Promontory Sightlines

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Promontory Sightlines: Consumer Financial Protection Developments

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February 5, 2014

Dear clients and friends,

The payment sector has emerged as a focal point of entrepreneurs looking to transform new technologies into profitable business ventures. Private equity funds and established financial services firms are eager to invest in companies with new approaches to payments — whether in improving the payments infrastructure, using data in a novel application, or offering a platform for lending — and the sector has become a steady source of financial services mergers and acquisitions.

Yet the inconsistent and often unfamiliar regulatory framework that applies to these innovative, early-stage companies poses risks to potential investors and acquirers. An accurate accounting of risks and costs in pricing deals and projecting growth relies upon a solid grasp of regulatory purposes and policies, as well as the principles that are driving change in them.

Though payment companies are accustomed to tightening regulatory oversight in areas such as money transmission and anti-money-laundering compliance, consumer protection provides a particularly compelling — and often overlooked — case study on how to evaluate the principles that underpin regulation in M&A transactions across retail banking. There, regulators increasingly emphasize fairness, customer value, and transparency, starting with an offering’s core value proposition — including protection against loss, theft, or errors — and extending throughout the customer’s experience with the product.

Assessing the regulatory dimensions of investing or acquiring in payment companies requires a careful look not just at current risks, but also at the regulatory obstacles the business may face as the scale and complexity of its operations change, or as its offerings are integrated into the operations of a more mature institution. Some considerations in making informed decisions about pricing and structuring an investment or acquisition include:

  • Business-Model Viability
    Many payment companies of greatest interest to investors and acquirers operate in unregulated or underregulated segments of the market. Rapid consumer adoption of new technologies or products tends to attract regulatory attention, so a company whose business depends upon gaps or loopholes in the current regulatory framework may not be viable in the long term. The startup companies that offer the least regulatory risk to investors and acquirers are those that have hard-wired the animating principles of relevant regulation not just into their products and services, but also their DNA. These companies are most likely to adapt to changing regulation.
     
  • Vendors, Partners, and Customers
    Payment companies assume regulatory risk from those with whom they do business — whether vendors, partners, or customers. A payment company dependent upon business from a customer engaged in unfair consumer practices is likely to find its own reputation and business prospects tarnished. One recently settled enforcement action brought by the Consumer Financial Protection Bureau alleged that a payment processor assisted or facilitated legal violations by processing payments for debt-settlement firms when it knew or consciously avoided knowing that those firms were charging illegal upfront fees. Payment processors that work with online payday lenders face similar risks.
     
  • Current Compliance Framework
    Demonstrating a commitment to working within the regulatory system is an important, but sometimes overlooked, factor in a payment company’s business. No matter how small, regulated entities are expected to have at least a rudimentary framework for managing compliance with regulatory requirements. The sophistication of the framework should be consistent with the size and scope of the business. An underdeveloped or nonexistent compliance framework can delay growth and profitability — especially if the firm will depend on partnerships with banks or other regulated entities. Poorly conceived or implemented programs also may complicate integrating regulatory compliance systems following a deal.
     
  • Competitive Landscape
    Even if the target’s business model comports with existing regulations, it is essential to know whether the same can be said of its competitors. A concentration of companies that operate outside of regulatory boundaries can invite swift, and sometimes overbroad, regulatory intervention; alternatively, compliant companies may find themselves at a competitive disadvantage until regulatory action appears imminent or likely.

A rigorous due-diligence review may conclude that regulatory change is likely or even imminent. But that should preclude investment or acquisition only for business models that appear fundamentally incompatible with core regulatory purposes. In other instances, a disciplined inquiry will help potential investors and acquirers value and assess companies that have emphasized regulatory compliance. Those are ultimately the firms that will be best able to manage, or benefit from, eventual regulatory intervention, as noncompliant actors disappear from the market.

