Financial Services Law

Supreme Court: FDCPA Doesn’t Cover Owned Debt

By Charles E. Washburn Jr., Partner, Financial Services

A bank or other person may collect debts that it purchased for its own account without triggering the statutory requirements of the Fair Debt Collection Practices Act, a unanimous Supreme Court recently ruled.

What happened

The FDCPA was enacted in 1977, placing specific requirements on debt collectors. As defined by Section 1692a(6) of the statute, a “debt collector” is anyone who “regularly collects or attempts to collect … debts owed or due … another.”

Ricky Henson borrowed money from CitiFinancial Auto to purchase a car and then defaulted on the loan. Santander Consumer USA Inc. purchased the loan from CitiFinancial and sought to collect it. Henson filed a putative class action alleging that Santander’s collection efforts ran afoul of the FDCPA.

But the bank moved to dismiss the suit, arguing that it did not qualify as a “debt collector” under the statute because it did not regularly seek to collect debts “owed … another.” Instead, Santander only attempted to collect debts that it purchased and owned. A district court and the U.S. Court of Appeals for the Fourth Circuit both agreed.

Henson filed a writ of certiorari with the Supreme Court, noting that a circuit split existed on the issue. While the Eleventh Circuit reached the same conclusion as the Fourth Circuit, the Third and Seventh Circuits ruled otherwise. The justices granted cert and heard oral argument earlier this term.

In a unanimous opinion—and the first authored by new justice Neil Gorsuch—the Court sided with the bank, finding it “hard to disagree with the Fourth Circuit’s interpretive handiwork.”

“After all, the Act defines debt collectors to include those who regularly seek to collect debts ‘owed … another,’” the justices said. “And by its plain terms this language seems to focus our attention on third party collection agents working for a debt owner—not on a debt owner seeking to collect debts for itself. Neither does this language appear to suggest that we should care how a debt owner came to be a debt owner—whether the owner originated the debt or came by it only through a later purchase. All that matters is whether the target of the lawsuit regularly seeks to collect debts for its own account or does so for ‘another.’”

The plaintiffs argued that this reading of the FDCPA did not account for tense, as “owed” is the past participle of the verb “to owe.” To Henson and the other borrowers, this meant the statute excludes loan originators but embraces debt purchasers like Santander. If Congress wanted to exempt all present debt owners from the definition, it would have used the present participle “owing,” the plaintiffs told the justices.

“But this much doesn’t follow even as a matter of good grammar, let alone ordinary meaning,” Justice Gorsuch wrote. Past participles are “routinely” used as adjectives to describe the present state of a thing (for example, “burnt toast is inedible” or “a fallen branch blocks the path”) and the definition also uses the word “due” to describe a debt currently due at the time of collection. “So to rule for [the plaintiffs] we would have to suppose Congress set two words cheek by jowl in the same phrase but meant them to speak to entirely different periods of time,” the Court said.

Neighboring provisions of the statute demonstrate that Congress used the word “owed” to refer to present and not past debt relationships, the justices added, and other contextual clues can be found as well, including that lawmakers had no problem distinguishing between originators and purchasers.

The plaintiffs also hung their hat on public policy, arguing that the FDCPA was intended to protect consumers and incentivize debt collectors to treat borrowers well. Given the growth of the defaulted debt market since the statute’s passage, Henson contended the Court should recognize the need to include banks like Santander in the definition of “debt collector” with an eye toward fulfilling Congress’ goal of deterring untoward debt collection practices.

But the justices were not persuaded. “All this seems to us quite a lot of speculation,” Justice Gorsuch wrote. “And while it is of course our job to apply faithfully the law Congress has written, it is never our job to rewrite a constitutionally valid statutory text under the banner of speculation about what Congress might have done had it faced a question that, on everyone’s account, it never faced.”

Sticking with the motto “that [the legislature] says … what it means and means … what it says,” the justices said the issue was a matter for Congress, and not the Court, to resolve, affirming dismissal of the lawsuit.

To read the opinion in Henson v. Santander Consumer USA, Inc., click here.

