The New UDAAP: The CFPB Abusive Standard Will You Know It When You See It?

The New UDAAP: The CFPB Abusive Standard Will You Know It When You See It? BY KEVIN L. PETRASIC & AMANDA J. KOWALSKI June 2013 Earlier this month, the Consumer Financial Protection Bureau ( CFPB ) reached an agreement with a Florida debt collection company (the Company ) 1 to settle the agency s first case involving abusive acts or practices prohibited by Section 1031(d) of the Dodd-Frank Act (the DFA ). 2 The basis of the CFPB s action, set forth in its complaint, 3 and subsequent settlement agreement 4 have broad implications for entities subject to the CFPB s enforcement authority, including indicating how the regulatory landscape may be shifting with respect to consumer protection enforcement actions. Specifically, the settlement is the result of the first enforcement action brought by the CFPB to limit so-called abusive practices. Prior to enactment of the DFA, consumer protection cases similar to this (but not pursuant to the new DFA abusive standard) were within the Federal Trade Commission s ( FTC ) jurisdiction pursuant to Section 5 of the Federal Trade Commission Act ( FTCA ), 5 which has historically provided a basis to prohibit unfair or deceptive acts or practices (the so-called UDAP standard). The introduction of the abusive standard is a new development in the arena of consumer financial protection and, until now, the CFPB had offered limited insight as to the types of practices that could be deemed to be abusive. Although the definition of abusive will continue to develop, the recent CFPB settlement is an important first step to understanding the future of consumer financial protection enforcement. Terms of the Settlement Agreement Between the CFPB and the Company Pursuant to the agreement with the CFPB, the Company agreed to pay damages of $499,248 and a civil penalty of $15,000, in response to a complaint the CFPB filed in federal district court in May. 6 The complaint alleged that the Company and its president: Misled consumers by falsely promising them it would begin to settle their debts within three to six months when, in reality, services rarely materialized; Enrolled consumers despite knowing that their income level made it highly unlikely that they could complete the debt-relief programs; Collected upfront enrollment fees from consumers who the Company knew could not afford the monthly payments required by the debt-relief programs, causing the consumers to spend their savings on fees for services from which they ultimately would not benefit; and 1

Failed to settle consumers debts within the promised time, forcing many consumers to drop out of the program and forfeit their enrollment fees without having received any debt-relief services. 7 The primary focus of the CFPB s complaint with respect to the abusive standard was that the Company enrolled consumers in its debt-relief programs, knowing that the consumers were highly unlikely to be able to complete the programs based on the consumers income levels. Despite knowing the consumers could not afford the programs, the Company collected significant enrollment fees without delivering a tangible benefit to the consumers. 8 According to the CFPB, this practice is abusive under DFA 1031(d) because it takes unreasonable advantage of consumers lack of understanding of how long it will take [the Company] to settle their debts and therefore how much money they will spend before realizing any benefits from the debt-relief program. 9 Additionally, consumers reasonably rel[ied] on the Company to act in their best interest by enrolling them in a debt-relief program they could reasonably be expected to complete, and by settling their debts as soon as possible. 10 These claims were the cornerstone of the CFPB s abusive practices claim and emphasized the agency s focus on fairness to consumers in applying the new abusive standard. The settlement also addressed the Company s unfair and deceptive acts and practices, as well as certain violations of the FTC s Telemarketing Sales Rule. 11 Traditional UDAP Authority for the FTC and Federal Banking Agencies Historically, laws, regulations, and related agency guidance setting forth UDAP restrictions have provided the framework for regulating consumer protection issues. Federal and state regulators and State Attorneys General traditionally have had the authority to bring UDAP claims against companies in various industries. The FTC had, and retains after the DFA, UDAP jurisdiction over certain nonbank entities, and the federal banking agencies ( FBAs ) had, and retain, UDAP enforcement authority over small insured depository institutions. 