ITT Pushes Back on CFPB Claims and Why You Should Care

By Terry Maher, Baird Holm LLP, and Marilyn Bochicchio, Paybefore

ITT Educational Services, the for-profit college chain whose TV commercials are ubiquitous, late last month filed a motion in the U.S. District Court in the Southern District of Indiana to dismiss the CFPB’s complaint against it. The CFPB sued ITT in February for predatory lending, involving UDAAP violations. ITT’s motion includes two key parts: the constitutionality of the CFPB and its actions, and the claim that the CFPB’s allegations are “legally flawed.”

Although this lawsuit involves lending practices (not prepaid or emerging payments issues), the industry would be wise to pay close attention because of its UDAAP implications, which are applicable to all entities the CFPB regulates.

To date, there have been few or no allegations made by the CFPB of UDAAP violations involving prepaid products. Yet, every responsible person working in the field understands the serious potential consequences of violating UDAAP as well as the formidable challenges of steering clear of such violations. The “abusive” arm of UDAAP is relatively new and untested, making it, at this point, frustratingly vague; some would even say subjective. Examining this case can provide valuable insight, with the goal of avoiding or reducing the opportunities for prepaid products to inadvertently cross the UDAAP line.

Getting Up to Speed on the ITT Lawsuit

The CFPB on February 26 filed its lawsuit against ITT. From its release on the subject, we know the CFPB alleged that the company “exploited its students and pushed them into high-cost private student loans that were very likely to end in default.” The lawsuit, which seeks restitution for victims, a civil fine and an injunction against the company, was filed under the authority given to the CFPB by the Dodd-Frank Act to take action against institutions engaging in unfair, deceptive or abusive practices (UDAAP).

The CFPB likened ITT’s alleged high pressure tactics to the mortgage market in the lead-up to the financial crisis, citing the possibility of “misaligned incentives.” It suggested that the price of an ITT degree causes “most students” to face a “tuition gap,” the difference between the amounts borrowed from federal student loan programs and the cost of tuition, that makes it necessary for students to find private sources of funding.

Specifically at issue is ITT’s zero-interest loan, Temporary Credit. The CFPB says the loan typically had to be paid in full at the end of the student’s first academic year, but ITT knew that many students would not be able to pay back the loan or fund next year’s tuition gap. The suit alleges that between July 2011 and December 2011, ITT “pushed students into repaying their Temporary Credit and funding their second-year tuition gaps through high-cost private student load programs.”

The CFPB alleges the following misconduct by ITT:

• Students were pressured into predatory loans.
• ITT credits typically were not transferrable to other schools.
• Students were misled about job prospects.
• ITT knew that the loans were likely to fail, projecting a 65 percent default rate.

ITT Responds

Late last month, ITT filed a motion to dismiss the lawsuit brought by the CFPB. As mentioned above, the motion to dismiss cited that the CFPB’s allegations were “legally flawed.” The motion also asserted that the CFPB’s lawsuit violates the Constitution because (i) the CFPB is an unconstitutional entity, lacking separation of powers and (ii) the Due Process Clause of the Fifth Amendment was violated as ITT did not have fair notice of prohibited conduct.^[i]

Constitutionality Issues

Let’s talk about the constitutionality argument first, starting with the allegation that the CFPB is an unconstitutional entity. The CFPB withstood the constitutionality test in a January 2014 California federal district court decision involving a CFPB enforcement action against Morgan Drexen, and the claims asserted by ITT essentially parallel those rejected in that decision. Although it’s possible that the Indiana court might come to a different conclusion than the California court, it doesn’t seem likely and we believe the CFPB is here to stay as a regulator.

The more interesting constitutional issue is ITT’s allegation that the CFPB lawsuit violates due process because regulated parties do not have fair notice of what constitutes “unfair” or “abusive” acts or practices:

• Count 1 of the CFPB complaint asserts that the third-party loans were “unfair” because ITT allegedly subjected students to undue influence or coercion “at or around the time the students signed the ITT Private Loan contracts.”
• Count 2 of the complaint asserts that the third-party private loans were “abusive”—and that ITT, not the third-party lenders, is responsible for that “abuse”—because ITT allegedly took unreasonable advantage of continuing students’ inability to protect their interests in selecting private loans.
• Count 3 of the complaint asserts that the third-party loans were “abusive” because ITT allegedly took unreasonable advantage of continuing students’ reliance on ITT to act in their interests.

In responding to the CFPB claims in its motion to dismiss, ITT asserts that, both on their face and as applied, the terms “unfair” and “abusive” fail to provide sufficient notice of what is proscribed and violate the Due Process Clause of the Fifth Amendment to the United States Constitution.

With respect to “unfair” acts or practices, the Consumer Financial Protection Act (CFPA) provides that the CFPB has no authority to declare an act or practice “unfair” unless there is a “reasonable basis to conclude” that “(A) the act or practice causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers and (B) such substantial injury is not outweighed by countervailing benefits to consumers or to competition.” ITT asserts in its motion that what constitutes “substantial injury” or is “reasonably avoidable” is as amorphous—and subjective—as the term “unfair,” and that the CFPB has not attempted to provide meaningful guidance through regulation, instead asserting that its interpretation of “unfair” practices may be informed by case law, enforcement actions and ad hoc policy statements.

