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Top 5 Questions About the CFPB's "Larger Participant Rule"

David N. Anthony, Alan D. Wingfield, Virginia Bell Flynn, and H. Scott Kelly

Corporate Counsel

01-14-2013


On January 2, the Consumer Financial Protection Bureau’s second “larger participant rule” [PDF] took effect. The rule covers which debt collectors, debt buyers, and collection law firms are subject to its examination and enforcement power. The new programs mark the first time that companies in these industries will be subject to examination by a federal regulator. The second rule follows the Bureau’s adoption of a first rule defining larger participants in the consumer reporting industry, which took effect in September 2012.

Accompanying the new rule, the CFPB also released a field guide [PDF] that outlines the procedures by which its examiners will investigate certain companies and banks engaged in debt collection. Those procedures include evaluations of whether debt collectors:

  • Provide required disclosures.
  • Provide accurate information.
  • Have a consumer complaint and dispute resolution process.
  • Communicate civilly and honestly with consumers.

 
1. Who is Covered?

Pursuant to the Final Consumer Debt Collection Rule, the CFPB’s new supervision authority covers three types of businesses:

  1. Companies that may buy defaulted debt and collect the proceeds for themselves.
  2. Companies that may collect defaulted debt owned by another company in return for a fee.
  3. Debt collection attorneys that collect through litigation.

According to the CFPB, the rule will extend to about 175 of the approximately 4,500 U.S. debt collectors, buyers, and firms engaged in the practice. Of the industry’s $12.2 billion in annual receipts, the CFPB’s influence will extend to 63 percent. In this way, the Bureau hopes to assert its emergent influence over every stage of the debt-collection process—from origination to ultimate collection or resolution.

2. What Does CFPB Supervision Mean?

Debt collectors can expect the CFPB examination process to be extensive and time-consuming. Among other things, firms must be prepared for, at least:

  • An initial conference between a CFPB examiner and company management, during which documents and records may be requested. The examiners may also review the entity’s compliance management system.
  • A determination by examiners of the scope and details of an on-site examination.
  • An on-site investigation, including discussions with management about the company’s processes and procedures; a review of documents and records; and more focus on compliance management systems.
  • Issuance of confidential examination reports, supervisory letters, and compliance ratings.
  • Depending on the nature of the complaints the company has received, examiners may interview consumers.

In short, supervision under the rule will require covered companies to submit reports to the CFPB and subject their businesses to thorough examinations by CFPB staff. The examinations will be looking to: (1) assess compliance with federal consumer financial law; (2) obtain information about activities and compliance systems or procedures; and (3) detect and assess risks to consumers and consumer financial markets.

Those entities within the CFPB’s ambit need to have a substantive compliance program and maintain procedures to ensure that complaints are received and dealt with in an appropriate fashion. According to the CFPB’s field guide, the basic information examiners will seek to obtain and review will be:

  • Organizational charts and process flowcharts
  • Board minutes, annual reports, or the equivalent
  • Relevant management reporting
  • Policies and procedures
  • Notes and disclosures
  • Telephone recordings
  • Operating checklists, worksheets, and review documents
  • Monitoring procedures
  • Compensation policies
  • Relevant computer program and system details
  • Consumer files, including original loan documents, and payment records systems
  • Historical examination information
  • Audit and compliance reports, and management responses to findings
  • Training programs and materials
  • Scripts for employee use
  • Third-party contracts and oversight materials, including monitoring reports and findings
  • Written correspondence with consumers
  • Court documents
  • Consumer complaints and disputes, including those submitted to the CFPB Consumer Response Center, the FTC’s Consumer Sentinel network, the Better Business Bureau, or other sources as appropriate

3. What Makes a “Larger Participant”?

Any third-party debt collection agency, debt buyer, or collection law firm with more than $10 million in annual receipts qualifies as a larger participant. For calculation purposes, the term “receipts” means “total income” plus “cost of goods sold” as defined by the IRS. This definition is of particular import for debt collection law firms, as the CFPB recognized that certain reimbursement funds, such as recording or filing fees, are not part of the total income calculus.

