California is poised to enact broad new legislation creating an entirely revamped financial protection regimen, including a powerful new Department of Financial Protection and Innovation (DFPI). In this article, we provide you with an overview of the key elements of the new law. This is the first in a series of articles discussing the new law and revamped agency, and what they may mean to entities falling under their scope and coverage.
The largest state in the union, California likewise already has an outsize influence on the regulation and enforcement of laws regulating businesses—particularly, certain types of financial institutions doing business in the state. The current entity, the California Department of Business Oversight (DBO), provides protection to consumers as well as services to businesses engaged in financial transactions. DBO regulates a variety of financial services, products and professionals. It supervises the operations of state-licensed financial institutions, including banks, credit unions, money transmitters, issuers of payment instruments and traveler’s checks, and premium finance companies. It likewise licenses and regulates a variety of financial businesses—including securities brokers and dealers, investment advisers, deferred deposit (commonly known as payday loans), and certain fiduciaries and lenders—and regulates the offer and sale of securities, franchises and off-exchange commodities.
After President Trump took office in January 2017, a number of states began to express concern about the impact of supervision and enforcement by the federal Bureau of Consumer Financial Protection (CFPB).
That concern was exacerbated when Director Richard Cordray suddenly resigned and was replaced on an acting basis by President Trump’s then-head of the Office of Management and Budget, Mick Mulvaney. Mr. Mulvaney proceeded to reduce and, in some cases, dismantle certain operations within the CFPB, much to the consternation of consumer groups and Democratic-run states. One state, Pennsylvania, established a smaller unit within the office of the attorney general. Another key state, New York, created a new division within the pre-existing Department of Financial Services. That entity, the Consumer Protection and Financial Enforcement Division, reflects more of a refocusing of existing statutory authority.
Not so for California’s initiative.
An effort championed by Governor Newsom through a budget proposal in January of this year to expand and transform DBO, which effort seemingly had died with the budget adopted in June, came back to life in August and has now resulted in Assembly Bill 1864 (AB 1864), which (with some last-minute carve-outs) passed the California Legislature on August 31, 2020. Governor Newsom has until September 30 to sign AB 1864 into law, and that signature is expected. When signed, AB 1864 will take effect January 1, 2021, with certain provisions becoming operative thereafter.
That purpose is reflected in AB 1864, with the bulk of the legislation adding the California Consumer Financial Protection Law (CCFPL) to the Financial Code. The CCFPL closely tracks the federal Consumer Financial Protection Act of 2010 (CFPA), which is Title X of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) that created the CFPB. The new state law converts the DBO into a “mini-CFPB” to implement and enforce the CCFPL. However, AB 1864 in some respects goes further than the CFPA, including provisions that provide for potential regulation of small-business lending.
Overview of AB 1864
Here are the key provisions you need to know now:
- Transformation of DBO Into DFPI. The DBO is renamed the Department of Financial Protection and Innovation (DFPI). The current Division of Corporations and Division of Financial Institutions are merged into a single Division of Corporations and Financial Institutions, and a new Division of Consumer Financial Protection is added. New offices within the DFPI are created, including a Financial Technology Innovation Office.
- Existing DBO authorities and powers generally continue under the DFPI. However, AB 1864 amends Section 326 of the Financial Code to provide the DFPI with equivalent authority given by the CFPA to state attorneys general to bring actions to enforce the CFPA and CFPB regulations issued thereunder “with respect to an entity that is licensed, registered, or subject to oversight by the commissioner” of the DFPI. Note that this power is added outside of the CCFPL discussed below, and so it is not subject to the exemptions in the CCFPL, including for banks.
- AB 1864 adds the CCFPL as a new Division 24 to the Financial Code, starting at Section 90000. As noted above and discussed below, the CCFPL very closely follows the CFPA, including with respect to key terms such as “covered person,” “service provider” and “consumer financial product or service.” Accordingly, and subject to the exemptions discussed below, a person who is a “covered person” (including a “service provider”) under the CFPA and doing business in California will be subject to many of the same rules they are already familiar with under the CFPA and CFPB regulations, but they will now be interpreted, applied and enforced by a regulator with a California sensibility as compared with the CFPB under current Director Kathy Kraninger.
- Covered Persons. Again, the CCFPL begins with essentially the same scope as the CFPA with respect to coverage. The CFPA covers a vast array of persons involved in making or servicing consumer financial products and services.
Exemptions From Scope. However, there are many exemptions from that starting point. Similar to the CFPA, merchants, retailers and sellers of nonfinancial goods and services generally are excluded from coverage except to the extent they qualify as regularly extending credit under the federal Truth in Lending Act. That may include merchants and others financing purchases through retail installment sale contracts meeting certain conditions, which could include, for example, healthcare professionals and hospitals.
Further, as the result of last-minute negotiations, the CCFPL exempts from coverage many entities already regulated in California. These include:
So who does that leave as being subject to the CCFPL? Quite a few persons and entities, actually. Examples include without limitation:
- Banks, savings associations and credit unions, as well as a bank or savings and loan holding companies. The exemption does not expressly include subsidiaries of these financial institutions or holding companies, however.
