On this week’s podcast, Ballard Spahr attorneys Bo Ranney, Chris Willis, and Reid Herlihy discuss the significant takeaways from the CFPB’s new report—the first edition of Supervisory Highlights issued under Acting Director Mick Mulvaney. Mr. Ranney, former Examiner-in-Charge at the CFPB, and Mr. Willis, who chairs Ballard Spahr’s Consumer Financial Services Litigation Group, discuss the CFPB’s findings regarding debt collection, payday loans, automobile servicing, and small business lending. They also identify potential areas where the CFPB might focus in future examinations and offer recommendations for addressing the operational concerns raised by the report. Mr. Herlihy, a partner in Ballard Spahr’s Mortgage Banking Group, discusses the high-priority, mortgage-related topics identified in the Bureau’s report, lessons the mortgage industry can learn from the Bureau’s findings, and how the CFPB’s approach in this new report differs from its approach under prior leadership.

To listen and subscribe to the podcast, click here.

On September 21, 2018, the CFPB announced that it will be relocating its southeast regional office from Washington, D.C. to Atlanta, Georgia in late 2019.  In addition to the CFPB’s headquarters, the Bureau currently leases office space in downtown Washington, D.C. that will be surrendered after the southeast regional team is moved to Atlanta.  The plan for a southeast regional office has been in the works since 2016.  Per the CFPB’s February 2016 Strategic Plan, Budget, and Performance Plan and Report, the CFPB planned to coordinate with the General Services Administration “regarding its space needs for personnel at the headquarters location and in the Southeast region.”  The city selection process “took into account factors including the average rental cost in the region, proximity to institutions examined by the Bureau, and ease of travel for examiners.”  The CFPB stated that Atlanta was selected as “the city that best enables the Bureau to fulfill its statutory mission and enhance its collaboration with its regulatory partners, while being as efficient as possible.”  The new office will be housed in a building owned by the General Services Administration.  In addition to reducing costs, the move will align the CFPB with other regulatory agencies with offices in Atlanta such as the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency.  The CFPB also has regional offices in New York, Chicago, and San Francisco.

On September 17, 2018, four Amici filed briefs in the CFPB’s case against All American Check Cashing, which is now before the Fifth Circuit Court of Appeals. The Court is considering whether the structure of the CFPB is constitutional and what impact its structure, right or wrong, has on its ability to continue to prosecute claims against regulated entities. The Amici, all supporting the CFPB, were as follows:

  • Certain current and former Members of Congress involved in drafting Dodd-Frank;
  • Five people calling themselves “CFPB Separation of Powers Scholars,” including Harold Bruff, Gillian Metzger, Peter Shane, Peter Strauss, and Paul Verkuil;
  • Nine consumer advocacy groups, including Public Citizen, Inc., Americans for Financial Reform Education Fund, Center for Responsible Lending, Consumer Federation of America, Consumers Union, National Association of Consumer Advocates, National Consumer Law Center, Tzedek DC, and U.S. Public Interest Research Group Education Fund, Inc.; and
  • The Appleseed Foundation, Inc.

The Amici made substantially the same arguments made by amici supporting the CFPB in connection with the PHH case.

California Governor Jerry Brown has signed into law Assembly Bill 38, which significantly modifies the scope, administration, and servicing requirements of the state’s Student Loan Servicing Act.  The bill was approved by the California Assembly 55-23-2 and the California Senate 28-11-1 with the intent to “build upon existing law to ensure that the Student Loan Servicing Act’s goals are met as the federal government enacts new regulations.”  The bill contains no provisions delaying its immediate effectiveness.

In its most dramatic change, the bill narrows the scope of the Act by adding an exemption and redefining several terms.  The bill carves out from coverage guaranty agencies engaged in default aversion through an agreement with the Secretary of Education and redefines “student loan servicer” to exclude a debt collector who exclusively services defaulted student loans—federal loans where no payment has been received for 270 days or more and private student loans in default according to the terms of the borrower’s agreement.  The Act also adds a section to clarify that any person claiming an exemption or an exception from a definition has the burden of proving that exemption or exception.

Reflecting these changes, the licensing trigger has been restricted to those who “engage in the business of servicing a student loan in this state.”  The previous definition included any person “directly or indirectly” engaged in servicing.  However, an out-of-state entity is still deemed to be servicing “in this state” if it services loans to California residents.  In further modifying the Act’s scope, the term “student loan” has also been changed from a loan made “primarily” to finance a postsecondary education to a loan made “solely” to finance a postsecondary education.

