Legislative Update

January – March 2006

AmeriDebt Settles FTC's Charges of Unfair or Deceptive Practices

On January 9, AmeriDebt, its founder, Andris Pukke, and DebtWorks Inc. (another of Pukke’s companies) entered into a consent agreement with the Federal Trade Commission (FTC) to settle the FTC’s charges that the defendants had engaged in unfair or deceptive practices while promoting and offering credit counseling and debt management plans (a system under which consumers make one consolidated monthly debt payment to an administrator who then disburses payments to the consumer’s creditors).

AmeriDebt advertised that it was a nonprofit credit counseling firm and urged consumers to call to speak to “credit counselors,” who were in fact customer service representatives, about how to “handle credit in the future.” The customer service representatives were trained to sell debt management plans (DMPs) to consumers, and they received compensation based on how many customers they enrolled. Once a consumer agreed to enter into a DMP, the employee pressured him or her to submit the first monthly payment immediately in order to be formally enrolled in the program. Often, the defendants kept the consumer’s first payment as an up-front fee for participating in the DMP and did not disburse any of it to creditors. The DMP contract mentions the up-front payments, but they are referred to as “voluntary” contributions. However, consumers were never made to feel they had the choice of whether or when to pay the fee.

After enrolling the customer in a DMP, AmeriDebt sent the file to its servicing company, DebtWorks, which earned monthly fees of between $20 and $70 per customer, depending on the number of accounts covered under the customer’s plan. According to the FTC, AmeriDebt described itself as a nonprofit company, when its primary purpose was to funnel profitable servicing business to DebtWorks. For these reasons, the FTC charged them in 2003 with (1) misrepresenting their up-front fees; (2) deceptively omitting notice that the company retains most, if not all, of a customer’s first payment as an up-front fee; (3) misrepresenting that the company teaches consumers how to handle credit; and (4) misrepresenting AmeriDebt as a nonprofit entity.

While the defendants did not admit liability for any of the practices alleged in the FTC’s complaint, they did agree to settle the claims by entering into a consent order that, among other things, bars them from ever again engaging in or participating in credit counseling, credit education, or debt management. The defendants are also required to pay $172 million in monetary relief, which the FTC will hold in a trust for consumer victims.

ChoicePoint Settles Allegations That It Failed to Protect Consumer Information

ChoicePoint Inc. is a consumer reporting agency that collects and maintains personal identifying information about individuals and furnishes it to subscribers for a fee. A person can become a subscriber by submitting an application along with documentation that the applicant is a legitimate business with a reasonable business purpose for purchasing consumer data. The Federal Trade Commission (FTC) alleged that ChoicePoint permitted illegitimate businesses or persons to become subscribers, which led to at least 800 cases of identity theft.

The FTC alleged that ChoicePoint failed to authenticate the identities and qualifications of its applicants, which in some cases were false or misleading. In addition, the FTC alleged that ChoicePoint failed to identify unauthorized activity by subscribers even after law enforcement authorities issued subpoenas alerting the company to fraudulent accounts, or when its own encounters with a subscriber should have reasonably led it to suspect fraudulent activity (such as an apartment leasing subscriber claiming to need a large number of consumer reports, in a short period of time, that significantly exceeded the total number of rental units in the subscriber’s application). The FTC claimed that these practices violated sections of the Fair Credit Reporting Act and the FTC Act.

Without admitting the truth of, or liability for, these allegations, ChoicePoint agreed to settle the charges with the FTC by entering into a consent order that requires it to pay a civil penalty of $10 million, in addition to a $5 million payment for consumer redress. Furthermore, the company is prohibited from furnishing consumer reports to anyone without a legitimate business purpose for obtaining them. Even for subscribers with a legitimate need for the consumer reports, ChoicePoint is directed to maintain procedures to limit the number of reports that are furnished to any one subscriber.

ChoicePoint is also required to establish and implement a comprehensive information security program that identifies internal and external risks to the confidentiality of consumer information. The company must also submit to biennial assessments for 20 years from a qualified third party that will evaluate the company’s compliance with the information security program requirements.

