December 21, 2010

The Birth of a New Financial Services Regulator

Michael A. Benoit

The new Bureau of Consumer Financial Protection is a massive new regulator with largely subjective standards.

On July 21, 2010, President Obama signed into law the Wall Street Reform and Consumer Protection Act of 2010 (Act), the most far-reaching financial reform legislation since the Depression. Title X of the Act establishes the new Bureau of Consumer Financial Protection (BCFP or Bureau), a division of the Federal Reserve Board (FRB) that effectively will be an independent agency overseeing all aspects of consumer protection with respect to financial products and services.

Purpose and Objectives

Section 1021 of the Act requires the BCFP "to implement and, where applicable, enforce Federal consumer financial law consistently for the purpose of ensuring that all consumers have access to markets for consumer financial products and services" and that such markets are fair, transparent, and competitive.

It will take over as the primary enforcement authority for federal consumer financial law (discussed below) for the purposes of ensuring that:

  • consumers are provided with timely and understandable information to make responsible decisions about financial transactions;
  • consumers are protected from unfair, deceptive, or abusive acts and practices and from discrimination;
  • outdated, unnecessary, or unduly burdensome regulations are regularly identified and addressed in order to reduce unwarranted regulatory burdens;
  • federal consumer financial law is enforced consistently, without regard to the status of a person as a depository institution, in order to promote fair competition; and
  • markets for consumer financial products and services operate transparently and efficiently to facilitate access and innovation.

Much of the Act goes into effect on the "designated transfer date" (DTD), which as of this writing is July 21, 2011. The Treasury secretary may extend the DTD for an additional six months if he transmits to appropriate committees of Congress:

  • a written determination that orderly implementation of Title X of the Act cannot be feasible accomplished by July 21, 2011;
  • an explanation of why an extension is necessary for the orderly implementation of Title X; and
  • a description of the steps that will be taken to effect an orderly and timely implementation of Title X within the extended time period.

Governance and Funding

One striking aspect of the BCFP is the near-total lack of oversight to which it can be subjected. The first example of that is its governance structure. The BCFP will be headed by a single director who will serve for five years and who may only be removed from office by the President, and then, only for cause. This is a departure from other independent agency governance, where a commission is in charge and no more than 3 (assuming a five person commission) can be from the same political party.

Until the director is confirmed, Treasury has interim authority to do all that the director could. While the President has yet to appoint a director, he has appointed Professor Elizabeth Warren from Harvard, a noted consumer advocate, as a special assistant to the president in charge of getting the BCFP off the ground until a permanent director is confirmed. Given that the BCFP is Professor Warren's brainchild, we can assume that she will be intimately involved in its activities during the Obama administration.

Second, the BCFP will not have to endure the appropriations process; the primary means Congress uses to keep independent agencies in check. Instead, the director may request, and the FRB must provide, up to 10 percent of its annual operating budget in the first year, rising to 12 percent over the next two years, and then adjusted thereafter for inflation. In year one, the maximum amount the BCFP can obtain is estimated to be approximately $550 million. To put that into perspective, the Federal Trade Commission budget is $314 million; a budget that applies not only to its consumer protection mission, but all of its other activities (e.g., competition) as well.

Should the director determine that its portion of the FRB budget is insufficient for its operational needs, it may still avail itself of the appropriations process and obtain an additional $200 million per year. Together, this could represent a budget of $750 million in year one--more than enough for the BCFP to get its mission off the ground.

Jurisdictional Authority

The BCFP has jurisdictional authority primarily over "covered persons" and "service providers."

In general, a "covered person" is "any person engaged in offering or providing a consumer financial product or service." "Consumer products and services" can include extending credit, data services, real estate services, stored value cards, deposit taking activities, etc., but does not include insurance activities or "electronic conduit" activities. While much of the focus has been on traditional financial institutions and nonbank mortgage lenders, the BCFP is mandated to define by rule classes of "non-depository covered persons" that will be subject to full BCFP authority. In other words, Congress has delegated authority to the BCFP to determine what sectors of the financial services industry it wants to regulate.

A "service provider" is "any person that provides a 'material service' to a covered person in connection with the offering or provision by such covered person of a consumer financial product or service." With such a subjective definition at its disposal, the BCFP will have significant reach into the financial services industry's vendor ranks.

Prohibiting Unfair, Deceptive, or Abusive Acts or Practices

The BCFP may take any action authorized under the Act to "prevent a covered person or service provider from committing or engaging in an unfair, deceptive, or abusive act or practice under Federal law in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service."

While we have years of jurisprudence from which providers may glean what acts or practices may be unfair or deceptive, the standard for "abusive" practices is new and untested. Specifically, an act or practice is abusive if it:

  • materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service; or
  • takes unreasonable advantage of
    • a lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service;
    • the inability of the consumer to protect his or her interests in selecting or using a consumer financial product or service; or
    • the reasonable reliance by the consumer on a covered person to act in the consumer's interests.

To provide some certainty and understanding to consumer financial services providers, clear regulatory guidance from the BCFP defining abusive acts and practices with more clarity will be necessary. Absent clear guidance, it would not be surprising to see providers somewhat reluctant to offer products and services directed to none but the least sophisticated consumers. On the other hand, history has shown the financial services industry to be adaptive to the environments imposed on it, and the same is likely to occur in this instance.

