Following up on the administration’s June 17 “white paper” proposal to create a Consumer Financial Protection Agency (CFPA)—summarized in our June 22, 2009, advisory—the U.S. Department of the Treasury recently released a draft bill (“Bill”) that would implement most features of the proposal. Financial Services Committee Chairman Barney Frank has already introduced the Bill in the U.S. House of Representatives, and we understand that the committee has scheduled daily hearings, briefings and votes in an effort to pass some version of the Bill before the August recess. Clients that may be impacted will want to monitor the Bill’s progress and potentially involve themselves in influencing its content and chances for enactment.

As mentioned, the Bill departs in some notable respects from the June 17 proposal. The Bill adds proposals, including protection for whistleblower employees who report their employers to the CFPA. The Bill also omits a few significant white paper proposals, such as the proposal to subject owners of special-purpose credit-card banks to the Bank Holding Company Act. Later draft bills based on the white paper may address omitted matters.

This advisory briefly discusses the more significant provisions of the Bill, including those specifying how the CFPA will be structured and what its powers will be. The advisory goes on to summarize a number of substantive restrictions in the Bill that would impact entities subject to the CFPA’s jurisdiction.

Organization and structure of the CFPA

Under the Bill, the CFPA would be an independent agency in the executive branch. The agency’s mission is: (i) to regulate the provision of consumer financial products and services under the Bill; (ii) to oversee the regulation and enforcement of certain enumerated consumer laws, including the Truth in Lending Act, the Fair Credit Reporting Act, the Equal Credit Opportunity Act, the Fair Debt Collection Practices Act, the Gramm-Leach-Bliley Act, the Home Mortgage Disclosure Act, and others (which the Bill defines collectively as the “enumerated consumer laws”); and (iii) to assume the consumer protection functions of various other federal agencies. The Bill would define a “consumer financial product or service” as “any financial product or service to be used by a consumer primarily for personal, family or household purposes.”

Board. The CFPA would be governed by a board of directors (the “Board”) consisting of five members, four of whom would be appointed by the President with the advice and consent of the Senate from among U.S. citizens who have “strong competencies and experiences related to consumer financial products or services.” The fifth seat would be taken by the Director of the National Bank Supervisor, a safety-and-soundness regulator to be established by Congress. The President would designate one member to serve as director from among the four appointed members. The members would serve staggered five-year terms.

The Board would exercise all executive and administrative functions of the CFPA, including establishing rules for conducting the CFPA’s general business; directing the creation and maintenance of divisions of the CFPA in order to fulfill its responsibilities under the Bill; and coordinating and overseeing the operation of all administrative, enforcement, and research activities of the CFPA. Generally, the Board would act by a majority vote.

Structure. In addition to the central rulemaking, monitoring and enforcement functions of the CFPA (summarized below), the Bill provides for the creation of three internal “special functional units.”

The “research” unit would research, analyze, and report on: (i) developments in markets for consumer financial products or services; (ii) consumer awareness regarding disclosures relating to, and costs, risks and benefits of, consumer financial products or services; and (iii) consumer behavior with respect to consumer financial products or services.

The “community affairs” unit would provide information, guidance and technical assistance regarding the provision of consumer financial products or services to traditionally underserved consumers and communities.

Finally, the “consumer complaints” unit would establish a central database for collecting and tracking information on consumer complaints (and the resolution of complaints) and would share data and coordinate consumer complaints with federal banking agencies, other federal agencies, and state regulators.

In addition, the Bill would establish a Consumer Advisory Board to advise and consult with the CFPA, at least twice a year, in the exercise of the CFPA’s functions under the Bill and to provide information on emerging practices in the consumer financial products or services industry. Members of the Consumer Advisory Board, appointed by the CFPA, would be “experts in financial services, community development, and consumer financial products or services.”

Funding. The Bill appropriates such funds to the CFPA “as are necessary,” and the CFPA is empowered to “recover the amount of fees expended by the [CFPA] under [the Bill] through the collection of annual fees or assessments on covered persons.” The Bill defines “covered persons” as “(A) any person who engages directly or indirectly in a financial activity, in connection with the provision of a consumer financial product or service; or (B) any person who, in connection with the provision of a consumer financial product or service, provides a material service to, or processes a transaction on behalf of, a person described in paragraph (A).” (Note that the definition apparently would include third-party processors.)