The bill also provides significant licensing changes. Now, the commissioner may require that applications, filings, and assessments be completed through the Nationwide Multistate Licensing System & Registry (NMLS).  The commissioner is further empowered  to waive or modify NMLS requirements, use NMLS “as a channeling agent for requesting information from and distributing information to” the Department of Justice and other governmental agencies, and to create a process by which licensees may challenge information entered into the NMLS by the commissioner.

The criteria for denying a license application have been clarified, and now include: failure to meet a material requirement for issuance of a license; violations of a similar regulatory scheme of California or a foreign jurisdiction; liability in any civil action by final judgment or an administrative judgment by any public agency within the past seven years; and failure to establish that the business will be operated honestly, fairly, efficiently, and in accordance with the requirements of the Act.  Additionally, applicants must now appoint the commissioner as an agent for service of process.

With respect to servicing requirements, the bill extends the timeframe within which a servicer must acknowledge a borrower’s Qualified Written Request (QWR) to ten business days.  Previously, the Act and the most recent round of regulations required that servicers acknowledge a QWR within five business days, except when the servicer fulfilled the borrower’s request within that period.

Earlier this week, the CFPB’s Office of Research released its third “Data Point” report on Americans who are “credit invisible” – that is, those without an established credit history with the three national credit reporting agencies – and who therefore cannot be scored by most traditional credit scoring models.  The report, entitled “The Geography of Credit Invisibility,” focuses on the geographic concentrations of credit invisible consumers, to determine whether there are “credit deserts” in which access to credit is largely absent, leading to consumers in those areas being unable to become “credit visible” by establishing a credit history.

The report makes a number of interesting observations about the incidence of credit invisibility, focusing on adults over the age of 25 (because, according to the report, most Americans succeed in transitioning into credit visibility between the ages of 18 and 25, typically through credit cards or student loans).  Some of those observations are:

  • The report indicates that credit invisible consumers are concentrated in two types of geographies: in core urban areas (as opposed to suburban areas), and in rural or small-town areas.
  • Rural and small-town areas have the highest proportional incidence of credit invisibility, but because of the higher populations in urban areas, about 2/3 of credit invisible adults over age 25 reside in those areas.
  • The report provides data showing that average income level in a neighborhood is correlated with credit invisibility in urban areas, but this link between income and invisibility is absent in rural areas.
  • Because many consumers use credit cards as an “entry” product that makes them credit “visible,” the report presents data about the use of credit cards by consumers in various types of areas, and by income level. In urban and suburban areas, the use of credit cards is higher as an “entry” product, and the use of credit cards increases with income level.  In rural and small-town areas, the use of credit cards is lower, and does not increase significantly with income level.
  • Testing the hypothesis that proximity of traditional banking services may be a factor in credit invisibility, the report then examines data showing the use of credit cards as an “entry” product, sorted by the distance to the nearest bank branch. The report highlights that proximity to a bank branch is somewhat correlated with higher credit card usage as an “entry” product in urban and suburban areas, but there is no such correlation in rural areas.
  • Based on this data, the report observes that “[t]hese results provide little evidence that bank branch proximity is an important factor in explaining why consumers are credit invisible.” In fact, the report goes on to note that branch proximity is not one of the more common reasons why consumers say that they do not have a bank account.  More common reasons provided are not having enough money to put in a bank account, and a distrust of banks.
  • The report also contains data demonstrating a relationship between the availability of high-speed internet service and credit invisibility, showing that areas with less availability of internet service have significantly higher rates of credit invisibility. The report notes that credit cards, a typical “entry” product for credit invisible consumers, are typically marketed and offered online, suggesting a potential causal link between internet access and the ability to obtain a credit card.

The report does not make any policy recommendations about the subject of credit invisibility, and does not present the issue as a fair lending concern – there is no data correlating credit invisibility with any protected status under the Equal Credit Opportunity Act.  What, then, should we make of the report, and its implications for the CFPB’s future activities with respect to making credit more widely available to “invisible” consumers?

