Senator Dodd's proposal for a Bureau of Consumer Financial Protection has pleased no one, apparently.  The banks and their allies continue to complain that the safety and soundness of the banking system will be undermined by the Bureau unless it is subordinated to the safety and soundness regulators.  The proponents of a separate and totally independent consumer protection agency complain that the Bureau's consumer protection mission will be subverted by the ability of safety and soundness regulators to overrule consumer protections adopted by the Bureau.  Of course, another way to look at the proposal is that it properly balances the concerns of both sides by adopting one of the most effective tools in the U.S. Constitution against human hubris, checks and balances. 

Although in Dodd's proposal the Bureau will be housed in the Federal Reserve, its head will be appointed by the President, and it will be expressly independent of any interference by the Federal Reserve, receiving a fixed percentage of funding from the Federal Reserve budget which will be guaranteed by law.  The Bureau's regulations will be subject to review by the Financial Stability Oversight Council, comprised of the Treasury Secretary, Fed Chairman, head of the SEC, head of the CFTC, head of the FDIC, director of the federal housing finance agency, head of the OCC, an independent member with insurance expertise and the head of the Bureau of Consumer Financial Protection.  Any member of the Council can challenge a regulation published by the Bureau and after study by the Council members, separately and together the regulation can be annulled by vote of 2/3s of the members, or 6 out of 9.  The Council will have strict time limits within which to make its determination, so any controversy will be decided expeditiously. 

The scheme of checks and balances that the writers of our Constitution ingeniously employed in constructing our system of government acknowledges and embraces the tendency of human beings to differ on nearly any issue while rarely taking into account the validity of the point of view of the other side.  Subjecting all branches of the government, executive, legislative and judicial, to review or overturning by others often prevents short-sighted policy from being implemented, or at least ensures that opposing points of view have a hearing.

The proponents of an agency focused on consumer protection are likely correct that without an independent governmental advocate, the consumer protection voice in government is easily overwhelmed.  On the other hand, regulatory agencies need checks and balances too, and Congress is often too distracted to fulfill that function effectively. Enabling the Council to review and potentially overturn regulations adopted by the Bureau for safety and soundness concerns seems eminently prudent, and a 2/3s vote requirement is high enough to assure that substantial consensus exists on the question.

Of course, the opposition to the Bureau from the large banks and their allies is broader than the issues described.  The esoteric issue of preemption of state regulation of federally-chartered financial institutions addressed in the proposed legislation is an ongoing battle between national financial institutions and their regulators on the one hand and the state regulators and their allies on the other, but that is a topic for another day.
 

Senator Dodd's version of financial regulatory reform legislation was released yesterday after months of negotiations with Republicans and Democrats.  The Consumer Financial Protection Agency that would be created by the House version of this legislation is, in Senator Dodd's proposal, the Bureau of Consumer Financial Protection, housed in the Federal Reserve.  Despite the change of address, the House's vision of the Consumer Financial Protection Agency and Senator Dodd's Bureau have many more similarities than differences, although the Senate bill corrects most of the drafting ambiguities and lack of bounds on powers that concerned me with the House bill.  

The House bill was ambiguous primarily due to poorly drafted definitions of important terms, making it difficult to find limits on the powers of the agency, not to mention nearly impossible to understand in some sections.  I have written about the House legislation  (http://www.bwplawyer.com/CFPA_Analysis.html).  In contrast, the Senate bill's definitions are clear and concise and boundaries to the powers of the Bureau are clearer. 

Most of the press reporting on the consumer protection aspects of the Dodd proposal seems to focus on where the Bureau is located and powers over large national banks but, as in the House bill, the non-bank consumer financial services industry will have another regulator if the legislation ever becomes law. 

