Consumer Financial Services Alert - March 19, 2013 March 19, 2013
In This Issue

CFPB Issues Rule to Define “Larger Participants” of the Student Loan Servicing Market

In alignment with its recent focus on the student loan market (see January 10, 2013 Alert), the CFPB announcedproposal to include certain student loan servicers of both Federal and private student loans as "larger participants" subject to its supervision. Under the Dodd-Frank Act, the CFPB has the authority to supervise nonbank "larger participant[s] in markets for other consumer financial products or services." The CFPB has already finalized rules defining "larger participants" of the debt collection and consumer reporting markets (see November 13, 2012 Alert and July 24, 2012 Alert, respectively).

The proposal establishes a test to determine whether a nonbank entity is a "larger participant" of the student loan servicing market. An entity with an "account volume" that exceeds one (1) million will be considered a "larger participant" of the student loan servicing market. "Account volume" is the number of accounts with respect to which a nonbank entity performs student loan servicing, which includes receiving any scheduled periodic payments from a borrower, maintaining account records and communicating with the borrower on behalf of loan holders, as well as interactions with borrowers such as collection and processing of loan payments. The CFPB defines interactions with borrowers broadly to include any interaction with a borrower to facilitate receiving or making of payments or maintaining of account records, such as activities designed to help delinquent borrowers avoid or prevent default. The proposed account volume threshold would ultimately give the CFPB supervisory authority over the 7 largest student loan servicers which are responsible for approximately 71% to 94% of the activity in the student loan servicing market.

FRB-OIG Workplan Includes Evaluation of CFPB’s Use of Enforcement Attorneys During Examination Process

The Office of the Inspector General for the FRB and the CFPB recently updated its Work Plan (see October 16, 2012 Alert), which generally outlines the OIG’s initiatives and priorities to assist the FRB and the CFPB in fulfilling their responsibilities. Of particular import, the OIG noted that it is currently evaluating the CFPB’s practice of using enforcement attorneys in its examinations. Such practice has already been called into question previously by the CFPB Ombudsman. In its first annual report, the CFPB Ombudsman recommended that the CFPB review this practice, which has been a cause for concern among consumer financial service providers (see December 11, 2012 Alert). The OIG plans to assess the risks associated with the CFPB’s practice and the effectiveness of any safeguards the CFPB has put in place to mitigate those risks. The OIG anticipates completing its evaluation in the second quarter of 2013.

CFPB Issues Preliminary List of Rural and Underserved Areas

In anticipation of the June 1, 2013 effective date of the rule on escrow requirements for higher-priced mortgage loans under Regulation Z (see January 22, 2013 Alert), the CFPB released a preliminary list of rural and underserved areas. Under the escrows rule, creditors are required to establish and maintain escrow accounts for at least 5 years after originating a higher-priced mortgage loan. However, small creditors meeting certain conditions and operating in predominately rural or underserved areas are exempt from the escrow requirements. "Rural" counties are determined using the United States Department of Agriculture Economic Research Service’s urban influence codes; whereas "underserved" counties are determined by reference to the data collected under the Home Mortgage Disclosure Act. Small creditors meeting certain conditions and operating in predominately rural and underserved areas are also exempt from certain requirements in the ability-to-repay rule and qualified mortgage standard (see January 10, 2013 Alert), the rule on appraisals for higher-priced mortgage loans (see January 22, 2013 Alert), and the HEOPA rule; all of which are effective in January 2014. The list of rural and underserved areas will be updated yearly.