Summary of Federal Legislation – Board of Governors of the Federal Reserve System

Electronic Fund Transfers (1/10)

The Board of Governors of the Federal Reserve System (the Board) issued a final rule that requires merchants to receive a customer’s authorization each time they initiate an electronic fund transfer (EFT) on behalf of the customer. The rule defines EFTs as the transfer of funds through an electronic terminal, telephone, or computer, including point-of-sale transfers, automated teller machine transfers, direct deposits or withdrawals of funds, and transfers resulting from debit and credit transactions, whether or not they are initiated through an electronic terminal.

When a check or point-of-sale purchase can be processed as a one-time EFT from a consumer’s account, the consumer must be notified that the check may be processed as an EFT, and he or she must authorize the transaction. A merchant must also inform the consumer that the transaction “may” result in funds being debited from the consumer’s account more quickly and that the check may not be returned to the consumer’s financial institution after processing. In addition, automated teller machine operators must post notices on their machines that fees may be imposed for EFTs and balance inquiry services.

This final rule became effective on February 9. For more information, see 71 Federal Register, pp. 1638-64.

Payroll Cards (1/10)

The Board of Governors of the Federal Reserve System (the Board) issued an interim final rule that stipulates that Regulation E governs payroll card accounts. Payroll card accounts can be set up either directly or indirectly by employers on behalf of employees. The accounts receive electronic fund transfer infusions of an employee’s salary, wages, or other compensation. They are managed by the employer, a third-party payroll processor, a depository institution, or another entity.

The rule does not require financial institutions to furnish periodic statements for payroll card accounts, as long as the institution provides the consumer with a telephone number that he or she can call to receive the account’s balance. The institution must also provide a website at which the consumer can access at least a 60-day history of the account’s transactions. At the consumer’s request, an institution must also provide a written history of transactions occurring in the preceding 60 days.

This interim final rule will become effective on July 1, 2007, and comments on it were due March 13, 2006. For more information, see 71 Federal Register, pp. 1473-83.

Summary of Federal Regulations – Federal Trade Commission

Accuracy of Consumer Reporting Information (3/22)

The Federal Trade Commission, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Office of Thrift Supervision, and the National Credit Union Administration (together, the Agencies) issued an advance notice of a proposed rule to implement provisions of the Fair and Accurate Credit Transactions Act (FACTA) that require furnishers of credit information to ensure the accuracy of their information and to reinvestigate disputed information at a consumer’s request. (For more information about FACTA, see Banking Legislation and Policy, October-December 2003).

Among other things, FACTA requires the Agencies to establish guidelines that information furnishers can use to maintain the accuracy and integrity of the information they provide to consumer reporting agencies (CRAs). To do so, the law instructs the Agencies to identify patterns, practices, and specific forms of activity that can compromise the accuracy and integrity of information furnished to CRAs. Also, the Agencies must review the methods that are used to furnish the information. In addition, the Agencies must examine the policies and processes that furnishers use to conduct reinvestigations and to correct inaccurate information that has already been furnished to CRAs.

The law also requires the Agencies to identify the circumstances under which a furnisher must reinvestigate a dispute over the accuracy of information included in a consumer report at the request of the consumer. In prescribing their regulation, the Agencies must weigh the benefits to consumers against the costs to furnishers. The Agencies must also consider the effect the regulation will have on the overall accuracy and integrity of consumer reports and determine if direct contact between the consumer and the furnisher would result in the fastest resolution of a dispute.

In issuing this advance notice of proposed rulemaking, the Agencies request comment on these factors they must consider before issuing a proposed rule. Comments on this advance notice of proposed rulemaking are due May 22. For more information, see 71 Federal Register, pp. 14419-25.

