By Kevin L. Petrasic and Amanda M. Jabour, Paul Hastings
Earlier this summer, the comment period closed on the Bureau of Consumer Financial Protection's (“CFPB”) proposed rule establishing procedural requirements for designating when a nonbank financial firm would be subject to CFPB examination and supervision.1 The proposed rule highlights one of several provisions of the Dodd-Frank Act (“DFA”) authorizing the CFPB to examine and supervise nonbank “covered persons.”2 The proposal solicited comment on procedures to implement the CFPB's authority to supervise a nonbank covered person when it has reasonable cause to determine, after notice and an opportunity to respond, that the person is engaging or has engaged in conduct that poses risks to consumers with regard to the offering or provisions of consumer financial products or services.
Standing alone, the proposed rule provides considerable latitude to the new consumer financial watchdog agency to supervise nonbank financial firms. Viewed collectively with the other nonbank supervisory powers provided the CFPB by the DFA, we see an agency with unprecedented and unparalleled power to oversee the operations of nonbank financial firms. While the agency's supervisory powers over large bank consumer financial operations has received significant attention and was certainly a catalyst for the agency's broad nonbank supervisory program, i.e., to ensure consistency and uniformity with respect to oversight and supervision of consumer financial protection laws and compliance, ultimately the agency's nonbank powers enable it to establish national policy with respect to consumer financial protection. While there is considerable debate about the effectiveness of the federal banking agencies' oversight of large banks' consumer compliance programs, large banks have always been subject to such jurisdiction. A reason often cited for the breakdown in consumer protections in the banking industry was the lack of meaningful consumer financial protection oversight of numerous unregulated and lightly regulated nonbank financial firms.
The ability to regulate the previously unregulated is what distinguishes and defines the agency's unprecedented powers, authority and ability to formulate and execute consumer financial protection policy on a nationwide basis. The breadth of the CFPB's powers also poses the greatest threat to the agency's ability to retain and defend such authority. The agency's ability to understand how to use its nonbank supervisory authority while maintaining boundaries on when, where and how to deploy such authority may ultimately determine its ability to survive.
No single agency, other than perhaps the IRS, has the ability to directly impact so many of our everyday lives. Managed with a deft touch, the agency will almost assuredly prosper; however, too light a touch or a heavy hand with respect to the supervision and oversight of nonbank financial firms could have repercussions on the U.S. economy as well as for the ability of U.S. financial firms to compete internationally. Certainly, no one really anticipates that any of these events could materialize, but the CFPB does have the authority to influence and even disable nonbank financial firms operating in the U.S. if the agency determines a firm is not operating in a manner compliant with the numerous consumer financial laws, rules and regulations that it administers and oversees. And, in some cases, the agency's ability to wield its power may not require it to do much more than open an inquiry that invites 51 State Attorneys General and/or numerous private class action litigants to hop on and enjoy the ride.
Before speculating about such possibilities, it is first important to understand the true scope of the CFPB's nonbank supervisory authority.
The CFPB's supervisory authority over nonbank financial firms (i.e., covered persons) varies depending on several factors, including the consumer financial product or service market at issue and the activities being conducted by a nonbank firm. Generally, the agency's nonbank supervisory authority falls into the following categories:
• The CFPB has specific statutory authority to supervise nonbank covered persons that offer or provide to consumers:
i. Residential mortgage loans, including origination, brokerage, or servicing services;
ii. Private education loans; and
iii. Payday loans.3
• In addition, the CFPB has rulemaking authority to define its jurisdiction over so called (nonbank) “larger participants” of markets of “other consumer financial products or services.”4
• In connection with its statutory authority for the proposed rule referenced above, the CFPB is authorized to supervise any nonbank covered person that it has “reasonable cause to determine, by order,” following notice and an opportunity to respond, that such covered person “is engaging, or has engaged, in conduct that poses risks to consumers with regard to the offering or provision of consumer financial products or services.”5
• Finally, the CFPB has jurisdiction of entities that operate as service providers of any of the above entities, as well as to large depository institutions subject to the agency's consumer financial jurisdiction.6
In addition to the above categories, the CFPB has jurisdiction of nonbank financial firms that are specifically within the agency's jurisdiction by virtue of being covered by one of the enumerated consumer laws in which jurisdiction was transferred to the agency by the DFA.7
Under the CFPB's recent proposal, the agency would have the ability to supervise nonbank covered persons by requiring the submission of reports and by conducting examinations to:
• Assess compliance with federal consumer financial laws;
• Obtain information about a covered person's activities and compliance systems and procedures; and
• Detect and assess risks posed to consumers and to markets arising from consumer financial products and services.8
The proposed rule would establish procedures for the CFPB to exercise this nonbank supervisory authority, but would not impose any new or additional consumer protection requirements on a nonbank financial firm.9 Interestingly, the proposal notes that “nonbank entities are subject to the [CFPB's] regulatory and enforcement authority and any applicable Federal consumer financial law, regardless of whether they are subject to the [CFPB's] supervisory authority.”10 Thus, even in defining the parameters of its nonbank supervisory authority, the agency is careful not to curtail the potential breadth and scope of its reach in pursuing actions and enforcing laws involving consumer financial protection against entities over which it may have no specific supervisory jurisdiction.
