BANKTHINK

Will CFPB Make Policy via Rules — or Enforcement?

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The political jousting over the structure and leadership of the Consumer Financial Protection Bureau continues, but the real work of the agency and its professionals has begun. That work will ultimately determine, among other things, whether the CFPB will be a rules-based or enforcement-based agency.

Financial institutions are accustomed to the rules-based culture of the federal banking agencies, where the first option is usually the proposal and adoption of a regulation. Once a rule is adopted, it may of course be followed by enforcement where violations occur.

In enforcement-based agencies, rules may not be the first option, and targeted enforcement actions may be relied on to create de facto rules. The differences between these approaches are sometimes quite nuanced, and both methods of creating public policy may be equally effective. But they are not always equivalent in the eyes of the businesses they may impact. Indeed, which methodology becomes dominant is critical to determining how companies interact with an agency.

The creation of regulations require formal administrative rulemaking, which includes public comment before a rule can be finalized and carry the force and effect of law. The Administrative Procedure Act ensures that this is not a hollow exercise by holding agencies to strict standards by which they must analyze and evaluate the public input that they receive, and explain their final positions in a statement of basis and purpose, also known as the "preamble," which accompanies the final regulation. The final regulation is then subject to challenge in federal court under standards established by the APA. Such a challenge may be brought by a wide array of parties, including trade associations, which may have federal standing on behalf of their members.

Alternatively, federal agencies create de facto standards of conduct through the initiation of formal enforcement or litigation actions. Those actions need not necessarily be based upon rules that have previously been articulated or publicly aired. Such enforcement actions are also subject to challenge in federal court, but mounting such challenges can be a more complex problem for several reasons: the continuing reputational impact they may have on the financial institution involved, the higher legal hurdles that must be met to set aside formal enforcement and litigation actions, and the fact that only the financial institution that is the target of the enforcement action may challenge it. As a result, most enforcement actions are settled before a court ever gets to decide the issue, in effect establishing the agency’s view of the law as the standard.

The Department of Justice's approach to fair lending cases during the 1990s, though not a perfect example of this form of de facto regulation, illustrates the potential impact of creating policy through enforcement or litigation. In those cases, all of which ended in settlements as opposed to judicial decisions, the DOJ was able to establish how the concepts of "disparate impact" and "disparate treatment" should apply to loan approvals, pricing and marketing, though they had never been defined in a regulation. Moreover, the financial institutions whose conduct was challenged by the DOJ typically chose in all cases to settle them to avoid, among other things, the reputational harm that could arise from a protracted suit by the government for alleged discriminatory practices.

As a result, the theories of the law relied upon by the DOJ, though never upheld by a court, effectively became the law. Anti-money laundering and bank secrecy act cases have generally also been settled over the last decade, and the impact is similar — standards have been created without the give and take of a rulemaking process or the affirmation of a court.

One particularly important threshold issue where the approach that the CFPB takes will be important involves how it defines the new concept of "unfair, deceptive or abusive practices." If the CFPB does promulgate formal administrative rules to define unfair, deceptive or abusive practices, under the Dodd-Frank Act, it will be subject to limitations not generally imposed on other federal bank regulatory agencies. For example, the CFPB is required to balance the costs and benefits to financial services providers and consumers, "including the potential reduction of access by customers to consumer financial services." It is also required in its rulemaking to consult with the appropriate prudential federal regulators, and it regulations may, under certain circumstances, be set aside by the Financial Stability Oversight Council.

These checks and balances do not apply to the civil investigatory, administrative enforcement and civil litigation authorities granted to the CFPB, possibly creating an internal agency bias in certain circumstances to take the enforcement route. Indeed, unlike any other federal bank regulatory agency, it has been given broad authority to initiate litigation in civil courts against financial institutions.

Whether the CFPB develops rules-based policies or undertakes a "quick strike" approach through administrative enforcement or civil litigation actions will impact the nature of its relationships with those it regulates and, in some ways, the impact it will have in the marketplace.

Thomas P. Vartanian is a partner resident in the Washington, D.C. office of the law firm, Dechert LLP and the head of the firm's financial institutions transactions practice. He was previously a general counsel and at the Federal Home Loan Bank Board and a senior trial counsel the Office of the Comptroller of the Currency.

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