How CFPB Reshapes Market with Enforcement Actions — Not Rules

WASHINGTON — While most federal banking regulators use enforcement actions as a way to shape industry practices, the Consumer Financial Protection Bureau is taking that to a whole other level, frequently using orders as a substitute for new rules or guidelines.

"The use of consent orders to establish new standards or de facto rules for an industry has been the hallmark of the CFPB since its inception," said Christopher Willis, who leads the Consumer Financial Services Litigation Group at Ballard Spahr. "The thing that makes the CFPB different is the sheer number of enforcement actions in which the agency has done de facto rulemaking."

One frequently cited case is an action taken by CFPB last year against PHH Corp., which the agency accused of illegally taking mortgage kickbacks from mortgage insurers through customer referrals. It was the first time a case had been decided through the CFPB's internal administrative law proceeding in which CFPB Director Richard Cordray partly overruled the administrative judge's decision. Cordray ruled in June 2015 that the company's actions occurred more often and dated back further than what the judge determined, raising the fine from a suggested $6 million to $109 million.

In the process, the CFPB interpreted the Real Estate Settlement Procedures Act differently from how the Department of Housing and Urban Development applied the law in the past, according to several industry observers. As a result, major lenders such as Wells Fargo Home Mortgage and Prospect Mortgage have stopped using marketing services agreements, which were cited in the case.

"The PHH case was definitely a game changer. That was the nail in the coffin for marketing services agreements," said Joe Rodriguez, of counsel at Morrison & Foerster, who formerly worked in the CFPB's Office of Fair Lending.

Though the CFPB did eventually release guidance on marketing services agreements in October 2015, three months after the PHH decision, observers said it was clear that the policy was already in place — and lenders were expected to already know that.

The financial services industry generally "wants to do the right thing and comply with the law, but they need certainty," Rodriguez said. "It's difficult when regulators implicitly allow certain practices, such as in the Respa context, and then sandbag industry with a novel interpretation of the law in an enforcement action rather than notice-and-comment rulemaking."

The CFPB says it uses enforcement actions and rules where appropriate.

"We have taken enforcement actions where we believe violations of the law warranted that response. When it comes to specific enforcement actions, there are a number of factors that go into each filed action and negotiated resolution. In all cases, we aim to deter unlawful behavior and return money to harmed consumers," said Sam Gilford, a spokesman for the agency. "We have issued bulletins and guidance to industry where appropriate, and have also engaged in notice and comment rulemaking to promulgate new rules, or amendments to pre-existing rules."

The CFPB has also been known to retroactively punish practices when it applies a law, effectively enforcing a new standard before it has been outlined. In the PHH case, the CFPB cited the firm for actions stretching back before the 2008 date determined by the judge, well before the agency was created in 2011.

"Many in the industry engaged in marketing services agreements based on HUD's guidance before the CFPB was in existence, so the fact that the CFPB essentially retroactively changed the rules, that part doesn't sit well from a legal or fairness perspective," said Richard Horn, a former senior counsel and special adviser at the CFPB who now runs his own law firm.

While agencies like the Department of Justice and Federal Trade Commission have often regulated whole industries through enforcement actions, sources said it's different for the CFPB because it has broader rule-writing authority within the financial services sector.

"The CFPB has other tools in its toolbox that it can use to regulate an industry, but they haven't been shy about using enforcement actions to send a message," Rodriguez said. "But when you're sending a message against an industry-wide practice that had the implicit consent of former regulators and making an example out of a few companies when all their competitors are doing the same exact thing, there is understandable frustration for those companies being cited."

One area that the industry continues to push the CFPB to write a rule is with regard to indirect auto lending. The bureau has cited Ally Financial, American Honda Finance Corp. and Fifth Third Bank in the hopes that the settlements would spur more lenders to lower or eliminate the interest rate markups that they allow partnering dealerships to make as a means of compensation.

But few companies have followed suit outside of those under an enforcement action since the agency first issued a bulletin warning about dealer markups in March 2013. That's because the indirect auto lending market is so fragmented that competitors who are not under a consent order with the CFPB can easily take the business from dealerships, observers said.

"The fragmented nature of the indirect auto finance industry means individual enforcement actions will never capture a significant share of the market," Willis said. "In this case, rulemaking would be better because it would apply at the same time to everybody and therefore equalize the market."

Debt collection is another area in which the CFPB is quickly changing some of the common policies and practices through enforcement actions. The agency has gone after companies for furnishing inaccurate consumer data to the credit reporting agencies, improperly handling consumer requests for corrections and harassing consumers for debt collection — all of which has caused many debt buyers and sellers to rethink transactions.

One of the most recent cases was when the CFPB reached a settlement agreement in December with Georgia-based Frederick J. Hanna & Associates over allegations that it illegally filed debt collection lawsuits against consumers. Part of the $3.1 million agreement requires Hanna to "review and analyze the processes and procedures" of any debt holder submitting an affidavit as part of the debt collection suit on an annual basis. This is a step beyond what regulators typically require, in which lenders are asked to oversee service providers, but service providers aren't mandated to oversee their own clients.

"In the Hanna case, now the service provider is required to exercise oversight over its clients, which is different than previous enforcement actions and the CFPB's Bulletin on service providers, which require lenders to maintain oversight of their service providers," Willis said.

The CFPB has already slated to begin a rulemaking process on debt collection this year. But many sources said it is often more efficient and faster to change an industry through enforcement actions rather than waiting years for a new regulation to take effect.

"The CFPB might identify a practice it believes is a violation of the law, and although it might be a novel issue that it has not issued guidance on before, it likely does not want to delay a year or more to issue guidance or a new rule when it perceives consumers being harmed," Horn said. "But they have to decide whether their interpretation is supported by the existing law, so there's a judgment call that has to be made."