The ability to regulate the previously unregulated is what distinguishes and defines the agency's unprecedented powers, authority and ability to formulate and execute consumer financial protection policy on a nationwide basis. The breadth of the CFPB's powers also poses the greatest threat to the agency's ability to retain and defend such authority.
Rather than attempting to define or establish more concrete parameters for what may constitute “reasonable cause” in asserting its nonbank supervisory jurisdiction under DFA §1024(a)(1)(C), the CFPB sets forth procedural requirements to define its nonbank supervisory program under this authority. These requirements appear intended to protect the rights of targeted firms by ensuring adequate “due process” while retaining maximum flexibility for the CFPB to adapt and evolve its nonbank supervisory program. This, of course, provides considerable uncertainty regarding just how far the CFPB may stretch to reach a nonbank covered person; however, this impact appears specifically intended by the CFPB and even designed into the agency's overall approach in pursuing its statutory mandate. Before considering the implications of this approach, it is instructive to understand the procedural requirements the CFPB proposes to define the scope of its nonbank supervision program under its statutory authority for the proposed rule.11
The procedural requirements set forth in the CFPB's “reasonable cause” proposal are intended to provide a form of due process by which a nonbank financial firm may either contest or consent to the CFPB's examination and supervisory jurisdiction. Following are the key procedural elements of the proposed rule:
• Notice of Reasonable Cause — The CFPB would initiate a proceeding by issuing to a nonbank covered person a Notice of Reasonable Cause12 (“Notice”) stating that the agency may have “reasonable cause” to determine that such covered person is engaging, or has engaged, in conduct that poses risks to consumers with regard to the offering or provision of consumer financial products or services.13
• Reasonable Cause — The CFPB's determination of reasonable cause to issue a Notice could be based on a number of factors, including complaints collected by the CFPB regarding the nonbank covered person or information collected by the CFPB from other sources.14
• Opportunity to Respond — A nonbank covered person would be provided a reasonable opportunity to respond to a Notice.15
• Response — The proposed rule would provide respondents with two opportunities to respond to a Notice — first in writing and then, if requested by a respondent, through a supplemental oral response generally to be conducted by telephone.16
Timing Considerations — An important consideration both with respect to the filing of the written response and a subsequent oral response is that requests for extensions of time would be strongly disfavored by the CFPB.17 Coupled with the proposed requirement that failure to timely raise an issue or submit documents would constitute a waiver of the right to raise such issue or provide the additional supporting documents, respondents could be placed under fairly significant time constraints in preparing a substantive written or subsequent oral response to a Notice.
• Determination — After receiving a response to a Notice, the CFPB Director could accept, reject or modify a recommended determination by CFPB staff. The result would be either an order subjecting a respondent to the CFPB's supervisory authority, or a notice stating that a respondent is not subject such authority.18
• Consent — The proposed rule also provides two ways in which a respondent could consent to the CFPB's supervisory authority, either by executing the consent agreement form attached to a Notice or, at any time during a proceeding, by voluntarily consenting to the CFPB's supervision under terms that the parties agree to.