Summary of Judicial Developments – Court Decisions

A National Bank Is a Citizen of the State in Which Its Main Office Is Located

On January 17, the Supreme Court ruled that a national bank is a citizen of the state in which its main office is located, as designated by its articles of association (Wachovia Bank v. Schmidt, No. 04-1186). The case stems from a group of South Carolina plaintiffs who filed suit in a South Carolina state court against Wachovia Bank (a national bank with its main office in North Carolina). Wachovia petitioned the federal courts to compel arbitration of the dispute, arguing that the federal court had jurisdiction because the parties were citizens of different states. The plaintiffs contended that national banking associations are citizens of the states in which they are located, which they interpreted to mean any state in which the bank maintains a branch. Under that definition, the plaintiffs argued, Wachovia was a citizen of South Carolina, as it had branches in the state, and that it was therefore under state court jurisdiction.

The Supreme Court did not agree with the plaintiffs’ interpretation of the term “located,” arguing that this would constrict national banks’ access to diversity jurisdiction. Diversity jurisdiction is granted by a federal court to opposing parties that reside in different states. Essentially, the court seeks to provide a level playing field for both parties by deciding the case in federal court rather than in state court.

Further, the Supreme Court said that if a bank were considered to be located in every state in which it had a branch office, it would be treated differently than all other corporations that operate establishments in multiple states, as these corporations are thought to be “located” only in the state in which their main offices are located. For that reason, the Supreme Court rejected the ruling of the U.S. Court of Appeals for the 4th Circuit and held that Wachovia Bank is a citizen of North Carolina and that the underlying case is subject to federal jurisdiction.

A Contract’s Arbitration Clause Is Binding, Even When the Contract Is Alleged to Be Illegal

On February 21, the Supreme Court ruled that if parties agree to a contract that contains an arbitration clause, disputes should be handled by an arbitrator, even if the disputed matter is whether the contract is legal and valid (Buckeye Check Cashing Inc. v. Cardegna, No. 04-1264). The case arose after plaintiffs John Cardegna and Donna Reuter entered into deferred-payment transactions – essentially, payday loans – with Buckeye Check Cashing. In these transactions, the plaintiffs received cash from Buckeye in exchange for a personal check in the amount of the cash plus a finance charge. Along with each of these transactions, the plaintiffs signed agreements that any dispute over the transaction would be settled by an arbitrator. Later, the plaintiffs brought suit against Buckeye in Florida state court, alleging that the company charged usurious interest rates for these transactions and therefore violated several Florida laws. The plaintiffs did not challenge the arbitration clause itself, arguing instead that the entire contract was void.

The Supreme Court found that “regardless of whether it is brought in federal or state court, a challenge to the validity of a contract as a whole, and not specifically to the arbitration clause within it, must go to the arbitrator, not the court.” The court gave three reasons for this. First, according to federal arbitration law, an arbitration provision is severable from the remainder of a contract. Next, unless the challenge is to the arbitration clause itself, it is the arbitrator’s responsibility to determine whether a contract is valid. Finally, federal arbitration law applies in federal and state courts. This finding was inconsistent with the Florida Supreme Court’s ruling before it, so the U.S. Supreme Court reversed the ruling and remanded the case for further proceedings.

Bankruptcy Courts Do Not Have the Authority to Deny Arbitration

The U.S. Court of Appeals for the 2nd Circuit ruled that a bankruptcy court did not have the authority to deny arbitration of charges of a bankruptcy stay violation (MBNA America Bank v. Hill, No. 04-2086-bk). In the case, Kathleen Hill was one of a class of individuals that filed suit against MBNA America Bank for allegedly violating a stay that the bankruptcy court had granted her when she filed for Chapter 7 bankruptcy. Prior to applying for protection from creditors under the bankruptcy code, Hill arranged for MBNA to withdraw monthly payments of $159.01 from her account to pay down the balance she owed on a consumer loan. After Hill filed for bankruptcy, the bankruptcy court notified all of her creditors by mail. Despite receiving the notice, MBNA continued to withdraw monthly payments from Hill’s account, which she alleged was a violation of the automatic stay provision of the Bankruptcy Code. MBNA appealed to the bankruptcy court to dismiss the case in favor of arbitration, since Hill’s credit agreement contained a clause that compelled arbitration to settle any claim or dispute related to the account. The bankruptcy court, and the district court after it, refused to dismiss the case in favor of arbitration, claiming that compelling arbitration would seriously jeopardize the objectives of the Bankruptcy Code, which are to provide debtors with a fresh start, protect the assets of the estate, and allow the bankruptcy court to centralize disputes concerning an estate.

