CFPB snapshot tracks complaints from servicemembers

By Stephanie K. Mann, J.D.

The Consumer Financial Protection Bureau reports that it has received more than 2,500 complaints from servicemembers, veterans, and their dependents about high-cost consumer credit as of November 2015. The bureau analyzes these complaints in “A snapshot of servicemember complaints: Products impacted by the new Military Lending Act rule.”

Complaints. Consumers submitted their complaints to the CFPB under two different product categories: under the “payday” loan complaint category, or under the “debt collection” complaint category with the “payday” sub-product. The “payday” loan complaint category currently represents 3 percent of total servicemember complaints, while the “payday” loan sub-product category represents 19 percent of the complaints submitted by military consumers under the “debt collection” complaint category.

“Debt collection” is the largest complaint category for military consumers, as well as for all consumer complaints. Within the “debt collection” category, the number of complaints stemming from the “payday” sub-product is more than auto loans, mortgages, and student loans combined. Recent studies show that military consumers struggle with the repayment of high-cost credit products more than any other type of financial product. However, according to the bureau, recent updates from the Department of Defense to the regulation implementing the Military Lending Act should help servicemembers and their families avoid this type of high-cost debt going forward.

Amendments. The bureau concluded the snapshot by summarizing the changes made under the MLA:

• Lenders will be expected to comply with the new rule on Oct. 3, 2016, for all covered products other than credit cards. The compliance date for credit cards is Oct. 3, 2017.
• For loans covered by the MLA, the all-in cost of credit will be limited to an annual rate of 36 percent (referred to as the Military Annual Percentage Rate or MAPR). Included in the MAPR are costs like finance charges, credit insurance premiums or fees, and additional fees associated with credit such as application or participation fees, with some exceptions.
• The new rule extends the protections of the MLA to a broader range of consumer credit products than previously covered. The MAPR cap and other MLA protections will now apply to all consumer credit subject to disclosure under the Truth in Lending Act, except for certain statutory exceptions. These exceptions include residential mortgages and certain other secured loans for the purchase of personal goods and vehicles.
• For credit cards, there is a limited exclusion for “bona fide fees” when calculating the MAPR. This means that for credit cards some common fees, such as cash advance fees and foreign transaction fees, generally need not be included in the overall price limit.

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Latest Volcker Rule FAQs discusses residual positions and relationships with covered transactions

By John M. Pachkowski, J.D.

The Federal Reserve Board has updated its Frequently Asked Questions regarding the application of section 13 to the Bank Holding Company Act of 1956 (BHC Act), commonly referred to as the Volcker Rule, and regulations adopted by the Fed, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation, Securities and Exchange Commission, and Commodity Futures Trading Commission. The Fed noted that while the FAQs apply to banking entities for which the Fed has jurisdiction under section 13 of the BHC Act, they have been developed by staff of all five agencies.

Treatment of residual positions. In FAQ No. 19, the agencies’ staff discussed the situation that may occur if a banking entity exits a permissible market-making business and the banking entity has to sell or unwind its residual market-making positions.

According to the staff, if a banking entity holds residual positions from its prior market-making activity, the banking entity may hold and dispose of these residual market-making positions, provided two conditions are met. First, the banking entity must hedge the risks of its residual positions in accordance with the risk-mitigating hedging exemption found in the implementing regulations. The second condition requires that the banking entity sells or unwinds the residual market-making positions as soon as commercially practicable.

When hedging the risks of the residual market-making positions, the banking entity must comply with the requirements of the risk-mitigating hedging exemption; and the banking entity cannot rely on the market-making exemption to manage the risks of its residual market-making positions. The staff noted that the market-making exemption only permits risk management activity conducted or directed by a trading desk in connection with the desk’s permitted market making-related activities conducted in conformance with all of the requirements of the market-making exemption set forth in the agencies’ regulations.

The staff cautioned that if a banking entity holds residual market-making positions and does not hedge the risks of those residual positions, then the subsequent sales of those residual positions would generally be considered proprietary trading under the regulations implementing the Volcker Rule.

Covered transactions. The second new FAQ examines the application of the Volcker Rule’s conformance period to existing and new “covered transactions” between a banking entity and a covered fund.