Why it matters

The Supreme Court’s decision resolves a significant split among the federal appellate courts with a declaration that the FDCPA’s definition of a “debt collector” does not apply to a company collecting debts in default that it purchased. The justices explicitly left two questions not pursued by the parties unanswered, however: whether a business engaged in third-party debt collection falls under the statute when collecting on its own accounts and whether the Court should apply a broader definition of “debt collector” that encompasses those engaged “in any business the principal purpose of which is the collection of any debts.” Financial institutions should also keep in mind that because the Court’s opinion is limited to the FDCPA, they could still face additional requirements and potential liability under state debt collection laws.

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House Passes Dodd-Frank “Repeal”

By Ellen R. Marshall, Partner, Financial Services

In a vote along party lines, the House of Representatives passed the Financial CHOICE Act of 2017, which would eliminate or scale back many of the provisions found in the Dodd-Frank Wall Street Reform and Consumer Protection Act.

What happened

Republicans have repeatedly promised to repeal the Dodd-Frank Act and made several attempts over the past few years. In the latest effort, House Financial Services Committee Chairman Jeb Hensarling (R-Texas) moved forward with H.R. 10, dubbed the Financial CHOICE (Creating Hope and Opportunity for Investors, Consumers, and Entrepreneurs) Act, originally introduced last July.

The nearly 600-page piece of legislation would repeal some parts of Dodd-Frank, modify other parts of that act and make changes to various other statutes affecting the way the financial industry is regulated and supervised, including:

  • Repeal Title II of Dodd-Frank and its Orderly Liquidation Authority, replacing it with a new chapter of the Bankruptcy Code designed to accommodate the failure of a large, complex financial institution.
  • End the Financial Stability Oversight Council’s (FSOC) broad power to designate firms as systemically important financial institutions with retroactive effect. Several firms have challenged their designation as a SIFI in the past, most notably General Electric.
  • Repeal Title VIII of Dodd-Frank, which gives the FSOC the authority to designate certain payments and clearing organizations as systemically important “financial market utilities,” as well as retroactively repeal all such designations.
  • Permit the Securities and Exchange Commission to triple monetary fines sought in both administrative and civil actions in certain cases where the penalties are tied to the defendant’s illegal profits and grant the agency new authority to impose sanctions equal to investor losses in cases involving “fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement” where the loss or risk of loss is significant, increasing the stakes for repeat offenders.
  • Increase the maximum criminal fines for individuals and firms that engage in insider trading and other corrupt practices, impose enhanced penalties for financial fraud and self-dealing, and promote greater transparency and accountability in the civil enforcement process.
  • Repeal Section 619 of Dodd-Frank, known as the Volcker Rule.
  • Eliminate the doctrine of judicial deference (known as Chevron deference), under which courts defer to an agency’s reasonable interpretation of its statutory authority.
  • Codify the “valid when made” doctrine, providing that a loan that is valid when it is made (with regard to its interest rate) remains valid regardless of a subsequent sale, assignment or transfer of the loan. This provision was inserted in response to the U.S. Court of Appeals for the Second Circuit decision in Madden v. Midland Funding LLC, in which the court apparently did not consider this principal doctrine to hold that the National Bank Act does not provide a shield against state usury claims even though the loan, when originated by a national bank, was not usurious.
  • Create a regulatory “off-ramp” that would permit banks and other financial institutions to opt out of many of the regulatory requirements (such as stress testing) if they maintain a 10 percent leverage capital ratio, among other conditions.
  • Substantially roll back the powers of the Consumer Financial Protection Bureau, beginning with a name change to the “Consumer Law Enforcement Agency” and a switch to an executive branch agency with a single director removable by the President at will. The legislation would also subject the agency to congressional oversight and the normal congressional appropriations process, eliminate the bureau’s supervisory function, and remove the CFPB’s “unfair, deceptive, or abusive acts and practices” authority.
  • Subject the federal banking regulators to greater congressional oversight and tighter budgetary control, with new requirements that agencies conduct a cost-benefit analysis for new proposed rulemakings and notify Congress and the public before participating in an international standard-setting process.

