The CFPB  has taken a significant step towards issuing regulations to implement Section 1071 of the Dodd-Frank Act by releasing an outline of the proposals it is considering in preparation for convening a small business review panel (Panel).  Section 1071 amended the ECOA to require financial institutions to collect and report certain data in connection with credit applications made by women- or minority-owned businesses and small businesses.  Such data includes the race, sex, and ethnicity of the principal owners of the business.  The Small Business Regulatory Enforcement Fairness Act (SBREFA) and the Dodd-Frank Act require the CFPB to convene a Panel when developing rules that may have a significant economic impact on a substantial number of small businesses.  It also requires the Panel to consult with representatives of small business entities that are likely to be subject to the rules under consideration.

The Bureau’s release of the SBREFA outline on September 15 meets the rulemaking timetable established by the Stipulated Settlement Agreement in the lawsuit filed against the Bureau alleging wrongful delay in adopting regulations to implement Section 1071.  Under the Stipulated Settlement Agreement, the Bureau agreed to release the SBREFA outline by September 15 and convene a Panel by October 15, 2020, or as soon as practicable thereafter if Panel members are not available to convene.  In its second status report filed with the court, the Bureau indicated that it would hold meetings with the Panel and small entity representatives during the week of October 19.  Since SBREFA requires the Panel to complete a report on the input received from the small business representatives within 60 days of convening, if convened on October 15, the Panel’s deadline for completing its report would be December 14, 2020.

The Bureau is considering a proposed rule that would include the following provisions:

Scope.  Section 1071(b) imposes requirements regarding “any application to a financial institution for credit for [a] women-owned, minority-owned, or small business.”  The Bureau is considering proposing that the data collection and reporting requirements of its Section 1071 rule apply to any application for credit for a “small business” as defined by the rule, including for a women-owned or minority-owned business that meets the “small business” definition.  Under this approach, a financial institution would not be required to collect and report Section 1071 data for women-owned or minority-owned businesses that are not a “small business.” 

Financial Institutions Covered.  The definition of “financial institution” in Section 1071(h) covers any entity that engages in financial activity and includes both depository and non-depository institutions. The Bureau is considering the following standards for exempting financial institutions from Section 1071 data collection and reporting requirements:

  • Size-based exemption for depository institutions.  The asset-based exemption under consideration would exempt depository institutions with assets less than one of two possible threshold levels, $100 million or $200 million in assets, to be determined either at the end of the last calendar year or the end of both of the last two calendar years.
  • Activity-based exemption for all financial institutions.  The activity-based exemption under consideration would exempt financial institutions with small business lending activity that is less than one of three possible threshold levels: originations of at least 25 loans or $2.5 million; originations of at least 50 loans or $5 million; or originations of at least 100 loans or $10 million, to be determined either at the end of the last calendar year or the end of both of the last two calendar years
  • Combined size- and activity-based exemptions.  A combined exemption would require all financial institutions that meet an activity-based threshold for the relevant time period to comply with Section 1071 data collection and reporting requirements but depository institutions with assets under a given asset threshold would be exempt from reporting, regardless of the number or dollar value of the small business loans they originated during the relevant time period.

“Small Business” Definition. Section 1071(h) defines a “small business” applicant as having the same meaning as a “small business concern” in the Small Business Act.  The Bureau is considering proposing to define “small business” by cross-referencing the SBA’s general “small business concern” definition but adopting a simplified size standard for purposes of its Section 1071 rule that uses one of the following three alternative approaches under consideration:

  • Gross annual revenues in the prior year of less than $1 million or $5 million
  • Maximum of 500 employees for manufacturing and wholesale industries and $8 million in gross annual revenues for all other industries
  • A size standard (for which the Bureau would need SBA approval) using gross annual revenues or number of employees that looks to the SBA’s industry-specific size standards which are expressed in terms of a business’s average annual receipts or average number of employees and that would result in eight different size standards and 13 industry categories.

The definition of a “business concern” under the SBA’s regulations is limited to for-profit entities with a place of business located in the United States and that operate primarily within the United States or which make a significant contribution to the U.S. economy through payment of taxes or use of American products, materials, or labor.  The Bureau indicates that if it adopts the SBA definition for purposes of Section 1071, financial institutions would not be required to collect and report Section 1071 data for not-for-profit entities or foreign companies. 

Product Coverage.  Section 1071 requires financial institutions to collect and report information regarding applications for “credit.”  The Bureau is considering proposing that a covered product under Section 1071 is one that meets the ECOA definition of “credit” and is not excluded under the Bureau’s rule. It is considering proposing that covered products include term loans, lines of credit, and business credit cards and that the following products are not covered:

  • Consumer credit used for business purposes.  Products designated by the creditor as consumer purpose products would not be covered.
  • Leases.  Leases would not be covered unless the product is a credit sale.
  • Trade credit.  Trade credit, which typically involves a transaction in which the seller allows a buyer to purchase its goods without requiring immediate payment and the seller is not otherwise in the financial services business, would not be covered.
  • Factoring.  Factoring, which typically involves a business’s sale of its unpaid invoices at a discount to a factor, would not be covered.  (Factoring is not generally considered subject to the ECOA or Regulation B.)
  • Merchant cash advances.  Merchant cash advances typically involve a merchant’s receipt of a cash advance which it promises to repay, plus an additional amount, by either pledging a percentage of its future revenue or agreeing to pay a fixed daily withdrawal amount to the advance provider until the agreed payment amount is satisfied.  The Bureau cites the “unique structure of the transactions” as a reason for not including merchant cash advances as a covered product.   

