After months of back and forth, Governor Gavin Newsom's state version of the federal Consumer Financial Protection Bureau, often referred to as California's "mini-CFPB," is finally a reality. In late August, the California Legislature passed AB 1864, which creates the Department of Financial Protection and Innovation ("DFPI") and enacts the related California Consumer Financial Protection Law. This comes nearly nine months after the Governor first included plans for the DFPI in his proposed 2020-2021 state budget. This new agency and related consumer protection law revamp the current financial services regulator, the Division of Business Oversight, and empower the new agency with heftier regulatory and enforcement powers aimed at the financial services sector. The passing of AB 1864 is particularly timely given the COVID-19 pandemic and related economic fallout, and the concern that financially distressed consumers will be subjected to predatory financial products and practices in the coming months. AB 1864 awaits the Governor's signature, which is sure to come given his outspoken and adamant support for the bill throughout this past year.
Out with the Old: The Department of Business Oversight
Currently, financial services and state licensed financial institutions are regulated by the California Department of Business Oversight (the "DBO"). The DBO licenses and regulates financial services providers—including state-chartered banks, money transmitters, credit unions, broker-dealers, nonbank installment lenders, payday lenders, mortgage lenders and servicers. It also 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.
In with the New: The Department of Financial Protection and Innovation
Pursuant to AB 1864, the DBO will be revamped as the DFPI. The DFPI is intended to provide consumers greater protection from predatory practices while facilitating innovation and ensuring a level playing field for all companies operating responsibly in California. Along with this new name comes a new budget, specifically, $10.2 million in 2020-2021, which grows to $19.3 million in 2022-2023, to facilitate the DFPI's expanded role.
The big game changer in AB 1864 is the newly enacted Consumer Financial Protection Law (the "CFPL"). This law grants the DFPI regulatory and enforcement authority over "any person that engages in the offering or providing of a consumer financial product or service to a California resident." "Consumer financial product or service" includes either a "financial product or service that is delivered, offered, or provided for use by consumers primarily for personal, family, or household purposes" or a financial product or service specifically identified in the bill. The CFPL is largely based on the federal Consumer Financial Protection Act that is part of the Dodd-Frank Act.
From the DBO to the DFPI: Why the Change?
Governor Newsom proposed this new law in order to address the perceived rollback of consumer financial protections at the federal level under the current administration. The Governor explained in a statement reported by the LA Times, "The federal government's rollback of the CFPB [Consumer Financial Protection Bureau] leaves Californians vulnerable to predatory businesses and leaves companies without the clarity they need to innovate." As such, protecting Californians "will be accomplished by expanding the Department's authority to pursue unlicensed financial services providers not currently subject to regulatory oversight such as debt collectors, credit reporting agencies, and financial technology (fintech) companies, among others."
A coalition of fintechs, small-business lenders, community development agencies and consumer advocates also lined up to support the new agency proposal, telling lawmakers that small-business protections must not be removed. For example, Suzanne Martindale, senior policy counsel and western states legislative manager for Consumer Reports has stated that "Predatory financial firms are taking advantage of the crisis by peddling high-priced loans and other risky products that could make things even worse for families desperate for cash. California's revamped financial watchdog will have the authority and resources it needs to monitor companies that currently evade state oversight and stop illegal practices that cheat vulnerable consumers out of their money."
With Expanded Consumer Protection Comes Expanded Regulatory and Enforcement Action
According to the new law, the DFPI's duties will include licensing and examining new industries that are currently under-regulated, analyzing patterns and developments in the market to inform evidence-based policies and enforcement, consumer education programs, creating a new Financial Technology Innovation Office that will proactively cultivate the responsible development of new consumer financial products, providing legal support for the administration of the new law, and adding additional staff to support the Department's increased regulatory responsibilities.
The main change the financial services industry will see is an expansion of enforcement powers granted to the DFPI through the CFPL. The CFPL prohibits not just only "unfair and deceptive" acts and practices consistent with California Business and Professions Code Section 17211, but also expands this prohibition to include "unfair, deceptive, and abusive" acts and practices, which is akin to the prohibitions outlined in the federal law the CFPL is mirrored after. "Abusive" is an ill-defined term in the legislation, which could be used to the new agency's advantage in enforcement.
Consumers and companies will also see an expanded class of regulated entities. In addition to those entities already regulated by the DBO, the DFPI will also regulate debt collectors, credit reporting agencies, and fintech companies. This will bring about a significant change for fintech companies in particular, including cryptocurrency companies, that previously did not face broad and consistent regulatory coverage under past state laws.
The powers of the DFPI too will "pack more punch" than the prior DBO. The DFPI will be charged with "all the investigatory and subpoena powers" set forth in Sections 11180 to 11191 of the Government code. The new agency will also have the power to assess a number of penalties, including rescinding contracts, refunding money, payment of damages, and notifying the public of the violation. The DFPI can also assess fines of up to $1 million and may bring civil actions against alleged wrongdoers.
In addition to the above, the new law also grants the DFPI, among other duties, the power to promulgate regulations, hold hearings, issue publications, conduct investigations, and implement outreach and education programs. The bill also requires the DFPI to promulgate specified regulations and to promulgate rules regarding registration requirements applicable to a covered person within certain timeframes and subject to specified conditions. The bill further requires the state Legislature to conduct public hearings to obtain input on feasibility, and requires the commissioner to annually appear before and present information on enforcement actions and various other activities under the CFPL to the appropriate legislative committees.
The CFPL further requires that the DFPI establish the new Financial Technology Innovation Office ("FTIO"). The CFPL recognizes 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" but also recognizes that it "poses risks to consumers and challenges to law enforcement in addressing those risks." The FTIO is intended to "identify emerging industry trends and the effects and potential risks of new financial products."
At the same time, AB 1864 partially limits the scope of the expanded authority on banks and certain lenders. The bill exempts the following: (1) licensees of any state agency other than the DFPI when acting under the authority of that license; and (2) certain broker-dealer or investment advisers; (3) certain licensees regulated by the DFPI, including escrow agents, finance lenders, brokers, program administrators, mortgage loan originators, and residential mortgage lenders, services, or mortgage loan originators under certain provisions of the Financial Code; and (4) certain check sellers, bill payers, or proraters under the Financial Code. The CFPL also carves-out federally chartered banks or those chartered outside the state of California, bank holding companies, trust companies, saving and loan associations, savings and loan holding companies, credit unions, and organizations subject to oversight of the Farm Credit Administration.
Who's Footing the (AB 1864) Bill?
The funding for the new agency and its efforts will initially come from settlement revenues currently in the State Corporations Fund and the Financial Institutions Fund. Funding will also come from funds obtained through the enforcement of the CFPL, including moneys received through fines, penalties, settlements, judgements, or otherwise. The new department will also generate funding through "New Covered Persons" registration fees for "any person or affiliate of a person, that engages in offering or providing a consumer financial product or service to Californians that the DBO does not currently regulate." Thus, companies will likely to see increased fees for engaging in business in California given that the DFPI will be self-funded to a certain extent.
What This Means for You
With any new law comes new regulations and pitfalls to avoid. Financial entities subject to regulation by the DBO and newly regulated entities under the CFPL should be wary of increased scrutiny by the DFPI. It's not all regulatory and enforcement action in the future though, as the DFPI's focus on innovation could also provide new guidance for fintech companies, and more clarity surrounding financial regulations in California for both financial entities and consumers alike.
Originally published by Jeffer Mangels, September 2020
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