Why CFPB payday revamp is an even bigger deal than you think
The Consumer Financial Protection Bureau's overhaul of its payday lending rule rolls back a key policy of the prior Obama-appointed leadership. But some observers say the move goes beyond any single regulation.
In proposing to unwind the rule, the CFPB appears to rely on a legal doctrine regarding "unfair, deceptive or abusive acts or practices." A UDAAP is prohibited under the Dodd-Frank Act, but the CFPB can determine what types of conduct meet that designation.
By softening its view toward payday lenders, some experts say the CFPB is also clarifying what constitutes a UDAAP. Such a move, long sought by the financial services industry, could have wide-ranging effects on how the bureau enforces rules at companies other than payday lenders.
“A major concern of businesses subject to UDAAP is that it’s ill-defined and is extraordinarily expansive,” said Nick Gess, of counsel at Morgan, Lewis & Bockius. “The proposal is a clear indication" of how CFPB Director Kathy Kraninger views UDAAP "and how it could be applied in any matter that comes before her.”
The bureau had cited UDAAP in the original 2017 rule, which required payday lenders to verify borrowers' repayment ability. The agency had said then that high-cost, small-dollar loans were both “unfair” and “abusive.”
But under Kraninger, the agency rescinded that finding and proposed that the underwriting requirement be eliminated.
“A deeper and more rigorous analysis of the unfairness and abusive standards is a refreshing change,” said Jenny Lee, a partner at Arent Fox and a former CFPB enforcement attorney.
Some see the move as more generally narrowing the agency’s reach.
“They are putting on the record a narrower interpretation of UDAAP, and are making a second argument — that the bureau misapplied the law the first time around,” said Casey Jennings, an attorney at Seward & Kissel and a former CFPB attorney, who worked on the 2017 payday rule.
A prohibition on "unfair" and "deceptive" conduct predates Dodd-Frank. But the 2010 law added "abusive" and gave the CFPB authority both to issue enforcement actions for UDAAP violations and to write rules defining the standard. Kraninger’s February proposal on payday lending devotes more than 30 pages to the legal findings.
UDAAP has long been a pain point for banks and other financial firms because violators can be fined up to $1 million a day.
Kraninger's proposal argued that former CFPB Director Richard Cordray's interpretation of UDAAP was “problematic,” because it relied on “insufficiently robust” evidence.
Cordray's rule found that consumers did not understand the risks of short-term, small-dollar loans. It also found that repeated rollovers of payday loans forced many borrowers into a cycle of debt. As a result, the final 2017 payday rule determined that small-dollar loans are both unfair and abusive unless a lender can determine a borrower's ability to repay a loan.
But lenders argue that Cordray's payday rule failed to take into account consumer choice, and that borrowers of high-interest loans pay annual interest rates of 300% to 500% because they need money in an emergency.
"The elephant in the room in UDAAP cases is whether the likelihood of harm can be reasonably avoided for the consumer," Lee said. "This new approach in the new proposal opens a door to challenge the policy assumption that consumers that choose these products are not allowed to make that choice."
Kraninger's proposal delves into whether Cordray's proposal met the legal criteria to determine whether short-term loans are "unfair" — one, that a consumer could not reasonably avoid an injury from the product and, two, if substantial injury is not outweighed by "countervailing benefits" to consumers.
Determining what is abusive is a tougher standard because little case law exists.
Dodd-Frank defined four different categories of abusiveness using broad language to determine whether a consumer lacked an understanding of the costs and risks of a product, and if the lender took "unreasonable advantage" of the consumer.
Last year, then-acting CFPB Director Mick Mulvaney said the bureau planned a rulemaking to define what types of practices qualify as “abusive” to provide more clarity to industry.
"The CFPB has to talk about abusive in this proposal because they don't want to be inconsistent if they move forward with a further rule on abusiveness," Cordray said in an interview. "It was something Republicans in Congress were hot about early on because they feared the bureau would throw the term around loosely and be too aggressive with it."
Cordray said that he used the term "abusive" sparingly in enforcement actions. However, one example where that standard was used was the $100 million fine against Wells Fargo for opening unauthorized checking and credit card accounts, which the bureau determined was both unfair and abusive.
He said he was disappointed with Kraninger’s proposal and the arguments about UDAAP.
"They are trying to suggest that the term abusive in the statute should be read to mirror the term unfair, which on its face is an unusual reading, since Congress added [abusive as] a third term," Cordray said.
Kraninger is looking to garner support for the bureau’s proposal by soliciting other regulators to file comments backing the rescission of tough underwriting requirements for small-dollar lenders, lawyers said.
In the short term, financial firms could cite Kraninger’s proposal to counter actions filed by state or other federal regulators.
Gess at Morgan Lewis said that if a company is litigating a UDAAP case outside of the payday rule, the company could point to Kraninger's proposal as precedent to push back against an enforcement action.
Cordray said there is still a long fight ahead over the CFPB's payday rule.
“It’s going to be a legal battle and it may be up to several courts to decide,” he said. “One of the things a court will have to consider is how thorough is the support for the rule and for the proposed rescission.”