Legislative Update

April - June 2008

Proposed Unfair or Deceptive Acts or Practices Rule

On May 19, the Office of Thrift Supervision (OTS), the Board of Governors of the Federal Reserve, and the National Credit Union Administration (NCUA) published a proposed joint amendment to Regulation AA (73, Federal Register, pp. 28904-64), which defines unfair or deceptive acts or practices (UDAP) in consumer lending and establishes consumer complaint procedures. The proposed amendment targets certain practices of the credit card industry, as well as bank overdraft protection services.¹ Comments from the public were due on August 4, 2008.

Background

Section 18(f)(1) of the Federal Trade Commission Act authorizes the Commission, the Federal Reserve Board, the Office of Thrift Supervision, and the National Credit Union Administration to define and prohibit unfair or deceptive practices by the financial institutions they regulate.²

In June 2007, the Federal Reserve Board asked for comments on a proposed amendment to Regulation Z, which implements the Truth in Lending Act (TILA). The TILA, passed in 1968 as part of the Consumer Credit Protection Act, is designed to promote the use of consumer credit by requiring clear disclosures of the costs and terms of lending, including credit cards.

The Fed’s proposed amendment would affect the open-end credit (not home-secured) provisions of Regulation Z, with the goal of improving the effectiveness of disclosures that lenders provide to consumers. The comments on this proposal were generally favorable and included suggestions that the Fed take additional action to regulate credit card markets.

In August 2007, the OTS also requested comments to determine whether it should broaden its prohibitions against unfair or deceptive practices. The proposed rule is an outgrowth of that request.

The Proposal

Billing methods used by credit card issuers would be more heavily regulated under this rule. Issuers would be prohibited from treating payments as late unless they have given consumers a “reasonable” amount of time to make the payments. The rule provides a safe harbor for issuers who mail periodic statements at least 21 days prior to the due date.

For credit card accounts that charge multiple annual percentage rates (APRs) – one for balances on purchases and another for cash advances, for example – issuers would be required to allocate payments in excess of the required minimum payment in a way that is no less beneficial than one of three methods. These methods are allocating the entire excess payment to the balance with the highest APR, splitting the payment evenly between the balances, and allocating the payment in proportion to the balances. Issuers would be allowed to create other methods of payment allocation as long as they resulted in interest charges over the life of the loan no higher than those that would result under the least favorable of the methods listed above, and they informed the consumer of the method of allocation. In addition, if an account carries any balances that are subject to promotional or discounted APRs, payments in excess of the minimum would need to be allocated first to balances on which APRs are not discounted.

Under the proposed rule “double-cycle” billing would be prohibited. This is the practice of charging interest based on the average daily balance from the current and previous month’s billing cycles if the consumer carried a balance in either month that has not been paid in full.³

The proposed rule would also limit potential triggers for “penalty pricing” – the practice of changing the interest rate charged on existing balances when certain events occur. Under the proposal, issuers could increase the interest rate only if (1) the rate was variable and the index rate changed; (2) a promotional interest rate had expired; or (3) a payment had not been received within 30 days of the due date. Lenders would always retain the ability to change terms at the expiration of a contract.

The proposal would also limit fees charged when an account is opened (including security deposits and membership fees) to 50 percent or less of the initial credit limit. A lender could charge up to 25 percent of the credit limit in the first billing cycle, and any additional charges (up to 50 percent of the credit limit) would need to be spread evenly over the remaining 11 billing cycles of the year.

Issuers would be prohibited from charging a fee when a credit limit is exceeded merely because of a hold placed on available credit. Fees would be allowed only if the final charge exceeded the credit limit.

Finally, the proposed rule would require banks making firm offers of credit to disclose in a clear and conspicuous way the factors that would determine a consumer’s eligibility for the lowest APR and highest credit limit advertised when a range of such options is offered.

The remainder of the proposed rule deals with overdraft services provided by banks. Under this proposal, banks would be prohibited from charging a fee for paying an overdraft on any account unless they provided the consumer with a chance to opt out of the payment of overdrafts and the consumer chose not to do so. Finally, similar to the proposed rule regarding holds on credit cards, banks would be prohibited from charging an overdraft fee on a debit card if the overdraft was solely because a hold was placed on funds in the consumer’s account.

Related Action by the Board of Governors of the Federal Reserve

On May 19, the Board of Governors of the Federal Reserve System also published proposed amendments to Regulation DD (73, Federal Register, pp. 28739-51) and Regulation Z (73, Federal Register, pp. 28866-901), the rules implementing the Truth in Savings and Truth in Lending acts. Comments from the public on these rules were due on July 18, 2008.

