Treasury Issues Report Proposing Changes to FSOC Designation Process

By Gordon S. Woodward

On April 21, 2017, President Trump issued a Presidential Memorandum directing the U.S. Department of the Treasury to evaluate and make recommendations on the Financial Stability Oversight Council’s (FSOC) designation process.  The FSOC is a panel consisting of the heads of U.S. financial regulatory agencies, including the Treasury, the SEC and the CFPB, which was created by the Dodd-Frank-Act of 2010 to monitor the financial system. The panel may designate nonbank firms as “systemically important financial institutions” (SIFIs), which subjects them to enhanced supervision by the Federal Reserve. The intent was to identify and monitor firms, other than big banks, whose failure could imperil the economy (large banks such as JPMorgan Chase and Goldman Sachs were automatically designated as SIFIs under Dodd-Frank).

On November 17, 2017, the U.S. Department of the Treasury responded to the April 21st Presidential Memorandum with a report proposing changes to FSOC’s designation process. Proposed changes include enhancing communication between FSOC and the companies under review. In addition, FSOC should assess the likelihood of a firm’s financial distress and conduct a cost-benefit analysis, designating a firm only if the “expected benefits to financial stability outweigh the costs of designation.” The report also calls for an “off-ramp” that companies may follow to avoid the SIFI designation.

The Treasury proposal differs significantly from the approach proposed in the Financial CHOICE Act, which the U.S. House of Representatives passed in June. That act would strip the FSOC of most of its regulatory authority, including the ability to designate nonbank financial firms as SIFIs.

As a result, the administration has signaled a middle ground approach to SIFI regulation.  The FSOC will, for the time being, survive Congress’s deregulatory push but with limitations designed to address Wall Street’s most significant concerns.

Joining a split among the circuits, the Fourth Circuit holds that the FDCPA permits debtors to dispute debts orally

By Stephen J. Shapiro

The Fair Debt Collection Practices Act (FDCPA), in § 1692g(a)(3), requires a debt collector to send a consumer from whom it is attempting to collect a debt a notice.  Among other things, the notice must state that “unless the consumer, within 30 days after receipt of the notice, disputes the validity of the debt, or any portion thereof, the debt will be assumed to be valid by the debt collector.”  The Fourth Circuit, joining a conflict among the circuits, recently held that a consumer may dispute a debt orally, and, therefore, a notice that purports to require a consumer to dispute a debt in writing violates the FDCPA.

In Clark v. Absolute Collection Service, Inc., after plaintiffs did not pay a debt they owed to a health care facility, the facility engaged the defendant debt collector to collect the debt.  The debt collector sent the plaintiffs a notice that stated that “ALL PORTIONS OF THIS CLAIM SHALL BE ASSUMED VALID UNLESS DISPUTED IN WRITING WITHIN THIRTY (30) DAYS.”  Plaintiffs, on behalf of a putative class of debtors who received such notices, sued the debt collector alleging that, because the FDCPA did not require them to dispute the debt in writing, the debt collector violated the FDCPA by sending them a notice stating otherwise.  The debt collector moved to dismiss, arguing that § 1692g(a)(3) of the FDCPA contained an “inherent” requirement that debtors dispute debts in writing.  The district court agreed and dismissed the case.

On appeal, the Fourth Circuit vacated the decision and remanded the case for further proceedings.  The Court first noted that § 1692g(a)(3) on its face does not require debtors to dispute debts in writing and declined the defendant’s invitation “to read into [§ 1692g(a)(3)] words that are not there.”  The Court noted that other sections of the FDCPA explicitly require written communications, which suggests, under standard principles of statutory construction, that Congress intended to omit such a requirement from § 1692g(a)(3).

The Court also rejected the defendant’s argument that a reading of § 1692g(a)(3) that permits consumers to dispute debts orally would be absurd and inconsistent because debtors who do not dispute debts in writing waive protections afforded them by other provisions of the FDCPA.  The Court noted that, although consumers who give oral notice of a dispute would not be entitled to invoke some of the FDCPA’s protections, those consumers would not sacrifice all of the protections in the statute.  Therefore, the Court concluded, permitting debtors to dispute a debt orally would not lead to an absurd result.

In conclusion, the Court held that “[S]ection 1692g(a)(3) permits consumers to dispute the validity of a debt orally, and it does not impose a writing requirement.”  The Court noted that its holding departed from a contrary decision by the Third Circuit, but comported with decisions by the Second Circuit and the Ninth Circuit.

CFPB releases preliminary results of arbitration study

By Christopher Reese

On December 12, 2013, the Consumer Financial Protection Bureau (CFPB) released the preliminary results of its investigation into the use of arbitration agreements in connection with consumer financial products or services. Section 1028(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 required the CFPB to conduct such an investigation and provide a report to Congress summarizing the results.  The CFPB noted that its analysis is preliminary and is subject to change as more results are received.

