February 2022 in Brief: Business Regulation & Regulated Industries

Banking Law

Federal Court Upholds OCC and FDIC Valid When Made Rules

By Colin Quillinan, Arthur J. Rotatori, & Robert W. Savoie, McGlinchey Stafford, PLLC

On February 8, 2022, the United States District Court for the Northern District of California issued two separate orders that upheld the “valid-when-made” rules of the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC).

In 2020, the OCC and FDIC issued separate rules addressing, among other things, uncertainty in secondary markets following the decision of Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015), which established that usury claims against non-bank assignees were not preempted by the National Banking Act of 1864 (NBA). The OCC promulgated a rule entitled “Permissible Interest on Loans That Are Sold, Assigned, or Otherwise Transferred.” Additionally, the FDIC promulgated its own “valid when made” rule entitled “Federal Interest Rate Authority.”

As expected, a small number of states mounted a legal challenge related to policy concerns with these rules, which, they argued, may enable “rent-a-charter” schemes that seek to evade state usury limits. In a major victory for the OCC and FDIC, United States District Court Judge Jeffrey S. White issued two separate orders (OCC Order and FDIC Order) that granted summary judgment in favor of the agencies in lawsuits brought by the states.

In both cases, the Plaintiff states alleged that the agencies violated the Administrative Procedures Act when they promulgated their respective rules. In its order granting the FDIC’s cross-motion for summary judgment, the Court found that the FDIC did not exceed its statutory authority when it promulgated its rule. The Court turned to a Chevron analysis and concluded that the FDIC’s rule was not unreasonable or arbitrary and capricious and that the rule was consistent with the principle that “the assignee steps into the shoes of the assignor.”

Likewise, in its order granting the OCC’s cross-motion for summary judgment, while acknowledging the “true lender” rule also promulgated by the OCC in 2020 had been invalidated by Congress pursuant to the Congressional Review Act, the Court did not consider that outcome relevant to the valid-when-made rule. The Court also found that the OCC did not exceed its statutory authority when it promulgated its rule addressing permissible interest on loans that are sold, assigned, or transferred. The Court found that the OCC did not violate procedural statutory requirements set forth in the NBA when promulgating the rule and also found that the rule did not run afoul of the 2nd Circuit’s prior ruling in Madden v. Midland Funding, LLC in 2015, because the procedural claims presented before the Court were separate and distinct from what the 2nd Circuit was presented with in Madden. The Court then turned to a Chevron analysis and concluded the OCC’s rule was not unreasonable or arbitrary and capricious and cited the OCC’s reasoning that the rule was intended to resolve uncertainty following the Madden decision.

Consumer Finance

CFPB Joins Several Federal Agencies in Encouraging Lenders to Pursue Special Purpose Credit Programs

By Eric Mogilnicki & Uttara Dukkipati, Covington & Burling LLP

On February 22, 2022, seven federal agencies including the Consumer Financial Protection Bureau (CFPB) issued an “Interagency Statement on Special Purpose Credit Programs Under the Equal Credit Opportunity Act and Regulation B.” The statement seeks to encourage lenders to offer Special Purpose Credit Programs (“SPCPs”) to better serve historically disadvantaged communities.

In a related blog post, the Bureau pointed lenders to prior CFPB guidance on how they can participate in SPCPs and encouraged lenders to consult with their regulators to seek to resolve any uncertainty relating to the relevant Equal Credit Opportunity Act and Regulation B provisions.

The post also notes that “[r]ecent research has shown that the average white family has eight times more wealth than the average Black family.” Moreover, research indicates Black and Hispanic credit applicants are declined at higher rates and minority small business owners are approved for less financing than their white counterparts. The CFPB and other federal agencies are “committed to exploring incentives that better serve those who have been historically shut out of the mainstream credit markets.”