My guess is that the report will be used to support efforts to use innovation to increase access to credit for invisible consumers.  A few policy conclusions that could be drawn from the report include the following:

  1. The CFPB should encourage alternative scoring models that enable underwriting decisions to be made with respect to “invisible” consumers, and should refrain from heavy-handed application of the disparate impact theory with respect to such models. (That theory could, theoretically, be used to attack scoring models that approve members of protected classes proportionately less, but the business justification of the model’s ability to predict repayment performance should cause the Bureau to refrain from asserting it in this context).
  2. The report may suggest that models based on consumers’ internet activity may be ineffective in making credit available to consumers in areas with little internet access.
  3. Because the use of mobile devices is not dependent on the kind of high-speed home internet access the report shows to be correlated with higher rates of credit invisibility, this would suggest that the CFPB should encourage financial institutions to make products more available/accessible through mobile devices (using mobile-optimized web pages or mobile apps). This would, optimally, involve providing realistic guidance to financial institutions about how to make disclosures and obtain necessary consents through mobile devices in ways that do not deter consumers because of their cumbersome nature.
  4. The report may suggest that the Bureau’s education efforts with respect to access to credit should be concentrated in core urban and rural/small town areas.
  5. Finally, the report suggests that the problem of credit invisibility could be addressed in urban areas by products tailored to low-income consumers, and this in turn would indicate that the CFPB should encourage financial institutions to offer such products, again without heavy-handed application of “reverse redlining” theories under the Equal Credit Opportunity Act for financing sources who offer such products. This same data point would also support the Bureau’s effort to revise its small-dollar lending rule, to prevent small-dollar loans from being extinguished as an “entry” product for credit visibility.  (The report does not address this at all, since it relies on credit cards as the most common “entry” product to the three national credit reporting agencies.  However, there is credit reporting on small-dollar loans through specialty credit bureaus, and data on these credit interactions could be used to qualify consumers for other credit products).

We certainly hope that the Bureau uses the data in this report to guide its policy decisions in a direction that will make credit more available for “credit invisible” Americans.

Last Wednesday the Federal Reserve published approved final amendments to Regulation CC (Availability of Funds and Collections of Checks) which update the liability provisions of Reg. CC to address the nearly-complete conversion of the nation’s check collection system from a paper to an electronic environment.

Historically, when banks disputed which party should be responsible for the liability arising from an unauthorized check, the risks were split in two.  The paying bank (the bank that would pay on a check associated with an account it held) was responsible for forged checks; it would have a signature specimen from its customers, and be able to examine the signature of a presented check against the specimen signature; it would also know if the entire check was forged, since it was the bank’s check.  If the signatures didn’t match, or the check wasn’t an original check from the paying bank, yet the paying bank paid and there was a subsequent loss by the customer, the paying bank would be responsible for that loss, because it was in the best place to detect the forgery.

The depositary bank (the bank holding the account where check funds would be deposited) was responsible for altered checks; it was deemed to be in the best place to determine whether, for example, the amount of the check had been changed from $100 to $10,000.  This division of risk is old, originally established in 18th Century English law (in the case of Price v. Neal, 97 Eng. Rep. 871 (1762)), and enshrined in the U.S. under UCC Articles 3-407 and 3-417.  It also assumes the presentment and receipt of paper checks.

Virtually all checks presented in 2018 within the US are not presented in paper form.  Instead, an image of the check is taken, the original check is destroyed, and the depositary bank presents this check image (a truncated check) to the paying bank.  Notwithstanding the dramatic increase in settlement speed and dramatic reduction in processing costs, electronic images of checks create a potential problem in the event of a bank dispute over whether a check has been forged or altered.  The original check is destroyed, making it impossible to examine the original check to determine whether the check was altered, or whether it was a forgery.  Regulation CC currently does not provide any presumptions as to whether a check is altered or forged.

The new amendment provides this guidance, adding a new presumption of liability for substitute and electronic checks.  If there is a dispute between the paying bank and the depositary bank as to whether a substitute or electronic check is an altered or a forgery (now described as “derived from an original check that was issued with an unauthorized signature of the drawer”), the presumption is that the substitute/electronic check contains an alteration.  This generally shifts liability on fraudulent checks to depositary banks; this presumption may be overcome if a preponderance of the evidence proves the substitute or electronic check does not contain an alternation, or that it was a forgery.  The presumption does not apply if there is an original check to examine.

It’s a reasonable allocation of risk; the depositary bank is receiving, imaging and destroying the check, and then presenting the image to the paying bank.  If there is a later dispute over the fraudulent nature of the check, then the party that destroyed the original check, and was in the best place to preserve the check as evidence, should bear the risk associated with evidentiary questions.

The amendment goes into effect January 1, 2019.

