Payday Loan Bar Association Annual Conference Hyatt Regency Monterey Hotel Monterey, California

1. Payday Loan Bar Association Annual Conference Hyatt Regency Monterey Hotel Monterey, California November 12, 2010 WTF Does “Abusive” Mean? Catherine M. Brennan Mark J. Furletti Steve Schaller

2. WTF Does “Abusive” Mean? Questions Presented What does “abusive” means of Section 1031(d)(2)(B) of Title X? Where did this language come from? What is the legislative history of this language? Did Congress have specific harms in mind that it wants to deter as “abusive”? Are there any other statutes that use “abusive,” or any court decisions construing it or adopting it? What is an “unreasonable advantage” and can it be made “reasonable” through mitigating actions by the lender (e.g., disclosures)? What payday lending practices might be abusive?

3. What We Hope to Cover 1. Overview of Title X 2. What Legislative History? 3. Federal Guidance 4. State Guidance 5. Lender Mitigation! 6. What Consumer Advocates Want

4. What Title X Does Title X specifically applies to any person offering or providing a payday loan. Title X creates a Consumer Financial Protection Bureau (“Bureau”). The Bureau will have authority to issue rules prohibiting “unfair, deceptive, or abusive acts or practices” that opens the door for the Bureau to regulate financial product terms it doesn’t like.

5. What My Mom Thinks Abusive Means • Physical or psychological mistreatment • Improper treatment or usage • Misuse • Wrongly used • Misapplied

6. Powers of the Bureau The Bureau may prescribe rules applicable to a covered person or service provider identifying as unlawful, unfair, deceptive, or abusive acts or practices in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service. Rules under Section 1031 may include requirements for the purpose of preventing such acts or practices. In prescribing rules under Section 1031, the Bureau must consult with the Federal banking agencies, or other Federal agencies, as appropriate, concerning the consistency of the proposed rule with prudential, market, or systemic objectives administered by such agencies.

7. What Title X Doesn’t Do • No Usury Cap: The Bureau has no authority to establish a usury limit applicable to an extension of credit offered or made by a covered person to a consumer, unless explicitly authorized by law. Section 1027(o). • So, high interest rates cannot be abusive. Some 15 states and the military already limit interest to 36%. • Section manifests congressional intent that the Bureau cannot set interest rates. • Wouldinterest rates may be taken into account along with other factors in determining that a loan product is “abusive”? No doubt.

8. Deceptive Rulemaking Authority What is Deceptive? A material representation, omission or practice that is likely to mislead the reasonable consumer, to the consumer’s detriment.

9. Unfairness Rulemaking Authority The Bureau cannot declare an act or practice in connection with a transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service, to be unlawful on the grounds that such act or practice is unfair, unless the Bureau has a reasonable basis to conclude that: •  the act or practice causes or is likely to cause substantial injury to consumers not reasonably avoidable by consumers; and • countervailing benefits to consumers or to competition does not outweigh such substantial injury. In determining whether an act or practice is unfair, the Bureau may consider established public policies as evidence to be considered with all other evidence. Such public policy considerations cannot serve as a primary basis for such determination.

10. Abusive Rulemaking Authority The Bureau cannot declare an act or practice abusive in connection with the provision of a consumer financial product or service, unless the act or practice: • materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service; or • takes unreasonable advantage of: • a lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service; • the inability of the consumer to protect the interests of the consumer in selecting or using a consumer financial product or service; or • the reasonable reliance by the consumer on a covered person to act in the interests of the consumer.

11. Where Else Do We See “Abusive” in Federal Law? Telemarketing Sales Rule SEC Guidance

12. Telemarketing Sales Rule “Abusive” has been used in the Telemarketing and Consumer Fraud and Abuse Prevention Act.  15 U.S.C. §§6101 et seq.  This is the Act that directed creation of the FTC’s Telemarketing Sales Rule.  The Act tells the FTC to regulate deceptive or abusive telemarketing acts and practices.  In one of the Federal Register Notices where the FTC published a Statement of Basis and Purpose explaining the rule, it took the position that, under the TSR, it would apply the FTC’s “unfairness” standard to the term “abusive” in order to give that term some meaning.  Some lobbied to keep the term “abusive” out of Title X(duplicative of “unfair”), but that didn’t happen.

