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Why?

A look at the lending practices that led Citigroup to accept largest settlement in U.S. history

October 8, 2002

By TIM MEREDITH


Citigroup has agreed to the largest consumer protection settlement in U.S. history. With the settlement, the Federal Trade Commission (FTC) may be setting a new standard for what is and isn't acceptable behavior for companies that provide mortgage loans to consumers.

Citigroup recently agreed to pay up to $240 million to settle complaints that Associates First Capital engaged in unfair and deceptive practices prior to its acquisition by Citigroup.

If approved, the settlement will provide $215 million in redress to consumers who bought credit insurance in connection with loans made by The Associates over a five-year period between December 1, 1995, and November 30, 2000. The class action settlement will provide an additional $25 million to consumers whose Associates mortgage loans were refinanced, or "flipped," by The Associates during the same time period.

The FTC's settlement also requires CitiFinancial to provide annual reports to the Commission detailing its practices with respect to the sale and marketing of credit insurance and other add-on products, and the progress and status of steps taken to improve these practices. In addition, for three years, CitiFinancial must maintain documents relating to the sale and marketing of loans, credit insurance, and add-on products, and steps taken to improve these practices.

Lessons to Learn. You need to revisit all of you marketing materials and strategies and reevaluate the content in light of the allegations contained in the Complaint. The FTC often engages in setting new standards or new expectations for conduct through its enforcement proceedings. As a result, you should make an attempt to understand just what kinds of arguments the FTC made in its Complaint against Citigroup and consider whether it is establishing new standards for conduct that you may have to take into account as you conduct your business.

Think Twice Before Marketing.
A statement or practice is deceptive if three factors are present:

  • There is a representation, omission, act or practice that is likely to mislead.
  • The act or practice would be deceptive from the perspective of a reasonable consumer.
  • The representation, omission, act, or practice is material.

When is a representation, omission, act or practice likely to mislead? Practices that can be misleading or deceptive include:

  • False oral and written representations;
  • Misleading claims about costs of services or products;
  • Use of bait-and-switch techniques; and
  • Failure to provide promised services or products.

So, what is it that The Associates is alleged to have done that is worth more than the annual economies of several small nations?

According to the FTC, The Associates used marketing materials stating that it would work with each customer to find products and services that were in the customer's best interest. The Associates nurtured a relationship of trust that led customers to believe they could rely on The Associates for sound advice about organizing their finances. For example, The Associates delivered a document entitled "Welcome to the World of Associates: Passport" to its customers. According to the Complaint, the Passport contained the following "Quality Service Promises" to The Associates' customers:

  • To meet or exceed all YOUR needs and expectations to the best of our ability.
  • To recommend only those products and services that fit YOUR needs.
  • To explain our loan documents and financial products in non-technical terms that YOU can understand.
  • To provide YOU with competent employees who are caring, professional, motivated and personable.

The FTC then alleged that The Associates breached these promises by engaging in numerous deceptive practices and other violations of law to induce consumers to take out loans with high interest rates, costs and fees and to purchase high-cost credit insurance.

No one would argue that it is bad to push unsophisticated consumers into high cost loans and insurance products that they don't understand or need. But what is interesting about the FTC's Complaint is that the representations in the "puff" piece are themselves unfair and deceptive. In other words, if a creditor uses language in its marketing materials suggesting that it is the consumer's friend and will work with the consumer to identify those credit/insurance products that best fit the needs of the customer, then the creditor better do just that. No longer may the creditor argue that it is a business and entitled to engage in sales techniques that maximize its profits. It has promised to set aside its interest in maximizing profits and has undertaken to represent the best interests of the consumer. That is a major paradigm shift to read into language that some marketing wizard threw into the advertisement piece.

Marketing Consolidation Loans.
The marketing materials showed the benefits of a consolidation loan. They showed the monthly payment amount for a series of representative debts (store credit, car loan, credit card debt, etc.) and came up with a representative "current total monthly payment." It then showed that if all of those debts were consolidated into a home equity loan, the monthly payment would be reduced. Now, ask yourself, how could anyone object to a loan program that leaves the consumer with more money in her pocket each month? Well, consider the following points.

  • Lower monthly payments vs. saving $$.
    The marketing materials suggested that the consumer would save money. That statement is problematical when you are comparing a variety of different debts with different interest rates, amortizations and terms-to-maturity. For example, replacing a couple of 4-year car loans at 13% APR with a 20-year interest only balloon loan at 10% may lower the consumer's monthly payments, but it certainly does not save the consumer $$ over time. Better to make this point by touting lower monthly payments. Then, ask yourself whether the advertisement must also indicate that the consolidation loan may be more expensive over the long term even though it lowers monthly payments? Also, don't say things like "you will pay less interest with our consolidation loan." Be sure to state the term of the new loan and, if it involves a balloon payment, be sure to identify that fact.

  • Remember additional costs of mortgage loans.
    In some cases, The Associates showed the difference in monthly payments between a series of consumer loans that summed to $24,000 and a new $24,000 consolidation loan. What's wrong with this? Well, in order to get the $24,000 to pay off the other debts, the consumer would also have to pay (and, in most cases, finance) other costs. So, the numbers should reflect an example based on the $24,000 principal needed to consolidate the existing loans, plus representative closing costs. If those closing costs are routinely financed, then you may want to consider rolling them into the principal in the example. Then use this new principal amount to calculate the comparison monthly payment. The FTC also suggests that you should point out additional costs from required property insurance.

