Mortgage Banking Update - April 27, 2023
In This Issue:
- How We’re Helping Clients Respond to the CFPB’s “Junk Fees” Rhetoric; Ballard Spahr to Hold Webinar on May 16
- New Issue of FDIC Consumer Compliance Supervisory Highlights Looks At Referral Arrangements, Trigger Leads, Servicemember Protections, and Fair Lending Compliance
- California Federal District Court Denies DFPI Motion to Dismiss Lawsuit Challenging State’s Regulations Requiring Consumer-Like Disclosures for Commercial Transactions
- CFPB Pushes the ECOA Coverage Envelope Again
- CFPB Consumer Response Annual Report Highlights Increasing Complaints About Credit Reporting and Student Loans
- CFPB Announces Revised Methodology for Determining Average Prime Offer Rates
- CSBS Highlights Growth of State Examination System
- This Week’s Podcast Episode: Performance-Based Regulation—A New Approach to Consumer Financial Regulation, With Special Guest Lauren Willis, Professor of Law and Associate Dean for Research, LMU Loyola Law School
- CFPB to Hold Field Hearing on “Zombie Second Mortgages”
- SCOTUS Decision Allowing Constitutional Challenges to FTC and SEC to Be Brought in Federal District Court Has Broader Implications
- Opt-Out Deja Vu? Pending Colorado Legislation Would Opt Out of Federal Law Allowing Interest Rate Exportation by State Banks
- This Week’s Podcast Episode: A Close Look at Generative Artificial Intelligence and What It Means for the Consumer Finance Industry, With Special Guest Alex Johnson, Founder and Author of Fintech Takes Newsletter
- Did You Know?
I am very tired of the Biden Administration’s, most notably the CFPB’s, inflammatory rhetoric about “junk fees.” In its recent “Junk Fees Special Edition” of Supervisory Highlights, the CFPB defined “junk fees” as “unnecessary charges that inflate costs while adding little to no value to the consumer” and stated that “[t]hese unavoidable or surprise charges are often hidden or disclosed only at a later stage in the consumer’s purchasing process or sometimes not at all.” In other words, “junk fees” can include any and all fees charged after a transaction is entered into, regardless of whether such fees are lawful as a matter of federal or state law.
Let’s take the example of credit card late fees, which the CFPB has labeled a “junk fee.” Late fees are authorized under the federal CARD Act (and Regulation Z provides a safe harbor of $30 for the first default and $41 for subsequent defaults) and state law, and the Truth-in-Lending Act and Regulation Z require card issuers to disclose late fees in their credit card application and account-opening disclosures. As a result, there is no basis for cardholders to be surprised when late fees appear on their periodic statements. And, obviously, late charges can be avoided by making timely payments.
The CFPB’s continued indiscriminate use of the term “junk fees” has created a dire need for an analytical framework that the consumer financial services industry can use to identify which fees are likely to be considered “junk fees” by regulators. Since regulators have not provided any meaningful guidance, I wanted to share steps we take when clients have asked us to do a review of the fees charged for various loan, deposit, and other products. These steps have included the following:
- Confirmed that authority to charge the fee is provided in the client’s form of agreement. Such authority does not necessarily need to be in the original agreement. However, for fees that might be charged pursuant to an agreement entered into after the original agreement, it is preferable for the original agreement to disclose the current amount of such fees.
- Looked at whether there is express or implied authority under federal or state law to charge the fee, paying particular attention to state laws that provide that unless a fee is expressly authorized, it may not be charged and considering whether federal preemption may be available to provide authority for a fee that is not permitted by state law.
- Confirmed that the fee is clearly and conspicuously disclosed upfront, keeping in mind that a disclosure pursuant to the Truth-in-Lending Act may not be sufficient to avoid a claim that a fee was deceptively presented.
- Looked at the business rationale for charging the fee and whether it is sound.
- If the fee is one that the CFPB has found to be unfair or abusive, determined what changes, if any, can be made to avoid such a finding (such as changes to when the fee is charged or how it is disclosed).
We have conducted reviews of many clients’ fees, and there have been very few instances where we recommended that a fee be entirely eliminated. In some cases, particularly with respect to online disclosures, we have recommended changes to how fees were disclosed. Since “junk fees” can be expected to be a focus of CFPB examiners, it is very important for a company to conduct this review before its next CFPB examination.
