Following the departure of former CFPB Director Richard Cordray in 2017, consumer advocates and state attorneys general raised concerns regarding the new hands-off approach by the Trump administration pertaining to consumer protection in the financial services industry. Many states initiated or bolstered existing efforts to oversee market actors for compliance with consumer financial protection regulations. State attorneys general have also been stepping up enforcement actions and piloting programs to address the regulatory matters concerning new technologies, especially in the fintech industry. California has been one of the most active state regulators, expanding the jurisdiction of its current departments, creating new consumer protection and innovation offices, and hiring former CFPB officials and attorneys to strengthen its team.
California is the world’s fifth largest economy and takes its role of protecting its 40 million consumers seriously. The California Department of Business Oversight (DBO), led by former CFPB enforcement attorney Manny Alvarez, currently licenses and regulates financial services providers—including state-chartered banks, money transmitters, credit unions, broker-dealers, nonbank installment lenders, payday lenders, mortgage lenders and servicers—and has long been aggressive in its supervisory and enforcement approach. In January 2019, the DBO settled with a small loan lender that steered consumers into higher-cost loans to circumvent statutory interest rate caps. This enforcement action resulted in a $900,000 settlement, including $105,000 in costs and penalties and $100,000 in refunds to consumers.1 More recently, in December 2019, the DBO settled with an auto title lender that charged customers excessive interest rates and fees.2 This enforcement action resulted in $700,000 in customer refunds and $25,000 in penalties.
The DBO is now getting a facelift, along with a list of new directives, missions, and staff. As part of his draft state budget for 2020, on January 10, 2020, California Governor Gavin Newsom outlined his plan to restructure the DBO to better protect consumers and promote the development of novel financial products. The governor’s proposed budget includes $10.2 million for a financial protection fund, which would be used to enhance consumer protection against unfair and deceptive practices in the financial service industry, and includes the creation of more than forty new positions to be filled by consumer protection attorneys and policy makers. The governor intends to increase these figures to $19.3 million and ninety positions by the end of 2022 – sixteen of which would dedicated exclusively to enforcement efforts. Initially, these costs would be covered by available settlement proceeds contained in state funds, with future costs covered by fees on newly-regulated industries and increased fees on existing licensees.
Under the governor’s proposed budget for 2020 and 2021, the Department would be renamed the Department of Financial Protection and Innovation (DFPI). In his budget summary, Governor Newsom said “The federal government’s rollback of the CFPB leaves Californians vulnerable to predatory businesses and leaves companies without the clarity they need to innovate.” The proposal also would expand the DFPI’s enforcement capabilities, charging the organization with both establishing and administering a new California Consumer Financial Protection Law (CCPFL). This new law is designed to protected consumers accessing financial services and products. The law would also task the DFPI with expanding its licensing, supervisory, and enforcement authority over debt collectors, credit reporting agencies, and fintech companies. The governor is looking to lead a consumer-focused regulatory approach in California in light of the gaps he and his advisors perceive at the federal level, working towards accomplishing the following goals:
- Support new consumer-focused policies related to market developments and consumer financial products;
- License, examine, and ultimately regulate, new industries, products, and services;
- Offer consumer financial services education for the elderly, students, military and service members, and new immigrants;
- Pursue enforcement actions against consumer financial services providers to prevent unfair, deceptive, and abusive practices by examining, investigating, and supervising unregulated financial services products used by California consumers;
- Offer legal support for the administration of the CCFPL.
The proposal extends the DOB’s authority to provide greater oversight and regulatory guidance to financial services providers that are currently unlicensed and fall outside of the class of traditional financial service products and providers. These non-traditional service providers include fintech companies, consumer debt collectors, and credit reporting agencies. Governor Newsom said that one of the main priorities of the DBO’s reformation, in addition to facilitating new financial innovation, is “enforcement, expanding scope and tools to go after debt collectors, to go after payday lenders and the like” – continuing the trend of states augmenting their consumer financial oversight and enforcement capabilities.
The DBO’s increased scope of authority would include licensing and examination powers over under-regulated industries, as well as enforcement powers to protect consumers against UDAAP violations. According to Governor Newsom, “[the federal regulators] are getting out of the financial protection business, and [the states] are getting into it.”
In addition, the DBO also established the Financial Technology Innovation Office, a group of DBO examiners and regulators tasked with managing the responsible development of consumer financial products. The innovation office would be based in San Francisco and promote responsible Fintech innovation, which is a major economic driver of the California economy. The creation of the Financial Technology Innovation Office is an attempt to strike the balance between economic opportunity and consumer protection through anticipating trends in financial products and preemptively identifying and banning practices that ultimately harm consumers.
The Financial Technology Innovation Office is modeled after the CFPB. Like the CFPB, the Financial Technology Innovation Office and the greater DFPI would be tasked with enforcing new UDAAP protections as they relate to innovative financial technology and novel consumer financial services products. The Office promises to spur innovation and vows to clarify regulatory expectations for financial products and services. The Office will study new trends in developing financial products and services, while also engaging with California fintech companies. It would also seek to update and reform laws and policies related to state-charter industrial banks to allow fintech companies to operate nationwide while being regulated and supervised by the DBO.
However, fintechs might be hesitant to join a regulatory regime that is new and without well-defined operating procedures – especially safe harbor provisions which allow firms to develop untested fintech products and services without fear of liability. California Attorney General Xavier Becerra has strongly opposed these safe harbors in the past, viewing them as a vehicle for consumer financial services companies to avoid the laws that are designed to protect consumers. Striking the balance between consumer protection and innovation will be a difficult task, but with cooperation between regulators and innovators, as well as some guidance from other like-minded states and departments, the DOB will both protect consumers and foster innovation.
Governor Newsom’s mini-CFPB is only a proposal at this point; his budget must be approved by the state legislature by June 15, 2020 if it is to take effect and implement his desired consumer protection and enforcement initiatives. Therefore, the final forms of the California mini-CFPB will not be seen for some time. That does not mean, however, that consumer financial services providers should not preemptively assess compliance protocols as state and local regulatory authorities augment their enforcement and supervisory roles. State laws are often more comprehensive than federal laws in two main ways: (i) state laws are often much broader in scope; and (ii) state laws often do not include loopholes or safe harbor provisions. Section 1042 of the Dodd-Frank Act allows state attorneys general and regulators to bring civil actions for violations of unfair, deceptive, or abusive acts and practices. As states increasingly rely on the enabling statute of Dodd-Frank to enforce the CFPB’s federal protections to consumers at the state level, market participants would be wise to allocate greater resources to cover the costs associated with strengthened compliance and monitoring protocol.