Bureau to Focus on Lender Practices and Consumer Outcomes for Auto Loans

By Eric Mogilnicki & Uttara Dukkipati, Covington & Burling LLP

On February 24, 2022, the CFPB published a blog post describing its concerns and plans regarding auto loan debt. The Bureau notes that, due to rising inflation, “the total amount of debt and the average loan size will continue to increase and that larger car loans will put increased pressure on some consumers’ budgets for much of the next decade.” The Bureau also noted that auto loans are the third largest consumer credit market in the United States at over $1.4 trillion, double its size a decade ago.

The Bureau expresses several concerns related to this growth in auto lending:

• High auto prices, especially for used cars, might create incentives for lenders to repossess cars more quickly, assisted by new technology.
• When auto loans are made at the “edge of (or beyond) a consumer’s ability to repay, any economic disruption in the consumer’s life can result in repossession.”
  • Given the “uncertainty around the ongoing economic recovery” and the rising length and amount of loan terms, the Bureau will be “closely monitoring lender practices and consumer outcomes.”
  • In particular, the Bureau will evaluate “lending structures where lenders seem to rely on high interest rates and fees to profit even when consumers fail.”
• Consumers with subprime credit scores have less leverage and fewer options because they largely obtain loans indirectly “through a smaller pool of lenders that operate exclusively through dealers or from buy-here-pay-here dealers.”

Bureau Releases Guidance on the Obligations of Student Loan Servicers Regarding the Public Service Loan Forgiveness Program

By Eric Mogilnicki & Lucy Bartholomew, Covington & Burling LLP

On February 18, 2022, the CFPB released guidance summarizing student loan servicers’ legal obligations to communicate with borrowers about their eligibility for the Public Service Loan Forgiveness (“PSLF”) program, including the Biden administration’s temporary expansion of the PSLF program for public service workers. The bulletin states that the CFPB “plans to prioritize student loan servicing oversight work in deploying its enforcement and supervision resources in the coming year with a specific focus on monitoring engagement with borrowers about PSLF and the PSLF Waiver.” In connection with this oversight, the Bureau will pay particular attention to:

• the completeness and accuracy of communications about the PSLF program;
• policies and procedures regarding the PSLF program, including with respect to how the servicer responds to borrowers expressing interest in the program, and whether the servicer is directing borrowers to appropriate resources; and
• steps taken to promote benefits of the PSLF program to borrowers who express interest or whose files otherwise demonstrate eligibility.

In the press release accompanying the guidance, CFPB Director Rohit Chopra stated, “Illegal conduct by a student loan servicer can be ruinous for borrowers who miss out on the opportunity for debt cancelation,” and signaled that the Bureau “will be working closely with the U.S. Department of Education to ensure that loan cancellation promises for public service are honored.”

Bureau Emphasizes Appraisal Discrimination Is Illegal Under Federal Law

By Eric Mogilnicki & Uttara Dukkipati, Covington & Burling LLP

On February 4, 2022, the CFPB’s Fair Lending Director, Patrice Alexander Ficklin, joined a wide range of senior government officials in a letter to The Appraisal Foundation (“TAF”) emphasizing federal prohibitions against discrimination under the Fair Housing Act and the Equal Credit Opportunity Act. The letter urges TAF to provide clear guidance on the existing legal standards as they relate to appraisal bias.

In a related blog post, the Bureau noted that “a home’s valuation may be skewed by one’s skin color or the demographics of the surrounding community,” and that such a biased appraisal “can worsen racial inequities and distort the housing market.” The Bureau notes discriminatory statements the Fair Housing Administration recently identified in some home appraisals, and the appraisal disparities for communities of color found in Freddie Mac and Fannie Mae studies. The Bureau intends to “engag[e] with all relevant stakeholders and us[e] all of the CFPB’s tools” to address these issues.

