The inclusion of one word in the Dodd-Frank law is raising concerns among bankers that it will lead to a ban on certain financial products or services.
Federal regulators could already curb products that were defined as unfair or deceptive, but the regulatory reform law added a category: abusive.
Under the statute, the Consumer Financial Protection Bureau can limit or bar a product or practice that it deems unfair, deceptive or abusive. Many worry the third category will give the agency broad flexibility to crack down wherever it sees fit.
"We think the addition of abusive to the standard in the CFPB provisions" is "the most egregious" part of Dodd-Frank, said Richard Hunt, president of the Consumer Bankers Association. "This is the primary example of how this legislation will stifle innovation."
Although the Federal Reserve Board has long had the power to ban unfair or deceptive products, the central bank used its authority only reluctantly, preferring that regulators addressed any such practices on a case-by-case basis. It wasn't until 2008, under pressure from Congress, that the Fed banned certain credit card practices.
But the Dodd-Frank law stripped the Fed of that power and gave it to the CFPB, while adding "abusive" as a category under which the agency may restrict or ban a product.
While that may sound like a superficial addition, industry observers said it opens up a big can of worms. Terms like unfair and deceptive have been well defined by the courts and regulators. That is not the case with the term abusive.
"We know what unfair is, what deceptive is," said L. Richard Fischer, a partner with law firm Morrison & Foerster. "There is a lot of law around it, so you can deal with it. Abusive is totally new. … What it really comes down to is abusive in the context of the new bureau is whatever the bureau director says it is. That is extraordinary flexibility."
Laurence Platt, a partner at K&L Gates, said: "The difference is there is a lot of case law of what is unfair and deceptive, because it's under the Federal Trade Commission Act. Abusive, there is very little case law. … What it means is there are no standards at all out there that can limit the applicability of the concept."
Some industry observers said bankers may hesitate to roll out new products that could conceivably be viewed as abusive.
"Creditors will not know what regulators think abusive means, and that uncertainty runs the risk of having a great chilling effect, because people will be afraid of offering products that they don't know if they are in compliance with the law," said Jean Noonan, a partner at Hudson Cook LLP. "We don't have that problem with unfair and deceptive because we have case law clarifying what that means."
"The addition of abusive is akin to changing the speed limit every day," Hunt said. It "provides way too much uncertainty."
Dodd-Frank offered some guidance on the standard, defining a product or service as abusive if it materially interferes with the ability of a consumer to understand a term or condition of a product or takes unreasonable advantage of the ability of a consumer to understand it.
Banking lawyers called that definition too subjective.
"Institutions are concerned about it because the term is so broad and the definition is so broad," said Jean Veta, a partner at Covington & Burling LLP. "Their concern is even with their best efforts they will be considered out of compliance with it."
Lynn Barr, a partner at Goodwin Procter, said the term is defined "in a way to me that seems very subjective, because it's driven off consumer perception and that's a very difficult thing to regulate. … It's going to open up a lot of subjective analysis by examiners and the courts of what is abusive."
Industry representatives said it is unclear how a lender could guarantee a customer's understanding, or what would constitute "interfering" with it.
Richard Riese, director of the center for regulatory compliance for the American Bankers Association, said the law's definition places responsibility on both the financial provider and consumer.
"You can look at those terms and say that those standards are trying to define circumstances where the consumer has a certain level of responsibility and the provider has a certain level of responsibility," Riese said. "That's really going to be a trick going forward."
Ernest Patrikis, a partner at White & Case LLP, said the provision will force banks to focus on clear disclosures.
"The question is how much do you explain to the customer," he said.
Consumer advocates say there's nothing new here, that the term abusive has been used in the context of predatory-lending laws and state laws.
"There is, I think, a natural evolution here and I don't think people should have a knee-jerk reaction that rulemaking will result reduced access to credit," said David Berenbaum, chief program officer for the National Community Reinvestment Coalition. "In essence it is going to create a process whereby lenders need to confirm that products meet consumer protection standards."
Edmund Mierzwinski, consumer program director for U.S. Public Interest Research Group, said the new standard is more of an incremental addition than a seismic change.
"A product could be unfair, deceptive or abusive, so it might make the standard easier for whether a product would be banned. But I don't think it means the CFPB will be in the business of banning products from the get-go," Mierzwinski said. "That would be a pretty big leap. … It's an additional tool to make it easier to ban products, but it doesn't mean the industry is going to face this elimination of all of these products."
Some regulators support the change.
"I think the intent of legislators in including the term abusive is to ensure that there are no regulatory gaps and that borrowers are protected in their dealings with providers of financial services," New York Banking Superintendent Richard Neiman said. "Obviously there is going to be some overlap with the terms unfair and deceptive. The use of abusive was to make sure that consumers are not taken advantage of."
But a key question remains how far CFPB will go in using its new power. Elizabeth Warren, the Obama administration official in charge of setting up the new agency, said her first focus is on improving disclosures, not banning new products.
But the industry argues that even if CFPB doesn't aggressively use this authority, its very existence is troublesome.
"I do think its presence itself creates litigation risk, creates uncertainty and supervisory risk and will cause institutions to try to evaluate how they are delivering products in the absence of any greater clarity," Riese said.
This story has been reprinted with permission from American Banker.
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Corrected November 23, 2010 at 10:50AM: yes