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.
The Dodd-Frank Act authorizes the CFPB to supervise very large banks, thrifts, and credit unions, and their affiliates, and, in a more limited way, certain “nonbank covered persons” (covered persons).1 The CFPB may supervise covered persons that offer residential mortgage loans secured by real estate and related services; private education loans; and payday loans. The CFPB also may supervise any covered person that it has reasonable cause to believe “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.”2 The statute does not specify what risks are sufficient to warrant imposing supervision on a person.
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.
The CFPB has issued a proposed rule (Proposal) setting forth procedures for subjecting a covered person (respondent) to CFPB supervision.3 The CFPB would provide a respondent a notice (Notice) alleging that the person is engaging, or has engaged, in conduct that poses risks to consumers with regard to the provision of consumer financial products or services. The Proposal establishes a mechanism (Section 1024 Proceeding) to allow a respondent to respond to the Notice and for the Director of the CFPB (Director) to determine whether to place a person under supervision.
The Proposal generally incorporates definitions found in the Dodd-Frank Act.4 The term “covered person” includes any person that engages in offering or providing a consumer financial product or service and an affiliate that acts as a service provider to such person. A covered person does not include insured depository institutions or credit unions, and, in the case of such entities with assets of more than $10 billion, their affiliates.
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
There are two ways in which a respondent may consent to CFPB supervision. First, a respondent may execute and file, in lieu of a response, a model consent agreement that is attached to the Notice. Second, a respondent may negotiate its consent to CFPB supervision. A covered person entering into a consent waives any right to judicial review of that agreement.6
The CFPB's Deputy Assistant Director for Nonbank Supervision (Deputy) would commence a Section 1024 Proceeding by issuing a Notice that specifies the underlying allegations. The Notice will be based on complaints collected by the CFPB or, as Section 1024 provides, information from “other sources.” A Notice must include how to file a timely response, the required contents, an opportunity to request a “supplemental oral response,” and an option to voluntarily consent to CFPB supervision.
A respondent has two opportunities to respond, in writing and then through a supplemental oral response. To contest the allegations, a respondent must: (1) set forth the basis for objecting to supervision; (2) include all supporting documents; and (3) submit an affidavit attesting to the accuracy of the information in the response.
Supplemental oral responses will generally be held by telephone with a designee of the Director, to allow for more “flexibility” and be less burdensome than conducting an in-person response. The Assistant Director for Nonbank Supervision (Assistant Director) may impose limitations on the conduct of a supplemental oral response. The Proposal lists a non-exhaustive set of limitations to ensure that the oral response focuses on a respondent's and the Deputy's arguments supporting their respective positions.
The response would next be considered by the Assistant Director, who would provide to the Director a recommended determination, i.e., a proposed order subjecting a respondent to CFPB supervision or a notification to the contrary.
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.
A respondent may petition the Director for the termination of an order imposing supervision two years after the issuance of the order, and annually thereafter. In the case of a consent, a respondent may not petition for early termination during the period set forth in that agreement. A petition should set forth the reasons supporting termination, including the actions taken and the progress made to reduce risk to consumers after the issuance of an order. The Deputy may respond with a recommendation to terminate or modify the order, or to deny the petition. The Director must act on the petition within 90 days of a respondent's submission.
The timeframes contemplated by the Proposal are short. A respondent must file a response within 20 days of service of a Notice. The Assistant Director and the Deputy must have no less than 10 days to prepare for the oral response. The Assistant Director has 45 days to make a recommended decision where a respondent has not voluntarily consented to CFPB supervision, and has not requested the opportunity to present a supplemental oral response, measured from the receipt of a timely response. The Assistant Director must make a recommendation no later than 45 days after the service of a Notice when a respondent fails to make a timely response. If a respondent has requested the opportunity to present a supplemental oral response, a recommended determination shall be made no later than 90 days after the service of a Notice. To ensure the timely conclusion of matters, requests for extension of time are “strongly disfavored” and will be granted only to prevent substantial prejudice.
The CFPB characterized a Section 1024 Proceeding as informal rather than an adjudicatory proceeding under the Administrative Procedure Act (APA). A Notice would not constitute a notice of charges for alleged violations of Federal consumer financial law. No discovery would be permitted, a supplemental oral response would not constitute a hearing on the record, and no witnesses would be called. These prohibitions are intended to save the time and expense associated with discovery.
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.
The CFPB appears ambivalent in considering the applicability of the APA to the Proposal. On the one hand, the CFPB claims that the notice-and-comment requirements of the APA do not apply to the Proposal, as it relates solely to agency procedure and practice. This position ignores that a Section 1024 Proceeding will have a substantial impact on all respondents. Still, the CFPB invites comment on all aspects of this proposed rulemaking.
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.
The process contemplated in the Proposal gives rise to several comments or concerns which, in the aggregate, may garner criticism from commenters, due to the Proposal's tendency to limit a covered person's procedural rights and its failure to explain more fully why these restrictions are appropriate.
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.
Respondents may find it unattractive to engage in a supplemental oral response, since it will generally be held by telephone. There will be no opportunity to assess the demeanor of the deciding official on the other end of the telephone call, nor will that person be able to assess the demeanor of persons employed by the respondent. It is unclear from the Proposal how far down the chain of command a Director may go in choosing a “designee” to conduct the oral response. It also is unclear what limitations, reasonable or arbitrary, a designee may place on a respondent in presenting its arguments, in addition to those specified in the Proposal. Thus, a telephone hearing may be far less probative or meaningful than a hearing held in person. A respondent may not want to risk participating in this part of the process based on so many unknown and potentially adverse variables.
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.
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.9 Critics have said that the recess appointment of Mr. Cordray violated Constitutional procedure.10 A response to a proposed determination could well include a challenge to the appointment of the Director, his ability to make determinations, and the validity of the rules governing Section 1024 Proceedings, in addition to the specifics of any particular case.11
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.
The Proposal deserves attention as an indication that the CFPB intends to interpret its authority broadly. The CFPB may find it advantageous to review the Proposal to clarify that it intends its rules to be both fair to respondents as well as efficient.
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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