mail fromNyeLavalletoMs.House.Mr. Mudd, and Board of Director members Stephen Ashley, Ann Korologos, Frederic Malek, Donald Marron, Leslie Rahl, H. Patrick Swygert, and John Wulff, and others (July 22, 2005). 300 301 See u.s. v. Fairbanks Capital Corp., No. 03-12219 (D. Mass. Oct. 6,2003) (order preliminarily approving stipulated final judgment and order as to Fairbanks Capital Corp. and Fairbanks Capital Holding Corp.) (order preliminarily approving stipulated final judgment and order as to Fairbanks Capital Corp. and Fairbanks Capital Holding Corp.) [hereinafter "Consent Order"]. 302 Press Release, FTC, "Fairbanks Capital Settles FTC and HUD Charges" (Nov. 12,2003). 69 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE victims of the fraud. The companies' founder and former CEO, Thomas D. Basmajian, also paid $400,000 in a separate settlement. 303 Mr. Lavalle wants Fannie Mae to amend its Servicing Guide to include the servicing requirements contained in the Fairbanks consent order, as well as other requirements. He has drafted a Mortgage Servicing Best Practices Guide that he wants Fannie Mae to adopt. 304 Fannie Mae did, in fact, review the Fairbanks consent order and amend portions of its Selling and Servicing Guides. 305 The amendments were made in a series of three announcements in 2004. 306 The consent decree was resolving a case in which the FTC found that Fairbanks had violated numerous legal requirements and therefore, its provisions were remedial. In addition, most ofthe issues addressed in the consent order pertained to practices primarily used by subprime servicers. 307 Most of Fannie Mae's servicers are prime servicers. Fannie Mae officials felt that many of the consent order requirements were not relevant to its universe of servicers. 308 Fannie Mae adjusted those practices that it viewed as relevant. 309 In some cases, the Fairbanks consent order required Fairbanks to do more than was required by the 303 Jd. 304 E-mail from Nye Lavalle to Mark Cymrot (Feb. 27, 2006). The Mortgage Servicing Best Practices were included in a report on predatory lending and servicing that he sent to Ms. House, Mr. Raines. See E-mail from Mr. Lavalle to undisclosed recipients (June 4, 2004). 305 Interview with Marianne Sullivan, Single-Family Anti-Fraud Oversight (Senior Manager of Mortgage Servicing Policy); Telephone Interview with Ezzard Alves. Senior Manager of Mortgage Servicing Policy (Nov.I7, 2005). 306 See Announcement ("Ann.") 04-04: Test Period for Revised Appraisal Report Forms, Property Condition and Required Repairs Guidelines, and Special Servicing Guidelines; Ann. 04-06: Authoritative Online Selling and Servicing Guides, Purchase of Massachusetts "High Cost Home Mortgage Loans," Mortgage Loan Documents, Arbitration, Waiver of Prepayment Premium, Guaranty Fees, and Escrow Accounts; and Ann. 04-07: Mortgages Secured by Manufactured Homes, Fannie Mae Purchase of Indiana "High Cost Home Mortgage Loans," Quality Assurance-Documentation Requirements, Southwestern Regional Location-Change of Physical Address, Lenders' Analysis of the Contract For Sale and Sale History of the Subject Property, Property Flipping, Comment Period for Revised Test Appraisal Forms, Servicing Transfers, Lender-Placed Property Insurance. 307 308 309 Interview with Marianne Sullivan, Single-Family Anti-Fraud Oversight (Nov. 16,2005). !d. Jd. 70 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE loan instruments.31 0 Fannie Mae did not adopt those requirements because it thought it would face resistance from its servicers ifit mandated that they do more than was actually required. 311 The primary practices either prohibited by or mandated in the Fairbanks consent order relate to the following: (1) crediting payments, (2) misrepresentations, (3) escrow accounts, (4) force-placed insurance, (5) improper fees, (6) compliance with laws and regulations, (7) consumer complaints, (8) consumer information, (9) foreclosures, (10) late fees, and (11) forbearance agreements. 312 Fannie Mae's guidelines address many of these issues, but often not in as much detail or as explicitly. 1. Crediting Payments In terms of crediting payments, Fairbanks was required to accept partial payments and credit all payments as a/the date a/receipt. Fannie Mae's Servicing Guide was amended in 2004 to add a section stating: It is the servicer's responsibility to ensure that its payment collection and posting processes enable the timely crediting of borrowers' accounts (including borrowers in bankruptcy) so that late charges are not inappropriately assessed or other actions, such as inaccurate reporting of delinquencies to credit bureaus, are not taken. 313 Fannie Mae also encourages its servicers to periodically audit the automated processes they use to post payments to ensure they perform efficiently.314 Mr. Lavalle asserts that Fannie Mae should require its servicers to post payments within 24 hours of receipt, and instantaneously 3 \0 311 ld. !d. 312 313 See Consent Order. Ann. 04-04: Test Period for Revised Appraisal Report Forms, Property Condition and Required Repairs Guidelines, and Special Servicing Guidelines. 314 1d. 71 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE when payments are submitted electronically.315 Fannie Mae's current requirements are not as stringent as Fairbanks' requirement, nor as stringent as Mr. Lavalle has requested. As for partial payments, Fairbanks is enjoined from not accepting partial payments, but Fannie Mae's guidelines allow its servicers to reject partial payments in some cases. One provision of the Servicing Guide states that servicers should not automatically return partial payments to borrowers, but instead should base their decision on whether to accept the payment on the amount of the shortage and on any special circumstances that might justify the partial payment. 