Regulations governing collection of fees, to be established by the CFPA, will “specify and define the basis of fees or assessments (such as the outstanding value of consumer credit accounts, total assets under management, or consumer financial transactions), the amount and frequency of fees or assessments, and such other factors that the [CFPA] deems appropriate.” In addition, the CFPA would deposit into a newly created Consumer Financial Protection Agency Civil Penalty Fund (the “Fund”) any civil penalty received from enforcement of the Bill or any enumerated consumer law. Amounts in the Fund would be available to the CFPA “for payments to the victims of activities for which civil penalties have been imposed” under the Bill or any enumerated consumer law.

Responsibilities and powers of the CFPA

The Bill mandates that the CFPA “promote transparency, simplicity, fairness, accountability, and access in the market for consumer financial products or services.” Its objectives include ensuring that “(1) consumers have, understand, and can use the information they need to make responsible decisions about consumer financial products or services; (2) consumers are protected from abuse, unfairness, deception, and discrimination; (3) markets for consumer financial products or services operate fairly and efficiently with ample room for sustainable growth and innovation; and (4) traditionally underserved consumers have access to financial services.”

In addition to the responsibilities and powers summarized below, the Bill, with a small number of limited exceptions, would also transfer the consumer financial protection functions of other federal banking agencies, including the Board of Governors of the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Trade Commission, and the National Credit Union Administration, and certain of their employees, to the CFPA.

Coordination. The CFPA would coordinate with the Securities and Exchange Commission, the Commodity Futures Trading Commission, and other federal agencies and state regulators to promote consistent regulatory treatment of consumer and investment products and services. The CFPA would also coordinate with federal and state financial literacy agencies to enhance existing financial literacy and education initiatives and to improve efforts to educate consumers about financial matters generally.

Reports to Congress. The CFPA would prepare and submit reports to the President and the appropriate committees of Congress at the beginning of each regular session of Congress. The reports would include a list of the significant rules, orders, and initiatives adopted by the CFPA during the reporting period or planned for the next reporting period; an analysis of complaints collected during the reporting period; a list, with a brief statement of issues, of the public supervisory and enforcement actions to which the CFPA was a party during the reporting period; and an appraisal of significant actions, including actions under federal and state law, by state attorneys general or state regulators relating to the Bill or the enumerated consumer laws.

Between three and five years from the enactment of the Bill, the CFPA would issue a report assessing the effectiveness of each significant rule or order adopted by the CFPA in meeting the purposes of the Bill and goals of the CFPA. The report would incorporate public comment, solicited prior to preparing the report, on recommendations for modifying, expanding, or eliminating each newly adopted significant rule or order.

Rulemaking. The Bill gives the CFPA the exclusive authority to prescribe rules under the enumerated consumer laws and the Bill itself. In writing rules, the CFPA should “consider the potential benefits and costs to consumers and covered persons, including the potential reduction of consumers’ access to consumer financial services,” and consult with federal banking agencies “regarding the consistency of a proposed rule with prudential, market, or systemic objectives administered by such agencies.”

The Bill also allows the CFPA to exempt from its rules any person covered by the Bill as the CFPA “deems necessary or appropriate to carry out the purposes and objectives of” the Bill, taking into account a covered person’s total assets, volume of transactions involving consumer financial products or services, and engagement in one or more financial activities. In granting an exemption, the CFPA would also consider existing laws or regulations applicable to the regulated products or services and the extent to which such laws or regulations provide consumers with “adequate protections.”

In addition, the CFPA would be authorized to prescribe rules against unfair, deceptive, or abusive acts or practices so long as the CFPA has a “reasonable basis to conclude that the act or practice causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers and such substantial injury is not outweighed by countervailing benefits to consumers or to competition.” The CFPA may also prescribe rules establishing minimum standards to detect and deter unfair, deceptive or abusive acts or practices for any class of covered persons not subject to the jurisdiction of a federal banking agency or a comparable state regulator (and enforce compliance with those standards).