On May 16, 2023, from 12:00 p.m. to 1:30 p.m. ET, Ballard Spahr’s Consumer Financial Services Group will hold a webinar, “What the Biden Administration’s ‘Junk Fees’ Initiative Means for the Consumer Financial Services Industry: A Look at the Fees Under Attack.” For more information and to register, click here.
In the March 2023 issue of Consumer Compliance Supervisory Highlights, the FDIC discusses consumer compliance issues identified by its examiners during supervisory activities conducted in 2022 involving referral arrangements, trigger leads, servicemember protections, and fair lending compliance. The issue also looks at complaint trends.
Compliance Issues. Key findings include:
Real Estate Settlement Procedures Act Section 8: Referral Arrangements. The FDIC identified RESPA Section 8(a) violations in two scenarios. One scenario involved so-called “warm transfers” in which a bank arranges to have a third party call identified consumers and directly connect and introduce them to a specific mortgage representative on the phone. The other scenario involved a digital platform that purported to rank lender options based on neutral criteria but where the participating lenders merely rotated in the top spot. While noting that each case is fact specific, the FDIC identified the following activities performed by a third party that serve as indicators of risk in these arrangements:
- Initiating calls directly to consumers to steer them to a particular lender;
- Offering consumers only one lender or only transferring the consumer to one lender;
- Describing the lender in non-neutral terms such as preferred, skilled, or possessing specialized expertise;
- Receiving payment from the lender only if a “warm transfer” occurs; or
- On a consumer-facing digital platform that purports to rank settlement service providers based on objective factors, including providers that pay to take turns appearing in the top spot in a round-robin format.
The FDIC also noted that payment for activities that go beyond the simple provision of a “lead” may be improper payment for referrals when the activity affirmatively influences the consumer towards the selection of a particular lender. The FDIC listed the following examples of risk-mitigating activities:
- Training staff on RESPA Section 8, including the differences between a permitted lead and an illegal referral (including a warm transfer);
- Understanding the programs that lenders are involved with, how the programs function, and how the cost structure works;
- Developing policies and procedures that provide guidance to comply with regulatory requirements and management’s expectations with regard to lead generation programs;
- Requiring loan officers to annually certify applicable relationships to ensure that the bank is aware of the arrangements used by loan officers to generate loans and that these arrangements have been vetted and controls put in place for associated risks; and
- Monitoring lead generation activities regularly to ensure compliance with the bank’s policies and procedures, and regulatory requirements.
Fair Credit Reporting Act: Trigger Leads. A “trigger lead” is a kind of prescreening that involves a lender paying credit reporting agencies to produce a report on certain consumers’ credit activity. The lender provides credit criteria, either directly or through third parties, to the credit reporting agencies, which then provide the lender with a list of consumers who both match the lender’s criteria and had a “trigger” activity, such as recently applying for a mortgage loan. FDIC examiners noted issues involving financial institutions that purchased “trigger leads” but failed to provide consumers with “firm offers of credit.” By listening to recorded phone calls, reviewing scripts and consumer complaints, and interviewing loan officers, examiners identified instances where financial institution representatives were contacting consumers during sales calls, but did provide required FCRA prescreening disclosures during the calls. The FDIC stated that “FCRA does not state that a firm offer of credit must be in writing and does not explicitly prohibit verbal offers. However, these disclosure requirements of FCRA must still be met.”
The FDIC listed the following examples of risk-mitigating activities:
- Developing and implementing comprehensive oversight of marketing materials, including content approval and ongoing monitoring, to ensure compliance with applicable rules and regulations;
- Implementing an effective compliance management system for FCRA and the use of prescreen credit report information to ensure bank staff comply with regulatory requirements;
- Developing scripts that comply with FCRA prescreening requirements to use when calling consumers identified through the trigger lead process; and
- Developing and implementing offer letters meeting all regulatory requirements to send to all consumers meeting prescreening criteria. The letters should provide firm offers of credit that are clear and accurate, avoid misleading representations, and include the opt-out language found in Section 615(d) of FCRA.
Servicemembers Civil Relief Act: Automatically Applying Excess Interest Payments to Principal Loan Balance. FDIC examiners identified SCRA violations when banks unilaterally applied excess interest to a servicemember’s principal loan balance without giving the servicemember an option of how to receive the funds. The FDIC indicated that although the SCRA does not require a specific method for reimbursing the excess interest, and does not prohibit a creditor from providing it to the servicemember as a cash refund or timely applying it to current or future monthly payments, or applying it to past-due amounts, the SCRA prohibits accelerating principal (i.e., applying accrued interest savings or excess interest directly to principal), for both open-end and closed-end credit. As a result, a bank is permitted to apply the excess interest to the principal balance of the loan only if the servicemember affirmatively chooses that method after being offered other options (such as cash refund and/or timely application to current or future payments). The FDIC observed that in these situations, it would be beneficial for banks to have procedures in place that document the options provided to the servicemember and the choice selected by the servicemember for handling reimbursement of the forgiven excess interest.