316 The Servicing Guide states that the servicer of a first mortgage should accept a partial payment and hold it as unapplied funds, instead of returning the payment, if the borrower "has a good attitude toward the mortgage obligation; is not habitually delinquent; does not have a history of remitting checks that are returned for 'insufficient funds'; and can pay the balance of the payment within the next 30 days.,,317 Another provision states that "[a]s a rule, a servicer should accept partial payments only to help cure a delinquency" and that it should return partial payments when it believes that doing so will be an effective collection tool. 318 It also states, however, that servicers should not routinely return partial payments. 319 The Servicing Guide provides that when servicers accept partial payments, they should apply the portion of the payments that equals one or more full installments and should hold the remaining portion as "unapplied funds" until it receives enough money to make a full 315 316 317 318 Attachment from e-mail dated Feb. 27, 2006, from Nye Lavalle to Mark Cymrot. Servicing Guide, III-IOl.03: Payment Shortages. 1d. 1d. 319 Id. It also states: "FHA, HUO, and V A require that partial payments be accepted under certain conditions that they specify." 72 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE installment. 32o The total amount due for a conventional mortgage may include late charges or prepayment premiums, so Fannie Mae allows servicers to hold as unapplied, a payment that does not include a late or prepayment charge that is due.321 The servicer then can use a portion of the next payment to make up the shortage so that the payment can be applied. 322 If a servicer does not consider late charges and prepayment premiums as part of the total amount due, it may return a short payment. 323 In either case, the servicer should inform borrowers of the actions taken and why, and the total amount that is due. 324 Mr. Lavalle argues that servicers should never return payments to borrowers because payment reflects a borrower's willingness to fulfill its mortgage obligation. 325 He also argues that servicers should apply partial payments to principal and interest before applying them to any expenses or fees other than escrow expenses. 326 Fannie Mae does not agree with these opinions. 327 Fannie Mae's position is that some borrowers intentionally make partial payments or sporadic payments solely to prevent foreclosure, not to fulfill their mortgage obligations. 328 320 321 322 323 324 Servicing Guide, III-IOl.03: Payment Shortages. Id. Id. Id. Id. Id.. 325 326 327 Attachment from e-mail dated Feb. 27, 2006 from Nye Lavalle to Mark Cymrot. Servicing Guide, VII-202: Accepting Partial Payments (stating that servicers can return partial payments if they believe doing so will be an effective collection tool); and Servicing Guide, III-IOl.03: Payment Shortages (stating that servicers can hold payments that do not include late fees as unapplied and then apply a portion of the subsequent payment to make up the shortage). 328 Telephone Interview with Zach Oppenheimer, Senior Vice President, Single-Family Mortgage Business, and Sam Smith, Vice President, Single Family Operations, Eastern Business Center (March 6, 2006). 73 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE These provisions are therefore necessary to prevent borrowers from skirting their mortgage ' . . obl19atlOns, Fanme M ae argues. 329 2. Misrepresentations and Fee Disclosures As for servicer misrepresentations, Fairbanks is prohibited from misrepresenting the amount that a consumer owes, or misrepresenting that a fee is allowed if it is not, or the amount, nature or terms of the fee. It is also prohibited from "assessing and/or collecting any fee unless it is for services actually rendered and is (a) expressly authorized, and clearly and conspicuously disclosed, by the loan instruments and not prohibited by law; (b) expressly permitted by law and not prohibited by the loan instruments; or (c) a reasonable fee for a specific service requested by a consumer that is assessed and/or collected only after clear and conspicuous disclosure of the fee is provided to the consumer and explicit consent is obtained from the consumer to pay the fee in exchange for the service, and such fee is not otherwise prohibited by law or the loan instruments.,,33o In 2004, Fannie Mae amended its Servicing Guide to state that servicers should have clearly written policies regarding fee assessment that address four points in particular: • The types or categories of fees, and the specific amounts of fees, if known, that the servicer can charge borrowers for services that are not regular servicing activities and are not covered in the servicing fee; Any fees servicers charge to borrowers or that Fannie Mae reimburses servicers for must be related to work that was actually performed by the servicer, either directly or indirectly by third parties; Servicers must clearly disclose the assessment of any fees to borrowers in advance of performing the service where practical, or subsequently. This does not apply to fees • • 329 Id. 330 See Consent Order. 74 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE related to foreclosures and bankruptcy that are incurred to enforce the mortgage obligation, are allowed by the Servicing Guide, and that are disclosed if required by applicable law. If borrowers request services for which free or reduced-cost alternatives are available, the servicer must explain those options to borrowers before the services are provided; and • Servicers can charge fees on a repetitive basis only when Fannie Mae's Guides require or permit it, or where it is otherwise clearly sU8p0rted by the circumstances relating to a particular loan. 3 Mr. Lavalle asserts that all fees must be disclosed to borrowers, individually identified (i. e., the fee cannot be included or hidden within another fee), and cross-referenced to the provision of the promissory note or mortgage that allows it. 332 If borrowers challenge the legitimacy of the fees, servicers must provide a legal opinion and case law to support the fees, he argues. 333 In addition, he asserts that servicers should submit a schedule of fees it will charge borrowers to Fannie Mae for approva1. 334 Finally, he wants Fannie Mae to prohibit commissions, kickbacks, and rebates on fees. 335 Mr. Lavalle's demands regarding disclosure of fees are far beyond Fannie Mae's and Fairbanks' requirements. Both Fairbanks' and Fannie Mae's servicers are prohibited from charging fees for services that were not performed, and from charging fees that are not allowed by law or under the mortgage documents. 