The amendment to Regulation Z would create additional guidelines for billing practices. Any payment on a credit card balance that is received by the issuer by 5:00 p.m. local time on the due date would be counted as on time. If the due date is on a nonbusiness day, any payments received on the following business day would also be counted as on time.

Solicitation practices would also be revised under the Regulation Z amendment. If a creditor requires fees and a security deposit totaling more than 25 percent of the minimum credit limit in order to open an account, the creditor must disclose the amount of credit that would be available after the consumer opens the account. In this case, the consumer has the right to cancel the account before the card is used without paying any fees. Under the proposed rule, fees for transactions in foreign currencies and penalty rates for termination of credit privileges must be disclosed. The proposal would also add a de minimis dollar amount trigger of $1 for disclosing minimum interest or finance charges on both solicitations and applications. Any charges equal to or higher than this amount would need to be disclosed to consumers. Currently, card issuers are not required to disclose any minimum interest or finance charge until application and account opening.

The proposed amendment to Regulation DD would extend the disclosure requirements of banks for overdraft practices. All banks and savings associations would be required to disclose on periodic statements the full amounts of fees charged for overdraft payments and returned items. Also, any institution that provides automated account balance information would be required to disclose the amount of funds available for immediate use without including any potential overdraft funds from the bank whenever the account is accessed.

Proposed Risk-Based Pricing Notice Rule

On May 8, the Board of Governors of the Federal Reserve and the Federal Trade Commission (FTC) jointly proposed for comment regulations that would require creditors to provide consumers with a “risk-based pricing notice” when offering them credit on significantly less favorable terms on the basis of information contained in their credit report. Comments were due on August 18.

Background

Under the Fair Credit Reporting Act (FCRA) of 1970, when a firm declines to offer a consumer credit, insurance, or employment in part because of information found in the consumer’s credit report, the firm must provide an “adverse action notice” to the consumer.⁴ Among other things, the notice informs the consumer that the decision was based in part on information in his or her credit report and that he or she has the right to request a free copy of the report within a certain period of time and the right to dispute any inaccurate information contained in the report. Often, consumers are better able to identify mistakes in their credit reports, and they have strong incentives to correct their reports if they think a mistake has significantly affected their potential access to credit, insurance, employment, or other opportunities.⁵

In recent years some lenders have implemented risk-based pricing.⁶ For example, in addition to using credit bureau information to decide whether or not to offer credit to a consumer, a lender may also use it to determine the interest rate the consumer will pay. Thus, it is possible that negative information contained in a credit report may not result in the denial of a loan but might result in the loan costing the consumer more than it otherwise would. Some credit card lenders also perform routine account reviews, adjusting terms based on the current information in the consumer’s credit report.

Section 311 of the Fair and Accurate Credit Transactions Act (FACTA) of 2003 amends the FCRA to address risk-based pricing.⁷ In particular, it requires a creditor to provide a risk-based pricing notice to consumers who are offered material credit on terms “materially less favorable”than the best terms the firm offers to a substantial proportion of its customers. The act also requirethe Federal Reserve and the Federal Trade Commission to jointly issue rules to implement this
requirement.

Proposed Rule

The proposed rules specify the content of the risk-based pricing notice, the conditions that trigger an obligation to provide such a notice, and when it should be provided to the consumerrules also specify a set of exceptions to this notification requirement and several model notices that creditors could use.

The risk-based pricing notice requiremwould apply only to decisions involving the provision of consumer credit. Under the proposed rule, if there is an obligation to provide a risk-based pricing notice, it falls on the original creditor, i.e, the person or firm to whom the obligation is initially payable. Thus, the obligation would not fall on brokers or other intermediaries who locate lenders on behalf of the borrower.

For the purposes of the rule, the regulators propose to define the “material terms” of a credit offer as the annual percentage rate (APR). For credit cards, the relevant interest rate is the one charged on purchases. Other monetary terms would be used for forms of credit that do not have an APR. For a utility bill or cell phone contract, for example, the relevant terms might be the required deposit or down payment.

The risk-based pricing notice itself would be required to include a number of important disclosures. First, it must disclose that the terms being offered (including the APR) were determined at least in part on the basis of information contained in the consumer’s credit report and that those terms may be less favorable than the terms offered to consumers with better credit histories. For notices that result from periodic reviews of an existing account, the disclosure must indicate that the increase in the APR was based at least in part on information contained in the consumer’s credit report. The notice must disclose the name(s) and contact information of the credit bureau(s) that provided any reports. It must also inform the consumer of his or her right to request a free copy of the report as long as the request is made within 60 days of receiving the notice. Finally, the notice must include a statement encouraging the consumer to verify the accuracy of the information in his or her credit report and to dispute any inaccuracies he or she may find.

