Financial Regulatory Report - Updates and insights on issues in financial services regulation, compliance, enforcement and litigation

This posting was written by John R. Mussman.

On April 18, 2012, the Consumer Financial Protection Bureau (the “Bureau”) issued Bulletin 2012-04, announcing its approach to evaluating discrimination under the Equal Credit Opportunity Act (“ECOA”) and its implementing regulation, Regulation B. There were no surprises, as the CFPB reaffirmed the position taken previously in the 1994 Policy Statement on Discrimination in Lending (“Policy Statement”) by 10 federal banking agencies, the FTC, and the Justice Department, and in Regulation B and the Federal Reserve Board Staff Commentary on Regulation B. See Interagency Task Force on Fair Lending, Policy Statement on Discrimination in Lending, 59 Fed. Reg. 18266 (Apr. 15, 1994).   ECOA prohibits discrimination based on race, color, religion, national origin, sex, marital status, age (assuming the applicant can enter into a contract), receipt of public assistance program income, or the exercise of rights under the Consumer Credit Protection Act in every aspect of the credit process, including advertising, in the taking of applications and in credit underwriting.

Under the Dodd-Frank Act, Congress granted the Bureau authority to supervise and enforce ECOA as to lenders within the Bureau’s jurisdiction and to issue regulations and guidance under ECOA. In the Bulletin, the Bureau noted the methods identified in the Policy Statement that could be used to prove discrimination under ECOA:

• Overt evidence of discrimination

• Evidence of disparate treatment

• Evidence of disparate impact

In applying the disparate impact approach, the Bureau adopted the “effects test,” relied on by the Federal Reserve Board in Regulation B, which was originally adopted by the U.S. Supreme Court in two employment discrimination cases, Griggs v. Duke Power Co. and Albermarle Paper Co. v. Moody. In the Bulletin, the Bureau explained the effects test by citing the Federal Reserve Board Official Staff Commentary, indicating that discrimination may be established if an applicant can demonstrate that the

creditor practice … is discriminatory in effect because it has a disproportionately negative impact on a prohibited basis, even though the creditor has no intent to discriminate and the practice appears neutral on its face, unless the creditor practice meets a legitimate business need that cannot be achieved as well by means that are less disparate in their impact.

The effects test has been used by the Federal Reserve Board to explain how a variety of underwriting practices, including certain uses of credit scores, may violate ECOA, and has been used in a variety of challenges to certain credit underwriting practices.

In its Bulletin, the Bureau noted that it will also utilize the evaluative approach set forth in the Policy, including those covering disparate impact, in its ECOA Examination Procedures, Mortgage Origination Examination, and Mortgage Servicing Examination Procedures.

The Bureau’s adoption of positions that other federal agencies had already staked out is not insignificant. The Bulletin reflects that lenders covered by the expanded laundry list of entities under the authority of the Bureau will be subject to the regulatory definition of credit discrimination that has developed under the Policy. Moreover, the reaffirmation of the effects test in determining “credit discrimination” means that prudent lenders will need to continue to scrutinize their marketing strategies and underwriting criteria, not only to make sure that they are not demonstrably discriminatory on their face, but also to make sure that they have no inadvertent discriminatory effect on a protected class under ECOA and, if so, that there is no less discriminatory marketing or underwriting solution that can achieve the same results.

John R. Mussman is a member of the Financial Services Regulatory Group at Reed Smith LLP, resident in the firm’s Chicago office. John represents banks and other financial institutions, focusing on banking, corporate, and consumer credit law.

This posting was written by Michael E. Bleier.

On Friday, May 4, Michael Bleier will be making a presentation at the Annual Meeting in Washington, DC of the Lawyers Council for the Financial Services Roundtable. He will be talking about his observations regarding the role of General Counsel for a major financial services provider, in his case over the 14 years he was General Counsel for Pittsburgh's Mellon Financial Corporation.

