Overview of Federal Reserve and FTC Risk-Based Pricing Regulations
Bisirat Ghebray | Bloomberg Law
On December 4, 2003, Congress enacted the Fair and Accurate Credit Transactions Act (FACT Act), Pub. L. 108-159. The FACT Act amended the Fair Credit Reporting Act (FCRA), 15 U.S.C. §1681 et seq., to “enhance the ability of consumers to combat identity theft, increase the accuracy of consumer reports, and allow consumers the ability to exercise greater control over the type and amount of solicitation they receive.”1 Among other changes, Section 311 of the FACT Act amended the FCRA by adding new Section 615(h),2 to impose rules on creditors’ use of risk-based pricing in making credit risk assessments. Risk-based pricing involves “the practice of setting or adjusting the price and other terms of credit offered or extended to a particular consumer to reflect the risk of nonpayment by that consumer.”3
Creditors who engage in risk-based pricing rely heavily on consumer reports. In so doing, they generally offer favorable credit terms to consumers with positive credit histories, and unfavorable terms to those with negative credit histories. Recognizing the critical role of consumer reports in risk-based pricing, Congress decided to put measures in place to ensure the accuracy of consumer reports. Congress determined the best way to ensure accuracy is by informing consumers of negative information that appears in their reports, so consumers have an opportunity to make any necessary corrections. Accordingly, Congress enacted Section 615(h) to impose the following notice requirements:
[I]f any [creditor] uses a consumer report in connection with an application for, or a grant, extension, or other provision of, credit on material terms that are materially less favorable than the most favorable terms availa ble to a substantial proportion of consumers from or through that [creditor], based in whole or in part on a consumer report, the [creditor] shall provide an oral, written, or electronic notice to the consumer in the form and manner required by regulations prescribed in accordance with this subsection (emphasis added).4
Section 615(h) also imposes other-related requirements, such as content and delivery requirements for the notices.
On July 21, 2010, Congress amended Section 615(h) of the FRCA through its enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), Pub. L. 111-203. Specifically, Section 1100F5 of the Dodd-Frank Act expanded the scope of the content requirements for risk-based pricing notices by requiring that creditors provide credit scores in the notices, if the scores were relied on to set the material terms of a credit arrangement.
Accordingly, the Board of Governors of the Federal Reserve System (Federal Reserve) and Federal Trade Commission (FTC) (collectively, the agencies) have promulgated regulations implementing the various risk-based pricing requirements under Section 615(h) of the FCRA.
Regulatory Implementation of FACT Act Amendments
On January 15, 2010, the agencies adopted final rules6 implementing the risk-based pricing requirements imposed by the FACT Act. The rules went into effect on January 1, 2011. As indicated by the agencies, the final rules were largely based on the proposal.7 On May 29, 2008, however, the agencies issued acorrection8 to the proposed rule, mainly to make technical corrections to the model notice form.
In sum, the final rules require creditors provide notice to consumers who were offered “materially less favorable” credit terms because of negative information gleaned from their consumer reports. The agencies recognized the difficulty creditors would face in determining when credit terms are “materially less favorable” and therefore presented two alternative methods for making such a determination: (1) the credit score proxy method,9 and (2) the tiered pricing method.10 The rules also implement the other-related requirements, such as content and timing requirements, and include a model risk-based pricing notice for creditors to use as an exemplar.
As provided in Section 615(h)(3), the notice requirements are not applicable under the following scenarios:
[T]he consumer applied for specific material terms and was granted those terms, unless those terms were initially specified by the [creditor] after the transaction was initiated by the consumer and after the [creditor] obtained a consumer report; or
Moreover, the rules only apply to credit obtained primarily for personal, household, or family purposes. Credit obtained for commercial or business purposes is not subject to the requirements of Section 615(h). The rules also require that creditors inform recipients of risk-based pricing notices that they are entitled to a free consumer report.