The list of business models subject to jurisdiction of the Bureau is familiar, including (in general terms): real estate and other lenders and brokers; rent-to-buy businesses; real estate settlement service providers; money transmitters or other entities holding consumer funds; stored value issuers, sellers or providers (sellers or providers only if they exercise substantial control over the terms or conditions of the stored value); check cashing, check collection or check guarantee services; alternative payment service providers dealing directly with the public (e.g. Paypal); consumer financial advisory services (e.g. consumer credit counseling, debt management, and probably services such as Mint); collectors of consumer report and other account information for use in connection with offering or providing a consumer financial product or service; debt collection; or any other business that the Bureau deems seeks to evade consumer protection laws, or offers services like banking services that materially affect consumers.  The Bureau will also have limited jurisdiction (mainly monitoring and data collection functions) over "service providers" (e.g. processors) to the types of businesses described above.

The Bureau will have the power to adopt and enforce consumer protection regulations covering these types of entities, although any more protective existing or future state regulation will also apply.   Another consequence of coming under the jurisdiction of the Bureau is regulatory supervision and examination, although the proposed legislation limits the power of the Bureau to supervise non-real estate related entities to "larger participant[s]" in the relevant markets.  This is a "materiality" concept that shows up throughout both the House and Senate proposals urging the Bureau or Agency to stick to the big issues. 

There are several interesting issues or questions I see with the Senate proposal that I will discuss in future posts.  To close this entry I want to editorialize a bit by noting that factions in favor of and against an centralized federal consumer protection entity have raised legitimate public policy concerns that have been debated, negotiated and addressed in the Senate proposal in a seemingly reasonable way.  The public policy concerns of the two sides seem to boil down to (1) there needs to be a regulator with a consumer protection focus, and (2) safety and soundness concerns are paramount and a consumer protection regulator must be subservient to those concerns.  The Senate proposal (and for that matter the House proposal) seems to do a pretty good job of balancing those concerns, and in my view continuing objections from both sides are approaching pure political petulance. 

The CARD Act amended the Electronic Funds Transfer Act (“EFTA”) to bring gift cards under federal law for the first time.   The Federal Reserve proposed extending Regulation E, which implements the EFTA, to certain stored value cards as far back as 1996, but never adopted final rules.   The Federal Reserve did extend Regulation E to encompass payroll cards, effective July 2007. Regulation E is now being amended to implement the gift card requirements of the Card Act, effective August 22, 2010.

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The Federal Reserve is required under the Card Act to publish final regulations for gift cards before February 22, 2010.   The effective date for the rules will be six months later, August 22, 2010.  The comment period on the proposed rules published in November 2009 closed at the end of December. 

 

The Federal Reserve’s initial proposal was well thought out and cognizant of the complex realities of the prepaid card market, although constrained by the contents of the CARD Act itself, for which the same claim can’t easily be made.  Seemingly simple in concept, the gift card requirements of the CARD Act require bright line distinctions that the Federal Reserve struggled to implement in its proposed rules. 

 

For instance, one of the several exclusions from coverage under the CARD Act is for reloadable cards, codes or devices that are not marketed as gift cards. Recognizing that there are many uses for reloadable prepaid cards, the proposed rules and accompanying official commentary would deny the exclusion in any instance where any party in the marketing and distribution chain of the prepaid product even hinted that the card could be given as a gift.  For instance, celebratory graphics or other indication that the card could be given to others could constitute such a“hint”, even if the primary purpose of the card was, for instance, health care expenses or a general-purpose transaction account for the unbanked. 

 

Thinking this through, the Federal Reserve realized that issuers or program managers would be at the mercy of other parties in the distribution chain, so tried to create a safe harbor in the proposed rules and official commentary. Issuers or other affected parties can preserve the exclusion for reloadable cards, codes or devices if they implement reasonable procedures to prevent the cards from being marketed as gift cards.  This includes enforcement of contractual provisions with retail sellers requiring procedures designed to avoid the marketing of the prepaid cards as gift cards.  Unfortunately, the examples given of what qualifies and does not qualify for the safe harbor are problematic. 

