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Consumer warriors

Only 10 more days for market input on new capital rules

The March 26 dismissal of a lawsuit brought by the Consumer Financial Protection Bureau (CFPB) against a student loan trust is good news for the securitization market, but may be only the first skirmish between it and a more bellicose CFPB.

In fact, the manner in which CFPB appears to interpret elements of the 2010 Dodd-Frank Act now means that the structured finance industry stands squarely in its cross hairs. While the Delaware district court rejected the arguments made by the CFPB in its suit against the National Collegiate Master Student Loan Trusts, which hold more than 800,000 student loans, the alarm bell has sounded.

The suit was brought due to the actions of the debt servicers, who, among other failings, had pursued student debtors and their families in an often hostile manner. The CFPB claimed that the trust is responsible for this behaviour, and, further, that trusts qualify as “covered persons” as defined by the Dodd-Frank Act and so are subject to the CFPB. If an entity is not deemed a covered person, then the CFPB has no jurisdiction over it.

Crucially, in its rejection of the suit against National Collegiate, the Delaware court did not make ruling on the question of whether a trust used in a securitization can be legitimately deemed a covered person. Neither is it thought that a district court would be able to make a final judgement on this topic anyway. It remains hanging in the air, unanswered.

“Who is a covered person is one of the most important and least explored aspects of Dodd-Frank, and the CFPB has chosen to be aggressive in its interpretation. They can take the position that purchasers of consumer receivables are covered persons. We haven’t seen the end of this. The comments made by the judge were favourable but the issue is not resolved,” says Rachel Rodman, a partner and member of the white collar defence and investigations practice at Cadwalader, Wickersham and Taft, in New York.

Last September, the CFPB won a case against PEAKS Trust 2009-1 for what it deemed unfair and coercive lending practices. The trust incorporated loans made by the ITT Educational Services. In this case, the trust did not put up a fight but accepted the verdict.

Cases like these suggest that any structured finance vehicle which incorporates consumer debt, like ones used for credit card deals, auto loans or student loans, could be on the hook for the actions of the debt originators and servicers. The trust is, of course, not an active entity, but rather an operational device.

"To the extent that securitizations will be now held liable for the conduct of third parties, then this will have an impact. This becomes a risk that any consumer credit product seeking financing in the ABS markets will have to acknowledge," says Neil Weidner, a partner in the capital markets group at Cadwalader.

The Delaware court rejected the suit against National Collegiate on a constitutional technicality. In Seila Law LLC versus Consumer Financial Protection Bureau in June 2020, the Supreme Court ruled that the structure of the CFPB was unconstitutional in that the director of the bureau could only be removed “for cause” rather than by presidential edict, and this represented was deemed a violation of separation of powers.

Following that landmark decision, the director can now be removed on the orders of the executive. Previous actions initiated by the CFPB - when it was, in fact, an unconstitutional body - were allowed to proceed under an order of ratification. However, in the verdict delivered on March 26, the Delaware judge ruled that in the case under consideration ratification had occurred after the statute of limitations had passed and thus the suit was invalid.

The chances of an increasingly interventionist CFPB have increased with a new regime in Washington DC and the likelihood that President Biden’s nominee Rohit Chopra will be confirmed as the new director. Chopra, currently a commissioner at the Federal Trade Commission, is a darling of the leftist wing of the Democrats. “The CFPB was designed to be the cop on the beat policing the financial system for consumer abuses. If confirmed, Chopra will take aggressive action,” Aaron Klein, senior fellow of economic studies at the Brookings Institution, said recently.

“We’re seeing a return to form in terms of the CFPB being much more aggressive and asserting the full panoply of its authority - at least as the CFPB thinks were granted to it under Dodd-Frank,” affirms Rodman.

She was previously a senior legal counsel at the CFPB when Richard Corday was the body’s first director. Corday, who was the Democratic nominee for the governorship of Ohio in 2018, was a notoriously combative director, and Rodman believes those days are here again.

A trust is more likely to defeat a suit if it is able to hire expensive lawyers who are experts not only in securitization but also in the minutiae of litigation. This could be beyond the means of most trusts, which have a priority of payments and those are often capped.

Of course, many will argue that it trusts have to pay closer attention to loan origination and the actions of debt servicers, then that is no bad thing. But, as is the case with a great many high-minded undertakings, a law of unintended consequences may apply.

“If you’re hurting consumer securitization, you’re hurting the flow of money into consumer lending, and you wouldn’t want to do that in a recovery,” says Weidner.

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