Under the Volcker Rule, a banking entity that serves, directly or indirectly, as the investment manager, investment adviser, or sponsor to a hedge fund or private equity fund—a covered fund—or that organizes and offers a covered fund cannot enter into a transaction with the covered fund that would be considered to be a “covered transaction” under section 23A of the Federal Reserve Act. Covered transactions generally are arrangements under which the banking entity would have a credit exposure to the covered fund. They include not only loans, but also other credit exposures such as investments in the covered fund’s securities, guarantying credit extended to the fund by another lender, and securities lending transactions. The restrictions apply equally to affiliates of the banking entity.

The limitation on covered transactions also applies to a banking entity’s affiliates, as well as any covered fund that is controlled by the fund with which the banking entity or its affiliates have a relationship.

The staff noted in FAQ No. 20 that as a general matter, on or after July 21, 2015, a banking entity may not enter into a covered transaction with a covered fund where the banking entity serves as investment manager, investment adviser, or sponsor to the covered fund or relies on the Volcker Rule’s organizing/offering exemption.

The agencies’ staff also believed that restrictions on covered transactions would also apply to any increase in the amount of, extension of the maturity of, or adjustment to the interest-rate or other material term of, an existing extension of credit. The staff noted that a floating-rate loan does not become a new covered transaction whenever the interest rate changes as a result of an increase or decrease in the index rate. If the banking entity and the borrower, however, amend the loan agreement to change the interest rate term, for example, from “LIBOR plus 100 basis points” to “LIBOR plus 150 basis points,” or from reference to the LIBOR index to the banking entity's prime rate, the parties have engaged in a new covered transaction.

Banking entities were also advised, with respect to any existing covered transaction, to evaluate whether the transaction guarantees, assumes or otherwise insures the obligations or performance of the covered fund since these activities are prohibited by the agencies’ implementing regulations.

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Are litigation finance transactions ‘loans’?

By Thomas G. Wolfe, J.D.

Recently, the Supreme Court of Colorado was called upon to review the essential nature of litigation finance transactions in the state. The litigation finance companies in the case argued that the transactions were “asset purchases” or “investments” and were named and structured that way. In contrast, the Colorado Attorney General and the Colorado Uniform Consumer Credit Code Administrator argued that, despite their labels, these transactions were really “loans” that were subject to Colorado’s Uniform Consumer Credit Code (Colo. UCCC). In addition, many friend-of-the-court briefs were presented on the issue by groups representing the respective interests of consumer advocates, trial attorneys, defense attorneys, chambers of commerce, and property casualty insurers, among others.

Ultimately, in the case of Oasis Legal Finance Group, LLC v. Coffman, the Colorado Supreme Court decided that these litigation finance transactions constitute “loans” that are subject to the Colo. UCCC. More particularly, Colorado’s high court ruled that litigation finance companies that agree to advance money to tort plaintiffs in exchange for future litigation proceeds are making loans under Colorado law, even if the plaintiffs do not have an obligation to repay any deficiency should the litigation proceeds prove to be less than the amount due.

The court sketched the business model for litigation finance companies, relating that the companies typically buy interests in the potential proceeds of various personal injury cases—auto accidents, slip and falls, construction site injuries, and medical malpractice incidents, for example—by executing agreements with the tort plaintiffs. The litigation finance companies provide money, usually less than $1,500, to those tort plaintiffs while their cases are pending. In keeping with the agreement, the money is to be used by the tort plaintiffs to pay their personal expenses while they wait for their lawsuits to settle or go to trial. However, the money cannot be used to prosecute their legal claims.

To provide some background, several national litigation finance companies were involved in the case. Oasis Legal Finance Group, LLC, Oasis Legal Finance, LLC, Oasis Legal Finance Operating Company, LLC (collectively, Oasis), and Plaintiff Funding Holding, Inc. (doing business as LawCash) structured the core features of their litigation finance agreements similarly despite some minor differences.

Under the “Oasis Agreement,” the tort plaintiff was characterized as the “Seller” and the litigation finance company was labeled as the “Purchaser.” The Oasis Agreement specified that the seller-plaintiff would not receive any proceeds until the purchaser-company received the “Oasis ownership amount.” At the same time, the Oasis Agreement prominently stated that if the seller-plaintiff ultimately did not recover anything in the lawsuit, then the purchaser-company would receive nothing as well. Notably, the agreement called for the seller-plaintiff to refer to the litigation finance transaction as a “sale,” not a loan, for all purposes—including tax treatment. In addition, the seller-plaintiff was required to describe the purchased interest as an “asset,” not a debt obligation, in any bankruptcy proceedings.