 

The example given of a qualifying procedure is having sales displays for gift cards physically separated from displays for other prepaid cards.   The example given for a non-qualifying procedure is having all prepaid cards, gift cards and otherwise, on one kiosk with a sign reading “gift cards.”  Aside from the difficulty for many retailers in allocating more valuable selling floor space to two different types of prepaid cards, it is also not clear whether one kiosk with two different signs appropriately placed would qualify for the safe harbor, as perhaps it should. 

 

There will be many other indistinct lines that participants in the prepaid card marketplace will need to grapple with once the proposed rules become effective.  The prepaid card regulatory environment will be more complicated than ever.

Originally published on GetDebit.com. See GetDebit.com for more prepaid debit card news and information.

After months of lobbying, discussion, amendment and general puffery the House adopted yesterday H.R. 4173 which, among other things,  would create the Consumer Financial Protection Agency.  Although most of the press reports recently have focused on amendments to the CFPA provisions that restore much of the favored regulatory treatment received by federally-chartered institutions under federal preemption principles, the rest of the CFPA provisions reported out of the House Financial Services Subcommittee and adopted Friday by the full House survived more or less intact.  In an article published in Aspen Publishers Banking and Financial Policy Report in November I analyzed the House Financial Services Subcommittee version.  A copy of the publication with my article can be downloaded from my website at www.bwplawyer.com.  Some of the analysis will necessarily be moot due to amendments during the legislative grind, but the article is still a useful overview of the CFPA.

The discussion in the article of the preemption issues will of course be somewhat out of date, given the amendments to those provisions adopted by the House  The preemption amendments proposed by Representive Melissa Bean of Illinois and included in the final legislation give the national bank and federally-chartered savings institution regulators the power to preempt state consumer protection laws from application to their charges if the law is discriminatory or it "prevents, significantly interferes with, impairs, or hampers the ability of [a federally-chartered institution] to engage in the business of banking".  However, the federal regulator must justify any preemption decisions with findings on the record, including a finding that there exists an adequate federal consumer protection standard applicable to federally-chartered institutions, and a majority of the states can require the federal regulator to initiate a rule-making to consider toughening any federal standard.  These requirements prevent the recurrence of the  federal regulators' current preemption rules, which simply dismiss the application of any state consumer protection regulation against federally-chartered institutions with a peremptory wave of the hand. 

There are a couple of other amendments of interest to some Web 2.0 business models I will mention.  Person-to person lending operators will be subject to CFPA jurisdiction.  Private organizations offering educational loans will be required to be certified first by the educational institutions, but it is not clear whether this applies to person to person educational loan models as well. 

The Senate is considering its own version of legislation creating a CFPA, and it has been reported that opposition is stronger in that body.  A vote in the Senate could be as late as May of next year, so we can look forward to possibly 5-6 months of legislative grinding before we know the fate of the CFPA in the Senate, with even more time for reconciliation if the Senate adoptes a version that differs significantly from the House version. 

In the spirit of holiday season charity I have to acknowledge the committment and endurance of our legislators in pursuing their duties.  It is my observation that no business negotiation, however difficult and complex, can match the tedium and aggravation of the legislative process.  My favorite moment during the markup of the legislation in the House FInancial Services Subcommittee was when Barney Frank observed late in the evening, after listening to an apology by a Representive for mis-citing the source of a biblical homily in a previous soliloquy, that the book of the Bible he was most interested in at that moment was Exodus.

 I have just submitted an article analyzing in detail the latest version of the legislation in the House (H.R. 3126) that would create the Consumer Financial Protection Agency, to be published in the November edition of the Banking and Financial Services Policy Report by Aspen Publishers.  A copy of the article will be available on my website (www.bwplawyer.com) when it is published.  However, the House Committee on Financial Services will begin mark-up on Wednesday of H.R. 3126, so now is the time to point out a couple of flaws in the bill I hope are fixed during the mark-up.  I am not advocating for or against creation of the CFPA, just expecting Congress to make the effort to draft legislation that does not lead to unnecessary confusion and bad policy. 

