LICENSING AND REGULATORY AUDITS OF MORTGAGE BROKERS AND MORTGAGE BANKERS
THE LEGAL ADVISOR–FEBRUARY, 2004
BY MICHAEL T. DENIOUS, STOOPS, DENIOUS & WILSON, P.L.C.

Mortgage brokers, commercial mortgage brokers, and mortgage bankers are licensed and regulated by the Arizona State Banking Department pursuant to A.R.S. §§ 6-901, et seq.  (mortgage brokers) and A.R.S. §§ 6-941, et seq.  (mortgage bankers).  A “mortgage broker” includes a person, not otherwise exempt, who “for compensation or in the expectation of compensation either directly or indirectly makes, negotiates or offers to make or negotiate a mortgage loan.”  A.R.S. § 6-901(6).  The definition of a mortgage banker is similar to that of a mortgage broker, but also extends to mortgage bank loans, which are loans funded from the mortgage banker’s own resources.  A.R.S. § 6-941(5).

General licensing requirements

Under each of these articles, a mortgage broker or banker license may be issued to either a person or an entity.   Among various other requirements, the application for a mortgage broker’s or bankers’ license is contingent upon posting a bond issued by an authorized surety company, to be conditioned upon the faithful compliance of the licensee, including its employees, with the mortgage banking statutes.  See A.R.S. § 6-903(G-H); 6-943(H); 6-975(B-C).

An entity applying for a license must designate a “responsible individual” who meets all of the licensing requirements that would otherwise apply to a natural person licensed as such.  For example, the individual must complete the mortgage broker course and pass the examination, and have not less than three years experience as a mortgage broker or mortgage banker, respectively, or equivalent limited experience in a related business during the five years immediately preceding the license application.  See A.R.S. § 6-903(B)(1); A.R.S. § 6-943(C)(1).  The responsible individual is also required to be in “active management of the activities of the licensee,” A.R.S. § 6-903(E), A.R.S. § 6-943(F), & A.R.S. § 6-976(B), which is further defined under banking regulations to mean that responsible individual is knowledgeable about the licensee’s activities, and “supervises compliance” by the licensee with applicable banking statutes and rules.  A.A.C. R20-4-102(1).

 Regulation and Auditing by Banking Department

Pursuant to its regulatory oversight, the Banking Department conducts yearly audits of mortgage brokers and mortgage bankers on the authority granted to it under the respective mortgage broker and mortgage banker statutes, A.R.S. §§ 6-901, et seq., and 6-941, et seq., and under general powers to examine the business and affairs of any financial enterprise (which includes mortgage brokers and mortgage bankers) at the Department’s discretion, and in no event less than once every five years.  A.R.S. § 6-122(B)(3).  Mortgage brokers and mortgage bankers are, as is the case with all other financial institutions and enterprises regulated by the State Banking Department, required to “upon request of the Superintendent, make their books available for inspection and examination by the Superintendent or the Superintendent’s examiners.” A.R.S. § 6-124(C).

Mortgage brokers and mortgage bankers are bound to comply with various accounting, record-keeping, and disclosure requirements.  See A.R.S. § 6-906 (detailing accounting practices and record-keeping requirements); A.R.S. § 6-907 (detailing required disclosure to investors); A.R.S. § 6-946 (detailing accounting practices and record-keeping requirements for mortgage bankers).  In addition, the mortgage broker and mortgage banker statutes provide a list of “prohibited acts” under A.R.S. §§ 6-909 & 6-947 which include various taboos including the following:

•    Inducing, requiring or committing any document to be signed by a party to a transaction where the document includes any blank spaces to be filled in after it has been signed without specific authorization by the party with respect to certain documents; 

•     payment of compensation to an independent contractor who is acting as a mortgage broker or mortgage banker without being properly licensed to do so; 

•    commingling of monies held for the benefit of borrowers with monies of the mortgage broker or banker;  

•    use of false, misleading or deceptive statements or representations regarding rates, terms or conditions for a mortgage loan; 

•     making false promises or misrepresentations, concealing essential material facts in the course of the mortgage broker or banker business; 

•     failure to truthfully account for monies belonging to a party to a mortgage loan transaction or failure to disburse monies in accordance with the broker’s or banker’s agreements;

•     requiring a person seeking a loan to buy real property to obtain property insurance coverage in an amount exceeding the replacement cost of improvements as established by the property insurer; delaying or causing to delay, except in good faith, the closing of a loan that results in increased costs to a borrower;

•     entering into an agreement prohibiting a borrower from seeking a loan through another source with respect to a mortgage loan on a real property designed principally for the occupancy of from one to four families in an amount of $200,000 or less (“anti-shopping” clauses);

•    recording or causing to be recorded any document which would give rise to liabilities under A.R.S. § 33-420 (wrongful lien statute).

See A.R.S. §§ 6-909 & 6-947.

Where a licensee commits as violation or violations of applicable statutory requirements, he she may be subject to various sanctions by the Banking Department, including suspension or revocation of new mortgage broker’s or mortgage banker’s license, entry of civil penalties, and/or entry of an order finding licensee in violation of statutory requirements and requiring the licensee to cease and desist from any further action in violation of statutory requirements.  See A.R.S. §§ 6-132, 6-137, 6-905, & 6-945; Madsen v. Western American Mortg. Co., 143 Ariz. 614, 621, 694 P.2d 1228, 1235 (App. 1985)(summarizing provisions of mortgage broker statutes).  The Department may find evidence of violation through an investigation initiated upon a complaint received from a consumer or other public individual.  More likely, however, the means by which the Department may become aware of acts committed by a mortgage broker or mortgage banker in violation of applicable statutory requirements will be via an examination conducted by one of the Department’s financial examiners.  Such examinations are, in fact, the primary means of regulatory enforcement by the Banking Department, and for most mortgage brokers and bankers is their sole contact with the Department, other than yearly license renewal applications.  In their examination, Department examiners will spend between a half to a full day on site at a mortgage broker’s or mortgage banker’s business office.  They will physically review all or a substantial portion of files maintained on the premises to determine compliance with statutory accounting, record-keeping, disclosure, and other requirements.