However, in a significant victory for the retail industry, House Republicans at the last minute eliminated from the bill a provision that would have repealed the Durbin Amendment, which capped interchange fees that banks can receive on electronic debit transactions. The Durbin Amendment pits retailers against financial institutions, and there had been massive lobbying efforts by both groups related to the amendment. Ultimately, the repeal was dropped because House leadership feared that the issue is so contentious it would derail passage of the Financial CHOICE Act.

To read H.R. 10, click here.

Why it matters

The bill passed the House by a vote of 233 to 186, with no Democrats voting in favor of the measure and just one Republican voting against. The White House released a statement in support of the Financial CHOICE Act. The Treasury Department, though, is working on its own alternative approach to Dodd-Frank amending legislation. H.R. 10 now moves to the Senate, where it faces an unsure timetable and an uphill battle to passage.

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Fed Fines Foreign Bank $41M Over BSA/AML Failures

By Joseph G. Passaic, Jr., Partner, Corporate and Finance

The Board of Governors of the Federal Reserve System announced a $41 million penalty against the U.S. operation of a foreign bank over Bank Secrecy Act and anti-money laundering deficiencies.

What happened

In the most recent examination of the BSA/AML program at the U.S. bank holding company of a foreign bank, the Federal Reserve Bank of New York identified “significant deficiencies” in the bank’s risk management and compliance with BSA/AML requirements, the Federal Reserve explained in a recent order.

Examiners also found deficiencies in the bank’s transaction monitoring capabilities, which prevented it from properly assessing BSA/AML risk for “billions of dollars in potentially suspicious transactions” processed between 2011 and 2015 for certain bank affiliates in Europe that failed to provide sufficiently accurate and complete information, the Federal Reserve said.

To settle the matter without a formal proceeding, the Federal Reserve entered an order to cease and desist and an order of assessment of a civil money penalty against the bank.

The order began with requirements for corporate governance and management oversight of the bank’s U.S. operations, mandating that the bank submit a written plan within 60 days including actions to improve the framework for its BSA/AML compliance with supervision by U.S. senior management, ensuring that those carrying out compliance possess appropriate subject matter expertise, establishing procedures to escalate significant matters and providing adequate resources.

A written plan for a compliance risk management program must also be put in place at the bank, addressing the scope and frequency of BSA/AML compliance risk assessments; the identification of all business lines, activities and products to ensure they are all appropriately risk-rated and included in the assessments; and enhanced BSA/AML-related written policies and procedures. The Federal Reserve also required that interim measures be established to monitor and control BSA/AML-related risk until the improved program is fully implemented.

The bank needs to retain multiple independent third parties pursuant to the order, first to conduct a comprehensive review of its compliance and prepare a written report of findings, conclusions and recommendations, and second to conduct a review of the bank’s foreign correspondent banking activity conducted over a six-month period in 2016. Depending on the findings from that review, the Federal Reserve left open the possibility of additional time periods and business activities being considered.

As for the bank’s revised BSA/AML compliance program, the written plan submitted to the Federal Reserve should address the report from the independent third party, providing for a system of internal controls designed to ensure compliance with the applicable BSA/AML requirements, a comprehensive BSA/AML risk assessment (identifying and considering all products and services, customer types, and geographic risks) and identification of the management information systems used to achieve compliance with the requirements. Effective training for all appropriate personnel and improved independent testing procedures must also be included.

Other topics covered in the order were customer due diligence, suspicious activity monitoring and reporting, and a transaction monitoring system, with revised programs for all three required to be submitted to the Federal Reserve.

Finally, the regulator imposed a $41 million civil money penalty.

To read the Federal Reserve’s order, click here.

Why it matters

The order’s requirements—from retaining an independent third party to review the bank’s BSA/AML compliance to enhanced oversight by management to the $41 million penalty—settles the Federal Reserve’s allegations that the bank’s BSA/AML program had “significant deficiencies.”

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CFPB Encourages Changes to Deferred Interest Promotions

By Anita L. Boomstein, Partner, Global Payments

Deferred interest promotions should be more transparent, the Consumer Financial Protection Bureau told retail credit card companies in letters encouraging recipients to be more open with consumers.