There is, however, a new twist to this standard that has not been seen before. That is, this "abusive" standard includes a fiduciary element unprecedented in the consumer lending industry, i.e., taking unreasonable advantage of the "reasonable reliance by the consumer on a covered person to act in the consumer's interests." In virtually all instances, the relationship of a borrower to a lender is adversarial throughout the duration of the relationship. It is relatively easy to disclose to borrowers at application that they should not rely on the lender to act in their interests, and no borrower should ever assume that a lender has any obligation to do so. Each is looking to get the best deal possible for themselves at origination; query whether a borrower who needs a disclosure to understand this is competent to contract for financial services in the first instance?

It gets more complicated during the life of a loan. Lenders looking to enforce the contract at various points during the term may need to tread carefully. Those lenders who try to work with their borrowers who are experiencing difficulties making their payments may be less willing to do anything other than strictly enforce the contract terms if not doing so could make it difficult to enforce the contract when all efforts to help the consumer fail. Of course, they could disclose to the borrower in each interaction that they should not rely on the lender to act in their interest, but query how helpful that sounds to the borrower?


As of the DTD, the BCFP has will have exclusive rulemaking authority with regard its powers granted under the Act and the "enumerated" federal consumer financial laws (Enumerated Laws), e.g., the Truth in Lending Act and Regulation Z, the Consumer Leasing Act and Regulation M, the Equal Credit Opportunity Act and Regulation B, etc. The list of Enumerated Laws is long and comprehensive and can be found in ยง 1002(12) of the Act.

With some exception, the BCFP has exclusive examination authority and primary enforcement authority over any rules it promulgates, and will have the same authority with respect to the Enumerated Laws as of the DTD. It will also have the authority to collect information and the power to exempt classes of providers from the full reach of its authority.

In addition to depository institutions, the BCFP will supervise:

  • all mortgage-related non-depository institutions (lenders, servicers, mortgage brokers, etc.);
  • private student lenders;
  • pay day lenders;
  • service providers to non-depository institutions subject to the Bureau's supervision.

The BCFP may also exercise supervisory authority over "larger participants" of the market for other consumer financial products or services. Within one year after the DTD, it must issue a rule in consultation with the Federal Trade Commission (FTC) to define "larger participants." Finally, it may supervise other covered persons when it has "reasonable cause to determine that the covered person's offering or provision of consumer financial products or services conduct poses risks to consumers."

The BCFP will require reports from covered persons and conduct periodic compliance examinations. Its supervision will be risk-based, i.e., it will focus its resources on those providers or classes of providers whose products and service represent the greatest risk to consumers. Many of these providers will be state-regulated; the BCFP is required to coordinate its supervisory activities with the state agencies. Additionally, the BCFP may require specific record-keeping, as well as impose a requirement for background checks or other appropriate financial requirements as it sees fit.

Enforcement and Remedies

Except for FTC, the BCFP will have exclusive enforcement authority for all transferred and newly promulgated rules. It must coordinate its enforcement with the FTC and negotiate protocol with FTC for initiation and notice of enforcement actions.

With respect to its power to prohibit unfair, deceptive, and abusive practices, the BCFP may bring investigations, and issue Civil Investigative Demands (CIDs) in connection with those investigations. It may conduct cease-and-desist administrative proceedings, and it may bring enforcement actions in U.S. district court.

A court, or the BCFP in the case of an administrative proceeding, may "grant any appropriate legal or equitable relief with respect to a violation of Federal consumer financial law," including a violation of a rule or order under a federal consumer financial law. Such relief may include, without limitation,

  • rescission or reformation of contracts;
  • refund of moneys or return of real property, restitution;
  • disgorgement or compensation for unjust enrichment;
  • payment of damages or other monetary relief;
  • public notification regarding the violation, including the costs of notification;
  • limits on the activities or functions of the person; and
  • civil money penalties.

State attorneys general are authorized under section 1042 of the Act to bring court and/or administrative actions to enforce the Act and any regulations promulgated thereunder. Existing limitations on states' enforcement activities with respect to the Enumerated Laws remain intact. However, if the Bureau, a state attorney general, or any state regulator is the prevailing party in an action to enforce any federal consumer financial law, it may recover its costs in connection with prosecuting such action.

Final Thoughts

There is far more to the BCFP that may be covered in a simple column, and we will be learning new things about it every day. The BCFP is the new reality for both financial services providers and consumers.

Its primary goal is to protect consumers in financial transactions while keeping markets open and transparent, and ensuring that access to services and innovation is preserved. No doubt, achieving this goal will be no small feat. Achieving this goal without significantly increasing the costs of financial products and services for consumers is, more than likely, a statistical improbability.

All indications seem to be that the BCFP is interested in having an open dialogue with industry and consumers. Building any new organization of this scope is a monumental task, one made easier by developing a clear understanding of the facts and realities affecting its mission. It would be easy enough for the regulatory pendulum to swing too far one way or the other, and there are plenty of reasons (e.g., economic stability, access to credit, etc.) to try to forge a middle path.

In an effective regulatory environment, balance and cost controls are the key components. Regulations should protect those whom they are meant to protect, while at the same time imposing as little burden as possible on those being regulated. Congress, in its efforts to ensure it addressed every financial woe possible, has created a massive new regulator with no track record and provided it with largely subjective standards to enforce while at the same time eliminating much of its own ability to oversee it effectively. So query: What will drive the balance and regulatory cost controls at the BCFP?

Michael A. Benoit

Michael Benoit is a partner in the Washington, D.C., office of Hudson Cook LLP. Nothing in this article is intended to be legal advice and should not be taken as such. All legal questions should be addressed to competent counsel.