Multistate Predatory Lending Negotiations Exercise

The Bismark Bank (“Bismark”) is a state chartered bank headquartered in the State of North Dakota. It is now the nation’s largest bank, having been formed through a series of acquisitions consummated by its current president, George Bailey. It is one of the largest employers in North Dakota, with its corporate offices as well as its mortgage financing, credit card, and telemarketing centers all located in North Dakota.

Through Bailey’s leadership, Bismark also has acquired other financial institutions. As the real estate boom began to accelerate in 2004, Bailey acquired his “crown jewel,” Old Pacific Mortgage (“OPM”), a mortgage lending institution. OPM is the largest mortgage lending institution in the nation, and is based in California.

Old Pacific Mortgage grew rapidly as a result of the efforts of its leader, Miranda Priestly. Priestly is a scrappy businesswoman, who built OPM from a small, storefront lender centered in Queens and the Bronx to the nation’s leading lender to the underserved lower middle and poorer classes. Priestly’s parents ran a small supermarket in Queens, and could not afford their own home. Priestly believes home ownership should be the dream of every American, and she vowed to ensure that OPM would service worthy borrowers that other lenders would not touch. In the beginning she ensured that everyone she hired similarly believed in the “mission” of OPM.

As OPM grew larger, Priestly was no longer able to engage in day to day management of the company. One of the last management roles she had to give up was direct involvement in the hiring process of OPM employees. Instead, she resorted to instructing her top lieutenants to stay true to the mission, but to make sure the company was extremely profitable as well, so that it could continue to accomplish its goals — servicing borrowers in the lower middle and poorer communities in all 50 states. She also told her top lieutenants to ensure that all of their subordinates understood and carried out the mission.

Towards the end of 2006, two years after Bismark’s acquisition of OPM, the North Dakota Commissioner of Banking, Pat Geary, noticed an uptick in complaints against OPM. More and more customers were falling behind on their mortgages and going into foreclosure. After investigating the matter, Geary discovered that OPM was engaged in a number of practices that violated North Dakota’s banking law, including falsifying income statements on lending documents so that the consumers qualified for mortgages that they could not afford and requiring borrowers to pay penalties if they paid down their mortgages sooner than originally anticipated (“prepayment penalties”). For the period 2004–2008, there were 5,000 loans in North Dakota that involved falsified income states.

Geary’s staff also discovered that the falsified income statements were endemic to OPM’s nationwide practice. At a January 2008 conference with other state banking officials, Geary set up a special meeting with her counterparts in California, Illinois, and New Hampshire to discuss OPM’s practices. They informed the other banking regulators that in California there were 50,000 affected loans, in Illinois there were 40,000 affected loans, and in New Hampshire there were 5,000, all from 2004–2008. Nationwide, there were hundreds of thousands of such loans.

Geary also met with the Chief of the North Dakota Attorney General’s Consumer Protection division, Hamilton Burger, in January 2008 to discuss the problems with OPM. After reviewing the data, loan documents and borrower statements collected by the North Dakota Banking Department, Burger determined that there appeared to be numerous violations of North Dakota’s five–year–old predatory lending law, including failing to ensure loans were suitable for borrowers and requiring borrowers to pay prepayment penalties. Burger also thought these practices violated the state’s 50–year–old unfair and deceptive practices (“UDAP”) law.

In May 2008, Burger sent a packet of information about OPM’s practices to the chiefs of the consumer protection divisions of the Attorney General office of California (Paul Biegler), Illinois (Jack Ross), and New Hampshire (Julie March). After a series of emails and conference calls with 3 other states, a multistate task force was formed. The Executive Committee consisted of North Dakota, Illinois, and New Hampshire. California was not part of the Executive Committee, but was included in the discussions because it had initiated its own separate investigation.

The four AG consumer protection chiefs then held a series of conference calls over the summer and fall of 2008 to determine whether the activities of OPM violated laws in all four states, and whether to act collectively or on their own. The chiefs noted that of the four states, none, other than North Dakota, had a “suitability” requirement in its lending law. But all four chiefs believed that there was a strong argument that OPM’s activities were “unfair” under each state’s UDAP law, and thus likely violated the UDAP laws of most states.

On November 1, 2008, Burger called OPM’s general counsel, Marty Bach, to discuss the states’ concerns with OPM’s practices. Realizing that the allegations were serious, Bach then contacted Priestly and Bailey, and, at Priestly’s suggestion, the three decided to call OPM’s best outside litigator, Vincent Gambini, to represent OPM and Bismark in this matter. Gambini was no stranger to OPM’s legal troubles, having represented OPM in a prior SEC action (in which he defeated them in a preliminary injunction hearing) and in two nasty shareholder lawsuits. Gambini has a reputation of taking tough positions in negotiations and being willing to actually try cases if he doesn’t get his way. Meanwhile, a search on Westlaw reveals that other than Jack Ross, of Illinois, none of the states’ attorneys on the Executive Committee, has ever tried a multimillion dollar consumer case.

Gambini and Bach met four times with Burger, Biegler, Ross, and March, from January 2009 through August 2010, to discuss the states’ concerns. At the fourth meeting, in August 2010, Gambini and Bach told the states that they were willing to reform some practices, but that they believed that most states’ lending laws didn’t implicate any of OPM’s activities. They also indicated they were willing to pay about $10 million total to the states for restitution and investigative costs and attorneys’ fees (but no penalties), to distribute as they saw fit, and to sign a weak consent judgment that did not include a reference to 4 any lending laws, but that any consent decree had to “buy them peace,” i.e., settle with all the states. The states in turn had demanded that Bismark and OPM sign a consent decree that contained the following provisions:

1. A fund of $50 million to provide consumers in all 50 states with restitution for the loans that are in default,
2. $10 million in penalties,
3. $5 million in investigative costs and attorneys’ fees,
4. Injunctive relief that prohibits the companies from violating states’ lending laws, and
5. Priestly be named as a defendant and personally bound by the injunctive provisions of the settlement.