The FDIC listed the following examples of risk-mitigating activities:
- Developing and implementing formal policies and procedures that comply with the provisions of SCRA;
- Reviewing, monitoring, and auditing SCRA loans to ensure policies and procedures are implemented and followed; and
- Providing servicemembers with the option of how to receive the excess interest, or at a minimum, providing the excess interest in a cash payment.
Fair Lending. In 2022, the FDIC referred 12 fair lending matters to the DOJ. According to the FDIC, these matters involved redlining, pricing for indirect automobile financing, and policies for pricing or underwriting credit. It described the redlining matters as generally involving instances where the banks’ levels of lending did not penetrate geographies consisting of more than 50-percent minority populations (majority-minority census tracts) consistent with other lenders operating in the same markets. The FDIC attributed these lending issues to a combination of issues involving branching activity that did not penetrate majority-minority areas, a lack of marketing and outreach in those areas, or the delineation of a market area that reflected illegal credit discrimination. The FDIC described the indirect automobile pricing matters as generally involving issues where as a result of the banks incentivizing dealer discretion in credit pricing, borrowers were priced differently on a prohibited basis. The FDIC described the pricing or underwriting policy matters as involving the use of third parties in the credit process to underwrite or price credit, with some of these third parties operating online lending platforms that included various policies or application screening methods that violated anti-discrimination rules by including prohibited bases (such as the applicant’s marital status or the exercising of a right under a consumer credit protection act) in the credit decision process.
The FDIC listed the following examples of risk-mitigating activities:
- Evaluating written credit policies and procedures, including those of any third party with which the bank has a relationship, to ensure decision criteria and pricing methodologies do not reflect illegal credit discrimination;
- Reviewing any requirements or other criteria used to screen potential applicants to ensure there is no discriminatory impact;
- Conducting monitoring efforts or audits to ensure credit is not being priced in a discriminatory manner;
- Understanding the bank’s reasonably expected market area and the demographics of the geographies within that area;
- Evaluating the methods by which the bank obtains loan applications, including through branches or any marketing or outreach efforts; and
- Assessing the bank’s lending performance within its reasonably expected market area.
Consumer complaint trends. Key items include:
- The volume of third-party providers associated with complaints increased from 4,678 in 2021 to 5,093 in 2022, or 9 percent.
- Credit card complaints increased to 3,822 or 26 percent, to become the top product complained about in 2022.
- Checking account complaints dropped to the second top product in 2022, reflecting a decrease since it peaked in 2019. (The FDIC suggests the decrease may be attributable to the availability of alternative banking products.)
A California federal district court recently denied the motion filed by the California Department of Financial Protection and Innovation (DFPI) seeking to dismiss a lawsuit filed by an advocacy organization seeking to enjoin DFPI from enforcing its final regulations (Regulations) implementing California’s commercial financing disclosure law. SB 1235, which was signed into law in 2018, requires consumer-like disclosures to be made for certain commercial financing products, including small business loans and merchant cash advances. The Regulations became effective on December 9, 2022.
The plaintiff, the Small Business Finance Association (SBFA), alleges in its complaint that the Regulations violate the First Amendment rights of its members. More specifically, SBFA alleges that the compelled disclosures do not accurately inform customers about the terms of a provider’s products because they misleadingly indicate that sales-based financing (SBF) transactions and open-end credit (OEC) function like traditional bank loans. SBFA also alleges that the Regulations are preempted by the Truth in Lending Act (TILA) because they mandate disclosure of the “APR” and “finance charge” but define and calculate those terms differently than TILA.
SBFA’s members offer SBF transactions in which the provider purchases a portion of a business’s future receivables at a discount and collects the receivables as generated by the business. SBFA alleges that although an SBF transaction is a purchase and not a loan, the Regulations require providers to disclose an estimated payment and estimated term “even though there is no required payment given that the transaction is a purchase and sale.” According to SBFA, such disclosures are inaccurate or misleading because they “materially undercut the value proposition of the [SBF] transactions” since a “key differentiator of [SBF] products is that they have no fixed payment term or amount.”