Examinations. Under the Bill, the CFPA has exclusive authority to examine or require reports from a covered person, including any person not otherwise subject to the jurisdiction of any federal banking agency or state regulator, for purposes of ensuring compliance with the requirements of the Bill, the enumerated consumer laws, and any regulations promulgated by the CFPA. Reports may include information on the compliance systems or procedures of a covered person or matters related to the provision of consumer financial products or services, including the servicing or maintenance of accounts or extensions of credit.

The CFPA would have access to reports of covered persons provided to other federal agencies and provide access to such agencies in turn; wherever possible, the CFPA would conduct its examination of a covered person by attempting to use information in reports already provided by that person to other regulators or that is publicly available.

The agency would also have the power to gather information regarding the organization, business conduct, and practices of covered persons to conduct research on consumer financial products and services. To that end, the CFPA would have the right to require covered persons to provide reports regularly or on specific occasions and to make public all or a portion of the information contained in those reports.

Monitoring. The CFPA would monitor for risks to consumers in the provision of consumer financial products or services, including developments in markets for those products and services, by examining covered persons, using information contained in reports received from covered persons, and by assessing consumer complaints and surveys. The CFPA would publish annually at least one report of significant findings.

Enforcement. The CFPA would have authority to enforce the Bill, the enumerated consumer financial laws, regulations promulgated thereunder, and any other rules created by the CFPA, including rules preventing unfair, deceptive, or abusive acts or practices. Enforcement powers would include the authority to issue subpoenas and make civil investigatory demands for physical evidence, written reports, and/or testimony; to conduct hearings and adjudication proceedings, including cease-and-desist proceedings; and to commence a civil action in any federal or state court against a covered person in order to impose a civil penalty or to seek legal or equitable relief, including a permanent or temporary injunction.

The Bill would provide for statutory damages as follows: (i) for violations of final orders or conditions imposed by the CFPA, no more than $5,000 per violation per day; (ii) for violations of the provisions relating to “standard” products or services, and for reckless violations of the Bill or any enumerated consumer law, no more than $25,000 per violation per day; and (iii) for knowing violations of the Bill or any enumerated consumer law, no more than $1,000,000 per violation per day.

Equitable relief authorized under the Bill is broad and may include rescission or reformation of contracts, restitution, payment of damages, limits on the activities or functions of a covered person, and attorney’s fees; relief may not, however, include punitive or exemplary damages. The Bill does not provide for criminal penalties, though it authorizes the CFPA to transmit evidence of criminal violation of a federal statute to the U.S. Office of the Attorney General.

To the extent a federal law authorizes the CFPA and another federal agency to enforce that law, with certain exceptions, the CFPA would have primary enforcement authority over a covered person, and any other federal agency can recommend that the CFPA bring an enforcement proceeding.

State attorneys general would be authorized concurrently to enforce the Bill, though before initiating any court action, an attorney general would be required to provide a copy of the complaint to be filed and a notice describing the action to the CFPA. The CFPA may intervene in the action and appeal any ruling as if it were a party to the action.

“Standard” and “alternative” products or services. What the administration’s proposal termed “plain vanilla” products the Bill calls “standard” consumer financial products or services. The Bill would create two categories of consumer financial products or services, “standard” and “alternative.”

A “standard” product or service would be “transparent” in its terms or features, “pose lower risks to consumers,” and have other features as the CFPA may prescribe. An “alternative” product or service would be of the same “type or class” as a “standard” product or service but contain “different or additional terms, fees or features.” A “standard” product or service would also be “readily offered” by entities that offer “alternative” products or services and would “facilitate comparisons with and assessment of the benefits and costs of alternative products or services.”

The CFPA would adopt rules or issue guidance regarding the offer of a standard consumer financial product or service “at or before the time an alternative consumer financial product or service is offered to a consumer, including (A) warnings to consumers about the heightened risks of alternative consumer financial products or services; or (B) providing the consumer a meaningful opportunity to decline to obtain the standard consumer financial product or service.”