In the examination, the Department examiner will review the mortgage broker’s or mortgage banker’s mortgage loan files, loan application listings, written advertisements or solicitations, general ledgers, bank account records, financial statements, tax returns, personnel records, and business organization records (including organizational documents, minutes, and annual reports if applicable).  The compliance issues addressed on examination are very broad, but can be summarized into the following areas:

General Compliance

1.     Licensing and Locations
2.     Control of the Licensee
3.     Advertising and business solicitation
4.     Personnel Records/Employees

General Records Review

1.      Record Retention
2       Updating Records                       
3.      Corporate/LLC/Partnership Records
4.      External and Internal Audits
5.      Litigation

 Loan File Review

1.      Loan Log
2.      Loan Files
3.      Lenders Used
4.      Blank Spaces
5.      Replacement Insurance Coverage
6.      Federal Disclosures
            a.  Preliminary Good Faith Estimate (GFE)
            b.  Preliminary Truth-in-Lending (TIL)
            c.  Final TIL
            d.  Mortgage Servicing Transfer (MST)
            e.  Notice of Right to Rescind
            f.  Affiliated Business Arrangements
7.     Disclosure to Private Investors
8.     Balloon Payments disclosure
9.     Transfer or Return of Documents

Banking and Financial

1.     Bank Accounts
2.     Financial Statements
3.     Escrow Monies Received
4.     Handling Monies
5.     Advances, Trust Account, Trust Ledger and Agreements
6.     Receipts Record

Upon concluding an examination, the Department examiner will speak with the responsible individual to discuss the examiner’s findings.  The examiner will thereafter prepare a report of examination, a copy of which will be sent to the licensee.  The Department will typically direct the licensee to respond to any findings of violations and to describe any new or modified company practices or policies to be implemented to ensure that future violations are minimized or eliminated.  A well-drafted response detailing specific policies or practices to be eliminated may go a long way toward persuading the Department that no formal order or civil money penalties need be assessed.

Upon determining that a violation or violations have been committed, and upon evaluating the nature of the violations and the licensee’s response, the Department will determine whether to issue a cease and desist order and assess civil money penalties.  A cease and desist order will charge the licensee with the violations found to have occurred in the examination, order that the licensee cease from any further conduct or practices found to be in violation of the applicable statutes or regulations, and assess a monetary penalty in an amount based upon the number or severity of the violations found.  It is not uncommon for the Department to issue orders for civil money penalties of between $10,000 and $20,000 where sufficient violations are found, even where the violations are primarily accounting or record-keeping or disclosure deficiencies that have not resulted in any harm to consumers, and which were committed without any fraudulent or dishonest purpose.

The Department has published a list of “Violations Commonly Cited,” which details the violations most frequently cited pursuant to financial examinations of mortgage brokers.  Examples range from inadequate or non-existent pre-employment screening¹; provisions in loan agreements in violation of the banking statutes²; incomplete copies of loan agreements and related disclosures; incomplete corporate or LLC organizational documents and minutes.

A licensee should avoid, wherever possible, being the subject of a cease and desist order.  Even where the monetary fine assessed is minimal, the fact remains that the licensee is being charged with violations of the mortgage broker/banker statutes in a formal, public document issued by the primary state regulatory agency.  While an administrative appeal procedure is available, see generally A.R.S. §§ 41-1092 et seq., it is likely that the examiner’s findings will be supported with sufficient evidence for the Department to prevail at hearing.³

Where the licensee chooses not to contest the cease and desist order and pays the civil penalty, the matter will be resolved for the time being.  It is likely, however, that the Department may conduct future examinations of the licensee sooner and with more frequency, subjecting the licensee to, at best, additional time spent with the examiner or examiners rather than with clients; or worse, additional findings of violations resulting in additional cease and desist order and civil money penalties.  Repeat “offenders,” even those with inadvertent record-keeping, accounting or disclosure deficiencies, will likely experience far larger fines as well as potential license suspension or revocation.

With the foregoing in mind, mortgage brokers and bankers should consider doing an office-wide “performance” audit (as contemplated in paragraph 4 of the “General Records Review” described above) to ensure that they and their employees are utilizing procedures that minimize or prevent compliance problems from occurring.  It is not at all uncommon for employees to occasionally neglect to properly document a file (e.g., proper fee agreements, federal disclosures, etc.), and in most cases the deficiency cannot be resolved by generating proper documentation at a later date.  Neglect of employees is imputed to both the licensed entity and in many cases the responsible individual.  Therefore, preventive maintenance, rather than subsequent damage control, should be utilized wherever possible.
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             * Prior to joining Stoops, Denious & Wilson, P.L.C., Mr. Denious was an Assistant Attorney General with the Arizona Attorney General’s Office, where he represented the Arizona State Banking Department as well as the Arizona Department of Real Estate and the Arizona Department of Insurance.
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¹ For a discussion on this particular topic, see our prior article in this publication in early 2002 (Employee Investigation and Active Supervision Requirements for Licensed Mortgage Brokers and Bankers).
²  For a discussion on this topic, see our prior article in this publication in July 2002 (Mortgage Broker Fee Agreements in Arizona).
³  The burden of proof in an administrative appeal pursuant to A.R.S. §§ 41-1092 et seq. is the “preponderance” standard.