My first complaint about the bill is that it is nearly impossible to read and determine definitively who is a "covered person" subject to the rule-making and enforcement authorities of the CFPA.  I attempt to parse the definition of "covered person" in my article, but after hours of trying to make sense of the various inter-linked definitions in the bill can only claim to have a plausible interpretation.  It appears to me that the entities that are going to have the most trouble figuring out where they fall under the bill will be transaction processors, data communication providers, and value-added processing intermediaries. However, the CFPA is also given the express power to determine that activities and entities that do not strictly fall within the definition of covered person are nonetheless subject to its jurisdiction, so perhaps the rest of the definitions are actually irrelevant.  Sorry, but this seems rather arbitrary and, frankly, lazy lawmaking. 

There are very few restrictions in the bill on the power of the CFPA to engage in rule-making, and it appears to have the power to go beyond the scope of the enabling statutes adopted by Congress that the CFPA will have authority to interpret and enforce. 
if this is not the intent of Congress now is the time to clarify. 

Perhaps irony is overrated, but contrast the authority granted to states in the bill to adopt more protective legislation than any scheme adopted by the CFPA against the broad and otherwise nearly unrestricted powers that would be granted by Congress to the CFPA.  This is the "preemption" issue that is the subject of intense lobbying, for and against, reported in the press.  The preemption rules in the bill will be applicable only to rules adopted by the CFPA not based on currently existing consumer financial protection legislation such as the Truth in Lending Act, the Electronic Funds Transfer Act, the Fair Credit Reporting Act and other statutes responsibility for which is transferred to the CFPA in the bill.  Most of these existing statutory schemes have their own preemption rules and the bill expressly does not supersede them.  In the Truth and Lending Act and the Fair Credit Reporting Act there are certain aspects that the states can alter with more protective legislation, but the states are totally preempted by and cannot alter other aspects. In the latter cases either Congress or the regulatory agency responsible for adopting rules to enforce the statutes determined that the benefits of nationwide standards were more important than allowing states to alter the rules to make them more protective.  In future rule-making the CFPA will not have the ability to make a similar determination since the ability of the states to adopt more protective legislation is absolute in the bill.  This seems to be short-sighted at best, and it would seem better to give the CFPA the right to preempt state legislation if it determines that to do so would best achieve the goal of effective consumer financial protection.  In its current form the preemption provision in the bill reflects a federalism victory by the states, but federalism is a two way street for good reasons, and the bill's preemption provisions are bad public policy.

Reuters reports that Barney Frank has proposed some revisions to H.R. 3126 to address concerns about that legislation that would create the Consumer Financial Protection Agency.  These proposed revisions include eliminating the requirement that "vanilla" products be offered by financial institutions, and clarifying that the CFPA would not have authority to require sellers of financial products to assure that consumers understand the features and risks of the products they are buying. The CFPA instead would focus its efforts on ensuring meaningful and comprehensible disclosures. These are helpful revisions given the nearly unlimited authority that the original legislation seemed to impart.  The proposed revisions also would give the existing regulators a seat on a Consumer Financial Protection Oversight Board that would advise the Director of the CFPA.  This would help the coordination effort with other regulators with potentially conflicting safety and soundness regulatory concerns, and the revision would further create an independent body to which institutions subject to conflicting regulatory demands could appeal for relief.  These revisions are clearly a response to criticisms that bifurcating consumer protection responsibiities from prudential and safety and soundness regulation will create turf wars with the regulated in the middle.  Other proposed revisions would require that the CFPA coordinate its examination activities with respect to an entity with other regulators that have examination authority, and would address CFPA funding fairness issues that have been raised by the banking industry. Finally, the proposed revisions would clarify the standards applied by the CFPA to non-bank financial institutions subject to its jurisdiction.  The good news, I guess, is that the regulation can be no more strict than that applied to banks.