336 Fairbanks also is prohibited from imposing any fee or other action that is prohibited by any contractual agreement with the borrower. Fairbanks is 331 Ann. 04-04: Test Period for Revised Appraisal Report Forms, Property Condition and Required Repairs Guidelines, and Special Servicing Guidelines. 332 333 334 335 Attachment from e-mail dated Feb. 27, 2006, from Nye Lavalle to Mark Cymrot. Id. Id. Id. 336 Ann. 04-04: Test Period for Revised Appraisal Report Forms, Property Condition, and Required Repairs Guidelines, and Special Servicing Guidelines. 75 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE not required, and Fannie Mae does not require its servicers, to inform borrowers which provision in the mortgage documents allow a particular fee, or provide case law to support fees if borrowers dispute them. Fannie Mae mandates that its servicers provide additional protection to borrowers by explaining to them whether less expensive alternatives for the services they requested are available. Fairbanks is not required to provide this information. Under the consent order, Fairbanks is prohibited from assessing or collecting fees for demand letters or any other collection letters or notices, and, unless under certain conditions, for property inspections, broker's price opinions, and attorneys' fees. Fairbanks may not charge attorneys' fees to borrowers unless the fees are necessary to process a foreclosure sale or are otherwise expressly permitted by law or disclosed to borrowers who give consent, and a law firm has performed the services and charged Fairbanks for them. 337 Fannie Mae clarified in a 2004 announcement that servicers should not charge fees related to the following activities to borrowers: • • • Handling borrower disputes and facilitating routine borrower collections; Arranging repayment or forbearance plans; Sending demand or breach letters relating to the nonpayment of principal, interest, taxes, or insurance before sending a formal acceleration notice that matures the principal balance and begins the foreclosure process; and Updatin records to "reinstate" a loan that has been brought current.3 8 • s Fannie Mae servicers can charge for servicing activities that borrowers request and that are not covered in the servicing fee Fannie Mae pays them. These activities include "work related to a 337 338 Consent Order, p. 12. Ann. 04-04: Test Period for Revised Appraisal Report Forms, Property Condition and Required Repairs Guidelines, and Special Servicing Guidelines. 76 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE change in ownership of the security property, replacement of insurance policies, a release of the security, providing expedited service via fax, providing more than one payoff statement in a short period of time (or even a single payoff statement if applicable law expressly permits a borrower fee), providing duplicate copies of loan documents, accepting a 'phone pay' payment, and consummating the assumption or modification ofa loan.,,339 Fannie Mae's servicers also can charge borrowers for legal service fees in cases in which their mortgage states that the borrower will reimburse the servicer for any legal service fees and costs it incurs. 34o The Guide states that the "servicer's legal counsel should attempt to handle such matters by stipulation or any other expeditious manner that will reduce the fees and costs that the borrower has to pay.,,341 Mr. Lavalle argues that borrowers should not be charged fees for any services that Fannie Mae or the investor requested, including inspection fees and broker's price opinions. 342 Servicers also must provide invoices and cancelled checks for broker's price opinions, and inspections upon request from borrowers, he contends. 343 Additionally, he asserts that payoff statements should be routine and borrowers should be able to retrieve them on_line. 344 As for attorneys' fees, he asserts that when borrowers payoff or refinance their loans, they should not be charged for the attorneys' fees the servicers incurred when the borrower sued the servicer 339 340 341 Servicing Guide, 1-203.04: Fees for Special Services. Servicing Guide, III-501: Uncontested Routine Legal Actions. Id Attachment from e-mail dated Feb. 27, 2006, from Nye Lavalle to Mark Cymrot. 342 343 344 Id Id 77 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE over a dispute or to prevent foreclosure. 345 He also states that servicers must provide invoices and cancelled checks for legal fees upon request from borrowers. 346 Mr. Lavalle's demands exceed Fannie Mae's and Fairbanks' practices. Fairbanks does not charge for property inspections and broker's price opinions, but Fannie Mae does not prohibit its servicers from charging for these services. In addition, Fannie Mae does not require its servicers to provide invoices and cancelled checks for these services and for attorneys' fees. Fairbanks also is not required to provide borrowers with invoices and cancelled checks for attorneys' fees. Both Fannie Mae and Fairbanks do not charge borrowers for demand letters. 3. Escrow Disbursements The Fairbanks consent order prohibits Fairbanks from failing to make disbursements of escrow funds for insurance, taxes and other charges in a timely manner. 347 Fannie Mae amended its policies on escrow deposit accounts and escrow administration following the Fairbanks consent order, but the amendments dealt with the waiver of the escrow deposit account requirement and when a servicer is required to begin escrowing taxes and insurance. 348 Fannie Mae's Servicing Guide states that servicers of first mortgages must assume responsibility for administering escrow deposit accounts in accordance with the mortgage documents and all applicable laws and government regulations. 349 RESP A states that if the terms of a loan require the borrower to deposit money into an escrow account that the servicer ld. Id. 345 346 347 348 Consent Order, p. 8. Ann. 04-06: Authoritative Online Selling and Servicing Guides, Purchase of Massachusetts "High Cost Home Mortgage Loans," Mortgage Loan Documents, Arbitration, Waiver of Prepayment Premium, Guaranty Fees, and Escrow Accounts. 