Senate Committee Votes to Recommend Richard Cordray as Director of the CFPB

Despite the contentious confirmation hearing, the Senate Committee on Banking, Housing, and Urban Affairs voted to recommend Richard Cordray as Director of the CFPB. Mr. Cordray has served as acting director since his recess appointment in January 2012, but was re-nominated to obtain Senate consent before the recess appointment expires at the end of 2013. Shortly after Mr. Cordray’s re-nomination, the United States Court of Appeals for the District of Columbia Circuit called into question the constitutional validity of President Obama’s "recess" appointments. In Canning v. Nat’l Labor Rel. Brd., 705 F.3d 490 (Fed. Cir. 2013), the Federal Circuit held that the recess appointments of three members of the National Labor Relations Board was unconstitutional (see February 5, 2013 Alert). The Federal Circuit’s ruling could have implications for Mr. Cordray’s initial appointment as Director of the CFPB as he was appointed along with the members of the NLRB and his appointment has been challenged on similar constitutional grounds (see June 26, 2012 Alert).

Similar to past concerns raised, at the confirmation hearing, Senator Mike Crapo of Idaho expressed concerns that the CFPB was subject to inadequate Congressional oversight and noted that the Canning decision should also apply to Mr. Cordray. Prior to the hearing, Representative Jeb Hensarling, Chairman of the House Financial Services Committee, wrote a letter to the FRB questioning whether the CPFB could be lawfully funded without a lawfully appointed director at the helm to request the funds.

CFPB Will Hold Field Hearing on Consumer Complaint Database

The CFPB’s Office of Consumer Response will hold a field hearing on its consumer complaint database in Des Moines, Iowa on March 28, 2013. Last year, the CFPB launched the searchable consumer complaint database, which allows individuals to search for credit cards complaints filed against supervised entities (see June 26, 2012 Alert).

OCC, FRB and FDIC Release Proposal to Update Interagency Questions and Answers Regarding Community Reinvestment

In conjunction with the OCC and FDIC, the FRB announcedproposal to update the Interagency Questions and Answers Regarding Community Reinvestment. The proposal seeks to revise 5 questions and answers that address (1) community development activities outside institutions’ assessment areas, (2) additional ways to determine whether recipients of community services are low- or moderate-income and (3) providing a community development service by serving on the board of directors of a community development organization. For example, the proposal would clarify that community development activities in the broader statewide or regional area will be considered in the evaluation of an institution’s CRA performance. The proposal also seeks to add 2 new questions relating to qualified investments and community development lending in the lending test applicable to large institutions. Comments must be received by May 17, 2013.

FTC Releases Report and Recommendations for Mobile Payments Industry

Following up on a workshop conducted in April 2012, and a report on mobile privacy disclosures issued earlier this year (see February 5, 2013 Alert), the FTC issued a report specific to the mobile payments industry. The report, "Paper, Plastic… or Mobile? An FTC Workshop on Mobile Payments," focuses primarily on three topics: (1) dispute resolution, (2) data security and (3) privacy. For example, the report urges incorporation of "privacy by design" concepts into all elements of product development, such as enabling consumer choice in privacy settings, and ensuring disclosures and system protections are commensurate with the function at issue. The report also expresses specific concerns related to the relatively lightly regulated arena of mobile carrier billing, noting that a separate roundtable on the issue is being organized by the FTC, while applauding contractual protections that some companies voluntarily provide to their customers. While the report briefly addresses these overarching issues—dispute resolution, consumer data security and privacy—according to the FTC, the issues highlighted are areas for continued monitoring and attention.

FTC Releases Guidance on Disclosures for Digital Advertising

The FTC issued new guidance, .com Disclosures: How to Make Effective Disclosures in Digital Advertising, to update its previous guidance published in 2000, Dot Com Disclosures, to address mobile and other online advertising. The updated guidance is designed to address the increased use of smartphones and the rise of social media marketing by explaining how to make disclosures clear and conspicuous to avoid deception and violating federal consumer protection laws. The FTC Act—which generally prohibits unfair or deceptive practices or acts—"broadly covers advertising claims, marketing and promotional activities and sales practices in general," according to the FTC. The updated guidance generally provides that advertisers should ensure disclosure is clear and conspicuous on all devices and platforms that consumers may use to view advertising. Key elements of the updated guidance include: (1) recommending the placement of required disclosures as close as possible to the triggering claim, (2) avoiding the necessity of scrolling by consumers to find the disclosure, (3) similar to the prior guidance, suggesting that advertisers avoid using hyperlinks for disclosures that involve product cost and (4) cautioning against providing necessary disclosures through pop-ups. The updated guidance also provides several examples for providing appropriate disclosures to assist advertisers.