The rule proposes a number of methods a creditor may use to determine whether a consumer has received terms that are materially less favorable than those offered to its other customers. The first is a case-by-case analysis, which would require the firm to compare the interest rate offered to a consumer to the lowest rate offered to a substantial proportion of its customers for the same product. This difference would be deemed “materially less favorable” if it implied that the cost of credit to the consumer would be significantly greater than the cost incurred by these other customers. The proposed rule does not specify a quantitative definition of significantly greater costs.

The other two methods would presume that a consumer is being offered materially less favorable terms if he or she falls below a specified cut-off value in the ranking of the firm’s existing customers for the same product.

Under the first method, a consumer with a credit score that falls in the bottom 60 percent of the scores of the firm’s existing customers would receive a risk-based pricing notice.⁸ The cut-off values would be recalculated every two years. Firms introducing new products would be permitted to rely on third-party data to establish the cut-off value until they had sufficient customers to calculate the value based on internal data. For firms using this approach, an applicant who did not have a credit score would automatically qualify to receive a risk-based pricing notice if his or her application was accepted.⁹

The other approach that lenders would be able to employ is “tiered pricing” – the practice of assigning consumers to one of a discrete number of pricing tiers based at least in part on information contained in their credit reports. If only four or fewer pricing tiers are employed, all consumers who do not fall into the top tier (i.e., receiving the best terms) would receive a risk-based pricing notice. For firms that use five or more tiers, the cut-off is determined by ordering the tiers in terms of their pricing (from best to worst) and identifying the set of tiers (with lower APRs) that account for at least 30 percent of the firm’s customers but not more than 40 percent. Any consumer falling outside one of those better pricing tiers would receive a risk-based pricing notice.

Some determinations are specific to credit cards. Under the proposal, when a consumer applies for a credit card in connection with a solicitation offering a range of purchase APRs, and is granted credit at an APR higher than the lowest rate available under that offer, the lender would be required to provide a risk-based pricing notice to the consumer. Any periodic review of credit card accounts that is based at least in part on a credit report and would result in an increase in the interest rate charged to the consumer would trigger the obligation to provide a risk-based pricing notice. This notice must be provided to the consumer no later than five days after the interest rate change went into effect.

For new obligations that would trigger the obligation to provide a risk-based pricing notice, that notice must be provided before the consumer becomes contractually obligated but after the terms of credit have been determined. For open-ended credit, including credit cards, this would be before the first transaction but not before the formal credit approval was communicated to the consumer.

FACTA contains a statutory exception to the risk-based pricing notice requirement for instances where a consumer applies for credit on specific terms and is granted credit on those terms. Thus, under the proposed rule, no risk-based pricing notice would be required when a consumer responds to a prescreened offer of credit at a single, specific APR and is accepted at that rate, even if better terms were offered to many of the firm’s other customers.

FACTA permits the regulators to exempt transactions from the risk-based pricing notice requirement in cases where consumers would not significantly benefit from receiving the disclosures. The regulators have proposed a number of these. First, they propose to exempt prescreened offers of credit even where the terms offered are determined at least in part by information contained in the consumer’s credit report. However, this does not rule out the possibility that the lender would subsequently be obligated to provide such a notice, as described above, if the consumer responds to a solicitation describing a range of APRs.

The regulators also propose an exemption for creditors who provide all their applicants with an alternative “credit score disclosure,” described below, at no cost to the consumer. Typically, consumers pay $5-$10 to obtain their credit score. The regulators have concluded that if consumers are receiving a credit score disclosure, there would be little incremental benefit to also providing them with a risk-based pricing notice.

A credit score disclosure would include the consumer’s actual credit score and the date it was calculated. It must also include information about the distribution of that credit score across the population or a description of how the consumer’s score compares to those of other consumers. For consumers without a credit score, the regulators have proposed alternative language that could be used in the notice (the rule includes an example in a model disclosure).

The disclosure must also include information describing credit reports, credit scoring, and how these are often used in the underwriting process. The notice must specify the name and contact information of the bureau(s) that provided the credit report or score. The notice must include a statement encouraging the consumer to verify the accuracy of the information in his or her credit report and to dispute any inaccuracies he or she may find. It must also inform the consumer of his or her right to obtain a free copy of his or her credit report every 12 months from each of the three national credit bureaus.¹⁰

Judicial Decisions and Legislation Affecting the FCRA

Courts have reached a number of decisions this quarter involving provisions contained in the Fair Credit Reporting Act (FCRA). Additionally, on June 3 the President signed the Credit and Debit Card Receipt Clarification Act of 2007 (Public Law No: 110-241), amending the FCRA.