Michael E. Bleier joined Reed Smith after serving for nearly 14 years as General Counsel for Mellon Financial Corporation and Mellon Bank, NA, and as manager of legal affairs. Prior to joining Mellon in 1982, he was in the Legal Division of the Federal Reserve Board in Washington, DC for 11 years; when he left the Federal Reserve he was Assistant General Counsel, responsible for the bank holding company area. At Reed Smith he has counseled General Counsel clients, filed expansion applications with the Federal Reserve, the Comptroller of the Currency and the FDIC, and also advised financial institution clients on an array of regulatory matters.

This post was written by Lauren A. Abbott.

On March 26, 2012, the Consumer Financial Protection Bureau (“CFPB”) filed an amicus curiae brief in Rosenfield v. HSBC Bank, USA, et al. in the United States Court of Appeals for the 10th Circuit in support of the consumer-appellant, arguing that courts have not correctly interpreted the federal Truth-in-Lending Act (“TILA”) regarding how long a consumer has to rescind a mortgage loan. This brief is the first of four briefs that the CFPB intends to file in the appellate courts regarding this issue, which is being litigated in 10 separate appeals in four jurisdictions.

Existing Law

Section 1635(a) of TILA provides a consumer with the right to rescind certain qualifying mortgage transactions within three business days of the loan closing by notifying his or her mortgage lender of the intent to rescind the loan. 15 U.S.C. § 1635(a). In addition, TILA provides that a consumer will have up to three years after the mortgage loan closing by which to notify his or her lender of the consumer’s intent to rescind the mortgage loan, if the mortgage lender fails to provide the consumer with notice of the consumer’s right to rescind a mortgage loan and/or with the material terms of the mortgage transaction. Section 1635(f) of TILA expressly provides that:

[a]n obligor's right of rescission shall expire three years after the date of consummation of the transaction or upon the sale of the property, whichever occurs first, notwithstanding the fact that the information and forms required under this section or any other disclosures required under this chapter have not been delivered to the obligor . . .

15 U.S.C. § 1635(f).

In Rosenfield, the trial court granted defendant HSBC’s motion to dismiss because it found that the borrower did not file her lawsuit within three years of her mortgage loan closing. In doing so, the district court followed the majority of district courts, two appellate circuit courts, as well as the United States Supreme Court, in holding that a consumer’s desire to rescind a mortgage transaction “must both be noticed and (if ignored or rejected by the lender) sued upon within three years.” See CFPB Brief pg. 8 citing Beach v. Ocwen Federal Bank, 523 U.S. 410 (1998). The district court noted that Beach was not directly on point because, unlike the borrower in Rosenfield, who gave timely notice of her intent to rescind to HSBC, the borrower in Beach did not. CFPB Brief pg. 8. In issuing its ruling granting HSBC’s motion to dismiss, the district court held that the right of rescission must be “coterminous” with the filing of a lawsuit. Id.

In its brief, the CFPB cited only three district court cases that have held that section 1635 of TILA only limits the time period in which a consumer must provide notice to the lender, and in no way impacts the time frame for filing a lawsuit. However, the ruling in one of those district court cases, Barnes v. Chase Home Fin., LLC, No. 11-cv-142, 2011, WL 4950111 (D. Or. 2011), appears to be inconsistent with its controlling appellate court (the 9th Circuit).

CFPB’s Position

The CFPB argues that section 1635 of TILA does not require consumers to both provide notice to their lender of their intent to rescind a mortgage transaction and to file a lawsuit against the lender to recognize that the consumer has exercised the right of rescission within the three-year time period. The CFPB suggests that “[t]he timeliness of the consumer’s lawsuit is entirely independent of the timeliness of the consumer’s exercise of the right to rescind.” CFPB Brief pg. 18.

The CFPB argues that by requiring a consumer to file a lawsuit within the three-year time frame, it forces the rescission process into litigation that, according to the CFPB, should only occur when the lender does not acknowledge a consumer’s notice of intent to rescind. While the CFPB does not suggest a time frame to file a lawsuit, footnote 4 suggests that consumers could be provided “one year from the lender’s refusal to unwind the transaction after receiving the notice of rescission.” CFPB Brief pg. 24 (internal citations omitted). Presumably this suggests that a consumer should file the lawsuit within a year after the 20-day period prescribed in section 1635(b) of TILA passes without the rescission being acknowledged.