349 Servicing Guide, III-103: Escrow Deposit Accounts. See also Servicing Guide, 1-306: Compliance with Applicable Laws, which states, in part, that servicers must comply with any applicable law that addresses escrow account administration. 78 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE manages so that the servicer can assure tax, insurance premium and other payments, the servicer must make payments from the escrow account for those purposes "in a timely manner as such payments become due.,,35o Mr. Lavalle asserts that when borrowers write "qualified written request" letters, servicers should provide them with documentation, such as receipts, invoices and cancelled checks for payment of escrow charges. 351 A qualified written request is defined under RESP A as a written correspondence on something other than a payment medium (i. e., not written on the check) that identifies the borrower and his or her account and includes a statement as to why the borrower believes the account is in error or states other information that the borrower seeks. 352 In addition, Mr. Lavalle asserts that Fannie Mae should prohibit servicers from dumping late fees, broker's price opinion fees, appraisal fees, and attorneys' fees into escrow accounts. 353 He also contends that servicers dump fees discharged in bankruptcy into escrow accounts and other adjustments?54 Finally, Mr. Lavalle argues that servicers should provide programs on their website for borrowers to analyze their escrow accounts. 355 Both Fairbanks and other Fannie Mae servicers must disburse escrow funds in a timely manner. 356 Fannie Mae does not require its servicers to provide receipts, invoices and cancelled checks when borrowers send qualified written request letters about escrow account 350 351 12 U.S.C. § 2605(g). Ann. 04-06: Authoritative Online Selling and Servicing Guides, Purchase of Massachusetts "High Cost Home Mortgage Loans," Mortgage Loan Documents, Arbitration, Waiver of Prepayment Premium, Guaranty Fees, and Escrow Accounts. 12 U.S.C. § 2605(e)(l)(B). Attachment from e-mail dated Feb. 27, 2006, from Nye Lavalle to Mark Cymrot. ld. ld. 352 353 354 355 356 Servicing Guide, III-I 03: Escrow Deposit Accounts (requiring servicers to administer escrow accounts in compliance with all applicable laws); 12 U.S.c. § 2605(g) (requiring servicers to make payments from escrow accounts in a timely manner). 79 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE payments, and Fairbanks does not have to provide these items either. RESP A requires servicers to respond to qualified written requests by acknowledging receipt of the letter within 20 days of receipt, and by correcting the borrower's account or determining the account is correct within 60 days of receipt. 357 It does not require servicers to send the documentation Mr. Lavalle asserts they should send. The consent order and Fannie Mae's guides do not address Mr. Lavalle's allegations and complaints about broker's price opinion, appraisal and attorneys' fees and fees discharged in bankruptcy being dumped into escrow accounts. 4. Force-Placed Insurance Fairbanks was prohibited from charging for force-placed insurance before providing the consumer with adequate notice and time to demonstrate that he or she already has insurance coverage, and various related practices. 358 The Fairbanks consent order specifies how many notices Fairbanks must send, and when they must send them, before charging borrowers for force-placed insurance. 359 Fannie Mae amended its Servicing Guide in 2004 to require servicers to attempt to reach borrowers for evidence that they have insurance before issuing force-placed insurance coverage, which it refers to as lender-placed insurance. 36o The Servicing Guide states how servicers should attempt to contact borrowers, what information they must provide borrowers, and how long they must wait before charging borrowers for force-placed 357 358 359 360 12 U.S.C. § 2605(e). See Consent Order. Id. Servicing Guide Part II, Chapter 6: Lender-Placed Property Insurance. Fannie Mae amended the Servicing Guide in an Announcement on November 8, 2004 (Ann. 04-07), but servicers were not required to implement the new requirements until February 1,2005. 80 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE insurance. 361 Servicers also are to have adequate resources to process documentation that borrowers submit that shows they have coverage. 362 Mr. Lavalle asserts that servicers should pay borrowers' insurance instead of placing force-placed insurance, unless insurance companies will not accept it. 363 However, if servicers do place force-placed insurance, he asserts they should abide by a detailed timeline and procedures that provide more protection to borrowers. For instance, Fairbanks only must wait a total of 50 days after the mailing before charging for force-placed insurance, while Fannie Mae instructs its servicers to typically allow 60 days for the borrower to provide evidence of coverage before charging for force-placed insurance. Fairbanks, however, is required to send two letters to the borrower, while Fannie Mae only requires its servicers to send one letter to borrowers. Mr. Lavalle proposes that Fannie Mae servicers not be allowed to charge for force-placed insurance from 105 to 135 days after the first mailing. He also proposes servicers attempt to make contact with the borrower or its agent seven times before charging for force-placed insurance, while Fairbanks must make only two attempts. Fannie Mae requires it servicers to make "attempts" to contact the borrower before force-placing insurance, but does not stipulate how many are required. 364 As for confirmation of borrower-placed insurance, Fairbanks is prohibited from failing to accept reasonable confirmation from borrowers of insurance coverage or from placing force-placed insurance on borrowers' homes even if the servicer knows or did not take 361 Id. Id. 362 363 Ann. 04-06: Authoritative Online Selling and Servicing Guides, Purchase of Massachusetts "High Cost Home Mortgage Loans," Mortgage Loan Documents, Arbitration, Waiver of Prepayment Premium, Guaranty Fees, and Escrow Accounts. Servicing Guide Part II, Chapter 6: Lender-Placed Property Insurance. 