Insights

Over the summer, President Obama signed into law the most sweeping legislation regarding consumer credit to come in a generation – the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) – that creates the Bureau of Consumer Financial Protection (the “Bureau”). The Bureau will attempt to provide a “one-stop shop” for consumers navigating a maze of consumer financial products, including mortgage loans, credit cards, auto loans and retail installment contracts, and unsecured loans. The Bureau will now have primary responsibility for all entities offering a “consumer financial product or service” (with some exceptions). Entities that have not faced significant examination at the federal level, such as state-licensed small loan lenders and payday lenders, now must address the potential for examination by the Bureau.

The Act gives the Bureau authority to supervise, examine, and regulate “covered persons.” The Bureau has the power to supervise any covered person who is a larger participant of a market for other consumer financial products or services or offers or provides to a consumer a payday loan. Thus, all payday lenders fall unequivocally within the supervision of the Bureau, regardless of the size of the lender. Less clear, however, is the extent of the Bureau’s reach over multistate – but not nationwide – storefront consumer finance lenders. Key for these small lenders is the authority to supervise “larger participants.” The Act does not define “larger participants.” Instead, the Act gives the Bureau supervisory authority over anyone it deems by rule to be a “larger participant” of a market for other consumer financial products or services. The Act directs the Bureau to consult with the Federal Trade Commission prior to issuing a rule as to what constitutes a “larger participant” subject to supervision by the Bureau. The Bureau will take up this rulemaking regarding the entities it can regulate before it takes up any substantive rulemaking about what practices it deems unfair, deceptive, or abusive.

The Act also gives the Bureau the authority to write consumer protection rules for nondepository financial companies offering consumer financial services or products. Section 1021 of the Act directs the Bureau to implement and, where applicable, enforce Federal consumer financial law consistently for the purpose of ensuring (1) consumer access to markets for consumer financial products and services, and (2) fair, transparent, and competitive markets for consumer financial products and services. The Bureau may prescribe rules applicable to a covered person or service provider identifying as unlawful unfair, deceptive, or abusive acts or practices in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service. The guidelines for what makes an act or practice “unfair” or “deceptive” are well established. What is less clear is how the Bureau will address practices or acts that are “abusive.”

The Act provides that the Bureau cannot declare an act or practice abusive in connection with the provision of a consumer financial product or service, unless the act or practice:

• materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service; or
• takes unreasonable advantage of:
  • a lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service;
  • the inability of the consumer to protect the interests of the consumer in selecting or using a consumer financial product or service; or
  • the reasonable reliance by the consumer on a covered person to act in the interests of the consumer.

Installment lenders and payday lenders have expressed concerns that the Bureau may attempt to rein in their lending practices under the “abusive” rulemaking. It is unlikely that the loans originated by these lenders could be characterized as abusive because of some act or practice that “materially interferes” with the consumer’s ability to understand the loan. Indeed, the loans originated by these lenders – particularly payday lenders – are more than clear. The corollary of this supposition is that if the loan terms are clear, the lender cannot reasonably be accused of taking unreasonable advantage of the consumer’s lack of understanding of the cost of the loan. Further, the Act specifically provides that the Bureau cannot regulate interest rates, thus depriving consumer advocates of the Number One complaint they make about these types of loans – that these loans just cost too much. Finally, no one would reasonably argue that loans made by installment or payday lenders include practices that cause consumers to rely on the lender to protect their interests – that prong of the abusive test seems aimed at loan brokers.

So, it is likely that the Bureau – if it were to attack the practices of installment and payday lenders as abusive – would focus on the prong in which the lender takes “unreasonable advantage” of the consumer’s inability to protect their interests in selecting the product. But if the terms of the loan are clear, and the Bureau cannot regulate interest rates, what practices might the Bureau target?

The Act does not address rollovers or any other substantive aspect of installment or payday lending. The Act provides for a number of conditions that the Bureau must satisfy before it can declare any act or practice “abusive,” including “the inability of the consumer to protect the interests of the consumer in … using a consumer financial product or service.” It is likely this is the language on which the Bureau will rely to target the second most complained-of practices by payday and installment lenders – the rollover. In this context, “rollover” essentially means “refinance.” When the loan comes due, the consumer, rather than pay off the loan, chooses to pay additional fees to “extend” the loan to a date subsequent. Many states already limit the number of times a payday lender can rollover a loan. It is likely that the Bureau will look at the impact of rollovers on the ultimate cost of the credit originated by the payday or installment lender. It is equally likely that the Bureau – having determined that these loans are the only types of loans certain consumers qualify for – may decide that consumers cannot protect their own financial interest in selecting a payday or installment loan.

Payday and installment lenders should be prepared to counteract the likely promulgation of proposed rules regarding rollovers as an abusive practice. For example, such lenders might demonstrate that these consumers do qualify for other loans, and instead opt for their products. The ability to demonstrate a variety of choices available to the consumer – some of which might actually be more expensive – would go towards counteracting allegations of unreasonable advantage taken. For example, with regard to payday loans, consumers will sometimes obtain them in order to avoid overdrafting their checking accounts, an event that has a cascading impact that can result in the incursion of more fees than the cost of a payday loan. In any event, regardless of the practices or acts that the Bureau might target, focused consumer data should go a long way toward fending off the most devastating reforms the Bureau might adopt.

Catherine M. Brennan is a partner in the Maryland office of Hudson Cook, LLP. Cathy can be reached at 410-865-5405 or by email at cbrennan@hudco.com.