By Donald N. Lamson, Shearman & Sterling LLP
The Bureau of Consumer Financial Protection (CFPB) has proposed a regulation that at first blush would apply routine procedural rules in proceedings to determine whether a non-bank financial service provider that exposes its customers to risk should be subjected to increased supervision. Upon closer examination, it becomes apparent that the proposed procedure for such proceedings may be unfair. Moreover, the CFPB may lack the authority to adopt such rules in the first instance.
Nonbank entities already are subject to the CFPB's regulatory and enforcement authority and federal consumer financial law, regardless of whether they are subject to CFPB supervision. Supervision by the CFPB includes conducting examinations to: (1) assess compliance with federal consumer financial law; (2) obtain information about covered persons' activities and compliance systems or procedures; and (3) assess risks to consumers and markets for retail financial products and services. Covered persons also may have to submit various reports to the CFPB.
A “financial product or service” generally includes: (1) extending credit and servicing loans; (2) providing real estate settlement services or performing appraisals; (3) collecting or providing consumer reports or other account information in connection with decisions to extend credit or provide another product or service; and (4) collecting debt. The Proposal, like the statute, does not define what risks are sufficient to warrant imposing supervision on a person.
The CFPB has crafted definitions that expand upon the statute. For example, while the Dodd-Frank Act defines the term “Director” to mean the Director of the CFPB, the Proposal defines the term to mean the Director or her or his designee. If there is no Director, the term also covers a person authorized to perform the functions of the Director in accordance with the law, or her or his designee. The Proposal thus expands the definition, possibly to address potential legal challenges to the legitimacy of the appointment of the current Director, an issue addressed in more detail below.5
The Director would make a final determination by adopting without revision, modifying or rejecting the recommended determination. The Director may rely on the assistance and advice only of “decisional employees” in reaching a determination, i.e., any CFPB employee who has not assisted the Deputy in the proceeding. This walling off should help prevent conflicts of interest in the process and may instill more confidence that the employees assisting the Director are approaching the case without preconception.
The failure to timely raise an issue in, or submit supporting materials with, the response constitutes a waiver of a respondent's right to raise the issue, or submit those materials at a future stage of the proceedings, including in any petition for judicial review. The waiver would remove an incentive for a respondent to wait until after filing a response, such as at a supplemental oral response or during judicial review, to raise an argument or present documents or other information for the first time.
Although the CFPB claims the Proposal is not subject to this requirement, the CFPB in fact conducted a summary cost-benefit analysis and consulted or offered to consult with regulators in connection with this issue.7
The CFPB indicated that, where benefits or costs are not readily quantifiable or where data is not reasonably available, it will conduct qualitative analyses relying on information from available sources. Since there is little publicly available data with which to effectively measure or quantify the benefits, costs, and impacts of the Proposal, the CFPB defaulted to a brief, qualitative analysis.
The CFPB seems to have devoted little attention to this analysis. The CFPB found several benefits associated with the “major provisions” of the Proposal, which simply repeat the major procedural steps in the process. For example, the CFPB counted as a benefit the fact that the Proposal establishes a consistent procedure applicable to all affected persons, and provides a transparent process governing the commencement of a proceeding. Absent the Proposal, the public would lack any guidance regarding Section 1024 Proceedings.
For example, unless the CFPB provides a fuller explanation of the contents of a model consent agreement to be appended to a Notice, it is difficult to assess whether an agreement may contain provisions that would be generally disadvantageous to covered persons. The Notice may be based on information contained in consumer complaints or “other sources,” consistent with the statute. Still, it will be difficult for a covered person to assess the merits of a notice with only limited access to the underlying information prompting a complaint. In the absence of discovery rights, a covered person may well find it preferable to resist submitting to supervision.
The statute can subject any covered person to supervision merely for exposing a customer to “risk.” Economic risk exists at every point where a provider offers a financial product or service to a customer. Unless there is a clear interpretation of this term to cover only inappropriate or undisclosed risk, the CFPB may attract a challenge to void these proceedings and the underlying allegations as unnecessarily vague.
The elephant in the room for any rulemaking proposal by the CFPB, and certainly in this case, concerns whether the current Director, Richard Cordray, was properly appointed and, if not, what his authority may be.
Although the Proposal gives the Assistant Director and the Deputy no less than 10 days to prepare for the oral response, there is no corresponding minimum preparation time for respondents. The Proposal states only that the Assistant Director will serve on a respondent a Notice advising of the date and time of the supplemental oral response. Without the safeguard of a minimum period for preparation, there is no assurance that a respondent will have adequate time to prepare. This same consideration prompts the question why a respondent should not have access to discovery, given the profound change in its business that CFPB supervision may entail. It also seems ambitious to expect a respondent to be able to prepare and submit a response in as little as 20 days from receipt of a Notice.
The Proposal does not appear to take into account that time extensions may be appropriate even in the absence of the possibility of substantial prejudice, or explain why there should be what amounts to a strong presumption against extensions of time. Similarly, it appears inflexible for the Proposal to limit a respondent's ability to raise additional arguments subsequent to the filing of a response. This position does not take into account the possibility that additional evidence relevant to a determination may be discovered at a later point and the exclusion of such material could well be a disadvantage a respondent.
The Proposal does not explain clearly or convincingly why a Section 1024 Proceeding should afford fewer procedural protections than one initiated under other authority of the CFPB, even though the burdens associated with supervision by a federal agency can be as extensive and substantial as the burdens imposed under other authority of the CFPB for violations of law. What would justify diminishing the procedural due process rights of a covered person who exposes its customers to an unspecified level of risk compared to a person accused of clear and specific violations of consumer law?
Finally, the Proposal acknowledges that a respondent may seek judicial review of a determination, but there is no citation to the source of that right to review. Title X of the Dodd-Frank Act has only one section governing appeals from administrative orders, section 1053.8 There is virtually no discussion in the Proposal why there should be two types of administrative proceedings under Title X, but only one source of a right to judicial review following either type of proceeding.
A separate argument, that Mr. Cordray is a residual delegatee of the authority of the Secretary of the Treasury (Secretary), may be of little use to Mr. Cordray. The Secretary may delegate any of his powers to an officer or employee of the Treasury Department, and even assuming the Mr. Cordray can be considered a Treasury Department employee, the Secretary may not delegate authority that he does not possess. In this case the Secretary lacks the authority to adopt rules governing Section 1024 Proceedings.
Title X of the Dodd-Frank Act provides that, in the absence of a Senate-confirmed Director, the Secretary may set up the CFPB and may exercise authority under Subtitle F, the locus of several federal consumer laws that previously had been administered by other federal regulatory agencies. The CFPB also has several new authorities located outside of Subtitle F, including section 1024, none of which falls within the Secretary's authority. The Inspectors-General of the Treasury and Federal Reserve considered this issue and confirmed that the Director's authority under section 1024, including making determinations and promulgating implementing rules is “new,” and outside the Secretary's authority.12 Until the question of the legitimacy of the Director's appointment is resolved, the exercise of any of these additional authorities will be subject to challenge.
Donald N. Lamson is counsel in the Financial Institutions Advisory & Financial Regulatory Group of global law firm Shearman & Sterling LLP in Washington, D.C. Prior to joining the firm, he spent more than 30 years at the Office of the Comptroller of the Currency, where he specialized in the derivatives, investment, securities and trust activities of national banks. From 2009-2010 he was detailed to the Treasury Department, where he assisted in drafting a number of titles in the Administration's proposal for financial regulatory reform, including titles relating to derivatives, investor protection and credit ratings, consumer protection and the Volcker Rule.
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