364 81 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE reasonable actions to determine whether the borrowers have their own insurance. Fairbanks is also prohibited from placing a loan in default, assessing late fees, or initiating foreclosure proceedings solely due to the borrower's non-payment of insurance premiums. It is required, within 15 days of receiving confirmation of the borrower's existing insurance coverage, to refund all force-placed insurance premiums and any related fees paid during the period in which there was overlapping coverage. Fannie Mae's Servicing Guide states that if the borrower provides evidence of coverage, within a reasonable time the servicer must refund or credit to the borrower the total amount of any premiums it charged for force-placed insurance after the effective date of the borrower-placed coverage, as well as any late charges it assessed due to nonpayment of the force-placed insurance premiums. 365 Fannie Mae stated in a 2004 announcement that the "failure of a borrower to pay any miscellaneous fees assessed when the borrower is otherwise current with respect with the total amount due on his or her basic mortgage obligation (principal, interest, taxes, insurance, late charges, and any prepayment charges) generally should not result in the acceleration of the loan and commencement offoreclosure proceedings.,,366 Fannie Mae prohibits servicers from initiatingforeclosure proceedings due solely to late charges. 367 Nonetheless, a specific prohibition from initiating foreclosure proceedings due to non-payment of insurance is not contained in Fannie Mae's Guides. Mr. Lavalle argues that if insurance is ordered and the borrower then provides evidence that it was wrongly placed, any money deducted from the payments must be applied to ld. 365 366 Ann. 04-04: Test Period for Revised Appraisal Report Forms, Property Condition and Required Repairs Guidelines, and Special Servicing Guidelines. 367 Servicing Guide, VII- 201: Assessing Late Charges, stating "the servicer cannot foreclose the mortgage later if the only delinquent amount is unpaid late charges." 82 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE the loan and the loan must be reamortized from the point of misapplication. 368 He also claims that if borrowers secure insurance, servicers must cancel force-placed insurance on the date they receive notice of borrower-placed insurance, and must credit borrowers' accounts for any unused portion of the force-placed insurance on the date of notice. 369 Also, servicers should disclose the carrier, master policy number and commissions, rebates or any free services the carrier provides to the servicer, Mr. Lavalle argues. 370 Finally, he asserts that when servicing is transferred, the new servicer should not be able to cancel the prior force-placed insurance to create its own force- . 1 pace d msurance po 1·ICy. 371 Mr. Lavalle believes that borrowers should be credited for unnecessary forceplaced insurance quicker than Fairbanks and Fannie Mae's servicers are required to credit borrowers. Fairbanks must refund force-placed insurance premiums within 15 days of receiving confirmation of borrower-placed insurance, and Fannie Mae's servicers must refund the insurance "within a reasonable time.,,372 Mr. Lavalle asserts that if borrowers secure insurance, servicers must credit borrowers on the date of notice for any unused portion of the force-placed insurance. 373 Fannie Mae's Servicing Guide and the Fairbanks consent order do not address Mr. Lavalle's proposal that servicers disclose certain information about the insurance carrier, nor do they address the cancellation and placement of new force-placed insurance when servicing is transferred. Unlike the Fairbanks consent order, Fannie Mae's Servicing Guide does not contain a specific provision that states that servicers must accept reasonable confirmation of borrowerAttachment from e-mail dated Feb. 27, 2006, from Nye Lavalle to Mark Cymrot. Mortgage Servicing Best Practices, in the section entitled "Taxes & Insurance." Attachment from e-mail dated Feb. 27, 2006, from Nye Lavalle to Mark Cymrot. ld. Servicing Guide, II, Chapter 6: Lender-Placed Property Insurance. Attachment from e-mail dated Feb. 27, 2006, from Nye Lavalle to Mark Cymrot. 368 369 370 371 372 373 83 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE placed insurance and must not place force-placed insurance on borrowers' homes even if servicers know the borrower has insurance. The Servicing Guide also does not specifically prohibit servicers from placing loans into default, charging late fees, or initiating foreclosures due solely to borrowers not paying insurance premiums. The consent order resulted from a class action lawsuit, and thus prohibits specific acts that Fairbanks was alleged to have committed. By and large, Fannie Mae's servicers have not engaged in these actions, and thus Fannie Mae's Servicing Guide does not specifically state that these actions are prohibited. 5. Consumer Services Regarding consumer services, Fairbanks is required to maintain a toll-free number and address dedicated to handling consumer disputes and questions, and the toll-free number must be staffed for certain hours that are set in the consent order. The consent order also establishes deadlines by which Fairbanks must respond to and investigate consumer disputes. In addition, under the consent order, Fairbanks must not take "any legal or other action to collect the disputed amount and any related charges until the dispute has been investigated and the consumer has been informed of the results of the investigation.,,374 Fannie Mae requirements for its servicers, amended in 2004, are not as detailed as the ones contained in the consent order. Fannie Mae requires its servicers to respond promptly to all borrower inquiries about the terms of their mortgages, the status of their accounts, and any actions servicers took, or did not take, in servicing their mortgages. 375 Fannie Mae particularly expects its servicers to respond promptly to borrowers when they have a dispute with the servicer, as well as expects its servicers to have effective means to communicate with its 374 Consent Order, p. 17. 