SBFA’s members also offer OEC in the form of a line of credit with a specified limit. For OEC transactions, the Regulations require a provide to disclose the “actual cost of the financing,” with the actual cost calculated by assuming that the borrower “will make an initial draw of their full approved credit limit, that the recipient will choose to make only minimum monthly payments, and that the recipient will not make any subsequent draws.” SBFA alleges that this assumption is misleading and “effectively destroys the value” of an OEC because a reasonable borrower would not treat an open-end credit line in this way since it would inflate the ultimate cost of an OEC.
DFPI argued that SBFA had failed to state a First Amendment claim because the Regulations compel commercial disclosures in a constitutionally permissible manner. According to DFPI, the disclosures are not misleading because the terms are either consistent with their plain meaning or clearly disclose that they are based on estimates and assumptions. In ruling on DFPI’s motion to dismiss, the court determined that for a law compelling commercial speech to survive First Amendment scrutiny, the government must show that the disclosure is purely factual, noncontroversial, and not unjustified or unduly burdensome. The court found that SBFA had plausibly alleged that the Regulations compel speech that is not purely factual based on its allegations that small businesses could be misled by the required disclosures. It stated that “whether or not small business owners may be misled is a factual matter that the Court will not resolve on the pleadings.”
With regard to SBFA’s TILA preemption claim, the court concluded that the Regulations were not subject to express preemption because they apply to a different set of transactions (i.e. business purpose) than those to which TILA applies (i.e. consumer purpose). However, the court found that SBFA had sufficiently alleged that the Regulations may be subject to conflict preemption. The court highlighted SBFA’s allegations that (1) small business owners often finance their businesses through a combination of commercial and consumer finance products and therefore routinely compare products subject to TILA with products that are not subject to TILA, and (2) because the Regulations require disclosure of two key TILA terms for non-TILA products but define or calculate those terms differently from TILA, small business owners considering TILA products are likely to be confused.
The court found these allegations sufficient to show that the Regulations may obstruct TILA’s purpose of “avoid[ing] the uninformed use of credit.” According to the court, “resolution of the factual issues necessary to determine preemption–whether small business owners infact mix-and-match consumer and commercial credit options, and whether they would be confused by the differing terms—is inappropriate at this time.”
The court’s determination that the Regulations could be preempted by TILA as a matter of conflict preemption stands in stark contrast with the CFPB’s recent determination that California’s commercial financing disclosure law is not preempted by TILA. The CFPB concluded that California’s law did not stand as an obstacle to the accomplishment of TILA’s purposes, stating that commenters advocating preemption had not shown “that consumers when shopping for consumer-purpose credit would somehow be prevented from understanding the terms of credit available to them for those purposes by State disclosures provided in different (business-purpose) transactions.”
The CFPB has filed a Statement of Interest in a case pending before a Florida federal district court in which the plaintiffs allege that the defendant engaged in discriminatory targeting in violation of the Equal Credit Opportunity Act (ECOA).
In Roberson v. Health Career Institute LLC, the plaintiffs are students at a for-profit nursing school who allege that the school engaged in various unfair and deceptive practices and other unlawful conduct in connection with enrolling students in and operating its “functionally valueless” nursing program. A subclass of Black students allege that the school “intentionally used marketing, advertising, and recruiting techniques to target their nursing program to individuals on the basis of their race, with the understanding that such individuals were highly likely to require an extension of credit in order to pay for HCI’s nursing program.” They allege that the school caused students to apply for and take out credit in the form of federal and private student loans, including retail installment contracts.” According to the plaintiffs, the school engaged in “reverse redlining” by targeting the subclass for “an illusory program.”
In its motion to dismiss, the school argues that “[p]laintiffs fail to specify any aspect of any credit transaction that they allege is discriminatory based on race (or any other protected class under the [ECOA]) and fail to identify any specific loan term that they allege was unfair or predatory, let alone unfair or predatory based on race.”
In challenging the school’s argument in its Statement of Interest, the CFPB points to the ECOA language that prohibits discrimination “with respect to any aspect of a credit transaction.” Based on this language, the CFPB argues that “even where loan terms are not themselves unfair or predatory, a plaintiff may still proceed with a discriminatory targeting claim because, contrary to Defendants’ suggestion otherwise, ECOA covers every aspect of a credit transaction, not just the loan terms in the four corners of the contract.” According to the CFPB, by alleging “that HIS misrepresented program requirements-and consequently, the length, and therefore the cost of the program-to convince students to take out credit to pay for tuition for the nursing program,” the plaintiffs had identified ‘an aspect of a credit transaction’ with respect to which HCI discriminatorily targeted them and have accordingly stated a claim under the ECOA.”