The Court of Appeals rejected these findings, however, and ruled that the bankruptcy court did not have the authority to deny arbitration in this case. While the court acknowledged that bankruptcy courts generally have discretion to refuse to compel arbitration of core bankruptcy matters (those directly related to the bankruptcy case), they do not have the discretion to override an arbitration agreement unless it finds that the proceedings are based on provisions of the Bankruptcy Code that inherently conflict with federal arbitration laws or if they necessarily jeopardize the objectives of the Bankruptcy Code.

In this case, the court found that arbitration would not seriously jeopardize the Bankruptcy Code objectives because: (1) Hill’s estate had been fully administered and her debts had been discharged, meaning she no longer required protection from her creditors; (2) as a class-action case, her claims weren’t directly connected to her bankruptcy case; and (3) the bankruptcy court is not uniquely able to interpret and enforce provisions of an automatic stay, and therefore the matter can be decided by someone other than the bankruptcy court.

On January 10 in a similar case, the U.S. Court of Appeals for the 3rd Circuit also ruled that bankruptcy courts do not have the discretion to deny arbitration (Mintze v. American General Financial Services, No. 03-4745). In this case, Ethel Mintze sought a loan from American General Financial Services to pay for a new heater for her home. American General loaned her the money in exchange for consolidating that loan with her mortgage and the balance of her credit card debt. American General also financed the settlement charges plus the premiums for two life insurance policies. The loan agreement contained an arbitration clause that required all disputes to be handled by an arbitrator.

When Mintze began to fall behind in her payments to American General, she filed for Chapter 13 bankruptcy. In addition, she filed a complaint against American General in bankruptcy court, in which she alleged that the company induced her to enter into an abusive and illegal home equity loan. She sought to enforce a pre-petition rescission of the mortgage under the Truth in Lending Act. In response, American General petitioned the bankruptcy court to dismiss the case in favor of arbitration.

The bankruptcy court declined to dismiss the case, ruling that it was the proper jurisdiction for deciding the claims. Upon American General’s appeal, the district court affirmed the lower court’s ruling. The court of appeals, however, reversed the rulings of each of the lower courts. Based on federal arbitration laws, the court ruled that the bankruptcy court lacked the authority to deny arbitration. Therefore, the court remanded the case and instructed the bankruptcy court to compel arbitration.

Summary of Judicial Developments – Notable Settlements

Far West Credit Settles Allegations of FCRA Violations

Far West Credit, a consumer reporting agency (CRA), recently reached a settlement with the Federal Trade Commission (FTC) over charges that the company violated the Fair Credit Reporting Act (FCRA) by neglecting to verify the accuracy of information in its credit reports. As part of its business, the Utah-based company purchases credit information about consumers from nationwide CRAs, such as Equifax, TransUnion, and Experian, and then merges all of the information into one consolidated report. When there is insufficient information at the national CRAs, Far West accepts documentation from the consumer or other interested third parties (such as mortgage brokers or mortgage originators) to show credit status with businesses that do not report to the nationwide credit bureaus (such as landlords, cable companies, and utility companies). Far West often adds this information to the consumer’s credit report.

Far West provided credit reports to many companies, including Keystone Mortgage and Investment Company, a mortgage originator. Keystone, which had an interest in seeing its mortgage deals approved, provided Far West with information about its customers’ credit to be used in creating reports for consumers who had insufficient credit histories at nationwide CRAs. The FTC alleges that Far West did not verify the accuracy of Key-stone’s information and that much of the information was false and required more careful review. Once Far West added the information to the credit reports, it provided the enhanced reports to Keystone, where they were then used to obtain mortgage loans insured by the Federal Housing Administration (FHA) and the Department of Housing and Urban Development (HUD), some of which defaulted.