12 The DFA, in creating the CFPB, added a new regulator with exclusive rule writing, as well as supervisory and enforcement authority with respect to UDAP, and now with the addition of the abusive component, with respect to the scope and application of the new UDAAP standard. With respect to nonbanks now subject to the CFPB s jurisdiction, Section 5 of the FTCA has long been the primary mechanism for enforcing unfair and deceptive practices. FTCA 5 provides that an unfair act or practice is conduct that outweighs countervailing benefits to consumers or to competition, 13 while a deceptive act or practice is one that affirmatively misleads a consumer. 14 The FTC has clarified these definitions over years of regulation and enforcement, in part, working with the FBAs, and the standards are familiar within the consumer financial services industry. Previously, a consumer protection case such as this would have been brought pursuant to the FTC s UDAP enforcement authority, which, until DFA 1031(d), did not include an abusive element. The CFPB s expanded unfair, deceptive, or abusive acts or practices or UDAAP authority adds a new wrinkle to the existing scope of consumer protection authority. Specifically, the DFA expanded the CFPB s role by giving the agency the authority to define the basis for bringing claims challenging abusive practices and the UDAAP standard, generally. In describing the scope of the CFPB s authority, the DFA includes the UDAP standards set forth in the FTCA. In particular, the DFA defines an unfair practice as one that (i) causes or is likely to cause substantial injury, (ii) cannot be reasonably avoided and (iii) the injury is not outweighed by any benefits. 15 The deceptive component is not defined in the DFA; however, the CFPB has indicated that it plans to use 2

similar standards to those implemented pursuant to the FTCA. 16 While unfair and deceptive are well-developed concepts for the CFPB, the abusive component is new, relatively uncertain, and, until now, not defined by precedent, regulatory implementation or other agency guidance. Interestingly, while the CFPB and FTC have overlapping jurisdiction with respect to UDAP enforcement against nonbank entities, the FTC does not have the same explicit authority as the CFPB has to bring enforcement actions to limit abusive acts or practices. The New Abusive Standard Under the DFA The DFA prohibits abusive acts or practices in the consumer financial marketplace. Section 1031(d) of the Dodd-Frank Act provides, in part, that an act or practice is abusive if it: (i) materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service, or (ii) takes unreasonable advantage of... (a) a lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service; (b) the inability of the consumer to protect the interests of the consumer in selecting or using a consumer financial product or service; or (c) the reasonable reliance by the consumer on a covered person to act in the interests of the consumer. 17 This standard has drawn criticism for being vague and the CFPB has declined to provide additional clarification on what it would view as abusive conduct. Thus, the recent CFPB case is an important clarification for industry participants who have operated, until now, with little guidance as to what might constitute an abusive act or practice. The legislative history of the DFA indicates that the abusive standard was intended to focus on harm to consumers. As one commentator noted, during Congressional deliberations on the DFA, the definition of abusive evolved from a requirement of injury to consumers that could threaten market stability to simply a requirement focused entirely on preventing injury to consumers even when there was no risk to market stability. 18 While there is limited legislative history discussing the scope of the abusive standard, there have been several indications to date regarding how the CFPB views and may use its authority. In a hearing before the House Financial Services Committee, CFPB Director Richard Cordray acknowledged that acts and practices may be abusive without being unfair, 19 and stressed the reasonableness factor relevant to the abusive standard. Director Cordray noted that [abusive is] a facts and circumstances test, and that most good businesses recognize an abusive practice when they see one. 20 The CFPB Examination Handbook also includes procedures and considerations related to identifying and dealing with potentially abusive practices in the consumer financial protection context. 21 The Handbook notes that [a]lthough abusive acts also may be unfair or deceptive, examiners should be aware that the legal standards for abusive, unfair, and deceptive each are separate. 22 Aside from this limited guidance, while reasonableness is an important factor and abusive is a separate standard from unfair or deceptive, there has been little else to rely upon in determining what the CFPB may view as abusive. Moving forward, all we know is that if someone a person or a company takes unreasonable advantage of a consumer in certain ways or interferes with a consumer s ability to understand a term or condition of a financial product or service, the CFPB may take action. 23 3