The CFPB’s attempt to extend the ECOA to redlining was recently rejected by a federal district court in Townstone Mortgage, with the court holding that ECOA protections only apply to “applicants.” The CFPB has appealed that decision to the U.S. Court of Appeals for the Seventh Circuit. The CFPB’s Statement of Interest represents another attempt by the CFPB to extend the ECOA beyond its terms, in this case through an expansive reading of what is “any aspect of a credit transaction.”
The CFPB has issued its “Consumer Response Annual Report,” which analyzes patterns and trends in the approximately 1,287,000 consumer complaints submitted to the Bureau in 2022. The annual report is required by the Consumer Financial Protection Act.
The CFPB indicated that the largest increase in complaints, accounting for more than 75 percent of all consumer complaints, was related to dissatisfaction with credit reporting, including inaccurate information on credit reports and improper use of reports. The CFPB reported that on average, companies responded to more than 48,300 credit or consumer reporting complaints per month (compared to a monthly average of 24,500 complaints for the prior two years.) These complaints frequently focused on alleged incorrectly reported negative information, misattribution of account ownership, and credit inquiries from entities the consumer did not recognize.
The Annual Report highlighted another consumer complaint category that saw a significant increase in 2022—student loans. While still a small percentage of the overall total, consumer complaints about federal student loans increased 108 percent over the previous year and private student loan companies saw a 45-percent uptick in complaints. The CFPB categorized these complaints as directed at both servicers and lenders, and focusing on consumer confusion regarding pandemic payment pause extensions and forgiveness programs. The vast majority of those complaints (90 percent) that were forwarded to companies for review and response were closed with an explanation.
The CFPB encourages businesses to use the information in the Annual Report to prioritize which internal processes receive the appropriate resources. But they also encourage review to identify “potential weaknesses in a particular product, service, function, department, or vendor.”
The CFPB recently announced that it is revising the methodology used to determine average prime offer rates (APORs). The revised methodology is available on the website of the Federal Financial Institutions Examination Council (FFIEC). Both the revised methodology and prior methodology are available on the FFIEC website.
The CFPB has used information from the Freddie Mac Primary Mortgage Market Survey® (PMMS) on three products (30-year fixed-rate mortgages, 15-year fixed-rate mortgages, and five-year variable-rate Mortgages), and pricing data from CFPB’s own internal survey on one-year variable-rate mortgages, to calculate APORs on a weekly basis for various loan products. APORs are used for various purposes, including use in the determination for Regulation Z purposes of whether a mortgage loan is a qualified mortgage loan (QM) and, if so, whether it is a safe harbor or rebuttable presumption QM, and whether a mortgage loan is a higher-priced or high-cost mortgage loan.
The CFPB advises that Freddie Mac is changing the public version of PMMS to no longer include points, fees, and adjustable-rate data used by the CFPB to construct APORs. This required CFPB to identify an alternate source of data, and it has determined that “data from Intercontinental Exchange Mortgage Technology (ICE Mortgage Technology) is currently the most suitable option to replace PMMS.”
The CFPB will now use eight base loan products to calculate APORs. The eight products are 30-year fixed-rate mortgages, 20-year fixed-rate mortgages, 15-year fixed-rate mortgages, 10-year fixed-rate mortgages, 10/6-month adjustable-rate mortgages (ARMs), 7/6-month ARMs, 5/6-month ARMs, and 3/6-month ARMs. The revised methodology will be used by the CFPB to calculate APORs on or after April 21, 2023.
On April 3, 2023, the Conference of State Bank Supervisors (CSBS) released an update on the status of its State Examination System (SES). The SES is an examination system that is intended, in part, to foster standardization and enable state-level coordination by providing a platform for state agencies, regulators, and companies to conduct company exams from start to finish.
Launched in 2020, the SES allows state regulators to schedule exams, jointly track exam progress, and coordinate on exams across states. For instance, the SES would allow coordinating state agencies to make a single document request to a company, and also provide the company with a single location to which it could upload the requested files. These files could then be viewed by agency examiners participating in that multistate exam. Such coordination is intended to result in less burdens placed upon companies, by way of fewer concurrent exams and duplicate requests for information. With the exception of Florida and Utah, all states currently use SES for either their supervisory activities or for their complaints process (or both) in at least one state agency. CSBS states that over 3,800 exams have been conducted to date through the SES.