The CFPB also differentiated between receipts on amounts collected for another entity and fees earned in connection with such collections, indicating that only the latter will be counted as receipts. Additionally, the “annual receipts” test aggregates the activities of all affiliate companies, i.e., any company that controls, is controlled by, or is under common control of another.

In the end, the $10 million annual receipt threshold was maintained despite a strong dissent from the debt collection industry, whose trade group, ACA International, made substantial efforts to contest the figure during the rulemaking process. It argued that defining companies with revenues of $10 million as “larger participants” contradicts existing federal definitions for company size, most notably the Small Business Administration’s definition of a “small business”—currently slated at $7 million.

4.    Who Else May be Affected by the Rule?

“Service Providers”

Importantly, the new rule also covers “service providers”: any person who provides a material service to a larger participant in connection with their offering of a consumer financial product or service. The CFPB’s investigation and enforcement power over service providers, however, is not governed by the amount of their annual receipts.

As a result, the new rule threatens to affect many more debt collection firms than the CFPB’s projected estimate of 175. Law firms that provide services to a larger participant’s debt collection activities especially should be concerned with this broad CFPB reach, since they could be vulnerable despite limited engagement in debt collection activities.

“Risky” Businesses

While the CFPB has made strides in its attempt to supervise as many financial service companies as possible, the agency in May announced a proposal for a rule where a “riskiness” determination will allow it to supervise non-banks that it would otherwise not be able to reach. Likewise, the CFPB could theoretically try to assert supervision over entire industries based on its riskiness assessment. The bureau will be able to do so merely because of a subjective decision based upon company or industry conduct. This is an obvious and troublesome back door around the larger participant rule, which limits the CFPB’s supervision to non-banks offering consumer reporting whose annual receipts from consumer reporting exceed $7 million, and non-banks providing consumer debt collection whose annual receipts from such activity exceed $10 million.

5. What Should Companies and Firms Do Now?

While the CFPB has fundamentally altered the consumer protection regulatory landscape, the CFPB also is busy defining the scope of its direct examination and supervision powers, which will have a dramatic impact on the surprisingly broad sweep of the powers being claimed by the agency. At this stage, the force of the CFPB’s new supervisory authority over debt collectors still is being determined. Based on its recent enforcement actions, however—resulting in large settlements and fines of up to $250 million—any company under the CFPB’s purview must be knowledgeable about its practices and procedures. A CFPB investigation not only creates the risk of enormous compliance costs and settlement amounts, but also the danger of disclosing confidential documents and other privileged information. That disclosure presents a major risk of future litigation, especially given the high-profile nature of the CFPB enforcement actions.

For law firms engaging in debt collecting, moreover, the compliance pitfalls associated with a CFPB investigation are particularly significant. Legal professionals have heightened duties of confidentiality to their clients and must maintain certain ethical standards in their practices. These standards are established and regulated by state bars and could potentially be implicated during a CFPB enforcement action.

Although the CFPB contends that state bar regulations and conduct rules of federal consumer finance law are never in conflict, the legal basis for that claim has yet to be endorsed by any court. So law firms need to review their collection practices, including litigation involving security interests or other potentially defaulting assets. An internal audit by all companies potentially affected by the rule may be wise.

Ultimately, the takeaway for all “larger” debt collectors is that a CFPB investigation is no minor event. Establishing efficient compliance and response procedures now will only save more time and money in the future. Internal compliance audits should be under way to ensure preparedness for CFPB oversight in 2013 and beyond.

David N. Anthony and Alan D. Wingfield are partners in the Richmond, Virginia, office of Troutman Sanders and members of the firm’s CFPB team. Anthony also heads the firm’s financial services litigation practice group. Virginia Bell Flynn and H. Scott Kelly are associates with the CFPB team. They can be reached at cfpb@troutmansanders.com.