On July 28, 2017, California Governor Jerry Brown’s Office of Business and Economic Development recognized the California Department of Business Oversight for a successful Lean Six Sigma project that dramatically reduced the processing time for applications to amend financial services licenses.  Through the project, the Department cut the processing time from an average of 100 days to only 1.9 days!

We have previously commented that the time it takes state authorities to process license applications can be a significant factor for FinTech and other financial services companies to consider when determining how to structure their business.  State regulators who want to improve the business climate in their states would be well-advised to follow California’s lead in tackling this important issue.

The Minnesota Supreme Court recently ruled that two for-profit postsecondary education schools had charged usurious interest rates on student loans and could not charge rates greater than 8% without obtaining a lending license.

Minnesota’s general usury law caps interest rates at 8% for written contracts but allows a lender to charge up to 18% on a “consumer credit sale pursuant to an open end credit plan.”  In State of Minnesota v. Minnesota School of Business, et al., the Minnesota Attorney General sought to enjoin the schools from making private student loans that typically had interest rates between 12% and 18%, alleging that the loans were subject to the 8% cap.  The schools did not pay out money to the student and instead credited the loan amount against the student’s outstanding tuition balance.  The credit was not available to the student for any other purpose.  The student repaid the loan through monthly payments pursuant to a schedule that had a fixed date by which the entire loan and accrued interest had to be paid in full, and no additional funds were available if the student paid off the loan early.

At issue was whether the loans qualified as a “consumer credit sale pursuant to an open end credit plan” on which Minnesota allowed up to 18 percent interest to be charged.  (The decision states that the parties agreed that the loans “were consumer credit sales.”)   Although the Supreme Court found that the definition of “open end credit plan” under Minnesota law only incorporated the Truth in Lending Act and Regulation Z definition of “open-end credit plan” in effect in 1971 and not as subsequently amended to expressly require revolving credit, it found that revolving credit was nevertheless an essential part of the 1971 definition.

Reversing the Minnesota Court of Appeals, the Supreme Court concluded that the loans were not made pursuant to an open-end plan.   It found that the repayment schedule on the schools’ loans, which provided for a fixed end date, was consistent with a closed-end plan and also observed that the schools had required students to sign a form containing an acknowledgment that a loan was not an “extension of credit under an open-end consumer credit plan.”  According to the Supreme Court, the schools had “structured their loans to give themselves the benefit of open-end credit plans, charging interest in excess of 8 percent-without providing their students the benefit of revolving credit.”

Having found that the schools had charged usurious interest rates, the Supreme Court concluded that to charge rates higher than 8 percent on loans that were not made pursuant to an open-end credit plan, the schools needed to obtain a Minnesota lending license.

The opinion states that the schools did not contest “that they were [engaged] in the business of making loans” for purposes of the lending license statute.  Thus, it appears that the schools did not attempt to argue that, in extending credit to students to finance tuition, they were not acting as lenders making “loans” subject to Minnesota’s general usury law but instead were acting as sellers of goods or services extending credit to buyers to which the time-price doctrine applies.  Sellers making closed-end credit sales should consult with counsel as to how they can avoid the 8 percent rate cap by taking advantage of the time-price doctrine under Minnesota law.

 

 

 

A group of 19 state attorneys general and the District of Columbia attorney general have sent a letter to Senate Majority Leader Mitch McConnell and Senate Minority Leader Charles Schumer expressing the AGs’ “strong opposition” to S.J. Res. 47, the resolution introduced in the Senate to disapprove the CFPB’s final arbitration rule under the Congressional Review Act.

Last week, the House passed H. J. Res. 111 disapproving the arbitration rule under the CRA.  Under the CRA, to override the arbitration rule, both the House and Senate must pass a resolution of disapproval by a simple majority vote within 60 legislative days of the rule’s receipt by Congress.  A vote on the Senate resolution is not expected to occur until September.

In their letter, the AGs assert that they are “quite familiar with the many meritorious class actions filed every year across the country and have reviewed thousands of successful class settlements” because their offices review proposed federal court class action settlements pursuant to the federal Class Action Fairness Act.  They claim that these cases “supplement and expand our enforcement authority and prevent abuses that we do not always have the resources to address” and that “[s]uccessful cases also return millions of hard-earned dollars to low- and middle-income consumers who would otherwise have no remedy for overcharge, fraud and abuse.”