CSBS notes that the “SES already include[s] common exam standards for mortgage companies, debt [collection] companies and money services businesses. With the new consumer finance standards added to the suite of SES exam standards, state agencies can … achieve a more uniform process and minimize the need for companies to respond to differing, state-specific exam standards.” Further, the hope is that these standards will lead to even more state agencies coordinating exams via the SES.
Additional information about the SES can be found on the CSBS website.
This Week’s Podcast Episode: Performance-Based Regulation—A New Approach to Consumer Financial Regulation, With Special Guest Lauren Willis, Professor of Law and Associate Dean for Research, LMU Loyola Law School
Professor Willis advocates the adoption of a performance-based approach to regulation to replace or supplement the current approach of disclosure and design regulation. We first discuss how benchmarks would be used in a performance-based approach and discuss the shortcomings of the current disclosure and design approach as well as behavioral economics in designing regulations. We then discuss how benchmarks would be determined in a performance-based approach and how audits would be conducted. We conclude by looking at use cases involving overdrafts and data privacy, the role of legislation and regulation in implementing the new approach, and how the new approach is being used in other countries.
Alan Kaplinsky, Senior Counsel in Ballard Spahr’s Consumer Financial Services Group, leads the conversation.
To listen to the episode, click here.
On April 26, 2023, the CFPB will hold a field hearing in Brooklyn, New York on “zombie second mortgages.” At the event, Director Chopra will host a discussion with local community organizations, advocates, leaders, and members of the public about such mortgages and debt collection issues. The CFPB describes “zombie second mortgages” as “debts that consumers thought were satisfied long ago by loan modifications or bankruptcy proceedings or that were written off by lenders as uncollectable.”
The U.S. Supreme Court ruled last week that parties seeking to challenge the constitutionality of the structure of the Federal Trade Commission and the Securities and Exchange Commission cannot be required to raise such challenges in the first instance before an administrative law judge (ALJ) and may bring such challenges directly in a federal district court. The decision has implications for other federal agencies that use administrative law judges (ALJ), including the CFPB.
The ruling was made in two cases decided together by the Court: Axon Enterprises, Inc. v. FTC and SEC v. Cochran. The cases involve FTC and SEC enforcement actions that each agency had instituted before an ALJ. Each of the respondents (Axon and Cochran) then brought actions in federal district court asserting ordinary federal question jurisdiction. Both respondents alleged that the ALJs assigned to their cases could not constitutionally exercise power. More specifically, they argued that the ALJs’ for-cause removal protection violated Article II of the Constitution. Both Axon’s and Cochran’s lawsuits were dismissed by the district courts for lack of jurisdiction. In the two cases, the district courts found that the agencies’ similar review schemes, which provide for administrative review followed by judicial review in a federal court of appeals, displaced ordinary federal question jurisdiction.
On appeal from those decisions, the Fifth and Ninth Circuits split. The Ninth Circuit, considering Axon’s case, concluded that the Axon’s constitutional challenges fell within the FTC Act’s review scheme and affirmed the district court’s dismissal. The en banc Fifth Circuit, considering Cochran’s case, concluded that Cochran’s constitutional claim fell outside of the Exchange Act’s review scheme and reversed the district court’s dismissal.
The Supreme Court, agreeing with the Fifth Circuit, concluded that the FTC and SEC review schemes did not displace district court jurisdiction over the respondents’ “sweeping” constitutional claims. In reaching this conclusion, the Court applied various factors established by its own precedent for when Congress can preclude district courts from exercising jurisdiction over challenges to federal agency action. Notably, the Court found that judicial review of the respondents’ claims would come too late to be meaningful. This is because the respondents would lose their rights not to undergo the challenged agency proceedings if they could not assert their constitutional rights until the proceedings were over. It also found that the respondents’ claims were outside the agencies’ expertise.
The decision would allow constitutional challenges to the structure of any federal agency with a review scheme similar to that of the FTC and SEC, such as the CFPB, to be brought in federal district court. The Court, however, did not address the merits of the constitutional challenges, particularly the challenge to the ALJ’s exercise of power based on their for-cause removal protection. In Axon and Cochran, the respondents’ challenge to the ALJ’s exercise of power was based on the dual-layer nature of the ALJs’ protection from removal, meaning that the officials who could remove the ALJs also had for-cause protection from removal. While CFPB ALJs also have for-cause removal protection, the CFPB Director can be removed without cause.