FRB of Philadelphia Hosted Seminar on UDAP

The Federal Reserve Bank of Philadelphia hosted a consumer compliance seminar focused on unfair and deceptive acts or practices. In addition to providing a summary of the UDAP legal authority and examination framework, the seminar included a discussion of case studies and the risks faced by bank holding companies. For example, the seminar focused on the practice of bank underwriter’s misrepresenting consumers’ income, assets and debts to meet purchaser guidelines and practices related to automated overdraft programs. Areas of emerging UDAP risks were also identified to include, among other things, time-barred debt collection, servicing practices and third party vendor management. The seminar provided recommendations for the implementation of an effective UDAP program. For example, internal reviews incorporating UDAP reviews into the life cycle of a product or service and reviews of loan officer compensation practices were recommended.

FTC Settles with Payment Processer

The FTC announcedsettlement with a payment processor resolving an action brought by the FTC alleging that the payment processor violated the FTC Act by debiting millions of dollars from consumers’ bank accounts without their consent. The FTC’s complaint alleged that the payment processor: (1) encouraged its customers to utilize remotely created payment orders because they were not subject to the same level of scrutiny and oversight as ACH transactions, (2) failed to take reasonable steps to ensure that it was not debiting consumers’ accounts without their consent despite being on notice through high return rates and consumer complaints that debits were fraudulent and (3) instructed its customers on methods of avoiding detection to conceal its fraudulent and unauthorized debiting.

The settlement requires the payment processor to pay monetary relief and permanently bars the payment processor, as well as two of its officers, from engaging in payment processing in the future or referring its clients to other processors for money. Of import to the FTC’s action against the payment processor was the relationship and activities with two merchants that marketed reloadable prepaid cards. The merchants were under prior FTC orders resulting from, among other things, debiting consumers’ accounts without authorization. The FTC noted that the two merchants had consistently high return rates of 85% and 86%, compared to an average industry total return rate for ACH transactions of 1.5%. The FTC also noted that the specific reasons for the high return rates (e.g., "not authorized," "NSF," and "bad account") were indicative of fraud and unauthorized debiting.

First Circuit Holds Bank Not Required to Comply with State UCC Provision

The United States Court of Appeals for the First circuit affirmed a district court ruling that proper notice of sale was given under the Florida Uniform Commercial Code. Plaintiff brought an action against a lender challenging the repossession and sale of his property under the Florida UCC. In particular, plaintiff claimed that because the notice of sale was deficient, the lender was prohibited from collecting a deficiency judgment. Plaintiff’s challenge was based on the fact that the notice of sale provided by the lender did not provide the time and date of the sale as required under the terms of the mortgage. The district court granted summary judgment in favor of the lender and plaintiff appealed.

In affirming the lower court’s ruling, the First Circuit considered 2 different provisions of the mortgage instrument. The first provision, on which plaintiff relied, required 10 days’ advance notice of the time and place of sale. The second provision, cited by the lender, allowed the lender to exercise any "rights, privileges and remedies granted by applicable law"—in this instance the Florida UCC, which did not contain a 10-day notice requirement of the time and place of sale. The First Circuit recognized that this second provision was not related to or overlapping with the first, and constituted a separate remedy that was not constrained by the requirements of the first provision. The First Circuit noted that the mortgage’s plain terms favored the lender. In particular, the mortgage stated in the section on rights and remedies that if any default occurred, "the mortgagee may, at its option, do any one or more of the [seven rights and remedies, including the provision relied upon by the lender]." The lender had "seven distinct options and could elect to employ a single one…or a combination." As a result, the First Circuit upheld the district court’s granting of summary judgment in favor of the lender.