The preliminary report is likely just the first step toward the issuance of regulations by the CFPB prohibiting or regulating the use of arbitration clauses in agreements concerning consumer financial products and services.  Section 1028(b) of the Dodd-Frank Act permits the CFPB to impose such regulations, if it finds that they are in the public interest and for the protection of consumers based on the results of its study.

The CFPB focused its initial investigation on the use of arbitration agreements in connection with three consumer financial products and services: credit cards, checking accounts, and general purpose reloadable prepaid cards.  The CFPB noted that its investigation going forward may look at additional consumer financial products, such as student loans.  For this preliminary report, the CFPB looked only at what it called the “front-end” of disputes involving consumers – “who files these disputes, in what numbers, against whom, and about what.”  The report states that the CFPB intends to address the “back-end” in the future – “what happens, in how long, and at what cost.”  Additionally, the CFPB notes that it intends to look more deeply at consumer cases filed in federal and state courts other than small claims courts, along with additional investigation into consumer class actions.

The CFPB found that larger bank issuers of credit cards are more likely to include arbitration clauses in their credit card agreements than smaller bank issuers and credit unions.  This means that even though most issuers of credit cards do not include arbitration clauses in their credit card agreements, a majority of outstanding credit card loans are subject to arbitration agreements because issuers of large numbers of credits cards use such agreements.  The CFPB also found that larger banks tend to include arbitration clauses in their consumer checking contracts more often than do smaller banks and credit unions.  The result, again, is that even though most banks and credit unions do not include arbitration clauses in their checking account agreements, a significant percentage of insured deposits in checking accounts are subject to arbitration agreements.  As for prepaid cards, arbitration clauses are included in most agreements.

Ninety percent of the arbitration agreements reviewed by the CFPB include provisions prohibiting class arbitration, and the American Arbitration Association is the arbitration administrator most frequently selected.  Most of the arbitration agreements also contain small claims court carve-outs, which allow either party to file an action in small claims court, and thus avoid arbitration, where the disputed amount falls within the jurisdiction of the relevant small claims court.  Approximately one quarter of the arbitration agreements give consumers the option to opt out of them, and most require the consumer to opt out within either 30 or 60 days.  Very few of the arbitration agreements place time limits on the filing of claims in arbitration, while most provide disclosure to consumers of certain important differences between arbitration and litigation, such as the lack of a jury trial, limited discovery, and limited rights to appeal.

We will continue to closely monitor the CFPB’s activity in this area and will be prepared to provide analysis of any regulations the CFPB may issue based on its findings.

Consumer Financial Protection Bureau Puts Creditors on Notice of Rulemaking Under the Fair Debt Collection Practices Act

By Edward J. Sholinsky

Last week, the Consumer Financial Protection Bureau issued a news release and Advance Notice of Proposed Rulemaking that signals the Bureau’s intention to broadly exercise its claimed power under the Fair Debt Collection Practices Act to regulate creditors and debt collectors.  Most notably, the Bureau is claiming the power to regulate creditors.  Although creditors generally are exempted from liability under the Act, the 113-page Notice touches on nearly every aspect of debt collection under the Act, seeking comments on a wide variety of topics from traditional written notices to how contemporary communication technology – like social media, text messaging, and cell phones – affect debt collection practices.

Even while acknowledging that Congress specifically excluded creditors from the Act’s reach, the Bureau stated that it “believes it is important to examine whether rules covering the conduct of creditors . . . are warranted,” citing the Dodd-Frank Act as its authority for doing so.  The Bureau’s potential reach here is staggering and could impact creditors, like retailers, medical providers, and small business, which would not likely have considered themselves subject to the Bureau’s jurisdiction or the Act itself. The Bureau signaled earlier this fall that it wished to expand its reach when it claimed supervisory authority over any furnisher of information to credit agencies under the Fair Credit Reporting Act.  We discussed that bulletin in an earlier blog post.  This Notice seems to be the next step in the Bureau’s broad claim to jurisdiction over consumer creditors.

While far ranging, the Notice focuses specific attention on the adequacy of information that creditors provide to collectors and buyers of debts, and how creditors transmit that information.  The questions posed by the Bureau suggest that it is contemplating rules governing how creditors provide information to debt collectors and buyers when assigning or selling a debt and the oversight creditors have over the collection of the sold or assigned debt.  Additionally, the Bureau dedicated a section of the Notice to technology that both creditors and debt collectors and buyers can use to share information, and privacy concerns relating to that technology.

This Notice is the second signal since September that the Bureau is looking to expand its purview in the area of debt collection to creditors, who generally are considered to be outside of the reach of federal debt collection laws.