The Supreme Court could soon address the constitutionality of the use of ALJs by federal agencies if it grants the petition for certiorari filed by the SEC in Jarkesy v. Securities and Exchange Commission. (A reply to the certiorari petition must be filed by May 12, 2023.) The underlying case in Jarkesy involves an SEC investigation that resulted in an administrative action against the petitioners in which the SEC alleged that the petitioners had committed securities fraud and sought both monetary and equitable relief. After an SEC ALJ’s finding that the petitioners had committed securities fraud was affirmed the SEC, the petitioners sought review by the Fifth Circuit. A divided 3-judge Fifth Circuit panel ruled that the proceedings suffered from three constitutional defects, vacated the SEC’s decision, and remanded the matter to the SEC for further proceedings.
The SEC’s certiorari petition presents the following questions:
- Whether the statutory provision that empowers the SEC to initiate and adjudicate administrative enforcement proceedings seeking civil penalties violated the Seventh Amendment of the U.S. Constitution.
- Whether statutory provisions that authorized the SEC to choose to enforce the securities laws through an agency adjudication instead of filing a district court action violate the nondelegation doctrine.
- Whether Congress violated Article II of the Constitution by granting for-cause removal protection to ALJs in agencies whose heads can only be removed by the President for cause.
The first two questions could have significant implications for the use of ALJs by the FTC and CFPB. The third question could also have significant implications for the FTC (but not the CFPB since the CFPB Director can be removed without cause.)
Another issue with potential significant implications for both the FTC and CFPB is one raised by Justice Thomas in his concurring opinion in Axon and Cochran. In addition to challenging the authority of the FTC’s ALJ based on the ALJ’s for-cause removal protection, Axon claimed that the combination of prosecutorial and adjudicative functions in the FTC renders all of its enforcement actions unconstitutional. Justice Thomas suggested that any administrative review scheme that allows an administrative agency to adjudicate private rights (e.g. monetary penalties that implicate the private right to property) may raise “serious constitutional issues.” He indicated that “[i]n an appropriate case, we should consider whether such schemes and the appellate review model they embody are constitutional methods for the adjudication of private rights.” The CFPB’s “appellate review model” could also face the type of constitutional challenge raised by Justice Thomas.
Legislation to opt out of a 43-year-old federal law allowing FDIC-insured state banks to “export” interest on interstate loans to the same extent as their national bank counterparts is quietly, but swiftly, working its way through the Colorado legislature. The bill has passed the House and is expected to be the subject of a hearing next week before a Senate Committee. This potentially significant change would be made by an easily-overlooked provision found at the end of a bill to modify certain terms applicable to short-term loans under the Colorado Consumer Credit Code, House Bill 23-1229. The provision explicitly states that certain provisions of the Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDA) would not apply in Colorado.
Congress enacted DIDA in the wake of the U.S. Supreme Court’s landmark decision in Marquette v. First of Omaha Service Corp., 439 U.S. 299 (1978). In Marquette, the Supreme Court held that Section 85 of the National Bank Act (NBA) authorizes a national bank to charge interest on interstate loans at rates allowed by the state where the bank is located, regardless of any conflicting laws of the state where the borrower is located. Enacted 15 months after Marquette, DIDA Section 521 gives state-chartered insured depository institutions the authority to export interest rates permitted by their home state. Binding case law created since DIDA’s enactment establishes that such authority is identical to the authority enjoyed by national banks under Marquette. See, e.g., Greenwood Trust Co. v. Mass., 971 F.2d 818, 827(a) (1st Cir. 1992), cert. denied, 506 U.S. 1052 (1993) (treating NBA Section 85 and DIDA Section 521 the same).
DIDA Section 521 expressly states that Congress’ intention in giving this authority to state banks was “to prevent discrimination against State-chartered insured banks . . . with respect to interest rates.” Nevertheless, in DIDA Section 525, Congress gave states authority to legislatively opt out of Sections 521-523 “with respect to loans made in such State.” A handful of states, including Colorado, enacted opt-out legislation shortly after DIDA went into effect. With the exception of Puerto Rico and Iowa, these states (including Colorado) have all since repealed their original opt-out legislation, or allowed it to expire.