Yours truly,

David Stein
Director
dstein@promontory.com
+1 202 384 1183

David Stein
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CFPB Pushes Student Loan Payment-Allocation Policy to Promote TILA Compliance

On Feb. 3, the CFPB published a summary of the responses from a November information request of private student loan servicers on options available to customers making extra payments on student loans. The summary noted that some online payment platforms have limitations in automatically allocating payments and accepting payment instructions. Some servicers have changed policies so that they allocate excess payments “to balances with the highest interest rate, which is generally more favorable to borrowers,” the summary said. “For servicers that do not accept standing instructions or transparently communicate a simple prepayment method, this policy change may help servicers ensure compliance with the Truth-in-Lending Act’s prohibition on private student loan prepayment penalties.” The bureau also posted the summary on its blog.

CFPB Report Promises Faster Exam Reports; Finds Violations in Servicing Transfers

On Jan. 30, the CFPB said — via a report outlining its 2013 supervisory work — that it simplified its supervisory reports to reduce the time between an examination and the supervised institution’s receipt of the report. The new format eliminates recommendations for improving currently satisfactory processes (which will instead be communicated in person onsite); eliminates the list of CFPB team members participating in the review; and consolidates all items in need of attention in a single section.

The CFPB also said in the report that it had found legal violations in mortgage servicing, including in servicing transfers; waiving of rights in loss-mitigation agreements; payment processing; and giving of information to credit reporters. Two servicers did not honor existing permanent or trial loan modifications after a servicing transfer, and frequently required additional paperwork. According to the report, the servicers “engaged in deception in connection with this practice by communicating to borrowers that they should have made the payments required by the original note.”

CFPB Takes Action on Mortgage Insurance

The CFPB announced Jan. 29 that it filed a notice of charges against PHH Corp. and its affiliates alleging a mortgage insurance kickback scheme that dates to 1995. The bureau said PHH set up a system through which it received as much as 40% of premiums that consumers paid to mortgage insurers, overcharged consumers who did not buy mortgage insurance from kickback partners, and pressured insurers to purchase its own reinsurance in exchange for borrower referrals. The bureau seeks a civil fine, permanent injunctions, and restitution. The Department of Housing and Urban Development initiated the investigation, which the CFPB assumed in July 2011 when HUD’s authority over the investigation transferred to the bureau.

House Financial Services Committee Launches Web Form to Collect Data on CFPB

The House Financial Services Committee on Jan. 27 launched an online form to allow individuals to report to the committee how the CFPB has impacted them as consumers or business owners. “Holding Washington accountable to hardworking taxpayers is a never-ending battle. That’s especially true when it comes to the Bureau of Consumer Financial Protection, the most powerful and least accountable government agency in all of Washington,” said Chairman Jeb Hensarling (R-TX) in the committee’s press release. “The committee is already hearing from individuals and organizations about how the CFPB’s first major regulations — its ‘Qualified Mortgage’ rules — will take away homeownership opportunities for low and middle income Americans.”

Senate Schedules Hearings on Data Breaches; CFPB Issues Consumer Advisory

The Senate Banking Committee on Jan. 27 released information about an upcoming hearing on recent data breaches at U.S. retailers. Witnesses scheduled for the Feb. 3 hearing include William Noonan of the U.S. Secret Service; Jessica Rich, the director of the bureau of consumer protection at the Federal Trade Commission; James Reuter, an executive at FirstBank representing the American Bankers Association; Mallory Duncan at the National Retail Federation; and Ed Mierzwinski at U.S. Public Interest Research Group. Also on Jan. 27, the CFPB announced it issued a consumer advisory on recent payment-data breaches at retailers. The document advises consumers to monitor accounts for unauthorized charges; immediately alert card providers of suspected fraud; maintain records of correspondence with card providers; and avoid phishing scams soliciting account information through phone or email.

FTC Supports NACHA Proposal to Tighten Return-Rate Thresholds

On Jan. 24, the FTC filed a comment with NACHA (the Electronic Payments Association) supporting a proposal to change the way it monitors returned ACH transactions. The proposal would lower the automated clearinghouse transaction-return-rate threshold for inquiry, investigation, or enforcement proceedings from 1% to 0.5%, and establish for the first time return-rate thresholds of 3% for administrative returns and 15% for overall returns.