Despite the billions of dollars the arbitration rule will cost providers who currently use arbitration agreements to defend against additional class actions, the AGs urge lawmakers to consider the CFPB’s “careful and well-researched work in support of the rule, including its thoughtful analysis of the limited cost of the rule to businesses when compared to the benefits to consumers.” (emphasis added)

Unfortunately, the AGs’ position suffers from the same faulty assumption as the final arbitration rule itself – i.e., that class actions are “meritorious” even when they settle without a final adjudication of liability and the defendant denies liability.  As many courts have observed, many if not most class actions settle, not because they have merit, but because most companies cannot afford to lose them. See, e.g., Coopers & Lybrand v. Liveasay, 437 U.S. 463, 476 (1978) (“[c]ertification of a large class may so increase the defendant’s potential damages liability and litigation costs that he may find it economically prudent to settle and to abandon a meritorious defense”); Newton v. Merrill Lynch, Pierce, Fenner & Smith, 259 F.3d 154, 164 (3d Cir. 2001) (class certification “places inordinate or hydraulic pressure on defendants to settle”); In re Rhone-Poulenc Rorer, Inc., 51 F.3d 293, 299 (7th Cir. 1995) (class certification may require defendants to “stake their companies on the outcome of a single jury trial”).  See also Senate Report No. 14, The Class Action Fairness Act of 2005, 109th Congress, 1st Sess., 2005 WL 627977, at *14, 20-21 (Feb. 28, 2005) (“Because class actions are such a powerful tool, they can give a class attorney unbounded leverage, particularly in jurisdictions that are considered plaintiff-friendly.  Such leverage can essentially force corporate defendants to pay ransom to class attorneys by settling – rather than litigating – frivolous lawsuits.”).

The CFPB’s final rule will burden financial services providers with 6,042 additional class actions over the next five years, at a cost of between $2.6 billion and $5.3 billion, and there is no reason to believe that these additional class actions will be any more “meritorious” than the past ones. The CFPB acknowledges in the final rule that (a) none of the 562 class actions it studied was tried on the merits, (b) only 12.3% of the class actions had final settlements approved during the study period, (c) the average cash payment to settlement class members was $32 and (d) the attorneys for the plaintiffs were paid $424,495,451.  By contrast, awards to prevailing consumers in individual arbitrations averaged close to $5,400.

Nor does the AGs’ alleged lack of “resources” justify opening the class action floodgates. The CFPB itself has virtually unlimited resources, and the AGs collaborate with the CFPB and one another. This is what the Senate should keep in mind as it considers the joint resolution of disapproval.

 

Pennsylvania’s Attorney General, Josh Shapiro, announced last Friday that his office is creating a Consumer Financial Protection Unit “to better protect Pennsylvania consumers from financial scams.”

The announcement indicated that the new Unit “will focus on lenders that prey on seniors, families with students, and military service members, including for-profit colleges and mortgage and student loan servicers.”  The new Unit will be led by Nicholas Smyth, a former CFPB enforcement attorney, who was named Assistant Director of the Office of Attorney General’s Bureau of Consumer Protection.

 

 

Education Finance Council, a national trade association representing state-based nonprofit higher education finance organizations, has asked the Department of Education to “publicly state” that the ED’s rules governing servicers of federal student loans preempt state laws and regulations that would impose conflicting requirements on such servicers.

In a letter to Education Secretary Betsy DeVos, EFC expresses concern that state efforts to impose regulations on student loan servicers contracted by the federal government to service federal student loans threaten “to add an unnecessary web of regulations which are both duplicative and potentially contradictory to existing federal regulations and policies.”  EFC notes that the ED has previously “made clear its position on the preeminence of federal law in student loan servicing,” and asks the ED to make it clear “to both the public and to state entities that seek to impose their own conflicting regulations on federal student loan servicing contractors” that federal law takes precedence in the event of a conflict between federal and state laws.

 

 

The New Jersey Legislature is considering a law to restrict prepaid-account fees.  Assembly Bill 4965 ( the NJ Bill) seeks to impose fee constraints, disclosure mandates, and limits on consumer liability for unauthorized transfers, among other things.  While many aspects of the proposed law mirror the Consumer Financial Protection Bureau’s Final Prepaid Rule (the Bureau’s Prepaid Rule), the NJ Bill’s fee restrictions and disclosure mandates exceed federal requirements set to go into effect on April 1, 2018.  Proposed changes to the Bureau’s Prepaid Rule will likely delay this effective date, however.

Significantly, the NJ Bill regulates the types and amounts of prepaid account fees.  It permits only 13 categories of fees, and limits the amount or frequency of several categories.  For example, a fee for a replacement device may not exceed $5, and a periodic fee may not be charged more frequently than monthly.  The NJ Bill further states that financial institutions “shall not charge” annual fees, overdraft fees, activation fees, point-of-sale fees (including fees for declined transactions), or any other fee not specifically enumerated by the law.  The Bureau’s Prepaid Rule, in contrast, does not contain fee prohibitions, but rather emphasizes upfront disclosures about fees that may be charged.