13. SEC’s $1,000,000 Rule • In general, only an “accredited investor” may invest in a hedge fund or other securities offering not subject to particular Exchange Act protections. Regulation H, 17 C.F.R. §230.501(a), defines “accredited investor” as including: • Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of his purchase exceeds $1,000,000; • Dodd-Frank amends law to require exclusion of home equity from calculation.

14. What Do the States Say? • State law definitions of abusive • State elder financial abuse laws • State unfair and deceptive acts and practices laws • Behavioral law & econ and state laws

15. State Law Definitions of “Abusive” Generally Not Helpful Peters v. State, 166 Ala. 35, 38 (Ala. 1910) (finding violation of state law against sending an “abusive letter which tended to provoke a breach of the peace”) Dear Sirs: I wish to call your attention to the above matter and to remind you that it is unpaid. If you knew how contemptible you appear in this matter, you would pay this bill at once. If you do not pay this bill in a short time, I shall have to proceed in some other way to collect it. I know how worthless and contemptible you are, but this is news to you. Yours very truly, M. Peters.

16. State Law Definitions of “Abusive” Generally Not Helpful People v. Dietze, 75 N.Y.2d 47, 50 (N.Y. 1989) (finding that defendant used “abusive language” but holding that law banning such language was unconstitutional) Complainant and her son, both mentally retarded, walked down a public street in the Town of Norfolk. Defendant came to her doorway with a friend and, while facing the street, referred to complainant as a “bitch” and to her son as a “dog,” and said that she would “beat the crap out of [the complainant] some day or night on the street.” With that, complainant fled in tears and reported the incident to authorities.

17. State Law Definitions of “Abusive” Generally Not Helpful Haw. Rev. Stat §412:3-114.5 “Financial abuse” means financial abuse or economic exploitation

18. State Law Definitions of “Abusive” Generally Not Helpful Peters v. State, 166 Ala. 35, 38 (Ala. 1910) [A]buse is defined as: “To use improperly, or excessively, * * * to treat ill, use injuriously, hurt; to wrong in speech, reproach coarsely, disparage, revile, malign.” And “abusive” is defied as: “Employing harsh words, or ill treatment, hurtful, harsh, vituperative scurillous, wrongly used, improper.”

19. Statutes Protecting the Elderly and Benefit/Harm California Financial Abuse of Elderly Law – Cal. Wel. & Inst. Code §15610.30 A person or entity shall be deemed to have taken, secreted, appropriated, obtained, or retained property for a wrongful use if, among other things, the person or entity takes, secretes, appropriates, obtains, or retains the property and the person or entity knew or should have known that this conduct is likely to be harmful to the elder or dependent adult.

20. Statutes Protecting the Elderly and Benefit/Harm Missouri Financial Exploitation of the Elderly Law – Mo. Rev. Stat. §570.145 A person commits the crime of financial exploitation of an elderly or disabled person if such person knowingly and by deception, intimidation, or force obtains control over the elderly or disabled person’s property with the intent to permanently deprive the elderly or disabled person of the use, benefit or possession of his or her property thereby benefiting such person or detrimentally affecting the elderly or disabled person.

21. Statutes Protecting the Elderly and Benefit/Harm Rhode Island Exploitation of an Elder Law – R.I. Gen. Laws §11-68-2 Knowingly…obtains or uses, endeavors to obtain or use, or conspires with another to obtain or use an elder person’s funds, assets, or property with the intent to temporarily or permanently deprive the elder person of the use, benefit, or possession of the funds, assets, or property…by a person who knows or reasonably should know that the elder person lacks the capacity to consent.

22. Statutes Protecting the Elderly and Benefit/Harm Alaska Elder Abuse Law – Alaska Stat. § 44.21.415(g) “Fraud” means…exploitation of another person or another person’s resources for personal profit or advantage with no significant benefit accruing to the person who is exploited.

23. Abusive as Unconscionability “Light” Ohio’s UDAP, O.R.C. § 1345(B): (B) In determining whether an act or practice is unconscionable, the following circumstances shall be taken into consideration: (1) Whether the supplier has knowingly taken advantage of the inability of the consumer reasonably to protect the consumer’s interests because of the consumer’s physical or mental infirmities, ignorance, illiteracy, or inability to understand the language of an agreement; …

24. Abusive as Unconscionability “Light” Ohio courts have been reluctant to find unconscionability based on the inability of a consumer to protect him/herself. See, e.g., Equicredit Corp. of Amer. v. Jackson, 2004 Ohio 6376 (Ohio Ct. App. 2004) (home-secured loan for new siding) Jackson’s difficulty in understanding the terms of this contract does not necessarily prove that she was unable to reasonably protect here interests. She herself admitted that she could have asked her daughter for help. She also admitted that she never even tried to read the terms of the contracts she was entering into. Her ‘inability to reasonably protect her interests’ was as much the result of her own actions as it was any mental condition that may hay have had preventing her from understanding the contracts….