Implications

By requiring consumers to both provide notice to their lenders of their intent to rescind the loan and to file a lawsuit within the three-year period prescribed in section 1635(f), TILA provides certainty to both parties regarding enforceability of the loan.

Should the CFPB prevail in its argument that a consumer should not have to file a lawsuit within the three-year time period of section 1635(f) of TILA, the CFPB will have arguably succeeded in overturning a Supreme Court decision without having to revise Regulation Z through the regulatory review process, and thereby changing the landscape for how a court should interpret the rescission period of Regulation Z.

Lauren A. Abbott is an associate in the Financial Services Regulatory Group at Reed Smith LLP, resident in the firm’s Philadelphia office. Ms. Abbott is formerly an assistant counsel with the Pennsylvania Department of Banking, and regularly advises clients on bank regulatory and financial services litigation matters.

This post was written by Mark F. Oesterle.

Section 619 of the Dodd-Frank Act (“Act”), otherwise known as the “Volcker Rule (the “Rule”),” contains some of the most wide-sweeping and controversial provisions of the entire law. Basically, the Rule places restrictions on the proprietary trading and investment activities of insured depositories and their affiliates and subsidiaries. The purpose of this blog post, however, is not to analyze the content of section 619 and the proposed authorizing regulations. There has already been, and there necessarily will be, a great deal more said along those lines. Rather, in light of the complexity of the subject matter and the significance of the process associated with developing a final rule, this post intends to hit a more narrow target: to help the reader understand the timing and process for the finalization of the rule.

Section 619 not only contains the substantive provisions of the Volcker Rule, but it also sets forth a very specific schedule for finalizing the regulations and even provides an explicit statutory effective date.

The first statutory step in this process is contained in section 619(b)(1), which required the Financial Stability Oversight Council (“FSOC”) to study and make recommendations on implementing the Volcker Rule within six months from the passage of the Act. The FSOC met this responsibility and issued an 81-page report in January 2011. Completion of the study then triggered the next phase of the process, requiring that the bank regulators, the Securities and Exchange Commission (“SEC”), and the Commodities Futures Trading Commission (“CFTC”) propose enacting rules within nine months of the study. The bank regulators and the SEC met this deadline, publishing a nearly 300-page rule proposal (which contained approximately 1,300 questions relating to 400 topics) in October 2011. The CFTC published its proposed rule in February 2012.

The rule proposed by the bank regulators and the one proposed by the CFTC have received thousands of letters from a number of commentators, with a huge variety of perspectives. In fact, many of the thousands of comment letters are themselves hundreds of pages long. The regulators are now working through this voluminous amount of information as part of their effort to finalize the rule. Whether they have time to carefully consider all the comments, however, is not clear. This is because sections 619(c)(1)(A) and (B) provide that the Rule becomes effective on the earlier of 12 months after the issuance of final rules or two years after the date of enactment. The Act was passed July 21, 2010. Therefore, as things currently stand, the statute becomes effective within the next four months if the rules are not finalized.

The key question becomes then, “What will come first — final regulations or the two-year anniversary of the passage of the law?” Perhaps the best source on timing is Federal Reserve Board Chairman Ben Bernanke, who, while testifying before the House Financial Services Committee last month, indicated “I don’t think it (the Volcker Rule) will be ready for July.” Additionally, Federal Reserve Board Governor Daniel Tarullo noted last month in testimony before the Senate Banking Committee that “there is obviously a real possibility that we do not meet the July 21st date.”

Assuming that Chairman Bernanke and Governor Tarullo are correct, covered institutions will apparently have the responsibility of dealing with the compliance requirements of one of the most technical and difficult provisions of law without the help of clarifying regulations.