The states decided to set up one last meeting between the parties. All principals were asked to attend. This meeting is scheduled for November 11, 2010.

Prior to the last meeting, Mississippi announced that it had just hired famed plaintiffs’ class action attorney Frank Galvin from Chicago to represent the state on a contingency fee basis in this matter. None of the states’ lawyers knew Galvin personally, although they all had read the stories about his private jet and the millions he had made in the tobacco litigation, and they loathed what he represented. Galvin held a news conference surrounded by people who had lost their homes and a dozen bankers’ boxes of what he claimed were leaked internal memoranda showing that OPM knew it was driving people out of their homes and promising to file suit “in a few days.” Both the bankers and states thought this was just a publicity stunt. In any event, Mississippi’s Attorney General, Alicia Florrick, who just became President of the National Association of Attorneys’ General, insisted that Galvin be permitted to participate in the final negotiating session, and the bankers and the states reluctantly agreed.

On June 15, 2010, California and nine other states (none of which are on the Executive Committee in this matter) announced that they had reached a settlement of predatory lending practices against American Dream Mortgage Company (“American Dream”). The American Dream settlement resulted in a $40 million restitution fund, and $15 million in penalties and attorneys’ fees paid to 10 states. There was no mention of predatory lending law violations in the American Dream settlement — American Dream only agreed in general terms not to engage in unfair and deceptive practices in the future — and no company executive was named in the settlement. Suffice it to say, there is plenty of room to disagree about whether the activities of American Dream were better or worse than the alleged activities of OPM.

Before the final negotiating session, Bismark CEO Bailey called the North Dakota Attorney General, Rusty Sabich, to discuss North Dakota’s concerns about OPM’s lending activities. Bailey assured Sabich that he thought a reasonable settlement could be worked out. He also alerted Sabich to the news that would come out the following day: Bismark is considering flipping its charter, so that it would no longer be a state–chartered bank and instead would become a federal bank. The Bismark Free Press subsequently reported that if that happened, the North Dakota Bureau of Banking would lose fees from its largest state bank, which would cut the Bureau’s budget by 10%.

At the end of the last quarter, Bismark announced that it had a $1.2 billion loss for the quarter. Analysts blamed the loss on poor earnings resulting from delinquent loans to OPM customers. An article in the Wall Street Journal quoted unnamed analysts as suggesting that Bismark would be better off if it divested OPM, especially since there were rumors that Congress might hold hearings and subpoena Bismark and OPM officials to discuss predatory lending and its effects on poor, minority customers.

Following the Citizens United decision, Priestly announced that OPM would be making independent election contributions to support candidates who “believe in free enterprise and pursuit of the American Dream.” Its first contribution was $100,000 in independent contributions to support Jay Bulworth in his special election for U.S. Senate in which he defeated the Florida Attorney General, Claude Dancer. The Miami Herald reported that Dancer’s office had previously brought an enforcement action against OPM that had resulted in a $50,000 penalty. Priestly angrily denied that there was any connection between the enforcement action and the campaign contribution. This year, the California Attorney General, Daniel Kafee, is running for Governor, and the Mississippi Attorney General, Alicia Florrick, is running for re–election (and is currently behind in the polls), but the Attorneys General in the other states on the Executive Committee are not up for re–election.

Just prior to the negotiating session, New Hampshire’s Democratic Governor, Jack Slater, nominated the Chief of the New Hampshire Consumer Protection Division, Julie March, to a seat on the state Public Utilities Commission. Since the Executive Council in New Hampshire that considers such nominations is controlled by Republicans, one of whom who told the Manchester Union Leader that “this nomination should evaluated very carefully since I have heard that this Assistant Attorney General is anti–business,” it is not immediately clear when this nomination will be voted upon or approved.

The issues to be decided at the November 11 negotiations are:

1. The maximum size of the restitution fund, and whether the states’ consumers could access it for refunds.
2. Whether there will be penalties paid to the states, and if so, the amount of the penalties.
3. Whether there will be investigative fees and attorneys’ fees paid to the states, and if so, how much.
4. Whether the consent decree will prohibit activities that violate the lending laws of (a) all 50 states; (b) North Dakota only; or© none of the states, i.e., no specific reference to this issue at all.
5. Whether Priestly will be a named defendant and be bound by any injunction.

Parties to the negotiations on November 11 will be the consumer heads from North Dakota, California, Illinois, and New Hampshire for the states, Galvin on behalf of Mississippi, and the heads of Bismark and OPM, and their inside and outside counsel. Each individual negotiator will be given additional, private, instructions. The individual can keep these additional instructions secret, or disclose them if he or she thinks it would help the negotiations.

Each state team (including Galvin) and each company team can (and should) meet separately before the negotiations on November 11 to plan strategy, but the two opposing sides may not meet prior to November 11. Also, each team should not meet with their counterparts from the other team, i.e., the people assigned to the company team should not meet with members of the company team in the other negotiation. Each negotiator may add facts that logically flow from the common fact sheet and from his or her individual facts; no negotiator may add facts that do not logically flow from the given facts.