25. Abusive as Unconscionability “Light” Wilson v. World Omni Leasing, Inc., 540 So.2d 713, 717 (Ala. 1989) Rescission of a contract for unconscionability is an extraordinary remedy usually reserved for the protection of the unsophisticated and the uneducated.

26. Abusive as Unconscionability “Light” • Fiesta Dance Clubs v. Bailey, 597 S.W.2d 532 (Tex. Ct. Civ. App. 1980) (finding UDAP violation where dance school took “advantage of the lack of knowledge, ability, experience or capacity of a person to a grossly unfair degree”) • “The jury could properly infer from the evidence that plaintiff was a lonely widow who lacked the knowledge, ability, experience or capacity to withstand the premeditated attention lavished upon her by defendants, who purposely took advantage of her vulnerability to a grossly unfair degree.”

27. Abusive as Unconscionability “Light” Larry DiMatteo & Bruce Louis Rich, A Consent Theory Of Unconscionability: An Empirical Study Of Law In Action, 33 Fla. St. U.L. Rev. 1067, 1071 (2008) In order to determine if there is a relationship between the court’s decision and the presence of an unsophisticated, uneducated, low socio-economic status party, we calculated cross tabulations of the cases that indicated a party was of unsophisticated, uneducated, low socio-economic status. Results revealed that in 85% of the cases involving an unsophisticated/uneducated/low socio-economic status party, the court found unconscionability, suggesting [the h]ypothesis is supported.

28. Behavioral Law & Econ and State Laws • Oren Bar-Gill & Elizabeth Warren, Making Credit Safer, 157 U. Pa. L. Rev. 1 (2008) (lays out case for CFPB and examines PDLs) • Oren Bar-Gill, Seduction by Plastic, 98 Nw. U. L. Rev. 1373 (2004) • Karen E. Francis, Rollover, Rollover: A Behavioral Law & Economics Analysis of the Payday Loan Industry, 88 Tex. L. Rev. 611 (2010) • Other big names in behavioral law and econ field: Cass Sunstein, Ronald Mann and Christine Jolls

29. Behavioral Law & Econ and State Laws • Behavioral law and econ literature argues that, because of fierce competition, financial products are designed to exploit weaknesses in consumers: • Imperfect self control: leaving consumers unable to resist the temptation to take path of least resistance/lowest immediate cost • Optimism bias: leading consumers to think they will have more excess cash or fewer expenses in the future • Hyperbolic discounting: causing consumers to accept paying substantial costs in the future to have the (modest) immediate benefit of having cash in their pocket today

30. Behavioral Law & Econ and State Laws • These weaknesses necessitate government intervention according to Barr-Gill: • These welfare costs[, i.e., costs created by consumers not acting in their own best interest,] provide a prima facia case for legal intervention. The underestimation bias that underlies the identified welfare costs also qualifies the no-intervention presumption of the freedom of contract paradigm. If a contracting party misconceives the future consequences of the contract, then the normative power of contractual consent is significantly weakened.

31. Behavioral Law & Econ and State Laws • What kind of intervention? • “Perhaps the most dangerous feature of the payday loan product is the loan rollover” • - Bar-Gill & Warren

32. Behavioral Law & Econ and State Laws • What kind of intervention? • State laws signal a number of potential candidates for further regulation: • Rollovers • ACH authorizations • Multiple concurrent loans • And other things that are clearly not “deceptive” or “unfair” but that cause people to act in way that a behavioral economist might say is irrational or not in their self interest

33. Behavioral Law & Econ and State Laws • What kind of intervention? • Not necessarily an APR cap: “[P]rice regulation via usury caps is fraught with well-known problems.” Barr-Gill • Prominent Generic Disclosures: See Marianne Bertrand & Adair Morse, Information Disclosure, Cognitive Biases and Payday Borrowing, U. Chicago Booth School of Bus. Working Paper (finding that disclosure of rollover fees reduced future loan amounts by 23% and reduced future loan take up by 11%) • “Individualized disclosures”: YTD (or lifetime-to-date) fees/charges paid