The LawCash Agreement was first titled as a “Lawsuit Investment Agreement” and then later as a “Funding Agreement.” The underlying transaction was depicted as a “grant of a security interest” and as a “lien” in the proceeds. Further, the LawCash Agreement characterized the litigation finance transaction as “an investment and not a loan.”

After the Colo. UCCC Administrator determined that Oasis and LawCash had made loans in violation of the Colo. UCCC and the Colorado Consumer Protection Act, Oasis and Law Cash declined the Administrator’s offer to settle the matter through an “Assurance of Discontinuance and Final Agency Order.” Instead, the litigation finance companies filed a lawsuit against the Colo. UCCC Administrator and the Colo. Attorney General, “seeking a declaratory judgment that funding agreements of this type are not loans.”

Oasis and LawCash contended that they were involved in “asset purchases” and “investments” because, among other things, they took on the “risk of complete loss.” Oasis and LawCash maintained they had purposely structured their agreements “as sales and assignments of assets” and the agreements explicitly stated that the litigation finance transactions were not to be considered loans. Ultimately, however, the companies’ arguments did not prevail.

The Colorado Supreme Court emphasized that whether litigation finance transactions are or are not “good for consumers” was a question “better suited to the legislature.” Turning its attention to the definition of a “loan” under the Colo. UCCC, the court determined that the statutory provision made it clear that the presence of a “debt is a necessary, if not completely sufficient characteristic of the consumer transaction the Code seeks to regulate.” However, the court decided that an “unconditional” obligation to repay is not required.

From the court’s perspective, litigation finance agreements create debt because “they create repayment obligations, notwithstanding the finance companies’ “embrace of risks that, from time to time, require them to adjust or cancel some plaintiffs’ obligations. Most of the time, plaintiffs repay the full amount borrowed—and more.” Moreover, the court found it “significant that the obligation increases with the passage of time, another characteristic of a loan.”


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Green light for banks providing services for payday lenders

By Andrew A. Turner, J.D.

The Federal Deposit Insurance Corporation has updated previous guidance on payday lending by banks to make clear that it does not apply when banks are providing services to payday lenders. Banks that can effectively manage the resulting risks are not discouraged from offering services to any business that operates legally. 

“Financial institutions that can properly manage customer relationships and effectively mitigate risks are neither prohibited nor discouraged from providing services to any category of business customers or individual customers operating in compliance with applicable state and federal laws,” the FDIC said (FIL-52-2015, Nov. 16, 2015).

Payday loans are small-dollar, unsecured, short-term advances that have high fees relative to the size of the loan. When used frequently or for long periods, the total costs can rapidly exceed the amount borrowed. The payday loan guidance warned of risks from making high-cost, short-term loans on a recurring basis to customers with long-term credit needs.

The guidance, as clarified, is to be applied to banks with payday lending programs for consumers that the bank administers directly or that are administered by a third party contractor. It does not apply to banks offering products and services, such as deposit accounts and extensions of credit, to non-bank payday lenders.

The FDIC action comes amidst a swirl of controversy and activity regarding payday lending regulation.

CFPB payday loan plan. The Consumer Financial Protection Bureau is considering proposals that would require lenders to make certain that consumers can repay their loans while also restricting lenders from attempting to collect payments from consumers’ bank accounts in ways that tend to rack up excessive fees. The proposals are intended to stop the “debt traps” caused by payday loans, vehicle title loans, deposit advance products, and certain high-cost installment loans and open-end loans.

Operation Choke Point. Charging that the federal banking regulatory agencies are “engaged in a concerted campaign to drive them out of business by exerting back-room pressure on banks,” an association representing the payday lending industry and the association’s largest member have joined in a suit that attempts to put an end to what has become known as “Operation Choke Point.” The suit principally targets what it characterizes as efforts by the Federal Reserve Board, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation to pressure banks to end banking relationships with payday lenders due to risk to the banks’ reputations.

Most recently, the U.S. District Court for the District of Columbia dismissed the counts of the complaint pertaining to alleged violations of the federal Administrative Procedure Act (APA) but refused to dismiss the counts pertaining solely to the regulators’ alleged violations of the payday lenders’ procedural due process rights under the Fifth Amendment to the U.S. Constitution (Community Financial Services Association of America, Ltd. v. FDIC, Sept. 25, 2015, Kessler, G.).