The NJ Bill’s disclosure requirements also differ from the Bureau’s Prepaid Rule.  Under the NJ Bill, a financial institution that holds a consumer’s prepaid account must provide a consumer with “a table of any fees,” including the amount and description of each fee, that the financial institution may charge for using the prepaid account or making electronic fund transfers.  Significantly, this table of “any” fees must accompany “any application, offer, or solicitation for a prepaid account.”  The Bureau’s Prepaid Rule, in contrast, permits pre-acquisition disclosure of some—but not all—fees in its short-form disclosure, so long as the financial institution also provides information allowing a consumer to access its long form disclosure by telephone or website.

If enacted, the NJ Bill may force prepaid-account issuers to decide whether to offer prepaid products in New Jersey given the fee restrictions and the potential burden of offering special terms to New Jersey consumers.  Indeed, the proposed law authorizes a civil penalty of up to $1,000 per day for each day that a violation persists.

The NJ Bill was introduced on June 8, 2017, by New Jersey Assemblyman Troy Singleton (D) and is pending consideration by the New Jersey Assembly Financial Institutions and Insurance Committee.  It is Assemblyman Singleton’s second attempt to limit prepaid account fees.  In 2012, he co-sponsored a similar bill aimed at limiting prepaid account fees, but that bill died in committee.

California’s legislative effort to allow consumers to sue financial institutions for fraud even though they have agreed to arbitrate such disputes passed the Assembly Judiciary Committee this week and is expected to pass the full Assembly later this summer.  The bill, which passed the state Senate in May, would amend California’s civil procedure rules governing arbitration to prohibit courts from granting a motion to compel arbitration made by a financial institution which seeks to apply an otherwise valid arbitration agreement to a purported contractual relationship fraudulently created by the institution with the consumer’s personal identifying information and without the consumer’s consent.

We believe that this legislative effort is an exercise in futility since the bill, if passed, will be preempted by the Federal Arbitration Act (FAA), which makes arbitration agreements “valid, irrevocable, and enforceable.”  For example, the U.S. Supreme Court has held that states are prohibited from creating categorical exceptions to the FAA that Congress did not authorize.  Thus, it reversed a decision of West Virginia’s highest court which  refused to permit arbitration of personal injury and wrongful death claims brought against nursing homes.  And, this past May, in Kindred Nursing Centers Limited Partnership v. Clark, the Court reversed the Kentucky Supreme Court’s ruling that powers of attorney must specifically authorize the representative to enter into an arbitration agreement on behalf of the grantor, holding that the state court violated the fundamental FAA principle that arbitration agreements must be placed “on an equal footing with all other contracts” and cannot be singled out for special treatment.  Notably, even Professor Jeff Sovern, who is generally supportive of anti-arbitration initiatives and arguments, has asked,  “if California enacts the law, how can it avoid being preempted under the Federal Arbitration Act, as SCOTUS has interpreted it?”

Scores of consumer advocate groups have registered support for the California bill, while a similar number of industry and trade groups have voiced opposition.

 

The CFPB’s June 2017 complaint report could serve as a call to arms to state attorneys general and regulators.  Unlike the CFPB’s prior monthly complaint  reports, the June 2017 report does not highlight complaints about one product  or complaints from consumers from one state.  Instead, the new report, which the CFPB calls a “special edition,” provides expanded data and analysis on a state-by-state basis of all complaints received by the CFPB as of April 1, 2017.  It also provides similar data on a national level for complaints from servicemembers and older consumers.

The expanded data and analysis provided for each state and the District of Columbia includes the top five products by volume, the top issue reported by consumers for each of such products, and the five products that had the greatest percentage increase in complaint volume from the last quarter of 2016 to the first quarter of 2017.  Prior complaint reports showed on a state-by-state basis the total number of complaints received by the CFPB by product and the total of all complaints received by the CFPB through the month covered by the report.  However, the new report’s approach more readily identifies the products drawing the most complaints in a particular state and recent trends in complaint volume.  Such information could result in greater scrutiny by state AGs and regulators on companies providing the products that drew the most complaints from consumers in their states or showed the greatest recent increases in complaint volume.