There is some debate about the effect Colorado’s proposed legislation would have on out-of-state banks, since an opt-out would apply only to loans made in Colorado. Federal interpretations of DIDA Section 521 (codified at 12 U.S.C. 1813d) establish where a loan is made based on the parties’ contractual choice-of-law and the location where certain non-ministerial lending functions are performed, including where the credit decision is made, where the decision to grant credit is communicated from, and where the funds are disbursed. See FDIC General Counsel Opinion No. 11, 63 Fed. Reg. 27282 (May 18, 1998). Under these federal interpretations, out-of-state banks can establish controls to assure that interstate loans are made in the state where the bank is located rather than in the borrower’s state. However, because an effective opt-out establishes that DIDA Sections 521-523 do not apply to “loans made in” the opt-out state, the question would arise whether these federal law interpretations apply for purposes of determining whether a loan was made in an opt-out state. If they do not, courts in an opt-out state could determine that, even though interstate loans would be deemed made in the state where the bank is located under the federal interpretations, such loans were made in the opt-out state and, therefore, its usury laws apply.
We believe the far better conclusion is that the federal standards, which consider where certain non-ministerial functions are performed, should determine where a loan is made for purposes of whether a state’s opt-out has the effect of limiting the permissible interest rate on such loan, given that the opt-out right is established by federal law under DIDA Section 525. Although the federal standards are applied in interpreting Section 521, in accordance with the basic canon of statutory construction that the same words used in different parts of an act should have the same meaning (the presumption of consistent usage), those federal standards also should be applied to an interpretation of where a loan is “made” for purposes of Section 525.
It should be noted that because an opt-out would mean DIDA Section 521 does not apply to loans made by a state-chartered bank in the opt-out state, the FDIC’s “Madden fix” rule (which relies on the interest rate authority provided by Section 521) also would not apply. The FDIC’s rule (12 C.F.R. Section 160.110(d)) was adopted to address the uncertainty created by the Second Circuit’s decision in Madden v. Midland Funding, which held that a non-bank that purchased charged-off loans from a national bank could not charge the same rate of interest on the loans that the national bank charged under NBA Section 85. The FDIC’s rule provides that a loan made by an insured state-chartered bank that is permissible under Section 521 is not affected by the sale, assignment, or other transfer of the loan. Because they could not rely on the FDIC’s rule, buyers of loans made in an opt-out state by state–chartered banks would face uncertainty as to whether they could charge the contract rates on such loans if such rates were higher than the rates permitted by the borrowers’ states.
It should also be noted that the rate exportation authority of national banks and federal savings associations is not affected by state legislation opting out of DIDA. National banks’ rate exportation authority derives from the NBA, as discussed above; federal savings associations have exportation authority under the Home Owners’ Loan Act.
If the bill is interpreted by a Colorado appellate court to cover loans made by state banks located outside of Colorado and not allow such banks to export the rates permitted by their home states to Colorado, many of them may cease making loans to Colorado residents, thereby harming Colorado consumers who would face reduced credit availability. In addition, reduced competition might enable national banks and federal savings associations located outside of Colorado to increase the interest rates charged to Colorado residents and reduce or eliminate reward programs offered to Colorado consumers.
This Week’s Podcast Episode: A Close Look at Generative Artificial Intelligence and What It Means for the Consumer Finance Industry, With Special Guest Alex Johnson, Founder and Author of Fintech Takes Newsletter
Our discussion focuses on generative artificial intelligence, a new and emerging category of AI. We first discuss what generative AI is, its use of large language models, and the role of supervised training in developing generative AI models. We then discuss the potential benefits and limitations of generative AI in the following use cases in the consumer finance industry: marketing, fraud management, underwriting, collections, customer service, and back office functions. We conclude by discussing what additional steps are needed to expand the use of generative AI in the industry, why companies may choose to build their own AI models, expectations for how generative AI is likely to impact the industry in the coming years, and consumer use of AI.
Alan Kaplinsky, Senior Counsel in Ballard Spahr’s Consumer Financial Services Group, leads the discussion.
To listen to the episode, click here.
Did You Know?
On April 12, North Dakota Governor Doug Burgum signed into law House Bill 1068, which implements a new statutory licensing scheme in North Dakota covering residential mortgage loan servicing activities. This follows on the heels of the passage of last month’s North Dakota Senate Bill 2090, which overhauled North Dakota’s licensing requirements related to residential mortgage lending. Both licenses will be enforced by the North Dakota Department of Financial Institutions and are effective as of August 1, 2023.
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