What happened

Many retailers use credit cards with deferred interest promotions, where consumers are charged no interest for a set period if the promotional balance is paid in full by the end of the period. But in letters sent to “top retail credit card companies,” the CFPB outlined its concerns about the products, cautioning that consumers may be surprised by the “high, retroactive interest charges” that begin after the promotional period ends.

“With its back-end pricing, deferred interest can make the potential costs to consumers more confusing and less transparent,” bureau Director Richard Cordray said in a statement. “We encourage companies to consider more straightforward credit promotions that are less risky for consumers.”

In 2015, the CFPB studied deferred interest products. While the bureau found that the promotions offer substantial benefits to some consumers, they pose “significant costs and risks” to others. “In particular, our review raised concerns that deferred interest products may lack transparency to consumers, as a consequence of the back-end pricing that can be a feature of these products,” the CFPB wrote in its letters.

Because the costs are not incurred until the end of the promotional period, the costs of such offers are typically less transparent, the bureau said. Adding to the problem: consumers are unaware that interest actually starts accruing from the date of purchase and will be added back on top of the remaining principal balance if the promotional balance is not paid in full by the deadline at the end of the promotional period.

These charges can be “substantial,” the CFPB added, as the nonpromotional interest rate on such offers is generally around 25 percent. “Those who fail to pay off the balance in full, for example those with even a very small balance carried past the promotional expiration date, can end up owing much more in interest than the remaining balance due,” the bureau wrote. “We have received many consumer complaints from people who have found that they have incurred this unexpected charge.”

A large portion of the consumers who fail to repay their entire promotional balance before the deadline do manage to pay off the entire balance and associated interest charges shortly thereafter, leading the CFPB to speculate “that many consumers do not fully understand how deferred-interest promotions operate and the manner in which interest is assessed on these products,” a problem complicated when the account is used for other purchases as well.

“Successful implementation of deferred-interest programs requires robust compliance management systems and third-party oversight measures that ensure consumers are fully informed of the terms and true costs of promotional financing,” according to the letters.

The CFPB suggested an alternative: 0 percent interest promotions, where consumers are not assessed interest retroactively if the promotional balance is not paid in full by the end of the promotional period.

“As long as the end date of the promotional period is clearly disclosed, this approach is easier for consumers to understand,” the CFPB said. “And its costs may be more straightforward. If consumers do not fully repay by the promotional end date, they have the opportunity to resolve their debts without incurring an unexpectedly large lump-sum financial cost.”

While this change only benefits the consumers who fail to pay their promotional balances in full by the deadline at the end of the promotional period, “it is precisely these consumers who are likely to be most at risk,” the bureau noted, such as consumers who suffer an adverse economic shock like an unexpected medical bill or job loss. “This change in promotional terms may assist consumers who do not understand the full costs of failing to pay the deferred-interest promotional balances and make it easier for them to repay their debts following financial hardship.”

To read a sample letter from the CFPB, click here.

Why it matters

Why send the letters now? Last month a “major U.S. retailer, in partnership with one of the largest U.S. credit card issuers” decided to stop using deferred-interest promotions on its credit card program, the bureau said, switching to the 0 percent interest promotion option. “We commend this decision and want to bring it to your attention,” the letters stated. The CFPB’s letters also put retailers and card issuers on notice that the bureau is keeping an eye on deferred-interest promotions.

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OCC Offers Advice on Fintechs, Marketplace Lenders

By Brian S. Korn, Partner, Financial Services

In a new bulletin providing supplemental guidance on third-party relationships, the Office of the Comptroller of the Currency (OCC) answered frequently asked questions about the relationships between financial institutions and fintechs, among other topics.

What happened

Building on Bulletin 2013-29, “Third-Party Relationships: Risk Management Guidance,” Bulletin 2017-21 addressed in a Q-and-A format the management of operational, compliance, reputation, strategic and credit risks presented by third-party business relationships.

Defining a third-party relationship as “any business arrangement between the bank and another entity, by contract or otherwise,” the OCC explained that it can include activities that involve outsourced products and services; use of outside consultants, networking arrangements, merchant payment processing services, and services provided by affiliates and subsidiaries; joint ventures; and other business arrangements in which a bank has an ongoing third-party relationship or may have responsibility for the associated records.