As for “abusive” acts or practices, ITT’s motion notes that this term is even less defined. The CFPA states that an “abusive” act or practice is one that “takes unreasonable advantage of … 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.” In 2012, CFPB Director Richard Cordray testified that the term “abusive” is “a little bit of a puzzle because it is a new term,” and that the CFPB “ha[s] been looking at it, trying to understand it, and we have determined that that is going to have to be a fact and circumstances issue. … Probably not useful to try to define a term like that in the abstract; we are going to have to see what kind of situations may arise where that would seem to fit the bill under the prongs.”

ITT hits the nail on the head when it states in its motion: “[t]he Bureau’s ‘know it when I see it’ approach leaves regulated entities to ‘guess at its meaning and … application[,] violat[ing] the first essential of due process of law.’”

The authors agree with ITT that the UDAAP definitions are replete with vague and nebulous terms, such as “substantial,” “likely” and “reasonable,” which allow the CFPB complete discretion to declare acts or practices unfair, deceptive or abusive, and the proper way for the CFPB to meet constitutional due process standards is through rulemaking rather than guidance, consent orders and enforcement actions.

If ITT’s argument prevails, the logjam around the definition of “abuse” finally could be broken. The CFPB would need to define the term in a way that gives businesses a more complete and concrete understanding of what it means, in other words real guidance. And, this outcome would be constructive for the industry (providing a level of certainty to avoid complaints based on abuse) and, in our opinion, the CFPB, too (getting past this contentious and divisive issue in a way that promotes compliance).

ITT’s Contention that the CFPB’s Allegations Are “Legally Flawed”

So, which of the CFPB’s allegations is ITT saying are legally flawed?

1. Working with Third Parties. ITT claims it “does not provide consumer financial products, and its conduct as described in the Bureau’s complaint falls outside the Bureau’s jurisdiction. The complaint recognizes that the loans at issue in this case were made by third parties (i.e., ITT).”

ITT asserts that the CFPA limits the bureau’s authority to “covered person[s]” and “service provider[s]” and that ITT is neither. The CFPA defines “covered persons” as “any person that engages in offering or providing a consumer financial product or service.” A financial product or service means “extending credit and servicing loans, including … brokering … extensions of credit.” It also means “providing financial advisory services,” including “credit counseling” and “services to assist [with] debt management or debt settlement.” On the lending issue, ITT asserts that the complaint fails to allege facts showing that ITT sought to enter into a bargain with any student regarding the loan programs in question, that any student formed a loan contract with ITT or that ITT had any right of action against a student who defaulted on a loan.

ITT also asserts that the CFPB also incorrectly asserts that it may sue ITT as a “service provider.” A “service provider” is one who “provides a material service to a covered person in connection with” the covered person’s offering of a “consumer financial product.” A material service includes participating in “designing, operating or maintaining” the consumer financial product. ITT asserts that the third-party loan programs were designed in 2008 and 2009, and that the CFPB cannot exercise enforcement authority over ITT for “designing” a consumer financial product or service before the bureau obtained enforcement power on July 21, 2011. Further, ITT asserts that its providing financial aid assistance to students is not equivalent to providing a “material service” to third-party lenders in connection with operating or maintaining third-party loans.

2. Mystery Shopping. The CFPB used reports filed by mystery shoppers engaged by ITT to help verify that ITT’s activities conform to its policies and are compliant with regulations. ITT claims: “The complaint provides only out-of-context, edited quotations from select mystery shopper reports. The full quotations reveal a starkly different picture.”

The moral of the story is that audits and mystery shopping that a regulated entity may engage in to check its own adherence to company policies may end up being cited by the CFPB in a compliance action.

3. Extraneous Claims. ITT says: “The Bureau does not claim that [ITT] engaged in fraudulent or deceptive conduct. … Nearly every allegation … including the misleading and out-of-context ‘mystery shopper’ allegations—is window dressing that has nothing to do with the third-party loans or the causes of action the Bureau has chosen to plead.”

Is the bureau gilding the lily in the lawsuit, as ITT claims, or does the additional information presented by the CFPB add substance to its underlying arguments with respect to its predatory lending charges? That’s one for the court to determine, but—either way—the outcome will be interesting and potentially significant for future actions brought by the bureau.

What’s Next?

The CFPB will file a response to the ITT motion in the next few weeks, and the court will issue an opinion on the constitutionality issues over the next few months. It would be beneficial to all parties involved if the court addresses the due process concerns and the CFPB enter into formal rulemaking to give financial businesses clear standards against which their operations will be measured.

With these important issues hanging in the balance and the CFPB’s Notice of Proposed Rulemaking on GPR cards on its way later this month or next, the second half of 2014 will be pivotal in shaping the future of prepaid products and those that support them.

Stay tuned!

Terry Maher, a frequent contributor to Paybefore, is a partner with the Omaha, Neb., law firm Baird Holm LLP. His practice focuses on legal issues in payment systems and electronic financial services. He serves as counsel to the Network Branded Prepaid Card Association and may be reached at [email protected].

Marilyn Bochicchio, CEO of Paybefore, is a long-time observer of regulatory activities involving electronic payments. She serves on the board of the NBPCA and is a member of its executive committee.