• Supervision Timeframe — An initial determination resulting in an order subjecting a respondent to the CFPB's supervisory authority would be applicable for two years; however, the respondent could petition to terminate such order sooner. 19
The “reasonable cause” proposal represents an important marker in the CFPB's efforts to define the breadth and potential limitations to the agency's nonbank supervision program. The DFA provides considerable authority for the CFPB's jurisdiction of nonbank covered persons; however, there are parameters within which the CFPB must operate to exercise this authority, and protect its jurisdiction. Unclear is exactly where the lines should be drawn.
Regardless of the ultimate outcome of the proposed rule, one of the important takeaways for industry participants and observers is the CFPB's clear willingness to use and rely on consumer complaint data to investigate and pursue potential anti-consumer conduct involving consumer financial products and services.
For example, the proposed rule suggests that any nonbank entity not otherwise subject to the CFPB's jurisdiction pursuant to another provision of DFA §1024 would be subject to the agency's oversight under DFA § 1024(a)(1)(C) if the agency moves to assert its oversight based on the agency's own assessment of “reasonable cause” to do so. While rooted in due process, this approach provides the agency with a virtually unlimited palette upon which to develop its nonbank supervision program. Certainly, the literal language of Section 1024(a)(1)(C) can be read to support this conclusion. It is nonetheless extremely broad and potentially vulnerable to challenge for that very reason, as highlighted in the previous discussion on “reasonable cause.” What constitutes “reasonable cause” and exactly what kind of conduct falls within this regulatory/administrative framework is relatively unclear. More particularly, a court may find the lack of clarity on what conduct poses risks to consumers to be somewhat arbitrary. In addition, there is a continuum in which consumer financial responsibility and accountability must be measured and incorporated into the final analysis of assessing consumer financial risk. How to do that may pose challenges to the CFPB's efforts to implement the proposed rule, as well as other aspects of the agency's bank and nonbank supervisory programs.
Other challenges highlighted by the proposed rule include the potential repercussions for the CFPB's nonbank supervisory jurisdiction generally, and the extent to which the CFPB may be willing to go to define that jurisdiction in other areas, such as with the agency's larger participant jurisdiction. In particular, will certain conduct and practices cause an entity or industry segment to be covered by the larger participant rule, or will the CFPB use its authority under the proposed rule to address anti-consumer conduct? The latter approach, a type of enforcement by example, may be effective, but could also discourage new product innovation, as well as consumer financial responsibility.
Regardless of the ultimate outcome of the proposed rule, one of the important takeaways for industry participants and observers is the CFPB's clear willingness to use and rely on consumer complaint data to investigate and pursue potential anti-consumer conduct involving consumer financial products and services. This should be a clear signal to all industry participants involved in the offering and sale of consumer financial products and services to get their consumer complaint outreach and resolution programs in order. Failing to do so now could raise significant potential issues down the road.
The CFPB's “reasonable cause” proposal represents an important step in the CFPB's efforts to assert and implement the agency's supervisory jurisdiction over nonbank covered persons. While touted as a procedural rule to implement the CFPB's nonbank supervisory jurisdiction, the proposed rule highlights the breadth and, in certain contexts, the limitations that the agency may face going forward in implementing its nonbank supervisory authority. More importantly, the proposed rule serves as notice to nonbank financial firms that are not otherwise directly captured by the CFPB's other nonbank statutory authorities (including explicit jurisdiction over mortgage-related activities, private student lenders and payday lenders, as well as its “larger participant” authority), that adverse or excessive scrutiny of their consumer financial activities — including excessive consumer complaint activity — could lead to a new, challenging and potentially long-term supervisory relationship with the CFPB.
Kevin L. Petrasic is a partner in the Global Banking and Payments Systems practice of Paul Hastings and is based in the firm's Washington, D.C., office. He advises banks and financial services firms on a wide array of regulatory, legislative, transactional, and compliance issues. Amanda Jabour is an associate in the firm's Global Banking and Payment Systems practice, resident in the Washington, D.C. office. She advises banks, thrifts, and financial holding companies on a broad range of regulatory, transactional, and compliance issues arising under federal and state law.
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