CFPB Releases Report on Criminal Justice Financial Ecosystem

By Eric Mogilnicki & Uttara Dukkipati, Covington & Burling LLP

On January 31, 2022, the Bureau issued a press release announcing the publication of its review of the financial issues individuals and families who come in contact with the with the criminal justice system face. The report finds “an ecosystem rife with burdensome fees and lack of choice, and where families are increasingly being forced to shoulder the costs.” Director Chopra said the report “describes how private companies undermine the ability for individuals to successfully transition from incarceration.”

Specifically, the report found:

• Burdensome fees: Many who interact with the criminal justice system encounter fines, fees, and restitution, and may be subject to third-party debt collectors.
• Lack of consumer choice: There is limited choice with respect to such financial services as the transfer of funds into or out of a prison account, and that option may involve high fees or barriers to resolving errors.
• Shifting financial burdens: Governments are increasingly shifting the cost of such services as “court operations, a court-appointed public defender, drug testing, prison library use, and probation supervision” to private companies that set prices that are “wildly inflated over typical market costs.”

In sum, the Bureau found that “the available information raises serious questions about the transparency, fairness, and availability of consumer choice in markets associated with the justice system, as well as demonstrating the pervasive reach of predatory practices targeted at justice-involved individuals.”

Bureau Criticizes “Junk Fees,” Seeks Additional Information

By Eric Mogilnicki & Uttara Dukkipati, Covington & Burling LLP

On February 2, 2022, the Bureau published a blog post on the hidden cost of what it called “junk fees,” directing consumers to a related request for information. The Bureau states that “many companies are increasingly using fees to make additional money on fees you don’t shop for on the front-end.” The Bureau’s examples of such “junk fees” are “service charges” on ticket prices; “resort fees” that increase the cost of hotel stays; and mystery fees on phone and cable bills.

Within the financial services sector, the Bureau’s concern extends to fees and penalties related to late payments, overdrafts, returns, use of an out-of-network ATM, money transfers, and inactivity. The Bureau does not define “junk fees” nor reconcile its current concerns with the laws and regulations that already govern these fees, including disclosures previously touted by the Bureau as making such fees transparent to consumers. The Bureau has concluded that “[j]unk fees drain tens of billions of dollars per year from Americans’ budgets.”

The RFI asks stakeholders across the marketplace, including individuals, small business owners, academics, and government officials, to share their experiences with junk fees.

D.C. Circuit Questions Bureau’s Authority to Mandate Disclosure Clauses for Prepaid Cards and Digital Wallets

By Eric Mogilnicki & Lucy Bartholomew, Covington & Burling LLP

On February 10, 2022, the U.S. Court of Appeals for the D.C. Circuit heard oral arguments in PayPal, Inc. v. CFPB. The Bureau urged the panel to overrule a December 2020 district court opinion that invalidated portions of a 2016 CFPB rule requiring companies to use specific disclosures when providing prepaid cards and digital wallets. The district court concluded that although the Electronic Fund Transfer Act (“EFTA”) permitted the Bureau to draft “model clauses,” the agency exceeded its statutory authority by promulgating mandatory disclosures. During oral argument, the D.C. Circuit sharply questioned the CFPB’s attempt to issue obligatory clauses. Judge Neomi Rao stated that the EFTA does not allow the Bureau to issue a mandatory model clause, while Judge Sri Srinivasan expressed uncertainty as to whether the Bureau could obtain the fee disclosure information it sought under a non-mandatory framework.

Pennsylvania Amends Mortgage Licensing Act to Permit Work from Unlicensed “Remote Locations”

By Jed Mayk, Hudson Cook, LLP

On February 3, 2022, Pennsylvania Governor Tom Wolf signed into law Act 8 of 2022 (HB 1588), which amends the Mortgage Licensing Act (“MLA”) to permit mortgage loan originators to work from unlicensed “remote locations.” This amendment is effective immediately. Other MLA amendments in Act 8 are effective on April 4, 2022, including the elimination of the mortgage loan correspondent license category.