This obviously would create a very difficult situation for such firms. That said, at least two mechanisms appear to be available to provide assistance. The first, and the one most likely to be available, involves the regulators providing a combination of guidance and forbearance during the period after the Rule becomes effective and before final rules are promulgated. Under this scenario, the regulators would provide informal guidance to covered entities, so that they could conform their activities to regulatory expectations. Governor Tarullo, at the same Senate hearing where he noted that the deadlines could be missed, indicated that, “If we are not going to (meet the deadlines), I think it is incumbent on all the regulators to provide some guidance for firms to let them know exactly what the expectations will be and not let this hang out there as an unknown and I think we should be able to do that as needed.”

Secondly, bi-partisan legislation was recently introduced that would amend the Act to make the effective date the later of two years after enactment or 12 months after the date of the issuance of final rules. S. 2223, which was sponsored by Sen. Crapo and co-sponsored by Sens. Warner, Toomey, Hagan, Corker and Carper, would provide the regulators the ability to complete all the work necessary on the regulations prior to the Rule becoming effective. Firms would have the benefit of relying on completed regulations when developing their compliance regimes. At this point, no hearings have been scheduled on this legislation.

At a minimum, it appears that the regulators are aware of the difficulties that the lack of completed regulations present to the firms subject to the Volcker Rule. To address the uncertainties prior to completing the regulations, the regulators will very likely provide some form of guidance to these firms. The Reed Smith team is ready to help covered institutions respond to and implement whatever guidance they are so provided.

Additionally, the mere existence of bi-partisan legislation that addresses the timing of the effectiveness of the Volcker Rule should provide support. In the event the bill passes, covered firms and the regulators will be afforded the additional time to complete the regulations after having considered every aspect of the comments. Furthermore, a bi-partisan bill, even one that is not taken up and considered, demonstrates that there is the will in Congress for allowing the regulators to get the rules “right” in due course. This provides the regulators with an element of “cover,” and that cover may be all they need to finalize the regulations before the Rule is ultimately effective.

Mark F. Oesterle is a member of the Financial Services Regulatory Group at Reed Smith LLP, resident in the Washington D.C. office. Prior to joining Reed Smith, Mark served as Chief Minority Counsel for the U.S. Senate Committee on Banking, Housing and Urban Affairs. He joined the U.S. Senate Committee as Counsel in 2001, serving as Chief Counsel and Republican Deputy Chief of Staff, Parliamentarian, senior advisor to the Chair, and counsel to the Financial Institutions Subcommittee during his tenure of more than a decade.

The post was written by Travis P. Nelson and Leonard A. Bernstein.

Senate Bill 5462 (“S. 5462”), proposed by Sen. Joseph A. Griffo (R-47th (Utica)), Chairman of the Senate Committee on Banks (the “Committee”), was introduced last year in the New York State Senate and is currently pending in the Committee. If passed, this bill would significantly change the regulatory scheme for nonbank lenders with customers in New York. According to the most recent status update on the New York State Senate’s website, this bill was referred to the Committee January 4, 2012. While this bill has not seen much movement since being introduced last year and referred to the Committee in January 2012, the fact that it is sponsored by the Republican Chairman of the Committee on Banks, and is supported by the New York Department of Financial Services (the “Department” or “NYDFS”)—an agency headed by Superintendent Benjamin M. Lawsky, former Chief of Staff to Democrat Gov. Andrew Cuomo—suggests that should the bill make it through the Committee and pass the Senate, it will encounter little resistance from the Democrat-controlled New York State Assembly or Gov. Cuomo. Therefore, the time to influence this bill is now, while it is still with the Committee.

Under the current New York Licensed Lender Law (“NY-LLL”), a nonbank lender that makes loans to a New York resident, where the resident is a natural person, the interest rate on the loan is in excess of 16 percent, and the principal amount of the loan is not greater than $25,000 for consumer purpose loans and not greater than $50,000 for commercial purpose loans, the lender must be licensed by the Department. N.Y. Banking Law § 340. S. 5462 would change the scope and applicability of the NY-LLL in several ways, including the following:

First, under the current law, loans that are within the prescribed principle amounts that have an interest rate that does not exceed 16 percent are not subject to the NY-LLL. S. 5462 would appear to remove the interest rate trigger, thereby rendering all loans within the statutory limits coverage under the NY-LLL.