Meanwhile, the FDIC’s Office of Inspector General found the agency’s involvement in Operation Choke Point “inconsequential to the overall direction and outcome of the initiative.” More specifically, the IG audit report said that the FDIC’s supervisory approach was within its “broad authorities,” and there was no evidence that the FDIC used the high-risk list to target financial institutions. At the same time, however, the manner in which the FDIC’s supervisory approach was executed was not always consistent with written policy and guidance; moreover, in some instances, the FDIC “created the perception” that it discouraged institutions from conducting business with certain merchants, particularly payday lenders, the report found.

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Bitcoin–related businesses’ BSA/AML risks examined in Atlanta Fed paper

By J. Preston Carter, J.D., LL.M.

A working paper examining the Bank Secrecy Act (BSA)/Anti-Money Laundering (AML) risks for Bitcoin-related businesses has been published by the Federal Reserve Bank of Atlanta. The paper states that by making a commitment to BSA/AML compliance, Bitcoin-related businesses can both better position Bitcoin as a mainstream payment system and enhance the ability of financial institutions to successfully bank them.

Growing Bitcoin use and risk. In a Retail Payments Risk Forum Working Paper titled “Banking Bitcoin-Related Businesses: A Primer for ManagingBSA/AML Risks,” Douglas King states that Bitcoin is a fast, low-cost, and secure payment solution that can be used for many legitimate purposes. As investment and interest in the Bitcoin ecosystem have grown since its 2009 start, new businesses have emerged seeking to advance Bitcoin as a mainstream payment solution. However, he notes that the pseudonymous nature of Bitcoin transactions heightens BSA/AML compliance risks, making it especially challenging for these new businesses to establish banking relationships.

Mitigate risks. King examines the current regulatory environment for Bitcoin-related businesses as well as measures these businesses can adopt to mitigate the BSA/AML risks inherent in the use of Bitcoin. He also presents a framework for financial institutions to consider for managing the risks associated with banking these companies.

Because of BSA/AML-related risks and others associated with Bitcoin transactions and its “highly publicized history of facilitating payments for illegal transactions,” getting involved with bitcoins is considered high risk by many regulatory agencies and financial institutions. King states that, with some financial institutions in a risk-reduction mode, many are opting to avoid this industry as a whole.

Legitimate uses. However, within this high-risk category, he finds many legitimate uses for bitcoin and businesses that facilitate these legitimate transactions. King points to reports in early 2015 that approximately 100,000 merchants worldwide accept bitcoins. Also, Bitcoin investors obtain bitcoins for speculative purposes. These users do not intend to spend their bitcoins. Rather, they intend to buy and sell them much like a traditional investor trades in company stocks or commodities.

Banking due diligence. Financial institutions interested in banking Bitcoin-related businesses should have a full understanding of the Bitcoin ecosystem, the role of the different participants, and the unique BSA/AML circumstances involving this ecosystem, King advises. “A robust BSA/AML enhanced due diligence process is necessary when evaluating Bitcoin-based businesses,” he says.

Business practices. Beyond regulatory requirements, King writes, Bitcoin-related businesses can adopt certain processes and practices that have the ability to further legitimize the Bitcoin transactions that they are enabling. By focusing on a commitment to BSA/AML compliance through a robust compliance program, Bitcoin-related businesses can better position themselves for banking relationships with financial institutions. In return, he concludes, this dedication to compliance ultimately places financial institutions in a better position to successfully bank them.

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Debt collector appeals loss of interest rate preemption protection

By Richard Roth

A debt collector is asking the Supreme Court to review whether the National Bank Act’s preemption of state law interest rates continued after a credit card account was charged off and transferred to the debt collector for collection. According to the U.S. Court of Appeals for the Second Circuit, the state law usury limit no longer was preempted because after the transfer the national bank had no interest in the account. The state law would no longer interfere with the national bank’s exercise of powers granted by federal law (Madden v. Midland Funding, LLC). The petition was filed as Midland Funding, LLC, v. Madden, No. 15-610.

According to the Second Circuit, the suit over whether the debt collector could rely on the NBA preemption provision turned on conflict preemption—whether allowing the consumer to sue the debt collector for attempting to collect illegal interest under the Fair Debt Collection Practices Act would interfere with a national bank’s exercise of powers granted by federal law.

Preemption for nonbanks. It was true that NBA preemption extended to nonbanks in some situations, the appellate court said. However, that only happened when preemption of a state law was needed to prevent significant interference with a national bank’s exercise of its federally granted powers. A national bank’s operating subsidiaries could benefit from preemption, as could a bank’s agents, the court agreed. However, Midland, as a third-party debt buyer, was neither an operating subsidiary nor an agent. Midland was acting solely on its own behalf.