Implications for the Consumer Financial Services Industry The recent CFPB case is significant because it is the CFPB s first use of its authority to enforce allegedly abusive acts or practices. Additionally, the case sets the tone for an increasingly active regulatory environment with respect to consumer financial protection issues. Given the number of federal and state regulators with the authority to enforce UDAP laws and regulations, and now acts and practices triggering the new abusive standard, it is likely that there will be increasing overlap among regulators concerned with consumer financial protection. The CFPB settlement provides several important lessons for consumer financial services industry participants: The expanded scope of authority may result in a more active regulatory environment. In adding the abusive standard to the previously existing UDAP enforcement areas, Congress has identified an additional discrete area of enforcement. This will likely mean increased enforcement activity as the CFPB seeks to develop its new authority. Given the increased overlap between the regulatory agencies jurisdictions, regulators may take action to preserve their consumer protection authority. As discussed above, the FBAs and the FTC retain their UDAP enforcement authority (and expanded UDAAP authority, where applicable), in addition to the CFPB s new authority. The agencies may try to preserve and expand this authority by staking their claims to particular areas of consumer financial protection enforcement. This case is only the first to indicate the types of practices the regulators may consider abusive. There will likely be more guidance and/or enforcement actions that further delineate the scope of abusive in the future. Additional guidance will continue to hone the scope of the CFPB s and other regulators consumer financial protection authority. Finally, as noted by one commentator, it is possible that the CFPB could use its expanded abusive standard authority to actively manage certain types of consumer financial products and services, as well as to eliminate consumer financial products and services it views as dangerous. 24 While the recent CFPB settlement involves a debt-relief company, it is important to note that the CFPB has authority to enforce UDAAP restrictions with respect to various other nonbank entities, as well as on large depository institutions. The CFPB has indicated that it is working to ensure federal consumer financial laws are being followed at every stage of the process and is focusing not only on debt-relief companies, but also on those who facilitate their unlawful conduct and who may also violate federal consumer financial laws. (Emphasis added). Clearly, it is now crucial for all industry participants to be cognizant of their activities, as well as the types of acts and practices that are subject to the CFPB s (and other agencies ) implementation and enforcement of the new UDAAP standard. Conclusion The CFPB s recent settlement has broad implications for the future scope of consumer financial protection authority. In addition to setting forth perhaps the most detailed explanation of what may constitute an abusive practice to date, the case is also notable with respect to the CFPB s demonstration of its expanded UDAAP enforcement authority. As such, the recent agency action signals the potential for increased consumer protection activity across both federal and state 4

