On June 17, 2009, the Obama Administration released a landmark white paper setting forth its comprehensive plan for financial regulatory reform (the “Reform Plan”). A cornerstone of the Reform Plan is the creation of a significant new federal regulator, the Consumer Financial Protection Agency (“CFPA”), which would have extraordinary powers to oversee and regulate the provision of consumer financial products and services by depository institutions. The Obama Administration followed up its white paper with a draft bill to Congress on June 30, 2009, entitled “The Consumer Financial Protection Agency Act of 2009” (the “Act”), with the goal of quickly moving forward with the creation of the CFPA. Consistent with the Reform Plan, the Act contains provisions that drastically reduce the benefits of federal preemption of state laws in the area of consumer protection as applied to federally chartered banks and thrifts. This bulletin, the second in a series of bulletins that discusses the Reform Plan, provides an overview of the proposed CFPA and Act, and analyzes the effect it will have on banks. If adopted, the Act will require most, if not all, financial institutions to undergo a complete reevaluation of their financial products and services for compliance with this new regulatory compliance regime.
I. The CFPA and Its Regulatory Coverage
As drafted, the Act establishes the CFPA as an independent agency in the executive branch and provides it with plenary powers to regulate the provision of consumer financial products and services by depository institutions. In furtherance thereof, the Act provides that all consumer financial protection functions of the Board of Governors of the Federal Reserve (“FRB”), the Office of Comptroller of the Currency (“OCC”), the Office of Thrift Supervision (“OTS”), the Federal Deposit Insurance Corporation (“FDIC”), the Federal Trade Commission (“FTC”), and the National Credit Union Administration (“NCUA) (together, the “federal banking agencies”) will be transferred to the CFPA no sooner than six months and no later than eighteen months after the date of passage of the Act.
The Act itself has an extraordinarily expansive reach and if passed as drafted, will apply to virtually every consumer credit and deposit-taking activity engaged in by a depository institution. By its terms, the Act applies to all “covered persons,” who are defined as: (1) any person who engages directly or indirectly in a financial activity, in connection with the provision of a “consumer financial product or service”; or (2) 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 (1). A “consumer financial product or service” in turn means any “financial product or service” which is to be used by a consumer primarily for personal, family, or household purposes and which, directly or indirectly, results from or is related to engaging in one or more “financial activities.”
The Act defines “financial activity” to include any of the following:
- Extending credit and servicing loans, including: (i) acquiring, brokering, or servicing loans or other extensions of credit; and/or (ii) engaging in any other activity usual in connection with extending credit or servicing loans, including performing appraisals of real estate and personal property and selling or servicing credit insurance or mortgage insurance;
- Collecting, analyzing, maintaining, and providing consumer report information or other account information by covered persons, including information relating to the credit history of consumers and providing the information to a credit grantor who is considering a consumer application for credit or who has extended credit to the borrower;
- Collection of debt related to any consumer financial product or service;
- Providing real estate settlement services, including providing title insurance;
- Acting as financial adviser to any person, including: (i) providing financial and other related advisory services; (ii) providing educational courses, and instructional materials to consumers on individual financial management matters; or (iii) providing credit counseling, tax-planning or tax-preparation services to any person;
- Deposit-taking activities; or
- Any other activity that the CFPA defines, by rule, as a financial activity for the purposes of the Act, except that the CFPA may not define engaging in the business of insurance as a financial activity (other than with respect to credit insurance, mortgage insurance, or title insurance).
We believe that the Act begins a period of wholesale re-regulation of consumer finance, which we expect to continue at the federal level over the next several years and which will result in a significant increase in the consumer protection regulatory burden for all depository institutions. In addition, for the first time the Act would expand federal regulation of consumer financial products and services to previously unregulated or less regulated entities such as mortgage bankers, mortgage brokers, title insurance companies, investment banks and investment advisors, among others.
