WASHINGTON — The debt collection industry is bracing for significant reform as collectors are scrutinizing their own practices ahead of the first set of examinations by the Consumer Financial Protection Bureau.
The agency has begun targeting large nonbank debt collectors, starting with data requests that will eventually lead to physical audits of the companies' operations, including its handling of phone calls, consumer complaints and relationships with debt originators.
"We're really trying to take a comprehensive view of the credit system and where the risks are to consumers," said Alice Hrdy, deputy assistant director for the supervision policy office at the CFPB. "Our ability to conduct on-site examinations allows us to monitor every stage of the process — from credit origination to debt collection."
The exams have the potential to fundamentally reshape the debt collection industry, which banks and other lenders rely on for asset seizures.
The industry has already been hit hard by accusations that it signed automated affidavits without verifying documents, the same "robo-signing" practices that banks were criticized for employing in handling foreclosures. For an industry that often relies on lawsuits to collect debt, the allegations were especially damaging.
Regulators immediately jumped on the cases, making last year the most litigious for the Federal Trade Commission and the CFPB. (The FTC shares enforcement authority over debt collectors, but does not routinely examine them.)
The CFPB is targeting debt collectors through its "larger participant" rulemaking, which allows it to look at big financial services firms outside of its core jurisdiction. Yet the impact of its oversight of roughly 165 large debt collection firms is likely to be felt industrywide, observers agreed.
The bureau is primarily looking at three key areas in their exams: integrity and accuracy of data, communication with consumers and following the stream of debt sales.
It marks the first time many nonbank collectors will experience regular examinations, which is already causing some in the industry to overhaul their practices in expectation of enforcement actions.
"The debt collection industry has never had that before. So finally, and for the first time, a regulator is going to truly know what goes on behind the curtain," said Bill Bartmann, chief executive of the debt advisory firm Bartmann Enterprises and the debt collector CFS II. "The CFPB will come very strong, very soon. They will come with enforcement and follow it with regulations" related to unfair and deceptive practices laws.
Consumers' debt load has increased in the wake of the financial crisis, with roughly 30 million having debt in a collection process in 2012, according to the CFPB's annual report to Congress released last month.
Since the CFPB has not yet opened its complaint database to include debt collectors, it pulls from the complaint database at the FTC. The CFPB report shows that the two largest complaints on debt collectors in 2012 were for falsely representing character, amount or status of debt; and repeated or continuous calls to consumers — both of which violate fair-debt laws.
"Before this calendar year is up, there will be lawsuits filed against 10 million consumers" for debt collection and "30% are likely to be deficient, fraudulent or inadequate in how it's being performed," said Bartmann, whose firm prides itself in resolving debt collection outside of court. "For too long, the industry model has been to sue everybody and let God sort them out."
In the last year, court rulings have shown in favor of the consumer as attorneys general and regulators joined cases against collectors, including banks, for automatically suing customers without first validating documents. Two months ago, a federal appeals court overturned a $5.2 million settlement with Encore Capital Group for inadequately compensating 1.4 million consumers affected by robo-signed affidavits.
"There were a number of firms that accepted debt based on a spreadsheet, and I think that's just a disaster," said Robert Hiday, CEO of Hiday & Ricke, a Florida law firm that handles debt collection for creditors. "It has been rampant in the past, and I don't know how much is going on anymore, but I can tell you here … we insist on proper documentation or we aren't going to proceed."
But the issue has become increasingly complicated as lenders sold off large chunks of their defaulted credit portfolios to numerous buyers, making it difficult to determine who is responsible for improperly validating documents.
"Our information is as accurate as what we get from the creditors," said John Burns, vice president of corporate services at EOS CCA, one of the largest debt collectors in the nation. "There's a lot of information correlated and associated with debt collection, and our role is to try to resolve them."
The CFPB has taken a keen interest in looking at all parties of the debt cycle, no matter how many times the debt has been sold.
"One of the key things we are concerned with is whether there is a sufficient amount of information about the debt being conveyed with every sale," Hrdy said.
Because of this, collectors say their partners are heavily scrutinizing their work. And both parties are questioning relationships, regardless of whether the debt was sold.
"There has been a lot of reviews" between lenders and the collector or debt buyer, said Amy Matsuo, who heads KPMG's financial services regulatory compliance practice.
Matsuo noted banks that work with debt collectors are more frequently asking to see the collectors' policies and practices, including how employees are trained, security at premises, and listening in on calls to make sure disclosures are read.
"We had one client who sent us a 129-question security questionnaire," Burns said. "It takes two days just to answer the questionnaire."
Though the internal scrutiny adds further time and costs, it does seem to meet the CFPB's overarching goal to have a more self-regulated industry.
"It's in a company's interest to have a strong compliance management program and fix problems before we get there," Hrdy said.
The CFPB took its first critical step with debt collection in October, when it not only expanded its supervisions to nonbank debt collectors but immediately issued an enforcement action against three American Express subsidiaries it accused of engaging in deceptive debt collection practices.
The CFPB more recently noted in its annual report to Congress that it was "conducting several nonpublic investigations of companies to determine whether they engaged in collection practices that violated" Fair Debt Collection or Dodd-Frank rules.
While enforcement is often the faster way to resolve specific issues, observers are predicting more sweeping changes to come through the agency's rulemaking power.
A major issue with the debt collection industry is that collectors have to comply with the Fair Debt Collection Practices Act, a 36-year-old rule that came out well before mobile banking, social media and online payment products.
But since most of the nonbank debt collection rules are largely outdated, collectors have largely depended on court orders to guide their decisions. This has created problems within the industry in how to apply legal interpretations when judgments are overturned or there are conflicting outcomes in similar cases.
"We need a clearer understanding of some of the laws that have a Catch-22 where there is no answer" among state and federal law, Hiday said. "If we get a clear direction from the CFPB, that would be a blessing."
Burns agreed, noting that most of the largest collectors that the CFPB is examining already have risk management practices in place to comply with existing laws.
"The larger companies that are focused on audits are the companies most likely to have a clean slate in terms how to deal with the consumer," Burns said. "If they're looking to improve the process, rulemaking clarifying or interpreting the law is certainly welcome right now."