Prior to Act 8, a licensed mortgage loan originator had to be assigned to and work out of a “licensed location” (i.e., a principal or branch office) of the sponsoring licensee lender or mortgage broker, which location could be either the mortgage loan originator’s residence or a location of the licensee that was within 100 miles of the mortgage loan originator’s residence. This provision effectively required a mortgage loan originator who wanted to work from home to have his or her residence licensed as a branch office of the sponsoring licensee.

The above requirement was waived during the depths of the pandemic, and the Pennsylvania Department of Banking and Securities had suspended enforcement of the requirement until the spring of 2022. However, Act 8 now permanently eliminates a license requirement for defined “remote locations,” both by excluding that term from the definition of a “branch” and by providing that a mortgage loan originator must be assigned to and work out of either a licensed location of the sponsoring licensee or a remote location.

Under Act 8, a “remote location” is a location, other than a licensee’s principal place of business or branch, where a mortgage loan originator sponsored by the licensee, a person excepted from the MLA or excepted from MLA licensure, or any other employee of the licensee, may engage in licensed activities on behalf of the licensee under all of the following conditions:

• the licensed activities are conducted under the supervision of the licensee;
• the licensee has written policies and procedures for the supervision of personnel working from the location;
• access to the licensee’s platforms and customer information is conducted in accordance with the licensee’s comprehensive written information security plan;
• in-person consumer interaction does not occur at the remote location;
• physical records regarding the licensee’s mortgage loan business are maintained at the location;
• the location is not advertised or represented to consumers as an operating location of the licensee or the licensee’s employees who work at the location; and
• the location is not owned or controlled by the licensee. For the purposes of this definition, a location will not be considered owned or controlled by a licensee if the location is under the control of a subsidiary or affiliate of the licensee, is primarily used by the subsidiary or affiliate, and is only used by the licensee on an incidental basis for the convenience of consumers.

4th Circuit Confirms Dodd-Frank Bars Arbitration of TILA Claims Related to Residential Mortgage Loans

By Kevin Liu, Pilgrim Christakis LLP

In 2010, the Dodd-Frank Act amended the Truth in Lending Act by adding Section 1639c(e), which provides that “no residential mortgage loan and no extension of credit under an open end consumer credit plan secured by the principal dwelling of a consumer may include terms which require arbitration…” 15 U.S.C. § 1639c(e)(1). Further, “no other agreement between the consumer and the creditor relating to the residential mortgage loan or extension of credit … shall be applied or interpreted so as to bar a consumer from bringing an action in an appropriate district court of the United States, or any other court of competent jurisdiction, pursuant to section 1640 of this title or any other provision of law…” 15 U.S.C. § 1639c(e)(3). These provisions became effective as of June 1, 2013. On February 15, 2022, the United States Court of Appeals for the Fourth Circuit confirmed in William Lyons v. PNC Bank, N.A. that, based on these provisions, lenders cannot require consumers of home mortgage loans to arbitrate TILA claims.

In Lyons, the plaintiff had a home equity line of credit (HELOC) with National City Bank, which merged with PNC Bank in 2009. Plaintiff then opened a deposit account with PNC in 2010, and another deposit account in 2014. The account agreements permitted PNC to set off funds to pay any obligation owed by plaintiff to PNC. In 2013, an arbitration provision was added to the 2010 account agreement, while the 2014 account agreement already had the same arbitration provision. In 2019 and 2020, PNC set off funds from the two accounts to make overdue payments on the HELOC. Plaintiff then filed suit against PNC, asserting claims under TILA. PNC removed the case to federal court and moved to compel arbitration.

The district court found that the Dodd-Frank amendments to TILA barred arbitration of the plaintiff’s claims related to the 2014 account, because that account was opened after the effective date of the Dodd-Frank amendments (June 1, 2013). However, the district court found that the same restrictions did not apply retroactively to bar arbitration of the claims related to the 2010 account, since the 2013 arbitration agreement was effective as of February 1, 2013—several months before June 1, 2013.