CFPB Acting Director Mick Mulvaney recently responded to former CFPB Student Loan Ombudsman Seth Frotman’s vocal departure from the Bureau.  As previously reported, Frotman tendered his resignation in a letter—also delivered to members of Congress—which accused Mulvaney of being derelict in his oversight of the “student loan market.”  Among other things,  Frotman accused Mulvaney of undercutting enforcement, undermining the Bureau’s independence, and shielding “bad actors” from scrutiny—collectively, “us[ing] the Bureau to serve the wishes of the most powerful financial companies in America.”

In an interview addressing the letter, Mulvaney has emphasized that he is focused on the explicit statutory authority provided in the Dodd-Frank Act, including the limitations on his oversight of student loans.  When asked about Frotman’s resignation, Mulvaney responded that he “never met the gentleman” and “doesn’t know who he is.”  Mulvaney has served as Acting Director since November 2017.  Frotman joined the Bureau during its creation in 2011 to focus on military lending issues as a senior advisor to Holly Petraeus (the Assistant Director for the Office of Servicemember Affairs) and transitioned to the Private Education Loan Ombudsman in April 2016.  Mulvaney added, “I talked to his supervisor who met with him on a regular basis during the nine months I’ve [been] there; [Frotman] never complained about anything that was happening at the Bureau, so I think he was more interested in getting his name in the paper.”

In his resignation letter, Frotman noted that the “Student Loan Ombudsman,” statutorily created by Section 1035 of the Dodd-Frank Act, was authorized to “provide timely assistance to borrowers,” “compile and analyze” borrower complaints, and “make appropriate recommendations” to the Director of the CFPB, the Secretary of Education, the Secretary of the Treasury, and Congressional committees regarding student loans.  Frotman, however, omits any mention of statutory limits to the Ombudsman’s authority.  Section 1035—titled “Private Education Loan Ombudsman”—directs the Ombudsman to “provide timely assistance to borrowers of private education loans,” “compile and analyze data on borrower complaints regarding private education loans” and to “receive, review, and attempt to resolve informally complaints from borrowers of [private education] loans.”

With respect to federal student loans, Section 1035 of the Dodd Frank Act only contemplates the Private Education Loan Ombudsman’s cooperation with the Department of Education’s student loan ombudsman through a memorandum of understanding (MOU).  Mulvaney noted the somewhat informal nature of the MOU created during the Obama administration, referring to it as a “handshake agreement.”  Arguably signaling an intent to defer to the Department of Education on federal student loan issues, Mulvaney stated that the issue he is most “worr[ied] about [is] the growth in …student loans” because federal involvement in the market has created a “disconnect between the making of a loan and the repaying of [a] loan.”

We have been following very closely the lawsuit filed by the CFPB and the New York Attorney General against RD Legal Funding.  We earlier reported that on June 21 Judge Preska dismissed the CFPB’s claims based on the unconstitutionality of the CFPA. We subsequently reported that on September 12 Judge Preska dismissed the claims brought by the New York Attorney General under Section 1042 of Dodd -Frank (i. e., the provision authorizing state attorneys general to initiate lawsuits based on UDAAP violations) and also dismissed the Attorney General’s state law claims for lack of subject matter jurisdiction as a result of there being no remaining federal questions in the case.

The most recent development is that yesterday Judge Preska amended her September 12 order to provide that her dismissal of the New York Attorney General’s 1042 claims are “with prejudice”. That means that the New York Attorney General should not be able to re-file her 1042 claims in state court unless and until a higher court reverses Judge Preska’s order. The CFPB has already filed an appeal with the Second Circuit and it seems likely that the New York Attorney General will do the same.

The CFPB and its Acting Director are facing a proposed class action lawsuit alleging discrimination against minority and female workers based on allegations of lesser pay and fewer promotions than their white male counterparts. The case is captioned at, Jones et al v. Mulvaney, U.S. District Court, District of Columbia, No. 18-2132.

The Complaint, filed on September 13, 2018, in the D.C. District Court, alleges violations of the 1866 Civil Rights Act, Title VII of the 1964 Civil Rights Act and the 1963 Equal Pay Act. The lawsuit is seeking punitive damages and compensation for lost pay and benefits for minorities and women who have worked as consumer response specialists at the CFPB.

