On May 19, 2015, the Consumer Financial Protection Bureau (“CFPB” or “Bureau”) filed a complaint and proposed consent order against PayPal, Inc. and its subsidiary Bill Me Later, Inc. (collectively, “PayPal”) in the U.S. District Court for the District of Maryland. If approved by the court, the settlement will require PayPal to pay $15 million in redress to consumers and a $10 million civil money penalty. Although the case is not the largest settlement in CFPB history, it is interesting for at least two reasons: (1) it sheds important new light on the meaning of “abusive” acts and practices, which is slowly being defined through the CFPB’s enforcement actions¹; and (2) it continues a recent trend of filings in federal court instead of in an administrative proceeding.

PayPal Credit offered deferred-interest loans for online purchases

PayPal Credit (formerly called Bill Me Later) is a line of credit that PayPal offers to consumers making online purchases from eBay and other merchants. Chief among the problems cited by the CFPB with regard to PayPal Credit is that consumers were often enrolled in PayPal Credit without their consent, and/or did not receive promised promotional offers when they did enroll. The CFPB charged that these were unfair (and, with regard to the unrealized promotional offers, deceptive) acts or practices. In addition, the CFPB charged that the manner in which PayPal applied payments constituted an “abusive” act or practice. It is this aspect of the consent order that is most interesting and illuminating.

With each new purchase, according to the CFPB’s complaint, consumers who paid with PayPal Credit were frequently offered a deferred-interest period, which allowed consumers to avoid paying any interest so long as they paid off the balance before the end of the period and did not make any late payments. Critically, the “deferred-interest periods for the transactions would expire on different dates, depending on the date of the initial transaction. Consumers could thus have multiple deferred-interest balances.” The Bureau alleged that, “Numerous consumers believed they made a payment large enough to pay off purchases with expiring promotions, but the Defendants allocated payments in a way that resulted in the consumer incurring deferred interest.” The Bureau alleged that PayPal engaged in abusive practices by making it difficult for consumers who took out deferred-interest loans to avoid paying interest.

CFPB alleged abusiveness alongside unfairness and deception

In addition to five other counts², the Bureau alleged that PayPal violated prong (2)(B) of the abusiveness test, 12 U.S.C. § 5531(d)(2)(B), highlighted below:

ABUSIVE.—The Bureau shall have no authority under this section to declare an act or practice abusive in connection with the provision of a consumer financial product or service, unless the act or practice—

1. materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service; or
2. takes unreasonable advantage of—

• a lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service;
• 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.

(Emphasis added.)

Inadequately disclosed pro-creditor payment allocation method + poor customer service = abusive act or practice

In short, the CFPB alleged that PayPal engaged in abusive practices by (1) choosing a default³ payment allocation method that consumers would not have chosen: proportionally allocating payments in excess of the minimum balance to some or all promotional balances, instead of allocating the entire payment to the balance that was closest to the end of its deferred-interest period; (2) failing to adequately disclose this allocation method to consumers; and (3) making it difficult or impossible for consumers to change how excess payments were allocated. Specifically, the complaint alleges the following facts in support of its abusive practices charge:

• “Defendants provided little information to consumers about how it allocated payments to and among standard and multiple deferred-interest balances. Nor did Defendants explain that PayPal Credit’s practice was to apply amounts in excess of the minimum payment proportionally to most, or all, promotional balances.”
• “Defendants purported to allow consumers to control the allocation of payments by requesting that their payments be allocated to specific balances, but consumers seeking to make such requests often could not reach a customer-service representative.”
• “When consumers made specific allocation requests, Defendants often ignored such requests or allocated payments differently than consumers requested.”
• “As a result, consumers could not clearly understand how payments were applied to deferred-interest promotions and Defendants allocated payments in a way that consumers would not have chosen” (emphasis added).

CFPB will likely expand “abusive” to cover facts less stark than these

The CFPB has been developing the “abusive practices” precedent carefully, by relying on cases where the facts are quite stark. Here, the defendant not only had a payment-allocation method that “consumers would not have chosen,” but it also failed to adequately describe that method to consumers, and had poor customer service. Would one or two of these three facts alone have been enough to support an abusive practices charge, or must they all exist together?

I expect that in future cases, the CFPB will allege abusiveness based solely on the failure to clearly explain that payments will be applied in a way consumers would not choose, even where the defendant does not also have poor customer service. After all, if a lender applies payments in a way that consumers would not choose and it does not tell the consumer, it would not be a stretch for the CFPB to allege that the consumer cannot protect his or her own interests.