“Recently, many banks have developed relationships with financial technology (fintech) companies that involve some of these activities,” the OCC recognized in the new bulletin. “If a fintech company performs services or delivers products on behalf of a bank or banks, the relationship meets the definition of a third-party relationship and the OCC would expect bank management to include the fintech company in the bank’s third-party risk management process.”

Bank management should conduct in-depth due diligence and ongoing monitoring of each of the bank’s third-party service providers that support critical activities, according to the bulletin, adjusting its risk management practices for each relationship based on the level of risk. No single structure for the third-party risk management process exists, the OCC said, and multiple banks may collaborate to meet regulator expectations when they share the same third-party service providers (as long as it does not involve a customized product or service, however).

Whether or not a fintech company arrangement can be considered a critical activity depends on a number of factors, such as whether significant bank functions (payments, clearing, settlements and custody, for example) are involved or other activities that could have a major impact on bank operations if the bank has to find an alternative third party or if the outsourced activities have to be brought in-house. “The OCC expects banks to have more comprehensive and rigorous management of third-party relationships that involve critical activities,” the guidance noted.

Can a bank engage with a start-up fintech company with limited financial information? The agency answered this question by reiterating Bulletin 2013-29’s requirement that banks should consider the financial condition of the third party during the due diligence stage of the life cycle before selecting or entering into contracts or relationships.

“In assessing the financial condition of a start-up or less established fintech company, the bank may consider a company’s access to funds, its funding sources, earnings, net cash flow, expected growth, projected borrowing capacity, and other factors that may affect the third party’s overall financial stability,” the OCC wrote. “Assessing changes to the financial condition of third parties is an expectation of the ongoing monitoring stage of the life cycle. Because it may be receiving limited financial information, the bank should have appropriate contingency plans in case the start-up fintech company experiences a business interruption, fails, or declares bankruptcy and is unable to perform the agreed-upon activities or services.”

The bulletin also clarified that no requirement exists that a third party must meet the bank’s lending criteria in order to establish a relationship.

Banks are collaborating with fintechs to offer products or services to underbanked or underserved consumers, the OCC said, creating third-party relationships under the scope of Bulletin 2013-29 by establishing dedicated interactive kiosks or automated teller machines with video services that enable the consumer to speak directly to a bank teller, for example.

Turning to the possibility of a marketplace lending arrangement with nonbank entities, the agency said a bank’s board and management “should understand the relationships among the bank, the marketplace lender, and the borrowers; fully understand the legal, strategic, reputation, operational, and other risks that these arrangements pose; and evaluate the marketplace lender’s practices for compliance with applicable laws and regulations.”

Banks must also establish appropriate processes and systems to effectively monitor and control the risks inherent within the marketplace lending relationships, the OCC said, from adequate loan underwriting guidelines to cover credit risk management to ensuring the marketplace lender has adequate compliance management processes in place to satisfy compliance risk management concerns.

“To address these risks, banks’ due diligence of marketplace lenders should include consulting with the banks’ appropriate business units, such as credit, compliance, finance, audit, operations, accounting, legal, and information technology,” Bulletin 2017-21 explained. “Contracts or other governing documents should lay out the terms of service-level agreements and contractual obligations. Subsequent significant contractual changes should prompt reevaluation of bank policies, processes, and risk management practices.”

The guidance also addressed questions about whether Bulletin 2013-29 applies to a situation where a bank engages a third party to provide bank customers with the ability to make mobile payments using their bank accounts (yes) and whether a community bank may outsource the development, maintenance, monitoring and compliance responsibilities of its compliance management systems (yes, as long as the bank monitors and ensures the third party complies with current and subsequent changes to consumer laws and regulations).

To read Bulletin 2017-21, click here.

Why it matters

Required reading for financial institutions, the 14 FAQs in Bulletin 2017-21 cover topics ranging from collaboration among banks to meet regulatory expectations for managing third-party relationships to whether a relationship with a fintech company is a critical activity to the management of risks when entering a marketplace lending arrangement with nonbank entities.

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