The plaintiffs contend that while the CFPB and Acting Director Mulvaney are tasked with providing justice to American consumers, they have failed in their responsibility to their own employees. The plaintiffs, Ms. Carzanna Jones and Mr. Heynard Paz-Chow, are seeking certification to join in the case a class of racial minority and female employees, both past and present, working in the consumer response division, whom the plaintiffs allege were subjected to the same discrimination and retaliation while working for the CFPB. Ms. Jones is a current employee of the CFPB, and her allegations cover the length of her career at the bureau dating back to 2012. Mr. Paz-Chow is a former employee of the bureau from 2011-2014, and his allegations occurred under the leadership of former CFPB Director Richard Cordray. The consumer response division of the bureau is responsible for investigating consumer complaints and determining whether laws or regulations have been violated.

The pending lawsuit alleges that through an agency-wide pattern and practice of discrimination and retaliation, the CFPB has sought to disparately impact racial minority and female workers despite the continued objections of CFPB employees. Specifically, it is alleged that the CFPB instituted discriminatory policies and procedures in its training, assigning, evaluating, and compensation of minority and female employees. The Complaint also details specific instances of discrimination and retaliation alleged to have been suffered by the individual named plaintiffs including:

  • Denial of training and promotion opportunities
  • Unequal assignment of investigations leading to disproportionate case closings which impact employee evaluations
  • Denial of transfer requests
  • Pay disparities
  • Failure to abide by the requirements of the ADA and FMLA
  • Retaliatory actions after employees complained about inequalities

The allegations in the Complaint stretch back as far as 2011 and address statistical studies and congressional reports that have highlighted equality issues at the CFPB under multiple directors. According to the Complaint, those analyses and investigations have shown deficiencies in the pay and promotion of both racial minorities and female employees in line with the allegations of the Complaint. The Complaint cites to a Congressional Investigation by the U.S. House of Representatives initiated in 2014 and an Office of Inspector General (“OIG”) report from 2015. Both authorities found significant issues with widespread disparities negatively impacting racial minority and female employees with regard to performance ratings, pay, promotion and related areas. During a hearing of the U.S. House of Representatives Financial Services Committee, a CFPB attorney testified that the white males in authority at the bureau gave themselves the best performance evaluations to garner better raises and bonuses.

The BCPB has historically taken the position that it can use investigations to conduct compliance “sweeps” of entire industries. Indeed, a version of the BCFP’s Enforcement Policies and Procedures Manual made available to the public through a FOIA request in 2016 stated that: “It is not necessary to have evidence that a law has in fact been violated before opening a formal investigation. That means, for example, that the Bureau could conduct a ‘compliance’ sweep to investigate whether industry participants are complying with a law or regulation.”

The BCFP has historically used CIDs and investigations to supervise industries over which it otherwise lacked supervisory authority—imposing huge costs on industry participants without justification.  On September 6, 2018, the Fifth Circuit took a dim view of that tactic. In its opinion in the The Source for Public Data, L.P. case, the Fifth Circuit struck down a CID apparently issued as part of such an industry sweep. “Simply put,” the court held, “the CFPB does not have the ‘unfettered authority to cast about for potential wrongdoing.’”

Dodd-Frank requires the BCFP to include a “Notification of Purpose” in every CID stating “the nature of the conduct constituting the alleged violation which is under investigation and the provision of law applicable to such violation.” The BCFP has historically read this requirement very loosely. Paraphrasing, most Notifications of Purpose said no more than: “The purpose of this investigation is to determine whether anybody did anything wrong.”  They generally gave CID recipients no information whatsoever as to the conduct under investigation. Sometimes it was possible to guess based on the document requests and interrogatories included in the CIDs, but the Notifications of Purpose were not generally specific enough to allow recipients to meaningfully negotiate the scope of the CID or to know whether they were targets of an investigation or only third-party witnesses. The BCFP has taken and endorsed this approach even under Mulvaney, who recently denied a request to modify or set aside a CID containing a broad Notification of Purpose.

The Fifth Circuit acknowledged this as a real problem. It found that such broad Notifications of Purpose did not allow courts to meaningfully evaluate whether the information requested by the BCFP was “reasonably relevant” to the matter under investigation—the standard courts apply to government requests for information. As a result, the Fifth Circuit found that it could not enforce the CID and, reversing the lower court, struck the CID down entirely. In doing so, the Fifth Circuit joined with the D.C. Circuit which, in 2017, rejected a similarly broad Notification of Purpose in the ACICS case. In striking the CID, the Fifth Circuit held that “[t]here are consequences to ‘the absurdity of giving a notification that notifies of no purpose whatsoever.”