In an important respect the proposed revisions seem quite inadequate, and that is in clarifying the scope of jurisdiction of the CFPA - in other words, who is subject to CFPA jurisdiction (and why)?  The Frank memorandum states an intent that the CFPA would not have authority over non-financial businesses and their billing activities (the corner butcher can now relax), and further lists a number of proposed express exclusions from coverage under H.R. 3216, such as lawyers, accountants, tax preparers, retirement plan providers, realtors, auto dealers, and communications providers. 

Two additional exclusions merit discussion.  The memorandum proposes that consumer reporting agencies would now expressly be excluded and continue to be regulated by the Federal Trade Commission. However, the language in H.R. 3126 that makes entities engaged in credit reporting activities a "covered person" covers not only collection of "consumer report information" but also the collection of "other account information".  Unless this is further pared back when the revised bill is actually drafted, the CFPA apparently will have jurisdiction, as an example, over entities creating and maintaining transactional databases not amounting to consumer reports under the Fair Credit Reporting Act and providing them to third parties for use in behavioral marketing or for other purposes.  In fact, this would not be inconsistent with the transfer to the CFPA of authority under existing privacy laws, such as Gramm-Leach-Bliley.

The other proposed exclusion is for service providers that provide strictly ministerial and support services to financial institutions. This raises many questions, since the definition of a "covered person" subject to CFPA jurisdiction in H.R. 3126 currently includes providers of processing services and products that support consumer financial transactions.  Perhaps the intent of the memorandum was lost in the reporting by Reuters, but it is not clear if that coverage is proposed to be eliminated.  If not, then it would be helpful if the legislation was clearer about what aspects of a third party processor's or product supplier's business will be subject to CFPA jurisdiction.  The Federal Trade Commission has had to postpone effectiveness of its Red Flag Rules several times due to confusion about what businesses are covered under the enabling legislation, so perhaps Congress can be more helpful this time. 

What the Frank memorandum does not address are concerns about the interplay between regulations adopted by the CFPA and activities of the various States (the "preemption" issue) or the broad grant of rule-making powers to the CFPA with no clear requirement that there be express Congressional authority for the rules that are adopted.

I am addressing these questions and others in much more detail in an article I am writing for publication in November in the Banking and Financial Services Policy Report, from Aspen Publishing.

I wonder if it will matter whether there is one dedicated consumer protection regulator like the CFPA or many multi-function regulators with consumer protection responsibility (the current model) if the political winds shift again, as they inevitably will. << MORE >>

By definition the actual unintended consequences are impossible to foresee, but there are probably inevitable consequences from the creation of the CFPA, some of which which the enabling legislation itself tries to address. << MORE >>

As summer winds down and Congress returns from recess (sadly diminished by the loss of Senator Kennedy) the swarm of lobbyists fighting or advocating the proposed Consumer Financial Products Safety Commission (CFPA) will keep temperatures high in Washington D.C..  The legislation has many flaws, and is rife with potential for unintended consequences, particularly when the idealistic teflon that has coated the proposal (and protected it from any serious policy analysis in Congress) has worn off in the day to day fray of agency operations and practical politics. 

The issues implicated by the CFPA legislation are many, and deserve consideration before the agency is authorized with the powers that are proposed.  Most of the public debate so far has concerned the removal of consumer protection responsibilities from existing regulators into the CFPA, involving questions of whether it is possible or advisable to isolate prudential regulation of financial institutions from consumer protection regulation.  Actually, this is not a question with a clear answer, and the fact that the question is raised loudest by the existing regulators and the regulated financial institutions makes it easy for a politician to ignore if so inclined.  

In the coming few weeks I will provide here a disinterested analysis of the proposed CFPA legislation and suggestions for improvement where appropriate.  I am no one's lobbyist and do not expect that my life will be impacted one way or the other if the CFPA is created or not (which is not to say that others less fortunate will not be).  My only interest here is in furthering the application of common sense to law-making and policy creation.  I am no genius, but then common sense is not rocket science.  Or economics, but don't get me started on that ...