CFPB Proposes to Supervise International Money Transmitters

The CFPB on Jan. 23 proposed a rule to allow it to supervise large nonbank international money-transfer providers for the first time. The rule would subject to supervision any such providers that furnish more than 1 million transfers annually. The bureau outlined examiners’ areas of focus: better disclosures regarding exchange rates, fees, the amount of money delivered, and the date the money will be available; the creation of a minimum 30-minute window within which customers can cancel remittances; and the correction of errors, even some made by providers’ agents. The CFPB posted a fact sheet on the rule; the full rule is here.

Cordray Talks Complaint Numbers, Intends to Expand 311 Hotline

In a Jan. 22 speech before the U.S. Conference of Mayors, CFPB Director Richard Cordray called on mayors to help their constituents “understand that there is nothing strange or unusual about submitting a consumer complaint,” as 270,000 other people already have. “As people become more aware of us, we expect to continue to receive even more complaints.” The bureau has already received 27,000+ complaints about credit reporting; 31,000+ on debt collection; and 109,000+ on mortgages. He also announced a partnership with the U.S. Conference of Mayors to expand nationally its 3-1-1 hotline initiative. In Jan. 27 testimony before the House Financial Services Committee, Cordray added that in the past year, the bureau received “thousands of private student loan complaints and nearly 30,000 comments in response to our request for public information about how student debt is affecting individual consumers and the economy more generally.”

CFPB Orders Fidelity Mortgage Corp. to Pay $81,000 for Illegal Kickbacks

The CFPB on Jan. 16 ordered Missouri mortgage lender Fidelity Mortgage Corp. to pay $81,000 for illegally funneling kickbacks — disguised as inflated lease payments for rental office space — to a bank in exchange for real estate referrals, in violation of the Real Estate Settlement Procedures Act. The full consent order is available here.

TeleCheck Pays $3.5 Million to Settle FCRA Violations

The FTC announced on Jan. 16 that check-authorization company TeleCheck Services and its debt-collection entity, TRS Recovery Services Inc., have agreed to pay $3.5 million to settle charges that they violated the Fair Credit Reporting Act. The FTC said the companies allegedly failed to follow proper dispute procedures when consumers had checks denied. In addition, TRS is charged with violations of the furnisher rule, which requires firms reporting information to consumer reporting agencies to ensure the accuracy and integrity of data. The full complaint is here.

CFPB Seeks Applications for Advisory Boards

On Jan. 15 the CFPB announced that it is seeking applications for positions on its consumer advisory board, credit union advisory council, and community bank advisory council. Applications are due Feb. 28, 2014.

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Promontory's Consumer Protection Team includes:

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Konrad Alt

Konrad Alt
Managing Director
kalt@promontory.com
+1 415 986 4160

Michael Dawson

Michael Dawson
Managing Director
mdawson@promontory.com
+1 202 384 1080

Linda Gallagher

Linda Gallagher
Managing Director and Global Head
of the Consumer Protection Practice

lgallagher@promontory.com
+1 202 370 0411

Stuart King

Stuart King
Managing Director
sking@promontory.com
+44 207 997 3402

Simon McDougall

Simon McDougall
Managing Director
smcdougall@promontory.com
+44 207 377 2367

BJ Sanford

BJ Sanford
Managing Director
bsanford@promontory.com
+1 202 384 1020

Julie Williams Julie Williams
Managing Director and
Director of Domestic Advisory Practice

juwilliams@promontory.com
+1 202 384 1087
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Promontory Sightlines Consumer Financial Protection Developments

 
EDITOR IN CHIEF

P-R Stark

GLOBAL HEAD OF THE
CONSUMER PROTECTION PRACTICE

Linda Gallagher

FOUNDER AND CEO
Eugene A. Ludwig

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Promontory Financial Group, LLC
801 17th Street, N.W.
Suite 1100
Washington, DC 20006

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