Second, the principle amount ceilings of $25,000 for consumer purpose loans and $50,000 for commercial purpose loans would be increased to $50,000 and $100,000, respectively, thereby expanding the range of covered loans.

Third, the bill would confirm that the NY-LLL is applicable to an otherwise covered lender regardless of the lender’s physical presence in New York. Specifically, the statute would be clarified to include lenders who solicit loans “by any means, including but not limited to, mail, electronic mail, telephone, radio, television, the internet or any other electronic means.” This is consistent with the interpretation adopted by the Department in a 2006 staff interpretation. See NYDFS Staff Interp. (Dec. 21, 2006).

Fourth, the range of covered borrowers would be expanded from “individuals then resident in [New York]” to “individuals then resident or located in [New York].” In the past, based on the existing language of the NY-LLL, the Department has interpreted the statute as not applying to borrowers who were in New York on a transient basis. See NYDFS Op. Ltr. (July 12, 2005), (determining that military personnel who are temporarily in New York state at the time they receive the loans are not “residents” for purposes of the NY-LLL). This change would have the effect of expanding the scope of the statute’s covered borrowers to include all individuals who are physically present in the state at the time of the loan, not just those borrowers who permanently reside in New York. There may be other policy reasons for this change, but on its face the change would likely be subject to challenge under the Commerce Clause to the U.S. Constitution. See Pioneer Military Lending, Inc. v. Manning, 2 F.3d 280 (8th Cir. 1993) (where the court determined that a state’s attempt to apply state lending laws to an out-of-state lender that only made loans to non-resident military personnel temporarily stationed in the state violated the Commerce Clause of the U.S. Constitution, which prohibits a state from regulating interstate commerce); Pioneer Military Lending, Inc. v. Dufauchard, 2006 WL 2053486 (E.D. Cal. 2006) (same). Moreover, the Department’s own staff interpretations appear to have suggested that attempts by a state to regulate an out-of-state lender that makes loans exclusively to customers that are not permanent residents (i.e., non-domiciles) of the state, implicates the Commerce Clause. See NYDFS Interp. (July 12, 2005), (discussing Manning with approval; as well as a May 11, 1994, Department interpretation that no longer appears to be on the Department’s website). However, Commerce Clause challenges are not easy cases to prove and can be costly to litigate.

Fifth, the safe harbor for “isolated, incidental or occasional” activities under the current statute, which has been criticized by some as vague, would be replaced with more precise language specifying that lenders who do not make more than five otherwise covered loans with an aggregate principal amount of not more than $100,000 are exempt from licensure.

Of the above proposed amendments to the NY-LLL, the one that is the most troubling for nonbank lenders is the removal of the current 16 percent interest rate cap below which the statute would not apply. This change would likely bring under the statute’s purview almost any nonbank lender that makes small- to moderate-sized non-real estate loans to customers in New York, thereby subjecting countless additional lenders to the NY-LLL. The result might be fewer lenders that are willing to make loans to New York customers, or the imposition of certain fee add-ons. Moreover, removal of the interest rate trigger would ignore the historical purpose underlying the statute’s original enactment, which was to bring under state regulation lenders who might otherwise charge exorbitant interest rates to desperate borrowers. See Beneficial New York, Inc. v. Stewart, 25 Misc. 3d 797 (Sup. Ct., Kings County 2009).

Our team of New York and Washington, D.C.-based legislative and regulatory attorneys are watching S. 5462, and working with industry stakeholders to develop ways correct deficiencies in the legislation before it becomes law.

Travis P. Nelson is a senior associate in the Financial Services Regulatory Group at Reed Smith LLP, resident in the Princeton and New York offices. Prior to joining Reed Smith, Travis was an Enforcement Counsel with the Office of the Comptroller of the Currency, U.S. Treasury Department, in Washington, D.C. Travis is also adjunct faculty at Villanova University School of Law, and a frequent lecturer at national and regional banking conferences. Leonard A. Bernstein, Chair of the Financial Services Regulatory Group at Reed Smith LLP, and resident in the Philadelphia and Princeton offices, assisted Travis with this article.