Among other things, the FCRA regulates the collection and distribution of information about consumers’ access to credit and their repayment behaviors. Specifically, it lays out the steps that must be taken by credit reporting agencies (CRAs) and information furnishers¹¹ to protect consumers’ credit histories from unfair or inaccurate information. It is primarily enforced by the Federal Trade Commission (FTC).

"Firm Offer of Credit" Under the FCRA

On April 16, the U.S. Court of Appeals for the Seventh Circuit affirmed decisions on three putative class action suits that alleged unsolicited mailers had violated the Fair Credit Reporting Act (FCRA) by advertising “firm offers” of credit. Under the letter of the law, a consumer must initiate a transaction before a firm may obtain his or her credit information. However, the FCRA allows firms to purchase prescreened name and address lists from CRAs as long as the firms plan to make “firm offers of credit or insurance” to those prescreened consumers. In all three cases, consumers sued creditors under the FCRA for failing to meet the “firm offer” requirement.

In Murray v. New Cingular Wireless Services, Inc. (7th Cir., No. 06-2477, 4/16/08), the court ruled that an offer of free merchandise can function as a firm offer of credit. The defendant had sent a mailer offering a “free” cellular phone with the purchase of one year of service. The judge ruled that this is not a FCRA violation, concluding that since the phone was bundled with the service contract the cost of the phone was implicitly financed via monthly payments under the contract. The court saw the payment for the phone as being deferred and amortized over the length of the service contract, thus making the entire offer one of credit. The court also recommended that at least an eight-point type be used to print terms and conditions to be considered “conspicuous,” but Cingular’s use of six-point type was neither willful nor reckless and thus not a FCRA violation.

In Bruce v. KeyBank N.A. (7th Cir., No. 06-4368, 4/16/08), the plaintiff argued that KeyBank’s offer of home equity financing was not firm because it did not state all material terms and conditions. The court ruled that a prescreened mailer need not specify all the terms and conditions of the offer, since that would be impossible in a short mailer and would only confuse the consumer. The court also ruled that the lender may reserve the right to present a range of potential terms and change the specific offer as more detailed information is learned about the consumer.

In Price v. Capital One Bank (U.S.A.), N.A. (7th Cir., No. 07-2370, 4/16/08), Capital One’s offer of a Visa credit card was challenged because it did not state a minimum line of credit, making its value uncertain. The plaintiffs argued that under the court’s previous decision in Cole v. U.S. Capital, Inc. (7th Cir., No. 03-3331, 4/15/04) the offer needed to have value. But the court found that Cole applies only in situations in which merchandise is offered along with the credit and is thus irrelevant. In this case, the court ruled that if the offer is purely for credit, the creditor’s intent to realize the offer is more important than its value.

In a similar opinion on March 19 by the U.S. Court of Appeals for the First Circuit in Sullivan v. Greenwood Credit Union (1st Cir., No. 07-2354, 3/19/08), the court reached the same conclusions as the Seventh Circuit in Bruce and Price. This confirms for lenders that “an offer of credit meets the statutory definition so long as the creditor will not deny credit to the consumer if the consumer meets the creditor’s pre-selection criteria.” In addition, the offer need not specify every material term and condition as long as these are disclosed to the consumer before the parties enter into the contract.

Damages for Neglect by an Information Furnisher

On May 14, the U.S. Court of Appeals for the Fourth Circuit affirmed a jury’s award of $1,000 in statutory damages and $80,000 in punitive damages (Saunders v. Branch Banking and Trust of Virginia, 4th Cir., No. 07-1108, 5/14/08). The plaintiff had disputed the delinquent status of an auto loan with BB&T Bank because the delinquency had been caused by the bank’s error. The bank failed to furnish the dispute information to the CRA TransUnion as required by the FCRA, damaging the plaintiff’s credit score and hampering his ability to obtain another loan at a reasonable interest rate. The court ruled that BB&T willfully withheld the information, leaving the plaintiff financially vulnerable. The decision also affirmed the award as being neither excessive nor arbitrary, despite having punitive damages 80 times the statutory damages. Although punitive damages are often capped at 10 times the statutory damages, the court found the amount necessary to serve as a deterrent to this conduct.

