Insights

"Hard cases make bad law" is a maxim attributed to Oliver Wendell Holmes, an associate justice and acting chief justice of the U.S. Supreme Court at the turn of the last century. The maxim suggests that cases with extreme facts often prompt courts (and regulators) to stake out extreme legal positions in response. On July 29, the Consumer Financial Protection Bureau and 13 state attorneys general announced a consent order that represents just such "bad law."

The case is known as Rome Finance, and the facts are quite extreme. According to the CFPB's press release and earlier investigations conducted by the New York attorney general, Rome was a group of finance companies and related retailers that targeted servicemembers with "guaranteed credit" to purchase large-screen TVs, computers, and gaming systems.

Allegedly, Rome's affiliated retail store employees would go to the local big box store, buy merchandise at retail, mark it up 225 to 325%, and then sell it on credit to active duty servicemembers and their families (at 10 to 20% APR). Credit was provided on an affiliate's open-end plan. Stores allegedly refused returns of unopened merchandise, pursued aggressive and abusive collection tactics, and even collected on debt for merchandise that actually had been returned. Finally, to add an ultimate insult, Rome used the military's own pay system to deduct payments directly from a servicemember's salary.

By the time the CFPB became involved, more than one state attorney general had succeeded in obtaining relief for servicemembers; Rome's retail outlets had gone out of business; and the finance companies were in bankruptcy - but still trying to collect old debts. Much of that collection was for the benefit of creditors of Rome. It was this collection - some of it flowing to the individual principals of Rome - that the latest consent order shut down, along with banning the principals of the company from ever engaging in the consumer finance business.

Most readers would agree that regulators should take action against Rome's scheme of targeting vulnerable servicemembers, and the CFPB has a statutory mandate to protect that class of consumers. The CFPB does not, however, have the authority to regulate the retail price of goods and services. The legal principles the CFPB used to finally sack Rome are very close to claiming that authority. Here is what section 20 of the consent order declares:

"The prices of the consumer goods disclosed in the financing agreements were inflated to hide the true cost of the credit provided. The inflated goods prices resulted in inaccurate finance charges and annual percentage rates in disclosures provided in Corporate Respondents' financing agreements, in violation of Regulation Z."

The consent order goes on to allege that the same practice was both deceptive and unfair, terms that have particular legal meaning under the Dodd-Frank Act and include the idea that a reasonable consumer could not reasonably avoid the harm caused by the practice.

Here's the rub. In order to find a hidden finance charge in a retail price, a regulator must necessarily have the evidence and the authority to declare what the actual reasonable retail price is. There begins a slippery slope abandoned by most economies in the late 1980s in markets other than regulated public utilities. The CFPB's consent order does not explain facts to support its assertion that prices contained finance charges. Indeed, most of the facts in this article come from press reports about earlier state enforcement actions. Nor does the CFPB explain how consumers were unable to go to the big box store and thus avoid the "deceptive" pricing. Just how are consumers in this Internet age deceived as to the going prices for new, mass market consumer goods?

Until Rome, a posted retail price was a "cash price" for Truth in Lending Act purposes, absent some other compelling facts. Regulators relied on a consumer's ability to look on the Internet or go down the street for a better price (and they still do), if the price on a TV or even a used car was too high. That may no longer be true, especially if other compelling facts are present to support a legal argument that some portion of the price is a hidden finance charge. The parade of horribles that flows from this theory is several blocks long.

First, the problem for lawyers and businesses is that Truth-in-Lending is a strict liability statute. If a finance charge is understated by more than a minute tolerance, there is automatic civil penalty liability in a private civil action and regulatory liability for refunds and civil money penalties. If the Truth-in-Lending finance charge cannot be known, except in the eye of a future regulatory review, how is a business to comply?

Second, it is not clear that the "hidden finance charge" theory ends with Truth-in-Lending. In the Rome Finance case, the CFPB alleged that the understatement of finance charges (hidden in the price) was deceptive and violated UDAAP rules in the Dodd-Frank Act. Extrapolating the same theory, the "excessive" markup on other retail products could be a finance charge for other purposes, such as the Equal Credit Opportunity Act. As a technical mater, the Bureau could easily match its statistical proxies for race and ethnicity of auto finance customers with the variable prices those customers paid for ancillary products and answer the question: "Do minorities pay more for the same ancillary products than non-minorities?" If the answer is "yes," and if the CFPB deems some component of that "excess markup" paid by minorities to be a finance charge, then we have a fair lending case that will make the current campaign against dealer participation look like a tea party.

In summary, the difficult and extreme facts of Rome Finance called out for some remedy for service members as injured consumers. But the legal theories used in that case represent the kind of bad law Mr. Justice Holmes warned us about.

Richard P. Hackett is a partner in the Maine office of Hudson Cook, LLP. Rick can be reached at 207-541-9556 or by email at rhackett@hudco.com.