The Dodd-Frank Act empowers the CFPB to supervise three classes of nonbank covered persons: (1) participants in certain enumerated consumer financial markets including consumer mortgages, private education loans, and payday loans; (2) larger participants in other consumer financial markets, as further defined by CFPB rulemaking; and (3) other nonbanks engaging in “conduct that poses risks to consumers with regard to the offering or provision of consumer financial products or services.”
Unlike the first two classes, which are categorical, the third requires that the CFPB make individualized determinations about particular nonbanks. Specifically, the Act requires that CFPB use information available to it—including consumer complaints, but not expressly limited to any particular sources—to determine which nonbanks to supervise by order after notice and a reasonable opportunity for the nonbank to respond.
On May 25, the Bureau proposed a set of notice and response procedures. According to the CFPB, the rule “relates solely to agency procedure and practice,” and is therefore not subject to the requirements the Administrative Procedure Act (“APA”) imposes on formal rulemaking.
CFPB’s proposal puts forward an “informal” process of written and oral response that would not constitute an adjudicatory proceeding under the APA. A nonbank would receive a Notice of Reasonable Cause indicating the basis on which the Bureau believes that the nonbank poses risks to consumers and would have 20 days in which to submit a written response. Nonbanks would also be able to request a supplemental oral response, which would generally be by telephone. The CFPB would then make its determination no later than 45 days after the receipt of a timely-filed written response, if no supplemental oral response is requested, or no later than 90 days after the service of a Notice of Reasonable Cause, if a supplemental oral response is requested. Except when a nonbank accepts CFPB supervision for a defined time by agreement, determinations that a nonbank falls under CFPB supervision would be reviewable by petition two years after the initial determination, and annually thereafter.
Despite its outward simplicity, the proposed process presents several potential pitfalls for nonbanks.
First, the Bureau does not define “risk.” Dodd-Frank establishes a set of criteria the CFPB must consider when exercising its supervisory authority to ensure that it does so in a manner based on risks posed to consumers—including the size of the supervised entity, whether the entity is otherwise overseen by state or federal regulators, and the risks attributable to the products or services provided by the entity. However, these criteria will not necessarily apply to determinations as to which nonbanks to supervise and, even if they do, they offer little concrete guidance. Future clarification may require that the CFPB engage in formal rulemaking, as the definition of “risk” would not be a matter of internal agency procedure.
Second, the proposal establishes a strict waiver regime. A nonbank that does not timely raise arguments or submit evidence in its favor will be precluded from raising those issues at later stages of the Bureau’s evaluation. Specifically, failure to present an argument or evidence in an initial written response may constitute waiver of those issues in a supplemental oral response. As the Notice of Reasonable Cause will provide a description of the Bureau’s basis that is of as yet unknown specificity, and as the Bureau may choose not to further define the risks about which it is concerned, nonbanks receiving a Notice of Reasonable Cause may find that their initial response requires substantial effort to avoid waiving potentially relevant arguments.
Though the CFPB has articulated informal procedures to challenge its supervisory authority, its failure to define what constitutes a “risk” leaves a target without a clear standard to which it can craft an appeal. The waiver regime further complicates matters, as nonbanks initially uncertain as to how to respond to a Notice of Reasonable Cause may not be able to clarify their responses completely as the Bureau fleshes-out its argument for supervision.
Given the scope of the above pitfalls, it may not be sufficient for those nonbanks that are not already subject to CFPB supervision to react to CFPB notices. Instead, they may need to proactively develop a narrative and gather supporting documentation prior to service of a Notice of Reasonable Cause. Such steps could serve as an insurance policy to the risks created by the CFPB’s high stakes “informal” process.
Comments on the proposed rule are due July 24, 2012 and may be submitted online at regulations.gov.