The CFPB probably could have made out an unfairness count based on these facts. The Office of Enforcement may have chosen to allege “abusive” alone in response to criticism that pleading “abusive” and “unfair” or “deceptive” for the same conduct does not educate the industry on what “abusive” means.

CFPB is likely to turn to “abusive” where consumers lack choice or where products are complex

A common theme in speeches by CFPB Director Cordray is consumer choice, or lack thereof. In a February 2015 speech to the National Association of Attorneys General, he said that “when key information is deliberately withheld, or when the information provided is misleading, consumers similarly have a hard time making sound choices.” Tactics that prevent consumers from making sound choices has been a theme in the CFPB’s use of the “abusive” authority. The CFPB’s complaint against ITT Tech alleged a violation of prong (2)(B) of the “abusive” test based on, among other allegations, ITT “Pushing students into expensive, high-risk loans that ITT knew were likely to default” and “using aggressive repackaging tactics,” including barring students from class, withholding course materials, and threatening expulsion. In short, the CFPB alleged that ITT prevented students from making sound choices about their loans. In the unfairness count, the CFPB alleged, among other things, that ITT had engaged in a “variety of unfair acts and practices designed to interfere with the consumers’ ability to make informed, uncoerced choices.”

Congress banned similar pro-creditor payment allocation for credit cards

Remember, Congress banned credit card issuers from using pro-creditor payment allocation methods in the CARD Act, instead requiring that payments in excess of minimums be applied to the higher interest balances first. The Bureau does not need to rely on public policy to support a finding of abusive, but it may cite the CARD Act if it finds itself in litigation over payment allocation methods in the future.

Why did the CFPB file in federal court instead of administratively?

The CFPB has authority to pursue an enforcement action administratively or by filing a complaint in federal district court. The potential remedies are the same, regardless of which option the CFPB chooses. In the past, where it is the only plaintiff, the CFPB has typically filed consent orders in an administrative proceeding.

Lately, however, the CFPB has seemed to prefer federal court: the proposed consent order against PayPal – filed in the District of Maryland, where Bill Me Later is based – is the third proposed federal court consent order filed in May. The CFPB filed another in the District of New Jersey. In fact, nearly a month has passed since the Bureau’s last administrative consent order.

Before this month, the Bureau’s federal court cases mostly fell into three buckets: (1) cases where another enforcement agency was joining the case (see, for example, the complaint and proposed consent orders with the Maryland attorney general, or the complaint and proposed order with the Navajo Nation), (2) cases where the CFPB could not reach a settlement with the defendant⁴ (for example, the complaint against ITT), and (3) cases where the CFPB sought to immediately shut down an alleged scam (for example, the complaint against alleged phantom debt collectors). The PayPal and the New Jersey consent orders do not fall into any of these three categories, and why the agency chose to file them in federal court is not clear.

Filing in federal court instead of in an administrative proceeding has the potential to create additional hurdles for the Bureau because the court must approve the proposed settlement. Thus far, most courts have deferred to the Bureau’s judgment on what is a fair settlement. But a judge in the Southern District of New York recently said he would not approve a proposed consent order until the parties “submit a motion explaining why this proposed settlement is fair, reasonable, and does not disserve the public interest.” It will be interesting to see if this added obstacle nudges the CFPB to pursue future consent orders administratively.

Nicholas F. B. Smyth is a member of Reed Smith’s Financial Industry Group, in the Pittsburgh and Washington, D.C., offices. Nick advises clients on examinations and investigations by the CFPB and other bank regulators. He can also advise clients on investigations and can represent them in litigation with the FTC, DOJ, and state attorneys general. Prior to joining Reed Smith, Nick spent four years as an Enforcement Attorney at the CFPB and a year at the U.S. Treasury Department, where he helped draft the statute that created the CFPB.

1. The Consumer Financial Protection Act of 2010 permits the Bureau to prevent unfair, deceptive, or abusive acts or practices (UDAAP). 12 U.S.C. § 5531(a). The meanings of “unfair” and “deceptive” are well-settled by decades of case law and policy statements by the Federal Trade Commission. “Abusive” is a new standard that is being defined largely through the CFPB’s enforcement actions. For more on the Bureau’s use of its authority to prevent abusive practices, read my client alert from March.
2. The Bureau alleged four counts of unfair practices and one count of deceptive practices.
3. Default options are a common theme in the complaint: the CFPB alleged that PayPal set the default payment method to PayPal Credit, “causing consumers to use PayPal Credit even when intending to use another method of payment such as a linked credit card or checking account.”
4. Of course, the Bureau does not file all contested cases in federal court. It brought an administrative trial against PHH, concerning which Director Cordray is expected to rule on the appeal from the Administrative Law Judge’s recommended decision any day now.

Client Alert 2015-140