375 Ann. 04-04: Test Period for Revised Appraisal Report Forms, Property Condition and Required Repairs Guidelines, and Special Servicing Guidelines. 84 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE borrowers in such as way to help resolve the dispute. 376 Fannie Mae expects its servicers to resolve disputes without assessing additional fees on borrowers. 377 In 2004, Fannie Mae amended its policies to state that if a servicer is having an "ongoing bona fide dispute with a borrower," Fannie Mae expects that it "generally will not commence foreclosure proceedings without a thorough review of the circumstances surrounding that dispute and reasonable efforts to resolve the dispute.,,378 When borrowers send qualified written requests for information regarding servicing to Fannie Mae servicers, RESPA requires the servicers to provide a written response acknowledging receipt of a letter within 20 days of receipt. 379 Within 60 days of receipt of the request, servicers must correct the borrower's account and send the borrower a written notification of the correction. 38o After investigating the matter, servicers must provide the borrower with a written explanation that includes a statement of why the servicer believes its determination of the account is correct and who can provide assistance to the borrower, or provide the borrower with an explanation of why the information the borrower requested is unavailable and who can provide assistance to the borrower. 381 Mr. Lavalle asserts that servicers do not promptly respond to borrower inquiries. He states that a national mortgage ombudsman position should be created to provide servicer oversight. 382 The ombudsman would audit and review servicers and arbitrate disputes. 383 It Id. Id. 376 377 378 Ann. 04-04: Test Period for Revised Appraisal Report Forms, Property Condition and Required Repairs Guidelines, and Special Servicing Guidelines. 379 380 381 382 12 U.S.c. § 2605(e)(l)(A). 12 U.S.c. § 2605(e)(2). Id. Attachment from e-mail dated Feb. 27, 2006, from Nye Lavalle to Mark Cymrot. 85 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE would be supported by a center of mortgage experts and advocates and paid for by mortgage companies. 384 He also advocates a Borrower Bill of Rights, which would entitle borrowers to review all information servicers have about the borrowers and their mortgages, including transfers and the assignment of the promissory note, mortgage and servicing rights. 385 Borrowers also would have knowledge of all current servicers, including the master, subservicers and special servicers, and the trustee and trusts to which their loan belonged. 386 Borrowers would receive the general ledgers for current and past servicers, and a layman's guide to the terms and conditions of their loans. 387 Finally, borrowers would be able to determine their document custodians, have a right to inspect their notes, and receive their note on payoff or refinance. 388 In addition, Mr. Lavalle states that Fannie Mae's Servicing Guide should catalog all the activities that servicers cannot do when resolving consumer disputes?89 Fannie Mae requires its servicers to promptly respond to borrower inquiries, but Fannie Mae's requirements do not contain details as to how and when servicers should respond. RESPA, which Fannie Mae servicers must follow, provides a more concrete time line for responding to borrower inquires. 39o Neither the Fairbanks consent order nor Fannie Mae Servicing Guide requires servicers to inform borrowers of all the identities of those servicing their loan and the trustee and trust to which their loan belongs and the identity of the document custodian; to provide borrowers with all information about transfers and assignment of their 383 I d. Id.. Id. Id. Id. Id. 384 385 386 387 388 389 390 Attachment from e-mail dated Feb. 27, 2006, from Nye Lavalle to Mark Cymrot. See 12 U.S.C. § 2605(e). 86 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE notes and the general ledgers of all servicers; or to provide borrowers with their notes on payoff if not required by the state. 6. Consumer Credit Ratings As for consumer ratings, under the consent order, Fairbanks cannot threaten a borrower's credit rating or report the consumer as delinquent based on a disputed amount until the dispute has been investigated, and the borrower has been informed of the results of the investigation. Fannie Mae amended its Servicing Guide to state that when borrowers become seriously delinquent, servicers must inform them that the servicers have reported their mortgage delinquency to the major credit repositories, and that this may affect their ability to obtain credit. 391 RESPA prohibits Fannie Mae's servicers from providing information regarding an overdue payment to a consumer reporting agency within the 60 days of receiving a qualified written request from a borrower related to the dispute over payments. 392 The Servicing Guide states that servicers must accurately and completely report borrowers' mortgage status, resolve any disputes that result from the reported information, and promptly respond to borrowers' questions regarding the reported information. 393 Servicers also must comply with all applicable provisions of the Fair Credit Reporting Act. 394 In order to further consumer service, in 2004 Fannie Mae made an announcement suggesting that servicers consider the merits of implementing delinquency management, dispute resolution, and customer service improvements. 391 392 393 394 Servicing Guide, VII-I07: Notifying Credit Repositories. 12 U.S.C. § 2605(e)(3). Servicing Guide, VII-I07: Notifying Credit Repositories. Id 87 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE Mr. Lavalle asserts that borrowers should have access to credit scores, delinquency scores, and servicing scores for a minimum cost. 395 He also asserts that an industry database on borrower inquiries and complaints should be established, and Fannie Mae should audit it to determine if servicers are in compliance with its Guides and take action if they are not. 396 He also argues that lenders and servicers should fund a central web and phone complaint site where complaints are monitored and acted upon?97 An independent monitor and ombudsman committee would review the complaints, and borrowers would be offered arbitration and mediation for any dispute than could not be resolved. 