Eighth Circuit Affirms Rejection of Show-Me-the-Note Theory

The United States Court of Appeals for the Eighth Circuit rejected another action premised upon the largely discredited "show-me-the-note" theory of challenging foreclosures, and imposing sanctions against an attorney who continued to pursue the defunct theory. In the underlying case, plaintiffs, a group of mortgage loan borrowers, asserted claims for quiet title and slander of title after their mortgagee, defendant, initiated foreclosure proceedings under Minnesota’s non-judicial foreclosure statute. Plaintiffs claimed the foreclosure proceedings were invalid because the mortgagee lacked legal title to their mortgage. The district court dismissed the suit and imposed sanctions on plaintiffs’ counsel.

Highlighting its increasing impatience for such suits, the Eight Circuit affirmed the district court’s dismissal because it was based on the flawed "show-me-the-note" theory—a theory which had been already repudiated several times by the Eighth Circuit (see September 5, 2012 Alert). The Court also found the borrowers’ slander of title claim equally flawed—that claim was based on the theory that recorded foreclosure notices and mortgage assignments incorrectly identified the holder of their mortgages. The Court held the claim could not survive because slander of title requires a showing of malice, and the pleadings contained nothing but "naked assertions" that defendants lacked legal title to the mortgages. Notably, the Eighth Circuit admonished plaintiffs’ counsel for "the duplication of the claims" rejected in another case filed by the same counsel, Murphy v. Aurora Loans Servs., LLC, 699 F.3d 1027 (8th Cir. 2012), also based on the "show-me-the-note" theory. A fact which made counsel’s conduct "all the more egregious." Equally contributing to the imposition of sanctions by the Court was counsel’s "trite attempts to avoid federal court by engaging in "fraudulent joinder."

Massachusetts State Court Holds Zip Code Constitutes Personal Identification Information under Consumer Protection Statute

The Massachusetts Supreme Judicial Court held that zip codes are "personal identification information" under a Massachusetts consumer privacy statute which governs, among other things, credit card and check transactions. Plaintiff filed a putative class action in federal court alleging that, in violation of the Massachusetts consumer privacy statute, defendant requested and then electronically recorded her zip code as part of a credit card transaction. The federal court certified 3 questions to the Supreme Judicial Court, including whether: (1) a zip code could constitute "personal identification information" under that statute; (2) a plaintiff had to be a victim of identity fraud in order to have a claim under the statute and (3) the statute only applied to paper transactions and not electronic ones.

The Court found that the statute’s principal purpose was to safeguard consumer privacy in credit card transactions, and its definition of "personal identification information" left open the possibility that a zip code could qualify as such; although the statute defined "personal identification information" as a credit card holder’s address and telephone number, that definition was explicitly non-exhaustive, and the Court noted that combining a consumer’s zip code with other information collected through publicly available databases could enable the merchant to derive that consumer’s name or address. The Court also held that a plaintiff need not be an identity fraud victim in order to bring an action under the statute, which was intended to do more than simply protect consumers from identity theft, and that either an electronic or paper credit card transaction could form the basis for a valid claim.

House of Representatives Passes Bill Eliminating Annual Privacy Notice Requirement for Financial Institutions

The House of Representatives has passed a bill, the Eliminate Privacy Notice Confusion Act, 113 H.R. 749, that amends Section 503 of the Gramm-Leach-Bliley Act—which governs, among other things, certain annual privacy disclosures—to create an exception for financial institutions subject to the Act to provide an annual privacy notice to consumers. Under the bill, financial institutions would be excluded from the annual notice requirement if the financial institution: (1) provides nonpublic personal information pursuant to the limited exception for nonaffiliated third parties that perform services for or functions on behalf of the financial institution and the general exceptions under the Act; and (2) has not changed its policies and practices with regard to disclosing nonpublic personal information that was provided in the most recent annual privacy disclosure sent to consumers. In addition, the bill would exclude financial institutions from the annual privacy notice requirement until the financial institution ceases to comply with exceptions referenced above.