The report’s national statistics include the following:

  • Complaint volume rose 7 percent between 2015 and 2016 with the CFPB receiving 271,600 complaint in 2015 and 291,400 complaints in 2016.
  • Since the CFPB began accepting complaints in July 2011, companies have provided a timely response (i.e. within 15 days) to 97 percent of complaints they received from the CFPB.
  • Approximately 52 percent of the consumers who submitted complaints directly to the CFPB since 2015 have opted to have their narrative descriptions published.

 

We previously reported that the Connecticut Attorney General, on behalf of himself and the Attorneys General of Indiana, Kansas and Vermont (the “state AGs”), had filed a joint motion to intervene in a CFPB enforcement action against Sprint to request a Consent Order modification permitting unused settlement funds to be paid to the National Association of Attorneys General (“NAAG”).  Under the proposed modification, the undistributed settlement funds would be used by NAAG for the purpose of developing the National Attorneys General Training and Research Institute Center for Consumer Protection (“NAGTRI”).

Subsequently, in February 2017, the state AGs and the defendant filed a joint submission seeking to allocate $14 million of the unused settlement funds from the U.S. Treasury to NAAG and to redirect the remaining $1.14 million to a community organization that provides internet access to underprivileged high school students.  The court thereafter directed the CFPB and the DOJ to state, in separate submissions, their positions with respect to the modified proposal to redirect the unused settlement funds.

The CFPB filed what the court characterized as “a gossamer two-page memorandum, modifying its previous position of indifference to one of steadfast opposition to the State AGs’ proposal.”  In a “Statement of Interest of the United States of America,” which the court characterized as “a thoughtful submission,” the DOJ likewise opposed the proposal.  “If NAAG wishes to fund its program with federal dollars,” remarked the DOJ, “it may seek a Congressional appropriation, but no portion of the Redress Amount may be diverted for that purpose.”  Although still advocating for the proposed modification, the defendant “took a more measured tone” in its responsive memorandum, “in essence deferring to the Court on the issue.”  The State AGs filed a responsive memorandum, maintaining what the court characterized as “a full-court press, infusing their brief with a new basis to substantiate their modification request.”

In a well-reasoned Opinion and Order, the court recently granted the joint motion to intervene, and denied the modification request.  The court analyzed the proffered alternative bases for modification separately.

Rule 60(a) – Modification to Correct an Inadvertent Error:  In their motion and supporting memorandum, the State AGs asserted that their proposed modification was permissible, pursuant to Fed. R. Civ. P. 60(a), because it would correct an inadvertent error.  Specifically, they argued that “wiring the remaining funds to the U.S. Treasury contravenes the parties’ intent to use all funds for consumer protection purposes.”  The CFPB ultimately opposed the proposed modification on the basis that there is no clerical mistake or inadvertent error in the Consent Order.

The court framed “the critical question” with respect to the inadvertent error argument as whether the Final Judgment, which incorporates the Redress Plan by reference, establishes an intent “for the settlement funds to be used generally toward consumer protection initiatives, untethered to [the defendant’s] third-party billing practices.”

Under the Residual Clause of the Redress Plan, the Bureau was the only party that could apply the unused settlement funds toward other equitable relief.  The Residual Clause relegated the Federal Communications Commission (“FCC”) and the State AGs, which had been involved in parallel litigation with the defendant, to consulting with the Bureau concerning whether unused settlement funds might be used for other equitable relief.  However, with respect to the State AGs’ motion to redirect the unused settlement funds, the court noted “that the CFPB’s involvement at this juncture in the litigation has been underwhelming.”

The court observed that, “[u]ntil this Court issued its April 10 Order, the CFPB appeared uninterested in the fate of the unexpended funds.”  In the view of the court, this disinterest was evidenced by the fact that the unexpended funds still reside in the defendant’s account notwithstanding a Redress Plan provision directing the defendant to wire any remaining balance to the CFPB after nine months from the Claims Deadline.  The court perceived this as an abdication of responsibility that “leads this Court to ask who will guard the guardians.”

Secondly, the court noted that the Residual Clause expressly required that any other equitable relief must be “reasonably related to the allegations set forth in the Complaint” (i.e., the alleged third-party billing practices of the defendant).  “Nowhere in the Final Judgment or the Redress Plan,” the court stated, “is there any language supporting the State AGs’ view that leftover funds should broadly aid consumers.”  The absence of any such language may have prompted the court, in its Memorandum and Order directing the CFPB and the DOJ to address the State AGs’ proposal, to characterize the clerical error argument as “particularly galling.”