398 If these processes did not resolve the dispute, each side would submit their offer and proof of facts and a panel would make the award. 399 Mr. Lavalle asserts that Fannie Mae's suggestion that servicers create a staff to research and resolve borrower payment disputes while the borrower is on the telephone is not feasible. 4oo First, servicers do not have prior servicing records, which must be audited, Mr. Lavalle asserts. Second, many servicers outsource servicing representatives to other countries, which leads to miscommunication; thus, disputes cannot be resolved over the phone, he alleges. To resolve these problems, Fannie Mae should notify borrowers when it discovers fraud on their accounts and instruct MARl and MERS to open their databases to borrowers for a fee so . . b orrowers can . . mvestlgate servlcmg pro bl ems th emse Ives. 401 395 396 397 Attachment from e-mail dated Feb. 27, 2006, from Nye Lavalle to Mark Cymrot. Jd. Jd. 398 399 400 401 Id. Jd. Id. Id. 88 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE As for Fannie Mae's suggestion that servicers call borrowers who have loans greater than 90 days delinquent, Mr. Lavalle states that servicers must not contact borrowers who are represented by counsel in foreclosures. He argues that to ensure servicers do not contact represented borrowers, servicers should create certain processes, such as a field in their systems that indicate whether the borrower is represented. 402 As for programs for delinquent borrowers, Mr. Lavalle suggests web seminars and CDs that are available for download on-line and that inform borrowers of their rights and responsibilities and how to avoid foreclosure, and that provide information about credit scoring. 403 Unlike the Fairbanks consent order, Fannie Mae's Servicing Guide does not prevent borrowers from threatening a borrower's credit rating or report the borrower as delinquent based on a dispute until the dispute has been resolved and the borrower informed of the results. Again, the consent order specifies acts that Fairbanks was alleged to have committed, whereas the Servicing Guide contains general provisions for servicers to follow. The Guide states that its servicers must accurately report borrower mortgage status, and that servicers are responsible for resolving any dispute that results from reporting information about the borrower to credit repositories. 4 04 Furthermore, if borrowers send qualified written requests to servicers about a dispute over payment, RESP A prohibits servicers from reporting the overdue payment to credit repositories within 60 days of receiving the letter. 405 Servicers are required to follow all applicable laws, which include RESP A. 402 403 404. 405 Id. Id. Servicing Guide, VII-I07. 12 U.S.C. § 2605(e)(3). 89 CONFIDENTIAL - ATTORNEY -CLIENT PRIVILEGE Fannie Mae also has made several recommendations regarding customer service to its servicers. Mr. Lavalle has made several proposals that he wants the mortgage industry as a whole to implement, such as creating an industry-wide web and telephone complaint site and database, and creating an independent monitor and ombudsman committee to review complaints. 7. Consumer Information Fairbanks must timely inform consumers prior to the due date of each monthly payment of the following, with limited exceptions: information regarding unpaid principal balance; the due date and amount due; reasons for changes in the amount due; an itemization of each fee assessed during the statement period; the telephone number and address for consumers to use if they dispute any of the information provided; and the total amount due. Fannie Mae's Guides do not contain any provision that requires this information to be provided monthly. Under Fannie Mae's Servicing Guide, by January 31 of each year, the servicer must send "the borrower a statement of activity in his or her mortgage account during the past year." 406 The information in the statement varies depending on whether the mortgage is a regularly amortizing mortgage or a reverse mortgage. 407 In addition to this annual statement, "[t]he servicer also must provide a detailed analysis of all transactions relating to a borrower's payments or escrow deposit account whenever the borrower requests it. The servicer cannot charge the borrower for the annual statement or the detailed analysis.,,408 406 Servicing Guide, Ill-I 04: Mortgage Account Statements. Id. Id. 407 408 90 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE Aside from adopting the Fairbanks requirements regarding consumer information, Mr. Lavalle asserts that Fannie Mae should require its servicers to individually identify each fee charged and cross-reference them to the provisions of the loan documents that allow the fees. 409 Fairbanks is required to provide certain information to borrowers on a monthly basis. Fannie Mae does not require its servicers to provide this information each month, but it does require its servicers to provide borrowers with more comprehensive information - a detailed analysis of all transactions - whenever borrowers request it. 4lo Fannie Mae also is required to send an annual account of mortgage activity to borrowers. 411 8. Foreclosures As for foreclosures, Fairbanks is prohibited from taking any action towards foreclosure until it has (1) reviewed the consumer's records to verify that the consumer missed three monthly payments; (2) confirmed that the consumer has not been subjected to any of the acts or practices prohibited in the consent order, the loan instruments, or by law, or if the consumer has been subjected to those practices, that Fairbanks has remedied them; and (3) investigated any of the consumer's disputes and informed the consumer of the results of the investigation. Fannie Mae's Servicing Guide states that before referring a loan to a foreclosure attorney or trustee, servicers "should make every reasonable effort to conduct a personal face-toface interview with the borrower and to cure the delinquency through [Fannie Mae's] special relief provisions or loss mitigation alternatives before referring a loan to the foreclosure attorney 409 410 Attachment from e-mail dated Feb. 27, 2006, from Nye Lavalle to Mark Cymrot. Servicing Guide, III-I04: Mortgage Account Statements. 