II. Effect on State Law & Preemption
Perhaps the most significant provision of the Act for depository institutions is the amendment of the National Bank Act (“NBA”), and the Home Owners Loan Act (“HOLA”),1 to provide that “state consumer laws,” as defined under the Act, will now apply to national banks and federal thrifts, as well as their affiliates and subsidiaries. This is a significant departure from current practice, under which federal law preempts state consumer protection laws that are directly related to lending. Under the Act, “state consumer laws” are defined to include state predatory lending laws, state laws regarding loan disclosures, laws regarding the advertisement and sale of loan products, and even laws regulating loan features (e.g., prepayment penalties, late charges, loan amortization terms, balloon payments, etc.). The Act also provides that any state law that prevents assignees of loans, including depository institutions, from engaging in unfair or deceptive acts and practices is not preempted. Consequently, depository institutions would be subject to a dramatic increase in state regulation and would need to significantly revamp and upgrade their compliance abilities to oversee and keep up with the ever increasing patchwork of state regulation across the nation in addition to any new requirements issued by the CFPA. A recent decision by the United States Supreme Court (the “Court”) has reinforced the erosion of federal preemption of state consumer protection laws envisioned by the Act. On June 29, 2009, in the case Cuomo v. The Clearing House Association, LLC, the Court addressed national bank preemption and held that states have the power to enforce state fair lending laws against national banks. In Cuomo, the Court held that states could enforce New York fair lending laws by using the judicial process but they lack the authority to examine banks or subpoena documents or other information without utilizing the judicial process. The majority distinguished the Court’s 2007 decision in Watters v. Wachovia Bank, N.A. (which held that the NBA, and the regulations of the Office of the Comptroller of the Currency, preempt states from exercising licensing, registration, and visitation powers over national bank operating subsidiaries) by stating that a state’s visitorial powers were separate from its powers to enforce laws applicable to national banks. The majority concluded that the definition of visitorial powers does not extend to include prosecuting enforcement actions in state courts. While the Court’s decision in Watters dealt a blow to proponents of state’s rights, the more recent decision in Cuomo clearly erodes national bank preemption. On its own, the Cuomo decision could be subject to a narrow reading leaving open the question of its impact on whether substantive state consumer protection laws are preempted. However, taken together, the Act and the Cuomo decision indicate that we are moving towards a system in which federal banking agencies have authority over purely visitorial issues (i.e., chartering, and safety and soundness supervision) and the CFPA and state regulators have authority to regulate federal and state consumer protection laws. Again, the cost of compliance could significantly increase for depository institutions, particularly those with multi-state operations, potentially resulting in the corresponding increase in the cost of lending for some institutions being passed on to consumers nationwide and other institutions significantly cutting back on the states in which they currently lend.
III. CFPA Authority over Federal Consumer Laws
The Act also authorizes the CFPA to prescribe rules and issue orders and guidance to administer the provisions of the Act and makes conforming amendments to a host of other federal consumer laws that transfers the rulemaking authority for those statutes directly to the CFPA.2 In addition, notably, the Act expressly states that it does not preempt any state law except to the extent that such state law is inconsistent with the provisions of the Act and in doing so, sets a floor for consumer financial product and service regulation. The Act also empowers the CFPA to examine and supervise the consumer compliance functions of all entities subject to the Act. Notably, the Act permits the CFPA to prescribe exemptions from the Act or any federal consumer protection law.
We have set forth below examples of how the Act and the CFPA would alter the applicability of some of the most important federal consumer compliance statutes to depository institutions:
The Alternative Mortgage Transaction Parity Act. The Act would amend the Alternative Mortgage Transaction Parity Act to limit the preemption of state law by federally- and state-chartered depository institutions and non-depository institutions and require those institutions to adhere to state laws that regulate mortgage transactions generally, including any restrictions on prepayment penalties or late charges. The Act would also permit the CFPA to promulgate regulations under the Parity Act upon reviewing the existing federal banking agency regulations regarding alternative mortgage transactions, for fairness to consumers. This new CFPA authority, along with the amendments to the NBA and HOLA as discussed above, may lead to a further weakening of the federal preemption of state laws regarding alternative mortgage products previously enjoyed by depository institutions.
Fair Credit Reporting Act and Fair and Accurate Credit Transactions Act. The CFPA would become the primary regulator for the Fair Credit Reporting Act and the Fair and Accurate Credit Transactions Act, except that the Federal Trade Commission and federal banking agencies would fully retain their sole right to enforce and regulate the provisions related to red flag identity theft guidelines, affiliate information sharing rules, and record retention under those laws.
The Home Mortgage Disclosure Act. The Act would amend the Home Mortgage Disclosure Act to require the collection of additional loan level information. Under the amendments contained in the Act, institutions would be required to submit all of the loan level information required under that law (“HMDA data”) to both the CFPA and their current federal regulator. The Act would also institute additional amendments that would significantly increase the HMDA reporting burden, and which in turn would likely increase the fair housing and other similar litigation arising from publicly-reported HMDA data.
The Truth-in-Lending Act. The Act would amend the Truth-in-Lending Act to require the CFPA to publish a single, integrated disclosure for residential mortgage loan transactions, that would combine the current disclosure requirements of both the Real Estate Settlement Procedures Act and Truth-in-Lending Act into a single, easily readable document. This is consistent with the Obama Administration’s goal of simplifying consumer disclosures, and making them more understandable. The Act would also amend the Truth-in-Lending Act to add a new minimum payment warning disclosure for open-end credit plans (i.e., credit cards).
Importantly, the CFPA is also charged with creating requirements for standard “plain vanilla” consumer financial products (e.g., standard fixed-rate mortgages without prepayment penalties) and the regulation of consumer disclosures associated with financial products or services, as well as the sale and advertisement of those products or services. This expanded enforcement authority may be utilized by the CFPA to push for some of the more burdensome regulatory changes favored by the Obama Administration.