“Application” Definition.  Section 1071 does not define the term “application.”  The Bureau is considering proposing to define an “application” in a way that is largely consistent with Regulation B, which defines an “application” as “an oral or written request for an extension of credit that is made in accordance with procedures used by a creditor for the type of credit requested.”  However, the Bureau is proposing to exclude the following circumstances even if they would be considered an “application” under Regulation B:

  • Inquiries/prequalifications
  • Reevaluation, extension and renewal requests, except requests for additional credit amounts
  • Solicitations and firm offers of credit

The Bureau considered, but decided against, defining an “application” for purposes of Section 1071 as a “completed application” as defined under Regulation B or as particular documents or specific data points that, if collected, would trigger a duty to collect and report Section 1071 data.

Data Points.  Section 1071(b) requires a financial institution to inquire whether an applicant for credit is a women-owned, minority-owned, or small business and to maintain a record of the responses to that inquiry separate from the application and accompanying information.  The Bureau is considering proposing that collection and reporting of women-owned and minority-owned business status be based solely on the applicant’s self-reporting, without any obligation on the financial institution to verify the accuracy of that information.  The Bureau is not considering proposing the use of visual observation or surnames by institutions to determine an applicant’s status.

Section 1071(e) requires a financial institution to collect and report “the race, sex, and ethnicity of the principal owners of the business” but does not define “principal owner.”  The Bureau is considering proposing to define the term “principal owner” in a way that is consistent with FinCEN’s customer due diligence rule, which makes an individual the “principal owner” of a business if he or she directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, owns 25 percent or more of the equity interests in the business.  It is also considering proposing that financial institutions use HMDA aggregate race, sex, and ethnicity categories when requesting that applicants self-report race, sex, and ethnicity information.  As with the collection and reporting of women-owned and minority-owned business status, the Bureau is considering proposing that collecting and reporting of the race, sex, and ethnicity of a business’s principal owners be based solely on applicant self-reporting.

The Bureau indicates that while the definition of an “application” triggers a financial institution’s duty to collect and report Section 1071 data, that definition does not necessarily govern when during the application process Section 1071 data must be collected.  The Bureau is not currently considering specifying a particular time period in which financial institutions must seek to collect Section 1071 data from applicants.  The Bureau notes that it decided not to specify a time period despite the risk that absent such a designated time period, financial institutions may not seek to collect demographic information until late in the process when applicants may be less motivated to provide such information.

Public disclosure of Section 1071 data.  Section 1071(f) generally requires that Section 1071 data compiled and maintained under Section 1071 by institutions be made publicly available by the institution upon request and by the Bureau annually.  Section 1071(e) gives the Bureau discretion to “delete or modify data…which is or will be available to the public, if the Bureau determines that the deletion or modification of the data would advance a privacy interest.”  In exercising this discretion, the Bureau is proposing to use a “balancing test” that weighs the risks and benefits of public disclosure.  Under this test, data would be modified or deleted if its disclosure in unmodified form would pose risks to privacy interests that are not justified by the benefits of public disclosure in light of Section 1071’s purposes.  If the risks of disclosing unmodified data outweigh the benefits, the Bureau would consider whether modifications could bring them into balance.  The Bureau is considering applying the balancing test to the privacy interests of both non-natural persons and natural persons with respect to protecting, respectively, sensitive commercial information and sensitive personal information.  As an alternative to a balancing test, the Bureau is considering an approach in which it would modify data if an identified privacy risk crossed a significance threshold without weighing the risk against the benefits of disclosure.

In addition, the Bureau is also considering proposing an approach in which financial institutions can satisfy the requirement for them to make Section 1071 data publicly available upon request by referring the public to the Bureau’s website where such data would be available (with any modifications or deletions required based on the Bureau’s application of the balancing test).

Implementation.  The Bureau is considering proposing that financial institutions have approximately two calendar years for implementation following the Bureau’s issuance of a final Section 1071 rule.

A SBREFA outline would ordinarily be a strong indicator of the approach the Bureau is likely to take in a proposed rule implementing Section 1071.  However, if Joe Biden is elected President in November, a proposed rule would likely be issued under a new CFPB Director appointed by him.  As a result, the proposal might vary more than usual from the outline and be more closely aligned with views of consumer advocates.  The National Community Reinvestment Coalition issued a press release about the SBREFA outline in which it stated that “there are approaches outlined in the proposal that must not be included in further proposals.”  The Coalition cited the Bureau’s approaches to exemptions based on asset size and for “non-traditional lenders like merchant cash advance providers” as problematic.