411Id. 91 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE or trustee.,,412 Servicers also must inspect the property and analyze the individual circumstances ofthe delinquency before referring the loan for foreclosure. 413 Aside from those provisions, the Servicing Guide states that foreclosure proceedings generally can begin whenever at least three full monthly installments are past due. 414 Fannie Mae's policy is that failure to pay any miscellaneous fee generally should not result in acceleration of the loan if the borrower is otherwise current on the loan. 415 However, it does allow for acceleration due to the non-payment of miscellaneous fees in some cases. Fannie Mae stated in a 2004 announcement amending the Servicing Guide that "chronic or intentional disregard by the borrower of the obligation to pay legitimate fees secured by the mortgage obligation when the borrower appears to have the means to pay those fees, the fees have been clearly disclosed to the borrower, and the servicer has attempted to resolve any dispute regarding the fees, could be an acceptable instance in which to accelerate the loan obligation.,,416 Mr. Lavalle asserts that this policy led to his family's foreclosure. 417 He asserts that as long as principal, interest and escrow payment are made, servicers should not be permitted to foreclose. 418 He states that allowing servicers to accelerate the loan because it has not made other payments encourages foreclosures and predatory servicing because it enables 412 413 Servicing Guide, VIII, Chapter 1: Foreclosures. Jd. 414 415 Servicing Guide, VIII-102. Ann. 04-04: Test Period for Revised Appraisal Report Forms, Property Condition and Required Repairs Guidelines, and Special Servicing Guidelines (07/30/04). 4\6 Ann. 04-04: Test Period for Revised Appraisal Report Forms, Property Condition and Required Repairs Guidelines, and Special Servicing Guidelines (07/30/04). Attachment to e-mail dated Feb. 27, 2006, from Nye Lavalle to Mark Cymrot. Jd. 417 418 92 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE servicers to commit improper acts and trigger defaults. 419 He argues that the policy amounts to extortion - the servicer tells the borrower "PAY US WHAT WE CLAIM OR ELSE!,,42o Both the Fairbanks consent order and Fannie Mae's Servicing Guide state that a borrower must miss three monthly payments before a servicer can initiate foreclosure proceedings. 421 They also both contain provisions for protecting borrowers by requiring either the servicer to investigate borrowers' disputes or make every reasonable effort to cure the delinquency before foreclosure. Ordinarily, servicers cannot accelerate a loan due to the borrower not paying miscellaneous fees; however, servicers can in certain instances. Mr. Lavalle believes that accelerating a loan for this reason is never acceptable. 9. Late Charges As for late charges, Fairbanks is enjoined from pyramiding late charges (applying a portion of a payment to a previous late fee, leaving part of the scheduled payment overdue) and from charging a late fee or delinquency charge once a loan accoUflt has been accelerated to foreclosure status. Fannie Mae's policy states that if a payment is sufficient to cover the mortgage obligation except for late charges, servicers generally should apply the payment and defer collection of the late charge. 422 However, in certain cases, such as when borrowers chronically disregard late charges even when they appear to be able to pay them, Fannie Mae permits servicers to hold the payments as UfIapplied or return them to borrowers. 423 When the borrower 419 Id Id 420 421 422 Consent Order, p. 19; Servicing Guide, VIII-102. Ann. 04-04: Test Period for Revised Appraisal Report Forms, Property Condition and Required Repairs Guidelines, and Special Servicing Guidelines. Id 423 93 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE makes his or her next payment, the servicer can use a portion of the payment to make up the previous month's shortage and apply the payment. 424 Fannie Mae views these actions as effective collection tools to bring borrowers current. 425 Fannie Mae requires it servicers to notify borrowers of the actions taken and why, and the amount that must be paid. 426 It also generally requires its servicers to apply incomplete payments in accordance with the hierarchy established in borrowers' mortgage documents. 427 Mr. Lavalle argues that Fannie Mae should prohibit servicers from pyramiding late fees, from charging late fees while a charge is being disputed, and from charging late fees from prior servicers unless they produce the records from all prior servicers. 428 He argues that late fees should be charged only for late payments of principal and interest, and that late fees should not be charged for assessed fees and charges. 429 He also asserts that servicers must apply payments to principal and interest before applying them to late fees. 43o Mr. Lavalle states that Fannie Mae's policy of not applying payments or returning payments that do not include late fees also led to his family's problems. He argues that servicers must credit all principal and interest payments that bring the loan to within 60 days delinquent without regard to special or legal fees.43J He also asserts that servicers should never return payments to borrowers because payments reflect borrowers' willingness to pay their 424 425 Servicing Guide, III-I 0 1.03: Payment Shortages. Ann. 04-04: Test Period for Revised Appraisal Report Forms, Property Condition and Required Repairs Guidelines, and Special Servicing Guidelines. 426 ld. 427 Ann. 04-04: Test Period for Revised Appraisal Report Forms, Property Condition and Required Repairs Guidelines, and Special Servicing Guidelines. 428 429 Attachment to e-mail dated Feb. 27,2006, from Nye Lavalle to Mark Cymrot. ld. ld. ld. 430 431 94 CONFIDENTIAL - ATTORNEY-CLIENT PRIVILEGE