These changes could include: (1) heightened duties of care on mortgage brokers, such as a duty of best execution among available mortgage loans and a duty to determine whether a mortgage is affordable to a borrower; (2) new requirements that lenders offer standard “plain vanilla” financial products to consumers; (3) prohibitions against offering alternative financial products until after a consumer has opted out of the standard products; (4) a limit or ban on loan features that are viewed as anti-consumer, such as prepayment penalties; and (5) a requirement that lenders or securitizers retain some of the credit risk following securitization of loans, so that they retain “skin in the game.” In addition, the Act authorizes the CFPA to regulate individuals who deal directly with consumers (i.e., loan originators or brokers), and to ensure consumers are not harmed by their business and compensation practices (for instance, the CFPA may utilize this authority to prohibit or limit the current widespread use of yield spread premiums in the residential mortgage industry). The Act also gives the CFPA explicit authority to prescribe operational standards (e.g., licensing, bonding, and registration requirements) applicable to covered persons, other than federal or state depository institutions and entities already subject to state licensing, in order to deter and detect abusive or illegal transactions in the provision of consumer financial products or services. These changes may fundamentally alter how banks compensate and interact with third party service providers, such as mortgage brokers.
As these examples demonstrate, the Act and the CFPA will fundamentally alter the applicability and requirements of a number of the most significant consumer compliance obligations of depository institutions. Accordingly, it is imperative that banks monitor developments closely and be prepared to modify their compliance programs as required.
IV. Enforcement Authority and Procedures of the CFPA
In addition to broad authority to promulgate new federal consumer protection regulations, the Act gives specific authority for the CFPA to undertake actions to prevent covered persons from engaging in unfair, deceptive or abusive acts or practices under federal law in connection with any transaction with a consumer for a financial product or service
Under the Act, the CFPA has broad authority to enforce its regulatory powers including through the issuance of subpoenas and civil actions to impose civil penalties or other legal or equitable relief against a person who violates a provision of Act or any rule or order thereunder. The Act provides the CFPA with authority to seek administrative relief that may include: (1) rescission of contracts; (2) refund of moneys or return of real property; (3) restitution; (4) compensation for unjust enrichment; (5) payment of damages; (6) public notification regarding the violation; (7) limits on the activities or functions of the person; and (8) civil money penalties. Notably, however, exemplary and punitive damages are unavailable under the Act.
Please be advised, however, that the Act authorizes any state attorney general to bring an action in any state or federal court of appropriate jurisdiction to seek monetary or equitable damages for violation of any provisions of the Act or regulations issued thereunder, including against a national bank or federal thrift. The Act also significantly empowers state attorney generals to file claims involving violations of state consumer laws against all parties (both depositories and non-depositories alike). We anticipate that state attorney generals that have already been active in pro-consumer actions, such as Massachusetts Attorney General Coakley, New York Attorney General Cuomo, Illinois Attorney General Madigan to name but a few, will be further emboldened by the Act. This development could result in increased litigation costs on parties in the residential mortgage market and the consumer lending market as a whole, including against depository institutions, loan originators and purchasers in the secondary market.
Further, while no private rights of action are specifically authorized under the Act, we nonetheless anticipate that plaintiff’s and consumer attorneys will increasingly attempt to utilize state unfair and deceptive practices statutes or similar state laws that contain private rights of action to file claims under the Act.
The Act, as currently drafted, completely overhauls the federal regulatory consumer compliance scheme for banks. Non-depository lenders, servicers, brokers, and investors who are already heavily regulated can expect further regulations. The legislation scales back the scope of federal preemption that national banks and federal thrifts have relied upon to date and may compel these institutions to comply with certain other state laws that affect their lending and deposit taking activities or reduce the number of states they lend in. This new regulatory regime will pose significant compliance challenges for depository institutions, which should review their compliance programs to ensure that they can comply with the new federal laws and regulations as well as with the panoply of state regulations that may become applicable to such institutions.
On July 8, 2009, House Financial Services Committee Chairman Barney Frank (D-MA) introduced the Consumer Financial Protection Agency Act of 2009 (H.R. 3126), which largely tracks the proposed legislation offered by the Obama Administration. Chairman Frank’s version of the Act contained very minor differences from the Obama Administration draft, the most notable of which is the continued enforcement of the Community Reinvestment Act by federal banking regulators. Chairman Frank plans to move legislation creating the CFPA through the Financial Services Committee prior to the August congressional recess. In the Senate, the Banking Committee has indicated it will likely take up consumer protection and other financial services regulatory reform legislation in the fall. We will continue to monitor this landmark piece of legislation as it progresses through Congress.