It is hard to believe that the Dodd-Frank Act (“Act”) celebrated only its first birthday on July 21, 2011. It seems like it has been around a lot longer than that sometimes. Although the Act has already reshaped the regulatory regime for both financial and many non-financial entities, in actuality, its impact is just now beginning to be felt. This is the first of what is sure to be many articles examining the Act and its impact on community banks.
DISCLOSURE OF CREDIT SCORES AND FCRA
On July 15, 2011, the Federal Reserve Board (“FRB”) and the Federal Trade Commission (“FTC”) published new rules implementing the Act’s revisions to the Fair Credit Reporting Act (“FCRA”). The Act set out new content requirements for both risk-based pricing notices and adverse action notices.
The Act essentially says that if the consumer’s credit score is used by the creditor in setting the material terms of the credit (for a risk-based pricing notice) or in deciding to take adverse action as to that consumer (for an adverse action notice), then the creditor must provide the consumer with either a risk-based pricing notice or an adverse action notice containing the credit score and information the creditor used in making its decision.
From the Act’s broad edict, the new rules give more specific guidance on its implementation. Specifically, the new rules require that if a “credit score” is used by a creditor, then any risk-based pricing notice or adverse action notice should generally contain 1) a numerical credit score used in making the credit decision; 2) the range of possible scores under the model used; 3) up to four key factors that adversely affected the consumer’s credit score (or up to five factors if the number of inquiries made with respect to that consumer report is a key factor); 4) the date on which the credit score was created; and 5) the name of the person or entity that provided the report. To help effect this change, the rules include model notices for new accounts and for existing accounts.
Not surprisingly, the rules still leave many questions unanswered, which the FRB and FTC tried to clarify. A few noteworthy ones are as follows:
1. What is a “credit score”?
FCRA defines a credit score to mean “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.” The credit scores received from the credit reporting agencies clearly fall into this category. On the other hand, “proprietary scores,” or scores calculated by using other information that may or may not be in a consumer report, are not necessarily “credit scores,” so they need not necessarily be disclosed. If the proprietary score uses information that is not included in a consumer report, then it is not a “credit score.” For example, a “credit score” is not a mortgage score or rating of the automated underwriting system that uses one or more factors in addition to credit information, including loan-to-value ratio, the amount of a down payment or the financial assets of a consumer. Since the actual “credit score” that the creditor used must be disclosed, it is important to know what a “credit score” is.
2. When does one “use” a “credit score”?
If the creditor obtains a “credit score,” and considers it in any manner whatsoever, then the creditor must disclose that credit score. It makes no difference whether the “credit score” was a significant factor in the decision making, but only that it was a factor, in determining whether it must be disclosed.
3. What if the creditor obtained and used multiple “credit scores”?
The creditor need only disclose one of the “credit scores” that it used. The rules do not require that the creditor disclose the lowest. Interestingly, the rules lay the groundwork for the new Consumer Finance Protection Bureau to later address this question (and possibly require the lowest score to be disclosed).
4. As an alternative to risk-based pricing notices, do credit score exception notices still work?
Yes. It is important to remember that if one uses credit score exception notices, then they must be sent to all consumers who apply for credit and must be given as early as practicable, but no later than the consummation of the transaction.
5. What if the consumer does not have a “credit score”?
Do not worry about disclosing the credit score. The creditor cannot disclose a “credit score” if there is not one.
6. What if there are co-applicants on the Application?
For privacy and customer relation concerns, creditors should provide separate notices to each co-applicant containing that co-applicant’s separate credit score. Co-signers or guarantors are not applicants, and therefore, creditors need not send the notices to them.
7. When are the new rules effective?
The new rules are effective 30 days after appearing in the Federal Register or on August 15, 2011. It is important to note that section 1100F of the Act became effective on July 21, 2011. Therefore, the additional content required by this provision is already mandatory and became necessary as of July 21, 2011. Creditors should begin adding the additional content immediately.
8. Is it possible that community bankers and others will soon gain clarity and certainty as to the new rules that community banks and others will operate under?
Of course not! Look no further than the day after the Act’s first birthday. On July 22, 2011, the United States Court of Appeals, District of Columbia Circuit (which is considered by many to be the second highest court in the country) decided Business Roundtable, et al v. Securities and Exchange Commission, No. 10-13-5 (2011). Basically, at issue in this case was a shareholder proxy rule, which was newly required by the Act. In the decision that ultimately struck down the new rule, the Court ruled that the SEC had acted “arbitrarily and capriciously” for having failed to assess the economic effects of the rule, had relied upon insufficient empirical data in the rulemaking and was internally inconsistent in its reasoning.” Many commentators agree that this decision is likely to result in (a) slower rule-making as the agencies work harder to ensure that their rules are defensible and (b) increased litigation concerning the content and impact of the rules.
Regardless, the Act has and will continue to make regulatory and compliance work exciting and somewhat unnerving. Be careful, and take very little for granted, including, as this article points out, when and how to use “credit scores.”
If you have questions, please engage qualified counsel, because failure to abide by the regulations may subject your community bank to liability for damages, including punitive damages, and attorney fees.