Regulation Z Rule Enjoined by Federal Court
Blayne V. Scofield | Bloomberg Law
On September 23, 2011 the U.S. District Court for the District of South Dakota issued a preliminary injunction to block a rule issued by the Board of Governors of the Federal Reserve System (FRB).1 The rule was slated to take effect on October 1, 2011.
CARD Act Restricted Fees After Account Opening, FRB Rule Regulated Fees Prior to Account Opening
Congress adopted the Credit Card Accountability Responsibility and Disclosure Act of 2009 (CARD Act), Pub. L. 111-24, to strengthen consumer protections applicable to open-end credit accounts, such as credit cards. Section 105 of the CARD Act, 15 U.S.C. § 1637(n) amended the Truth in Lending Act (TILA) to address “fee harvester” credit cards. These cards typically had low credit limits and high fees, and were marketed to borrowers with poor credit histories. Generally, issuers of these cards charged upfront fees to the consumer’s credit card account, which consumed most of the credit limit and left the consumer with little actual credit. To combat this perceived problem, Section 105 limited the amount of upfront fees that could be charged to a consumer’s account in the first year during which the account is opened to 25 percent of the credit limit.
In February 2010, FRB issued a final rule to implement the CARD Act and incorporated the fee harvester provision into Regulation Z (see 75 Fed. Reg. 7658,7819 (Feb. 22, 2010)). Regulation Z mirrored the relevant language in the CARD Act.
After FRB issued the final rule, First Premier Bank devised a program pursuant to which it charged consumers an upfront fee, but required them to pay it in full before opening the account. The fee could not be charged to the consumer’s credit account and did not reduce the consumer’s credit limit.
In March 2011, FRB expanded the anti-fee harvester provision of Regulation Z (currently codified at 12 C.F.R. § 226.52) (March 2011 Rule) to cover upfront fees charged during the first year as well as fees charged prior to account opening. Following FRB’s adoption of the rule, First Premier filed suit against FRB alleging that the March 2011 Rule exceeded FRB’s authority. First Premier sought a preliminary injunction to prevent the rule from taking effect until a decision was made on its challenge.
Court Blocked Rule
Eighth Circuit courts consider four factors when evaluating a request for a preliminary injunction: the likelihood of success on the merits, the risk of irreparable harm to the party seeking the injunction, the balance of harms between the party seeking the injunction (if it is not granted) and other parties (if it is granted), and the public interest. In this case, the court quickly concluded that the other three factors favored First Premier and focused its analysis on First Premier’s likelihood of success on the merits.
— Which Test Applied?
For the likelihood of success factor, the issue before the court was whether FRB acted arbitrarily or capriciously under the Administrative Procedures Act (5 U.S.C. § 706) in promulgating the March 2011 Rule. To address the issue, the court applied the test set forth in Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). Chevron involves two steps. The court first asks whether the statutory language is unambiguous. If it is, the court carries out the statutory mandate and no further analysis is necessary. If the court concludes the statute is ambiguous, it proceeds to the second step and determines whether the agency’s interpretation was a reasonable construction of the statute.
FRB argued that this case was not subject to Chevron. FRB asserted that its authority for the March 2011 Rule derived from TILA’s antievasion provision, 15 U.S.C. § 1604(a), and that its use of this authority was governed by a series of pre-Chevron cases. These cases indicated that, because of the technical and complex nature of TILA, FRB’s interpretations of the antievasion provision were generally dispositive unless they were “demonstrably irrational”. In FRB’s view, the March 2011 Rule was a proper exercise of its antievasion authority because it prevented issuers from circumventing the CARD Act’s fee harvester provision by merely shifting the timing of the fees.
The court rejected this reasoning. It held that that FRB is always subject to Chevron and, at best, the pre-Chevron cases should be read as a gloss on Chevronstep two. Accordingly, it proceeded to analyze the CARD Act and the March 2011 Rule under Chevron.
— Chevron Analysis
First Premier’s argument was straightforward. It asserted that Chevron step one controlled because Congress unambiguously limited FRB’s fee-harvester rulemaking authority to the first year after a consumer opens a credit card account. The court agreed and held that the CARD Act was concerned only with eliminating deceptive fees that reduced credit availability during the first 365 days after an account was opened. Thus, the court held that the March 2011 Rule exceeded FRB’s statutory authority.
FRB claimed that the statute was ambiguous and that the March 2011 Rule was entitled to deference under Chevron step two. Specifically, FRB asserted that the statute expressly applied only to the one-year period after account opening but was silent as to all other periods. In FRB’s view, this silence created a gap which the March 2011 Rule filled. The court declined to follow this approach. It explained that FRB’s analysis would result in unlimited rulemaking authority for federal agencies except where expressly prohibited by Congress. This, the court found, was contrary to the principles established by Chevron.
FRB also argued that Congress must have intended for FRB to regulate the fees charged by First Premier because such fees were functionally equivalent to the fees prohibited by the CARD Act. The court rejected this view by distinguishing the fees. It stated that the CARD Act was intended to bar deceptive fees that creditors sneaked past consumers by charging the account directly. According to the court, First Premier’s pre-account opening fee avoided this pitfall because consumers had to pay the fee before obtaining a credit card and, thus, would necessarily be aware of the applicable upfront fees.
The court concluded that First Premier was likely to prevail in showing that FRB acted arbitrarily or capriciously in adopting March 2011 Rule. It granted the preliminary injunction. The parties are slated to meet on November 7, 2011 to proceed with discovery.
First Premier succeeded where at least two other entities have failed this year—it persuaded a federal court to block an FRB rule. In March, a court denied a challenge to an FRB rule regulating mortgage originator compensation filed by two mortgage industry groups. See Bloomberg Law Reports®—Banking & Finance, D.C. Circuit Court Refuses to Halt FRB Mortgage Originator Compensation Rule (Apr. 7, 2011). In April, TCF National Bank’s efforts to strike down the Dodd-Frank Act’s Durbin Rule and block FRB’s implementing regulations were also defeated. See Bloomberg Law Reports®—Banking & Finance,South Dakota District Court Refuses to Block Dodd-Frank Act’s Durbin Amendment (May 3, 2011).
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