An attempt by the Pennsylvania Attorney General to use her Dodd-Frank Section 1042 authority recently met with only partial success in Pennsylvania federal district court.  Section 1042 allows state attorneys general and regulators to bring civil actions for violations of Dodd-Frank’s prohibition of unfair, deceptive, or abusive acts or practices (UDAAP).  The AG’s action in Commonwealth of Pennsylvania v. Think Finance, Inc., et al., was brought against several companies and their individual principal for allegedly (1) engaging in “rent-a-bank” and “rent-a-tribe” schemes to market Internet loans, and (2) charging interest rates that were usurious under state law.

In addition to alleging various state law violations, including that the defendants had engaged in “racketeering,” the AG alleged that the defendants had violated the Dodd-Frank UDAAP prohibition by (1) conditioning loans on the borrower’s use of electronic payments in violation of the Electronic Fund Transfer Act (EFTA) prohibition on compulsory use; (2) “inducing consumers to provide highly personal information;” and (3) taking unreasonable advantage of consumers’ lack of understanding.  The AG also claimed that the defendants should be liable for the UDAAP claims under a “common enterprise” theory.

The AG claimed that the defendants had violated the EFTA and engaged in a UDAAP by giving customers “the option of receiving the loan proceeds in their bank account quickly if the consumer agrees to electronic direct deposit and repayment, while conditioning the alternative option of payment by mail on the consumer agreeing to wait as long as a week for the borrowed cash.”  The court ruled that the AG had not stated a claim for a UDAAP claim because the AG “fails to connect the Defendants’ incentivizing electronic payments with a lack of understanding on the part of the consumer.”  The court also observed that it “was difficult” to see how the automatic payment option was itself “unfair or deceptive.”  It noted that the AG had not pled that the option caused injury to consumers and commented that the defendants’ promise to provide loans by direct deposit “as soon as tomorrow” was not itself injurious but was “reflective of the desperation of the consumer prior to engaging with the Defendants.”

The court also found that the AG had failed to state a claim for a UDAAP violation based on the allegation that consumers were induced to provide “highly personal information.”  It agreed with the defendants’ argument that this ground failed because the AG had not indicated how consumers were harmed “beyond a general allegation that it ‘makes them vulnerable to future improper use of that information.'”

The court did, however, find that the AG had stated a claim for a UDAAP violation based on the allegation that the defendants had engaged in an abusive act or practice by taking unreasonable advantage of the consumer’s lack of understanding of material risks.  While agreeing with the defendants that the AG had not shown that the defendants had engaged in abusive conduct by failing to disclose the loan terms, it found that the AG had sufficiently pled abusive conduct by alleging that the defendants took unreasonable advantage of the consumer’s lack of knowledge by “[holding] these loans out to be legal.”

With regard to the AG’s attempted use of a “common enterprise” theory, the AG argued that because the FTC Act prohibits unfair or deceptive acts or practices and the FTC has been allowed to use the “common enterprise” theory in FTC Act enforcement actions, the theory should apply to Dodd-Frank UDAAP claims.  In rejecting that argument, the court distinguished the FTC Act by noting that it can only be enforced by the FTC and does not also prohibit abusive conduct.

While involving loans with triple-digit interest rates, the defendants’ inability to use federal preemption to obtain a dismissal of the AG’s racketeering and other state law claims also makes the decision particularly noteworthy for marketplace lenders that partner with banks to originate loans at much lower rates.  Most significantly, the court’s rejection of preemption demonstrates the need for marketplace lenders to be prepared to defend their bank partnerships against “true lender” challenges by revisiting their partnerships’ structure, documentation, and compliance controls with legal counsel.  For more information about the decision, see our legal alert.