On appeal, the Fourth Circuit expressly found that the “plain language of § 1639c(e)(3) is clear and unambiguous: a consumer cannot be prevented from bringing a TILA action in federal district court by a provision in an agreement ‘relate[d] to’ a residential mortgage loan—like a HELOC.” The Fourth Circuit rejected PNC’s argument that Section 1639c(e)(3) merely prevented consumers from agreeing to waive certain claims, but did not control the proper judicial forum for resolution of such claims.

In addition, the Fourth Circuit reversed the district court’s finding that the Dodd-Frank amendments were inapplicable to the 2010 account agreement. The appellate court noted that although the stated effective date of the 2013 arbitration agreement was February 1, 2013 (i.e., prior to when the Dodd-Frank amendments took effect), the plaintiff had the ability to opt out of arbitration by June 11, 2013 (i.e., 10 days after the Dodd-Frank amendments took effect). And, under Maryland law, the plaintiff’s silence by the June 11, 2013, deadline constituted acceptance. Accordingly, the arbitration agreement was not contractually formed until that day, and therefore Section 1639c(e)(3) was applicable even to the 2010 account agreement.

Tax Law

IRS Updates Guidance on New Schedules K-2 and K-3 for Tax Year 2021

By Timothy M. Todd, Liberty University School of Law

In 2021, the IRS released two new international-related schedules for flow-through entities regarding items of “international tax relevance”—Schedules K-2 and K-3. For partnerships, those schedules are called: (1) Schedule K-2, “Partners’ Distributive Share Items—International,” and (2) Schedule K-3, “Partner’s Share of Income, Deductions, Credits, etc.—International.” Similar forms were released for S corporations as well.

These new schedules were designed to replace some of the reporting currently done on Form 1065 Schedule K and Schedule K-1 (and, correspondingly, Forms 1120-S and 8865). According to the IRS in Notice 2021-39, the “new standardized format assists partnerships in providing partners with the information necessary to complete their returns with respect to the international tax aspects of the Code and allows the IRS to more efficiently verify tax compliance.” These new schedules were to be effective for the tax year 2021; as such, they would ordinarily be filed during the 2022 filing season.

Perhaps surprisingly, partnerships or S corporations with no foreign partners, foreign source income, or foreign taxes paid may still need to report information on Schedules K-2 and K-3. For example, information reported on those schedules may be needed to calculate individual-level items, such as the foreign tax credit for a partner with other foreign-source income.

However, on February 16, 2022, building on prior transition relief, the IRS offered additional details on its transition relief by FAQs, by allowing an additional exception for tax year 2021 filing requirements. In particular, FAQ #15 notes that certain domestic partnerships and S corporations will not need to file Schedules K-2 and K-3 for tax year 2021 if, among other things, (1) in tax year 2021, the direct partners in the domestic partnership are not foreign persons (e.g., foreign partnerships, foreign individuals, foreign trusts, etc.); (2) in tax year 2021, the domestic partnership (or S corporation) has no foreign activity (including foreign taxes paid); (3) in tax year 2020, the partnership (or S corporation) did not provide nor did the partners (or shareholders) request certain information regarding foreign transactions; and (4) that the domestic partnership (or S corporation) has no knowledge that partners (or shareholders) are requesting such information for tax year 2021. Additional details are provided in the FAQ.

If this exception is satisfied, then the domestic partnership or S corporation does not need to file Schedules K-2 or K-3 for tax year 2021. However, if a partner or shareholders notifies the entity that information contained in those schedules is needed, the entity must provide the information to the partner or shareholder.

For more information, see IRS News Release 2022-38 (Feb. 16, 2022) and the FAQs, which are available here: https://www.irs.gov/businesses/schedules-k-2-and-k-3-frequently-asked-questions-forms-1065-1120s-and-8865.