A federal district court ruled that a Consumer Financial Protection Bureau (CFPB) lawsuit against more than a dozen student loan ABS trusts can move forward, saying that the trusts are “covered persons” and subject to the agency’s enforcement.
The district court’s ruling, released on December 13, was certified for an interlocutory appeal (an appeal within the middle of a case) this month, in which it acknowledged that there might be room for disagreement on what constitutes “covered persons”.
At issue are CFPB claims that the National Collegiate Student Loan Trust (NCSLTs) had engaged in deceptive student loan debt collection and unfair litigation practices when servicing and collecting the student loans that served as collateral on the deals, therefore violating the Consumer Finance Protection Act of 2010. The CFPB sued 15 trusts in the NCSLTs’ program on those grounds four- and-a-half years ago, affecting about $12 billion in student loan ABS assets.
What are 'covered persons?'
The NCSLTs “embarked on the business of collecting debt and servicing loans when they contracted with the servicers and subservicers to collect their debt and service their loans,” according to the ruling.
The CFPB defines “covered persons” as “any person that engages in offering or providing a consumer financial product or service” or as any affiliate of that person if the affiliate acts as a service provider to the person.
The CFPB said the misconduct stemmed from actions taken by the NCSLTs’ subservicers and servicers while collecting debt - not any action taken by the trusts themselves. Despite the distinction, the CFPB named the NCSLTs as defendants in the suit.
In its decision, the court said that the “definition is broad enough to encompass actions taken on a person’s behalf by another, at least where that action is central to his enterprise.”
“This is a case we’ve followed for a while and it is certainly the latest twist in the saga,” said Kristi Leo, president of the Structured Finance Association, the trade organization for ABS. “(With the potential for) widespread implications on the market.”
It starts with student loans
The effect of the CFPB suit and the court’s ruling have rippled through the industry.
“There is no reason to think that the CFPB will limit its view on this issue to student loans, and it could apply to other consumer financial products,” said Steven Kaplan, partner at Mayer Brown, an international law firm, at a teleconference earlier this month addressing the implications of the case.
The NCSLTs have more than 800,000 private student loans worth $12 billion through 15 different Delaware statutory trusts created between 2001 and 2007.
ABS industry professionals are befuddled as to how the court can consider the NCSLTs programs as “covered persons,” because trusts have no employees, no internal management and it is the servicers and subservicers who collect on the student loans. They rely on agreements with several third-party service providers to administer each Trust.
“If there is someone who has allegedly violated the law, you go after that party,” the SFA’s Leo said. “You don’t go after the ‘Trust.’”
Judge Stephanos Bibas wrote this in his memorandum opinion:
“If a dairy farmer contracts with a farmhand to milk his cows and never does that job himself, he is still employed in or in the business of milking cows,” he wrote in his ruling.
Ten days after the December 13 ruling, the NCSLTs and other interested parties asked for an interlocutory appeal of the court order. Representatives for the NCSLTs argued that the platform does not act like one of “covered persons” because the trusts are “passive securitization vehicles that take no action related to the servicing of student loans or collecting debt.”
On February 11, the district court granted the NCSLTs’ request, finding that there might be room for disagreement on the interpretation of “covered persons.” On February 22, the Trusts asked the Court of Appeals to hear the appeal. The CFPB is expected to respond before the court decides whether to hear the appeal.
Will other ABS get involved?
The NCSLTs argue that the CFPB doesn’t have the authority to sue under the CFPA.
As a matter of caution during this time, parties should ensure that they do not engage in activities or include language that triggers potential risks under applicable law, Kaplan said. They should not appoint a servicer as an agent, Kaplan said. They should not engage in an activity that directly triggers liability under applicable consumer financial protection law, Kaplan said.
In addition, state licensing requirements may be triggered by virtue of holding legal title to the underlying asset, Kaplan said.
Fitch Ratings maintains a less than desirable cap at “BBBsf” for the NCSLTs’ transactions and a Rating Watch Negative (RNW) on all tranches with a rating of “B-sf” or higher.
“Fitch will resolve the RWN as soon as additional clarity is available on the outcome of the pending litigation involving the issuers and the transaction parties,” said Pasquale Giordano, senior director at Fitch Ratings.
Fitch said that from its perspective, unexpected financial losses on its rated securities could significantly affect the transaction performance and increase rating volatility, mainly because such losses and legal expenses to defend related claims are not predictable.
“‘Could the cash flows actually be taken out of the trust?’ is clearly one of those things that people are evaluating and that's if the trusts are found liable in the first place,” Leo said.
The situation raises other important questions, according to the NCSLTs. Does the CFPB have the authority to sue the NCSLTs under the CFPA? Even if it did have the right to sue, the CFPB erroneously filed its complaint because at the time of the filing, it was constitutionally unsound, the NCSLTs are arguing.