34. What’s “Abusive” in Other Products? Onerous Prepayment Penalties Balloon Payments Steering into higher cost loans Equity Stripping/Flipping Making Loan without Ability to Repay Coercive EFTs

35. Responses to What’s Abusive in Other Products? Onerous Prepayment Penalties – ban them Balloon Payments – ban them Steering into higher cost loans – ban it Equity Stripping/Flipping – ban it Making Loan without Ability to Repay – ban it Also, many state high cost loan laws require counseling, etc. before agreeing to a high cost loan

36. Rollovers • Rollovers an obvious target for an abusive practice • Akin to loan flipping, which many high-cost loan laws ban without some “net tangible benefit” • Some combinations of interest rates and rollovers are highly likely to be non-welfare-enhancing; therefore arguably “abusive” or “unfair” – consumer advocates likely to argue that rollovers themselves are abusive because of the “cycle of debt” dilemma

37. What Consumer Advocates Say • This is one of the few industries where the product is designed for overuse or the business model fails. • The industry recognizes this fundamental flaw and says that consumers should not overuse the product. • If people truly used the product on an isolated basis, consumer advocates could live with the product.

38. What Abusive Looks Like Retired nursing home aid on fixed income takes out a $550 payday loan to help pay for “unusual” moving expenses to move closer to family Retired nursing home aid ends up paying over $2,700 in interest How does this happen? Rollovers?

39. Consumer Advocates Hate Rollovers • Lenders “have deliberately built tricks and traps” into the product to “ensnare families in a cycle of high-cost debt.” • No disclosure can fix the fundamental problem of reuse – disclosures in this regards are used to “obfuscate rather than inform”

40. What about Net Tangible Benefit? • Anti-flipping prohibitions in high-cost loan laws allow lenders to overcome presumption of flipping for certain loans if they can show a “net tangible benefit” to borrowers, such as a lower interest rate or elimination of a prepayment penalty • Consumers advocates will fight this with regard to payday loans, because they argue that there can be no net tangible benefit to becoming ensnared in the cycle of debt

41. What Else is Abusive? Documenting Ability to Repay No doc loans have been characterized as abusive Payday loans are not always made on the underwriting conclusion that a customer can repay the loan Is this abusive? For payday lending to profit the lender, the lender counts on the customer not being able to repay – product has unaffordable repayment terms. Is this abusive?

42. Some Scenarios for Payday Lending Guidance from the Bureau Restrictions a la the FDIC’s Payday Guidance Limits on the number and frequency of extensions, deferrals, renewals and rewrites Ban additional advances to finance unpaid interest and fees Ban simultaneous loans to the same customer Cooling off/waiting periods between the time a payday loan is repaid and another application is made Establish the maximum # of loans per customer within a designated time period (e.g., one year) Only one loan outstanding at a time

43. Possible Bright Line Rule No payday loans to customers who had a payday loan outstanding at any lender for a total of 3 months during the prior 12 months. When a customer has used payday loans for 3 months or more in the past 12 months, the lender must refer them to or offer an alternative longer term product that better suits the customer. Lenders must consider the total use of payday loans at all lenders in applying this rule.

44. Other Tests of What’s Abusive Suitability Test • Is this a suitable product for the consumer’s needs? • Requires inquiry into why consumer gets the loan Effects Test • What impact/effect does the loan have on the consumer’s well-being? What’s the financial impact of the loan?

45. But This is Only Speculation The Act does not address rollovers or any other substantive aspect of payday lending. The Bureau can make regulations with respect to payday loans. No other language in Title X gives the Bureau authority to proscribe rollovers or any other feature of payday or small loans. Consumer groups will use “abusive” as a basis for urging proscription of some unspecified number of consecutive rollovers, possibly four or more, at the very least.

46. Catherine M. Brennan Hudson Cook, LLP 7250 Parkway Drive, 5th Floor Hanover, MD 21076 410-865-5405 cbrennan@hudco.com Mark J. Furletti Consumer Financial Services Group Ballard Spahr LLP 1735 Market Street, 51st Floor Philadelphia, PA 19103-7599 215-864-8138 furlettim@ballardspahr.com Contact Information