The agency is empowered to require covered persons to offer a standard product or service but only after adopting rules, after notice and comment, regarding the features or terms of that standard product or service. In addition, the CFPA may not require a covered person to offer a standard product or service unless that covered person: "(A) voluntarily offers or provides a product or service that is of the same type, or in the same class, as the standard product or service; or (B) maintains an account or has a relationship with a consumer involving a product or service that is substantively similar to the standard product or service."

Arbitration clauses. The Bill would authorize the CFPA to prohibit or impose conditions or limitations on agreements between a covered person and a consumer that require the consumer to arbitrate a dispute between the parties arising under the Bill or any enumerated consumer law if the CFPA finds that such prohibition, conditions or limitations “are in the public interest and for the protection of consumers.”

Sales practices. The CFPA may prescribe rules and issue orders and guidance regarding the manner, settings and circumstances for the provision of any consumer financial product or service to “ensure that the risks, costs, and benefits of the products or services, both initially and over the term of the products or services, are fully and accurately represented to consumers.”

Duties of intermediaries; compensation. The Bill would obligate the CFPA to prescribe rules imposing duties on a covered person, or such person’s employee, agent or independent contractor (other than attorneys or trustees of the covered person), who deals or communicates directly with consumers in the provision of a consumer financial product or service. The duties would take into account whether the person represents that they are acting in the interest of or provides advice to the consumer and whether the consumer’s reliance on such advice would be “reasonable and justifiable under the circumstances.”

In addition, the CFPA may prescribe rules regarding compensation practices for covered persons and their employees, agents or independent contractors “for the purpose of promoting fair dealing,” though the CFPA may not impose a limit on compensation.

Other provisions

Disclosures. The Bill would require covered persons, pursuant to rules prescribed by the CFPA, to provide consumer disclosures and communications that “(1) balance communication of the benefits of the product or service with communication of significant risks and costs; (2) prominently disclose the significant risks and costs, in reasonable proportion to the disclosure of the benefits; [and] (3) communicate significant risks and costs in a clear, concise, and timely manner designed to promote a consumer’s awareness and understanding of the risks and costs, as well as to use the information to make financial decisions.” Additionally, the CFPA would be authorized to prescribe rules to ensure the “appropriate and effective” disclosure or communication of the “costs, benefits, and risks” associated with any consumer financial product or service.

To further the foregoing, the June 17 proposal called for “qualitative and statistical” field tests so that consumers could verify their ability to understand and use disclosure forms. As an example, the June 17 proposal suggested that a credit card provider could try different methods to disclose the same product risk and determine which method is more effective by surveying consumers and evaluating their behaviors. Accordingly, the Bill would require the CFPA to establish standards and procedures for approval of “pilot” disclosures, to be provided to consumers by covered persons for limited periods and “reasonably designed to contribute materially to the understanding of, and responses to, disclosures or communications about the risks, costs, and benefits of consumer financial products or services.”

In addition, a covered person would be required to make available to a consumer, in electronic form, information “concerning the consumer financial product or service that the consumer obtained from such covered person including information relating to any transaction, series of transactions, or to the account including costs, charges, and usage data.” A covered person would not be required to maintain records on consumers, nor would the person be required to provide confidential commercial information, information gathered to prevent fraud or unlawful conduct, or any information required to be kept confidential by law.

Reverse pre-emption. The Bill annuls state law only to the extent that it is “inconsistent” with the Bill “and then only to the extent of the inconsistency.” More importantly, a state law is not “inconsistent” with the Bill if “the protection such statute … affords consumers is greater than the protection provided” under the Bill, as determined by the CFPA pursuant to rule, order, or guidance or in response to a petition initiated by any interested person.

Whistleblowers. The Bill prohibits a covered person from retaliating against any employee or representative who provides evidence or testimony to the CFPA or a court or initiates a proceeding under the Bill or an enumerated consumer law.

ECOA. The Bill would amend the Equal Credit Opportunity Act to require financial institutions to collect certain demographic information from small business owners applying for credit in order to facilitate better understanding of minority access to financial services.

The Bill can be found here.