In the process of finalizing the rules, the agencies reviewed 80 comment letters from, among others, creditors, industry trade associations, and consumer groups. In general, commenters supported the new regulatory language. A majority of the suggested changes were directed at definitions of key terms. In addition to definitional changes, however, some commenters suggested the notice requirement be imposed on intermediaries rather than original creditors in certain instances, such as in mortgage or automobile lending arrangements. The agencies, however, rejected this suggestion by explaining that the point in the process in which intermediaries get involved is too early to perform the direct comparison of material terms required by the statute.
Other commenters suggested that creditors be required to provide notice to all consumers rather than just a subset. Again, the agencies rejected this suggestion on the basis that such a requirement goes beyond the scope of the statute and defeats the purpose behind the notice requirement, namely to provide notice to consumers of negative credit information in their credit reports, so they have an opportunity to make any necessary corrections.
In the end, the agencies adopted the final regulatory language substantively as it appeared in the proposal.
Regulatory Implementation of Dodd-Frank Act Amendments
On July 15, 2011, the Federal Reserve System and FTC adopted final rules13 implementing the new content requirements for risk-based pricing imposed by Section 1100F of the Dodd-Frank Act. The rules went into effect on August 15, 2011, and were largely based on the proposal.14
Section 1100F amended Section 615(h) to require that creditors provide credit scores in risk-based pricing notices and other-related information, if the scores were relied on to set the material terms of a credit arrangement. The term “credit score” is defined in Section 609(f)(2)(A) of the FCRA as “a numerical value or a categorization derived from a statistical tool or modeling system used by a person who makes or arranges a loan to predict the likelihood of certain credit behaviors, including default ….”15
In sum, the implementing rules require that risk-based pricing notices include the following additional content:
- The numerical credit score used in making a credit decision;
- The range of possible scores under the model used to generate the credit score;
- All of the key factors that adversely affected the credit score (which, generally, shall not exceed four factors);
- The date on which the credit score was created; and
- The name of the person or entity that provided the credit score.16
In the process of finalizing the rules, the agencies reviewed 35 public comment letters from a variety of industry and consumer advocates. In general, the commenters supported the additional disclosure requirements. However, some industry commenters requested some flexibility in addressing the four key factors17 that adversely affect the credit score, asserting that the current process of addressing all of the key factors was burdensome and expensive. The agencies rejected this request and explained that a discussion of all of the factors is statutorily required.
Other commenters requested additional changes, beyond those that were statutorily required, such as a request to exempt certain entities from the requirements. Again, the agencies rejected the request and expressed their reluctance to go beyond what was statutorily required, especially in light of the impending transfer18 of Section 615(h)’s rulemaking authority to the newly created Consumer Financial Protection Bureau (CFPB) pursuant to Section 1061 of the Dodd-Frank Act. The transfer of authority took place on July 21, 2011.19
Judicial Challenge to Final Rule Implementing Dodd-Frank Act Amendments
On September 9, 2011, the final rule implemented under the Dodd-Frank Act was challenged20 in the United States Court of Appeals for the District of Columbia Circuit. Subsequently, on September 22, 2011, the rule was also challenged in the United States District Court for the District of Columbia. The petitioner in both cases — the National Automobile Dealers Association (NADA) — sought review of the FTC’s “Supplementary Information” which was attached to the final rule .
As noted by NADA, the Supplementary Information included an interpretive conclusion stating “that the FRCA User Requirement Provision21 applies to dealers who engage in three-party financing transactions even where they do not obtain a consumer report as part of those transactions.”22 NADA argued that the FTC exceeded its authority by extending the requirement to dealers and, alternatively, acted in an arbitrary and capricious manner by issuing “an unreasonable, implausible, and impracticable interpretation of the FRCA User Requirement Provision.”23 NADA requested the courts permanently enjoin the FTC from enforcing the interpretation. The petitions are pending before the courts.24
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