Credit and Debit Card Receipt Clarification Act of 2007

On June 3, the President signed into law the Credit and Debit Card Receipt Clarification Act of 2007 (Public Law No: 110-241), retroactively eliminating some potential liability of merchants who accidentally violated the Fair and Accurate Credit Transactions Act (FACTA) by printing the expiration date of credit and debit cards on receipts.

FACTA, enacted in 2003, amended the FCRA to require that merchants not print credit card expiration dates on receipts and print at most the final five digits of credit card numbers. In recent years, customers have brought hundreds of suits against merchants who violated this statute.

Believing that FACTA’s wording was confusing, Congress passed the Credit and Debit Card Receipt Clarification Act to protect merchants who had misunderstood the law. The act declares that any merchants who printed expiration dates between December 4, 2004, and the passage of the act could not be held as being in willful violation of the statute. The only exceptions are for cases where the merchants’ errors led to the theft of consumers’ identities, but no such cases have been reported.

This law appears to supersede all currently pending suits under the statute and has already led to the vacating of at least one previously settled case (Ehrheart v. Verizon Wireless, W.D. Pa., No. 2:07-cv-01165, 6/13/08).

Federal Legislation

A Bill to Prevent the Implementation of the Unlawful Internet Gambling Enforcement Act

On June 25, the House Financial Services Committee voted down a bill (H.R. 5767) to stop the Treasury and Federal Reserve from implementing any of the regulations prescribed in the Unlawful Internet Gambling Enforcement Act, 31 U.S.C. § 5631, passed in 2006. Banks have complained that the law burdens them with enforcing Internet gambling prohibitions without any clear guidance on what to detect or prevent. Opponents of the bill worried that it would weaken restrictions on Internet gambling by reducing the role of federal regulators in this area.

Federal Regulation

Office of the Comptroller of the Currency

Risk Management Guidance of Payment Processors

On April 24, the OCC issued a bulletin presenting guidance to national banks for dealing with entities that process payments for telemarketers and other risky merchant clients. The bulletin stresses effective due diligence, underwriting, and monitoring by banks of such clients to ensure that fraudulent or improper activity is not being conducted.

Judicial Rulings

Settlements

MasterCard Settles Antitrust Suit with American Express

On June 25, MasterCard Worldwide agreed to pay American Express Co. up to $1.8 billion to settle an antitrust lawsuit begun in 2004 (American Express Travel Related Services Company, Inc. v. Visa U.S.A. Inc., S.D. N.Y., No. 04-8967, 11/15/04). MasterCard will pay 15 percent of American Express's United States Global Network Services billings during the quarter, up to a maximum of $150 million per quarter for the next three years. American Express had sued Visa and MasterCard for attempting to block merchants using their networks from also using the American Express network. Visa settled the case out of court in 2007.

¹ Several bills have recently been introduced into Congress that would increase regulation of the credit card industry. For information on the Credit Cardholders’ Bill of Rights Act of 2008 (H.R. 5244) and the Credit Card Reform Act of 2008 (S. 2753), see Banking Legislation and Policy, Volume 27, Number 1.
² The Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) also have the power to enforce compliance with UDAP regulations by banks, as specified in Section 5(2) of the FTC Act.
³ For an example of double-cycle billing, see 73, Federal Register, pp. 28922-23.
⁴ See 15 U.S.C. § 1681g
⁵ For additional information on the issue of mistakes in credit reports and mechanisms for correcting them, see Robert M. Hunt, “A Century of Consumer Credit Reporting in America,” Working Paper 05-13 (2005).
⁶ For a discussion of the adoption of risk-based pricing in the credit card industry, see, for example, Mark Furletti, “Credit Card Pricing Developments and Their Disclosure,” Federal Reserve Bank of Philadelphia Payment Cards Center Discussion Paper 03-02 (2003).
⁷ See Public Law 108-59, 117 STAT. 1952.
⁸ A credit score is a number generated from a statistical model and credit bureau data that can be used to rank order consumers in terms of the likelihood that they will default over a given period of time. For additional details, see Loretta J. Mester, “What’s the Point of Credit Scoring?” Federal Reserve Bank of Philadelphia Business Review (September/October 1997).
⁹ Credit scoring models may not be able to produce a score for consumers with very few items in their credit report. These are sometimes described as “thin files.”
¹⁰ In contrast, consumers who receive a risk-based pricing notice may obtain a free credit report regardless of whether they had exercised their right to a free report within the last 12 months.
¹¹ Information furnishers are typically creditors such as banks and other issuers of mortgages, credit cards, and automobile loans.