  • Selling the monthly payment.
    The Associates also trained its employees to sell the "benefits" of the loan without explaining the full terms and costs of the loan. The Associates trained its employees to "sell the monthly payment," as opposed to the loan's annual percentage rate, points and costs, and loan term. In addition, The Associates' employees emphasized if the loan would result in cash to the customer and/or "pay off" other debts. The Associates also trained its employees to represent to consumers that there would be "no out-of-pocket fees" and "no up front out-of-pocket costs" with its loans. However, The Associates' employees did not disclose to consumers that The Associates typically charged high points on mortgage loans (e.g., 8 points), as well as closing costs, and that the points and closing costs were financed as part of the loan and were nonrefundable. Employees also did not disclose that The Associates' mortgage loans did not include the costs of property taxes and homeowner's insurance, and that the consumer was required to pay those costs himself.

  • Working the servicing: flipping?
    The FTC noted that The Associates acquired customers through a variety of channels and then immediately and consistently (every 90 days) contacted the customer to solicit him for more credit. A significant portion of this selling involved offering customers with unsecured accounts the opportunity to switch to home equity loans or accounts. These calls included some tricks the FTC deemed to be often false and/or unfair. Among these are: telling folks that their monthly payments will be lower, they will pay less interest, they will save money, they will own their home sooner. In addition, The Associates assured consumers that they were going to be approved in order to distract them from contacting other creditors for any kind of comparison shopping.

  • Homeowners Express Loan.
    In some cases, they offered consumers cash up front, pending completion of the home equity loan. They would give $5,000 to the customer in return for an unsecured promissory note, with a 6-month term and a 28% interest rate. However, the deal was that if the customer qualified for the home equity loan, she could use a portion of the home equity loan to pay the Homeowners Express Loan interest free. The FTC objected to this arrangement on two grounds. First, it asserted that the arrangement is unfair because it forces the customer to go through with the home equity loan in order to avoid the unreasonable interest payments on the Homeowners Express Loan. Second, the FTC considered the Express Loan to be nothing more than an initial advance on the home equity loan and decided that the transaction violated the rescission rules under TILA because the initial advance was made before any attempt at giving rescission disclosures. One assumes that the FTC would have lost on this point had each issue been litigated.

  • Upselling the Loan Amount.
    The FTC alleged that The Associates trained its sales crew to look at the amount of credit requested on a consumer's application and then automatically increase the loan amount up to the maximum permitted under loan program underwriting constraints (such as loan-to-value limits). Consumers would get confused and end up taking out more principal than needed, making the loan harder to pay back. The ostensible business reason for this practice is that the origination fee/loan fees were a percentage of the loan amount. Therefore, The Associates made more money if the principal was greater than the amount the consumer requested.

Credit insurance.
The FTC just does not find anything about this product that is at all redeemable. However, because the product remains a lawful insurance product, the FTC has to pick on how it gets sold if it wants to stop consumers from having access to the insurance. It alleged that The Associates engaged in a number of bad acts in the way that it sold the product.

  • Hiding the Package.
    The FTC alleged that salespeople were trained to quote proposed principal amounts and monthly payment amounts at preliminary stages of loan negotiations that included credit insurance. Once they got the customer comfortable with the payment amount, they would talk about the benefits of credit protection. The Associates trained its employees to state only the "benefits" of the credit insurance and not to mention the costs or limitations on coverage. For example, The Associates trained its employees to represent to customers that credit life insurance will pay off the balance of the loan in the event of the customer's death. This was often untrue, particularly in the case of mortgage loans, because the credit life insurance issued to customers was "truncated," i.e., issued for a shorter coverage term than the loan term (the insurance term was only for 120 months as opposed to the typical mortgage loan term of 180-240 months), and the credit life insurance often decreased at a more rapid rate than the loan balance.

  • High-pressure closings.
    The FTC alleged that the Associates rushed consumers through loan closings, presenting a multitude of lengthy, complex, highly technical documents (sounds like they were criticized for using mandatory TILA and RESPA disclosures) and simply telling customers where to sign (e.g., "sign here, sign here, sign here"). Until at least mid-1998, The Associates did not disclose to customers, at closing, the comparative cost of a loan with and without optional insurance products. (Note: there is no law that requires a creditor to give this kind of comparison.)

  • Mishandled cancellations.
    In numerous instances, where a customer requested that the credit insurance be removed, The Associates told the customer that changing the amount of the loan to eliminate credit insurance would require rescheduling the closing, knowing this posed a great hardship for the customer. If a customer continued to object, The Associates told the customer that if he closed the loan with the insurance included, he could cancel the insurance within a stated number of days (e.g., 30 days) without cost. The Associates knew from experience that few customers would try to cancel the insurance. For those that did cancel within the stated period of time, The Associates' policy was to credit the customer's account only for the amount of the insurance premium. The Associates did not rebate any interest that already had accrued on the premium or the financed points charged on the premium, causing borrowers to incur the costs of the non-rebated premium interest, the points on the premium, and the interest that accrued over time on those points.

Abusive Collections Practices.
The Associates promoted and encouraged aggressive action by its employees to resolve delinquencies in customers' accounts. The Associates trained its employees to use "permanent corrective arrangements," including soliciting eligible customers to refinance their delinquent loan through a new loan at prevailing rates and fees. If a customer did not qualify for a new loan using The Associates' standard underwriting criteria, The Associates would nonetheless offer to refinance the customer's loan balance with a "workout loan," often adding on costs which customers in arrears could ill afford to pay.

The Associates are also alleged to have engaged in other abusive collection tactics to obtain customers' past due payments, including repeated and continuous telephone calls to customers at their home and/or work place, and revealing consumers' debts to third parties without consumers' consent.


Tim Meredith is a founding partner at the law firm of Hudson Cook, LLP, which maintains a national consumer financial services practice and advises industry clients on multi-state and federal regulatory issues. Tim is also the publisher of BasisPoints, a monthly update on how to comply with laws affecting the mortgage industry.


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