Without admitting liability for these allegations, Far West agreed to enter into a consent agreement with the FTC to settle the charges. As part of the settlement, Far West must pay a civil penalty of $120,000. The company is also required to follow reasonable procedures to ensure the maximum possible accuracy of information in its consumer reports, and it must make its records available to the FTC for three years so the agency can monitor its compliance with the order.

CardSystems Solutions Reaches Settlement with the FTC

The Federal Trade Commission (FTC) announced that it had reached a settlement agreement with CardSystems Solutions and its successor, Solidus Networks. The FTC had charged the company with failing to protect consumers’ sensitive personal information stored on its computer networks. CardSystems Solutions is a credit card processing firm that obtains approval for debit and credit card purchases from the banks that issue the cards. In processing these transactions, CardSystems collects data from the magnetic strip of a card, including the card number, expiration date, the security code that proves authenticity, and other data. The company stores this information on its computer network for up to 30 days.

The FTC charged that CardSystems engaged in a number of unsafe practices, including unnecessarily storing information, inadequately assessing the vulnerability of its computer network, not implementing defenses to potential network attacks, failing to use strong passwords, and failing to employ measures to detect unauthorized access to the stored personal information. The FTC argued that these practices led to millions of dollars of fraudulent purchases and required banks to cancel and re-issue thousands of credit cards, all of which caused consumers to worry, be inconvenienced, and lose time dealing with the affected cards.

During the course of the FTC’s investigation, CardSystems Solutions was bought by Solidus Networks, which does business as Pay By Touch Solutions. As part of the settlement, CardSystems and Solidus agreed to establish and maintain a comprehensive information security program. Every other year for the next 20 years, they must also obtain an audit from a qualified, independent third-party professional to confirm that their security program meets the FTC’s standards. Furthermore, CardSystems and Solidus face potential liability under federal banking laws and regulations and in private litigation for losses related to the breach.

Summary of Third District Developments – Delaware

On January 26, the Delaware Court of Chancery prevented AmSouth Bancorporation shareholders from filing suit against its board of directors based on a Financial Crimes Enforcement Network (FinCEN) investigation of the bank’s compliance with the Bank Secrecy Act and other anti-money laundering regulations (Stone, et al. v. Ritter, et al., No. 1570-N). FinCEN began to investigate AmSouth in connection with investigations of two of its customers. During the course of the investigation, FinCEN found that the bank did not file suspicious activity reports when it should have and failed to develop an appropriate anti-money laundering program. In addition, FinCEN found that the program did not have sufficient board and management oversight and that it was fragmented, meaning that information about suspicious activity was not always communicated to the sections of the bank responsible for Bank Secrecy Act compliance.

AmSouth’s shareholders attempted to file suit against the bank’s board of directors based on FinCEN’s findings, but the chancery court prevented the suit, saying that the plaintiffs failed to provide specific facts to support their claims. Instead, the court said that the suit essentially reiterated FinCEN’s findings. Therefore, the court dismissed the plaintiffs’ claims. On January 24, Governor Ruth Ann Minner signed into law an act that allows Delaware banks to choose between two methods of calculating their liability for the state bank franchise tax. Beginning in 2007, banks can use the current method of calculating franchise tax, which is based on 56 percent of a bank’s in-state and out-of-state income, or use an alternative method whereby banks pay a tax based on income earned in Delaware.

To calculate their franchise tax liability, banks will use a formula that takes into account the bank’s Delaware receipts, payroll, and property as a percentage of its total receipts, payroll, and property. The receipts factor is a fraction, with the numerator being the bank’s total gross receipts from Delaware and the denominator being the bank’s total gross receipts from everywhere. The payroll factor fraction has a numerator of wages, salaries, and other compensation paid to employees who are Delaware residents, and the denominator is wages, salaries, and other compensation paid to all of the bank’s employees. The property factor is also a fraction: the numerator is the bank’s real and tangible property, owned or rented, in Delaware; the denominator is the bank’s real and tangible property everywhere. After the bank calculates each of these factors, it will multiply the receipts factor by two and then add it to the two other factors. The resulting number will be divided by four (or the number of the factors that were added together). The bank will multiply this number by its total net income to determine its tax base.