- Persons and entities licensed by DFPI under certain specified laws, including finance lenders and brokers, residential mortgage lenders, money transmitters, escrow agents, and check sellers, among other specified licensees.
- Persons and entities licensed under other California laws not administered by the DFPI “to the extent that licensee or employee is acting under the authority of the other state agency’s license.” An example could include a California-licensed real estate broker making or arranging loans secured by real estate.
- Licensees not included in the exemption list, including persons and entities licensed under the California Deferred Deposit Transaction Law (i.e., payday lenders) and student loan servicers
- Debt collectors
- Persons and entities providing debt settlement and credit repair services
- Credit bureaus
- UDAAPs. Supplementing existing state law, the heart of the CCFPL is the prohibition against engaging in unlawful, unfair, deceptive or abusive acts or practices (UDAAPs) with respect to consumer financial products or services. The terms “unfair” and “deceptive” will be interpreted by the DFPI consistent with Section 17200 of the California Business and Professions Code, including “any unlawful, unfair or fraudulent business act or practice and unfair, deceptive, untrue or misleading advertising.” But the CCFPL goes beyond that provision to include the federal term, “abusive,” which closely follows the definition of what may be found to be abusive in the federal CFPA. Likewise, we expect the DFPI to further define these terms by rulemaking, as the new law allows.
Enforcement. In addition to the expanded DFPI general enforcement authority noted above, the CCFPL provides robust enforcement powers to the DFPI, including the powers to bring administrative and civil actions, and to prosecute those civil actions before state and federal courts. Also, the DFPI will have all the investigatory and subpoena powers set forth in certain provisions of the government code, responding to which can be costly and time-consuming. Enforcement powers also include administrative hearings, which may result in, among other things, desist and refrain orders. Under the CCFPL, these powers do not usurp the powers of the California attorney general, and provide instead for cooperation between the agencies.
The CCFPL also provides for broad remedies for violations, including rescission, refunds, restitution, disgorgement, money damages, public notification regarding the violation, and/or limits on the activities or functions of the person. The new law authorizes the DFPI, just like the CFPB, to assess civil money penalties, including up to $1 million per day for a continuing, knowing violation. These are extraordinary powers that could bring almost any company to its knees, but which have been used with care by the CFPB. It is unclear whether the same may be said for the DFPI, which may feel less constrained in exercising those punitive measures.
- Licensing (Registration). Under the new law, the DFPI “may” by rule establish a “registration” system for covered persons, other than those already subject to licensure. This is broad new authority, and it will likely be used to establish a registration system for, among others, debt collectors, which currently are not subject to licensing in California. Any such system likely would utilize the NMLS, as the new law envisions. Expect this process to be a vigorous one—that is, the anticipated system would be more than simply providing contact information, and per the CCFPL, the system “may include background checks for principals, officers, directors, or key personnel and bonding or other appropriate financial requirements,” much like current licensing requirements.
- Yes, Commercial Finance Is Covered. As with its federal equivalent, the scope of the CCFPL is generally limited to consumer purpose transactions. But readers should take note that the DFPI, “by regulation, may define [UDAAPs] in connection with the offering or provision of commercial financing ... or other offering or provision of financial products and services to small business recipients, nonprofits, and family farms. The rulemaking may also include data collection and reporting on the provision of commercial financing or other financial products and services.” Critical here is the fact that this provision uses the definition of “commercial financing” found in the California Financial Code as added by SB 1235, and would extend to factoring and merchant cash advances as well as regular commercial purpose loans and lines of credit. Therefore, companies such as small-business lenders are now covered quite directly by the CCFPL.
- Fintech. The CCFPL recitals declare, among other things, that “[t]echnological innovation offers great promise to the more effective and efficient provision of consumer financial products and services to the population of California and also poses risks to consumers and challenges to law enforcement in addressing those risks.” Also, as noted above, the DFPI is required to establish a Financial Technology Innovation Office, and, among other things, the DFPI “may develop and implement initiatives to promote innovation, competition, and consumer access within financial services.” These provisions may result in a more flexible regulator with respect to “fintech” products and companies, including cryptocurrency, but also indicate the focus will be on consumer protection.
Why It Matters
Doing business in California? Not everyone is covered by the new law and enforcement regime, and that is good news for those concerned about the grant of such extraordinary powers to a progressive jurisdiction that is also the most populous state. But for those that will now be within coverage, there are many traps for the unwary. As a result, it would be wise to carefully review the new laws and prepare, in advance, for the changes about to take place.
One of the coauthors of this summary is Manatt Financial Services senior advisor and former DBO Commissioner Jan Lynn Owen. As Ms. Owen put it in a recent Bloomberg article, the new DFPI allows California to become “a gold standard as a financial services regulator.” With its broad new powers, expect the DFPI to not just supplement but in some cases supplant the role of the CFPB in pursuing those in California’s crosshairs.