Rule 60(b)(6) – Modification Due to Extraordinary Circumstances or Extreme Hardship:  The court next addressed a new argument asserted by the State AGs in their response to the CFPB and DOJ submissions – that the proposed modification was authorized by Fed. R. Civ. P. 60(b)(6) for other reasons that justify awarding the relief requested.  In this regard, the State AGs noted “the Consent Order represents a global settlement involving” the parties to the CFPB enforcement action, the FCC and the state attorneys general.  They further noted that, “should the Court deny the proposed modification, consumers, like those harmed by the acts and practices alleged in the Complaint, may not have the full benefit of a valuable resource for consumers – consumer protection attorneys well-trained by the NAGTRI Center for Consumer Protection.”

The court stated, however, that Rule 60(b) required the moving party to demonstrate extraordinary circumstances or extreme hardship and concluded that “[t]he equities in this action do not weigh in favor of the relief the State AGs seek.”  After acknowledging that the proposed alternative use of the funds “is perhaps a noble undertaking,” the court nevertheless concluded that the State AGs should seek a Congressional appropriation if they wish to fund the NAGTRI with federal dollars.  Absent other equitable relief reasonably related to the challenged third-party billing practices, noted the court, “[c]ondoning an unintended use of the settlement funds . . . . would circumvent ‘the congressional appropriations process under the guise of Article III’ and invoke questions regarding ‘the proper relationship of our Federal government’s three branches when dealing with the People’s money.’”  Observing that “[t]he proper body to which the State AGs must make their appeal is Congress,” the court stated that “[t]here is simply no extraordinary hardship or circumstance to justify re-writing the negotiated terms of the Redress Plan and Final Judgment.”

Finally, the court noted that the State AGs could have negotiated the requested relief in their separate settlement with the defendant.  Permitting them to do so now in the federal enforcement action by the Bureau would “hollow out the terms of the Final Judgment” and “permit State actors with, at best, a collateral interest in this Federal action to hijack a significant portion of the settlement funds under the guise of ‘consumer protection,’ . . . for the purpose of underwriting a project that principally benefits the states.”  In the view of the court, this result would erode the “extraordinary circumstances” standard for a modification pursuant to Rule 60(b) and “deprive the Federal agency here of its responsibility to monitor and enforce the settlement’s terms to completion.”

Accordingly, the court concluded that “[t]he time when these funds should have been remitted to the People is long past,” and directed the Bureau to deposit the unused settlement funds, including any accrued interest, with the U.S. Treasury as disgorgement forthwith.

Analogizing to the Sessions Memorandum:  One of our colleagues recently reported on the U.S. Attorney General’s memorandum (the “Sessions Memorandum”) prohibiting “payments to various non-governmental, third-party organizations as a condition of settlement with the United States.”  In the aftermath of its issuance, the Chair of the Senate Judiciary Committee sent a letter to Attorney General Sessions inquiring as to whether payments made to non-governmental third parties pursuant to Obama-era settlements with the DOJ “could lawfully be rescinded and re-directed back into the General Fund of the U.S. Treasury.”

In its decision, the court analogized to the Sessions Memorandum.  Although acknowledging that the Sessions Memorandum was not directly on point, the court nevertheless characterized it as instructive.  Specifically, the court noted that the Sessions Memorandum “recognizes that the ‘goals of any settlement are, first and foremost, to compensate victims, redress harm, or punish and deter unlawful conduct,’ and seeks to end the practice of using settlements to provide ‘payment or loan to any non-governmental person or entity that is not a party to the dispute.’” (emphasis in original).

The CFPB will hold a public event on June 22, 2017 in Raleigh, N.C. about student loan servicing. The CFPB’s announcement provides no description other than that the event will feature remarks from Director Cordray and North Carolina Attorney General Josh Stein.

The CFPB may be labeling the event a “public event” rather than a “field hearing” because it is not inviting “witnesses” to provide “testimony” as it typically does for field hearings.  However, similar to its field hearings, it is likely the CFPB will use the event as a venue for announcing a new development involving student loan servicing.  Isaac Boltansky of Compass Point has suggested that that the CFPB may announce the release of either an update on the industry’s consumer complaint profile or an updated supervisory highlights report.  It is also possible that the CFPB will discuss the comments it has received in response to the notice it published in the Federal Register in February 2017 regarding its plan to require student loan servicers to report quarterly data on aggregated servicing metrics and borrower outcomes.

Mr. Stein, the North Carolina AG, was among the group of state AGs who sent a letter to U.S. Department of Education Secretary Betsy DeVos in April 2017 criticizing the ED’s withdrawal of various memoranda issued during the Obama Administration regarding federal student loan servicing reforms.  He also recently announced the settlement of a lawsuit involving an alleged student loan debt relief scam.  Mr. Stein might discuss these developments at the CFPB event.