Neither of the Midland companies was a national bank, neither was a subsidiary or agent of a national bank, and neither was acting on behalf of a national bank, the appellate court said. That meant the application of New York’s usury law would not interfere with any national bank’s exercise of powers granted by federal law. New York’s usury law only would affect Midland’s activities. There was no reason for the state law to be preempted, the court decided.

Debt collector’s argument. In its petition for certiorari, Midland argues that denying it the protection of the NBA’s interest rate preemption would effectively allow a state to regulate national bank interest rates by “imposing interest rate limitations that are triggered as soon as a loan is sold or otherwise assigned.” The Second Circuit decision also ignored “a cardinal rule of usury, dating back centuries, that a loan which is valid when made cannot become usurious by virtue of a subsequent transaction.”

The petition points out that the Second Circuit decision threatens to have unusually significant effect because the circuit, which includes New York, is the home of much of the nation’s financial services industry. It also notes that the decision conflicts with a decision by the Eighth Circuit, Krispin v. May Department Stores, Inc., 218 F.3d 919 (2000), and a decision of the Fifth Circuit, FDIC v. Lattimore Land Corp., 656 F.2d 139 (1981).

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On Veteran's Day, agencies work to protect servicemembers, veterans

By Stephanie K. Mann, J.D.

As the nation celebrated Veteran’s Day on November 11, multiple government agencies have taken step to protect military servicemembers and veterans.

Increased protection from financial scams. The Department of Justice has announced that it has submitted a legislative package to Congress including amendments to existing laws that are intended to protect military servicemembers and veterans. The proposed amendment package, The Servicemembers and Veterans Initiative is intended to “drive enforcement, outreach and training efforts on behalf of servicemembers, veterans and their families,” according to a blog post by Acting Associate Attorney General Stuart F. Delery. Delery stated that “It is our responsibility to protect these individuals from financial scams, to preserve their right to return to their civilian employment after active duty and to strengthen their ability to cast a ballot when they are overseas.”

Amendments to current laws. The legislative package includes amendments to the following existing laws:

• the Uniformed Services Employment and Reemployment Rights Act (USERRA);
• the Servicemembers Civil Relief Act (SCRA);
• the Military Lending Act (MLA); and
• the Uniformed and Overseas Citizens Absentee Voting Act (UOCAVA).

The changes are intended to make it more difficult for “unscrupulous creditors to take advantage of servicemembers on active duty,” according to Delery. The proposed amendments seek to protect military families by affording dependent family members the same state residency rights as the servicemember, as well as requiring states to recognize a servicemember spouse’s professional licensures from other states.

The amendments would include the following changes.

1. The proposed amendments require parties seeking default judgments against servicemembers to check Department of Defense records to determine duty status.
2. The amendments also increase penalties that employers, as well as lending and rental businesses, will face for violating laws designed to protect servicemembers. 
3. The legislative proposals expand the number and types of cases the United States can bring in defense of servicemembers attempting to return to their civilian employment upon completion of their military service, and the available remedies for violations of the voting rights of servicemembers and their families while they are overseas.

Delery stated that the Justice Department “hopes these changes will enhance the department’s ability to bring enforcement actions, and allow these men and women to assert their rights on their own.”

Memorandum of Agreement. The Federal Trade Commission and the Veterans Administration have signed a Memorandum of Agreement to further their ongoing efforts to stop fraudulent and deceptive practices targeted at service members, veterans, and dependents who use military education benefits. Under the Memorandum of Agreement, the Deputy Undersecretary for Economic Opportunity, Veterans Benefits Administration, Department of Veterans Affairs, and the Director, Bureau of Consumer Protection, Federal Trade Commission, agree to provide mutual assistance in the oversight and enforcement of laws pertaining to the advertising, sales, and enrollment practices of institutions of higher learning and other establishments that offer training for military education benefits recipients.

The agreement is designed to enhance cooperation between the FTC and the VA in investigating and taking action against institutions that target service members with unfair or deceptive advertising or enrollment practices. It outlines terms under which the VA can refer potential violations to the FTC.

The FTC advises service members to watch out for any for-profit schools that may stretch the truth to encourage enrollment by exerting pressure on service members either to sign up for unnecessary courses or to take out loans that might be a challenge to pay off. The FTC encourages students interested in pursuing a higher education to check out its updated guidance, Choosing a College: Questions to Ask.

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