regulatory agencies. It is important for nonbank entities within the CFPB s jurisdiction to understand and continue to closely monitor the CFPB s enforcement activities, as well as any potential rulemakings, related to its expanded UDAAP authority. We expect that the scope and application of such authority will continue to evolve, and following the CFPB s (and other agencies ) developments will help consumer financial industry participants identify and mitigate areas of risk. Paul Hastings lawyers are actively assisting clients with a variety of matters involving the application of federal and state consumer financial protection laws, as well as issues related to ensuring that the offer and sale of consumer financial products and services do not pose potential risks related to unfair, deceptive, abusive, or fraudulent acts or practices for a financial services firm. Our lawyers are available to address any questions or issues regarding these potential risks, as well as to assist you regarding establishing and maintaining your consumer financial protection compliance programs. If you have any questions concerning these developing issues, please do not hesitate to contact any of the following Paul Hastings lawyers: Atlanta Chris Daniel 1.404.815.2217 chrisdaniel@paulhastings.com Heena A. Ali 1.404.815.2393 heenaali@paulhastings.com Todd W. Beauchamp 1.404.815.2154 toddbeauchamp@paulhastings.com Kevin Erwin 1.404.815.2312 kevinerwin@paulhastings.com Diane Pettit 1.404.815.2326 dianepettit@paulhastings.com Palo Alto Cathy S. Beyda 1.650.320.1824 cathybeyda@paulhastings.com San Francisco Thomas Brown 1.415.856.7248 tombrown@paulhastings.com Stanton R. Koppel 1.415.856.7284 stankoppel@paulhastings.com Kristin M. Hall 1.415.856.7071 kristinhall@paulhastings.com Samuel Zun 1.415.856.7206 samuelzun@paulhastings.com Washington, D.C. V. Gerard Comizio 1.202.551.1272 vgerardcomizio@paulhastings.com Behnam Dayanim 1.202.551.1737 bdayanim@paulhastings.com Kevin L. Petrasic 1.202.551.1896 kevinpetrasic@paulhastings.com Erica Berg-Brennan 1.202.551.1804 ericaberg@paulhastings.com Lawrence D. Kaplan 1.202.551.1829 lawrencekaplan@paulhastings.com Ryan A. Chiachiere 1.202.551.1767 ryanchiachiere@paulhastings.com Michael A. Hertzberg 1.202.551.1797 michaelhertzberg@paulhastings.com Amanda Jabour Kowalski 1.202.551.1976 amandakowalski@paulhastings.com Helen Y. Lee 1.202.551.1817 helenlee@paulhastings.com 5

1 See CFPB Press Release, available at http://www.consumerfinance.gov/pressreleases/cfpb-takes-action-to-stop-floridacompany-from-engaging-in-illegal-debt-relief-practices/. 2 Codified at 12 U.S.C. 5531(d). 3 A copy of the CFPB complaint ( Complaint ) is available at http://files.consumerfinance.gov/f/201305_cfpb_complaint_adss.pdf. 4 See Case No. 9:13-cv-80548-DMM (USDC, SD-FL) (June 7, 2013), available at http://files.consumerfinance.gov/f/201306_cfpb_finalorder_adss_signed-judgment.pdf. 5 15 U.S.C. 45. 6 See supra, n. 3. 7 See Complaint, supra n. 3. 8 Id. at 14-15. 9 Id. at 15. 10 Id. 11 16 C.F.R. Part 310. 12 In addition, the FBAs have backup enforcement authority over large (i.e., assets greater than $10 billion) insured depository institutions. DFA 1025(c)(3). 13 See 15 U.S.C. 45(n). 14 See Rebecca Schonberg, Introducing Abusive : A New and Improved Standard for Consumer Protection, 100 Cal. L. Rev. No. 5, 1401 (Sept. 27, 2012). 15 DFA 1031(c), codified at 12 U.S.C. 5531(c). 16 The CFPB Supervision and Examination Manual references the FTC Act definitions for the terms unfair and deceptive. 17 12 U.S.C. 5531(d)(1) and (2). 18 See Rebecca Schonberg, Introducing Abusive, supra n. 14. 19 During the hearing, Director Cordray offered the example of a lender persuading an 80-year-old widow who had nearly paid off her mortgage to refinance her home with an exotic loan. He noted that if the same loan were offered to a sophisticated consumer, it might not be abusive. See Testimony of Richard Cordray before the House Committee on Financial Services (Mar. 29, 2012). 20 See Testimony of Richard Cordray (Mar. 29, 2012). 21 See CFPB Supervision and Examination Manual at Procedures 6 ( [RESPA] protects borrowers against certain abusive practices, such as kickbacks. ). 22 See CFPB Manual at UDAP 9. 23 See CFPB Press Release dated May 30, 2013. 24 See supra, n. 18. Paul Hastings LLP www.paulhastings.com StayCurrent is published solely for the interests of friends and clients of Paul Hastings LLP and should in no way be relied upon or construed as legal advice. The views expressed in this publication reflect those of the authors and not necessarily the views of Paul Hastings. For specific information on recent developments or particular factual situations, the opinion of legal counsel should be sought. These materials may be considered ATTORNEY ADVERTISING in some jurisdictions. Paul Hastings is a limited liability partnership. Copyright 2013 Paul Hastings LLP. IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations governing tax practice, you are hereby advised that any written tax advice contained herein or attached was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code. 6