A Lower Debit Card Interchange Fee Cap is Unlikely to Eliminate Durbin Amendment Fee Increases Plaguing Small-Ticket Merchants

By Stephen J. Shapiro

The Durbin Amendment to the Dodd-Frank Act required the Federal Reserve to ensure that debit card interchange fees are “reasonable and proportional to the cost incurred by the [debit card] issuer with respect to the transaction.” Therefore, the Federal Reserve issued regulations, which became effective on October 1, 2011, that capped interchange fees on debit cards issued by banks subject to the Durbin Amendment (those with more than $10 billion in assets). Under the formula in the regulations, the interchange fee for the average debit card transaction of $40 would not exceed 24 cents, which is about half the amount that issuers had charged for the same transaction pre-regulation.

The regulations had an unintended consequence:  Merchants who sell small-ticket items actually saw their interchange fees increase. As explained in a paper by Zhu Wang, an economist at the Federal Reserve Bank of Richmond:

“Prior to the regulation, Visa, MasterCard, and most PIN networks offered discounted debit interchange fees for small-ticket transactions as a way to encourage card acceptance by merchants specializing in those transactions. For instance, Visa and MasterCard set the small-ticket signature debit interchange rates at 1.55 percent of the transaction value plus 4 cents for sales of $15 and below. As a result, a debit card would only charge a 7 cents interchange fee for a $2 sale or 11 cents for a $5 sale. However, in response to the regulation, most card networks eliminated the small-ticket discounts, and all transactions (except those on cards issued by exempt issuers) have to pay the maximum cap rate [of no less than 21 cents] set by the Durbin regulation. For merchants selling small-ticket items, this means that the cost of accepting the same debit card doubled or even tripled after the regulation.”

Shortly after the regulations went into effect, several merchant trade associations sued the Federal Reserve, arguing that the interchange fee cap was too high because the Federal Reserve did not properly implement the Durbin Amendment. Specifically, the Durbin Amendment identifies two categories of costs incurred by debit card issuers: (1) specified costs that the Federal Reserve could consider when setting the fee cap, and (2) specified costs that the Federal Reserve could not consider when setting the fee cap. In preparing the regulations, the Federal Reserve considered a third category of costs – costs not specified within either of the first two categories – and included some of those costs in the formula it used to calculate the fee cap. The merchants argued that, under the plain terms of the Durbin Amendment, the Federal Reserve only was permitted to consider costs within the first category when calculating the cap and, therefore, its inclusion of costs from the third category was improper and resulted in an inflated fee cap.

On July 31, 2013, the United States District Court for the District of Columbia agreed with the merchants and vacated the regulations in NACS v. Board of Governors of the Federal Reserve System. Among other factors that the Court offered in support of its conclusion, the Court mentioned the small-ticket merchant issue:  “By including in the interchange fee standard costs that are expressly prohibited by statute, the final regulation represents a significant price increase over pre-Durbin Amendment rates for small-ticket debit transactions . . . . Congress did not empower the Board to make policy judgments that would result in significantly higher interchange rates.”

The Federal Reserve has indicated that it intends to appeal the Court’s ruling, but assuming that the Federal Reserve eventually is required to lower the debit card interchange fee cap, the question becomes, will a lower cap fix the small-ticket merchant issue raised by the Court? Based on the analysis in Dr. Wang’s paper, probably not.

Dr. Wang explained that, pre-regulation, issuers were willing to reduce interchange fees for small-ticket transactions because those transactions acted as loss leaders. After the regulations went into effect, though, the economics no longer worked:

“Before the regulation, card networks were willing to offer discounted interchange fees to small-ticket merchants because their card acceptance boosts consumers’ card usage for large-ticket purchases from which card issuers can collect higher interchange fees. After the regulation, however, card issuers profit less from this kind of externality, so they discontinued the discounts.”

If Dr. Wang’s understanding is correct, a reduction in the interchange fee cap will not solve the small-ticket merchant problem. To the contrary, a reduction in the cap would make it even less likely that issuers will reinstate small-ticket merchant discounts because the reduced cap would further diminish the economic incentives that led issuers to offer the discounts in the first place. To be sure, lowering the fee cap will reduce the fees that all merchants – including small-ticket merchants – pay when compared to the fees changed under the existing regulations. However, fees will not return to the low levels small-ticket merchants paid pre-regulation (unless, that is, the cap for all merchants is lowered to the pre-regulation discounted rate for small-ticket merchants – a result that seems highly unlikely).

Dr. Wang’s report also exposes a potential flaw in the NACS Court’s analysis. The Court’s conclusion that the regulations did not adhere to the Congressional intent behind the Durbin Amendment because they resulted in increased interchange fees for small-ticket merchants suggests that it may have overlooked the economics upon which the small-ticket merchant discounts were based.

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