On June 15, 2010 the Board of Governors of the Federal Reserve System (the "Board") published rules related to the implementation of those provisions of the Credit Card Accountability Responsibility and Disclosure Act of 2009 (the “Act”) that take effect on August 22, 2010 (the “Rule”). (The Rule was published in the Federal Register on June 29, 2010 and incorporates revisions to the proposed rule (the “Proposal”) published in the Federal Register on Monday, March 15.) The Rule implements the final tranche of the Act's Truth-in-Lending Act (“TILA”) amendments, the first two of which took effect in August 2009 and February 2010. In addition to TILA, the Act amended other statutes and mandated various studies, including a study regarding interchange regulation.
The Rule generally requires that penalty fees imposed by credit card issuers ("issuers") be reasonable and proportional to the violation of the associated account terms. (The Act’s reference to “reasonable and proportional fees” is echoed by the reference in the pending Dodd-Frank Wall Street Reform and Consumer Protection Act to “reasonable and proportional” debit interchange fees.) The Rule requires issuers, every six months, to reevaluate annual percentage rates ("rates") increased on or after January 1, 2009. Additionally, the Rule requires that notices of rate increases for credit card accounts disclose the principal reasons for the increase. (In addition, the Rule provides further clarification on the use of bold text in applications, solicitations and account-opening disclosures as well as subsequent disclosure requirements.) These provisions of the Rule are not applicable to home-equity lines of credit accessed by credit cards or overdraft lines of credit accessed by debit cards.
Key provisions of the Rule are summarized below. Additional related comments, including, where useful, comparisons to the Proposal and summaries of public comments considered but rejected by the Board, also appear below.
I. Fees Subject to and Prohibited by the Reasonable and Proportional Requirement
A. Covered Fees. The Board provides the following as examples of fees the amounts of which are limited by §§52(b)(1) and (2) (“Penalty Fees”):
- Late payment fees
- Returned payment fees
- Over-the-limit fees
- Fees for declining account access checks. Comment 52(b)-1.i
Additional Related Comments. The fee for declining an account access check was added by the Board in issuing the final Rule. With respect to over-the-limit fees, some industry commenters argued that such fees should be exempt from §52(b) because, once a consumer has opted in to over-the-limit transactions, the fee for exceeding the limit is a fee for an optional service requested by the consumer rather than a penalty fee for violating the account terms. However, the Board declined to make an exception for over-the-limit fees since Congress expressly cited over-the-limit fees in TILA Section 149(a).
B. Fees Not Covered. The Board has determined that the following fees are not Penalty Fees:
- Balance transfer fees
- Cash advance fees
- Foreign transaction fees
- Annual fees or other fees for issuance or availability of credit (note that if the imposition of this fee is based on account usage, either aggregate dollars spent or transactions incurred, the fee will be deemed a Penalty Fee)
- Fees for insurance, debt suspension or debt cancellation, provided the fee is not caused by a violation of the credit card agreement
- Expedited payment fees
- Fees for optional services
- Fees for reissuing a lost or stolen card. Comment 52(b)-1.ii
Additional Related Comments: Presumably, issuers forced by the Rule to reduce Penalty Fees will consider increases in these excluded fees. Also, responding to comments from consumer groups asking that fees for the reinstatement of rewards points or similar benefits be covered, the Board responded that though such fees are generally not subject to §52(b), they cannot “be categorically excluded. Instead, whether the loss of a benefit as a result of a violation of the terms or other requirements is subject to §226.52(b) depends on the relevant facts and circumstances.”
C. Prohibited Fees. The Board has determined that the following fees may not be charged to cardholders at all:
- Inactivity fees. §52(b)(2)(i)(B)(2)
- Closed account fees. This includes any fee that would be assessed for closing or terminating an account. The prohibition includes assessing or increasing annual fees or monthly maintenance fees after an account is closed if that fee was not assessed while the account was open. §52(b)(2)(i)(B)(3); Comment 52(b)(2)(i)-6.
- The imposition of multiple fees based on a single event or transaction. For example, if a cardholder submits a check which subsequently bounces, the issuer could not charge both a fee for the bounced check and a late fee (which was the result of timely payment not being made due to the bounced check). §52(b)(2)(ii).
Additional Related Comments. Several industry commenters objected to the treatment of certain fees (e.g., inactivity fees) as prohibited by §52(b) since a consumer whose account is inactive may not have violated the cardholder agreement. However, the Board states that TILA Section 149 would not permit issuers to exempt a fee from §52(b) by placing the requirement on which that fee is based outside the account agreement. Therefore, §52(b) applies to fees imposed for violating the terms or other requirements of a credit card account.
With respect to multiple fees based on a single event or transaction, the Proposal was adopted as proposed. Industry commenters argued that this limitation would prevent full recovery of costs since each violation carries a particular cost. The Board rejected this argument, however, citing the relatively small number of instances to which this provision would apply and the ability to recover costs through upfront pricing. However, in response to requests for clarification as to how to apply §52(b)(2)(ii) in certain circumstances, revised comment 52(b)(2)(ii)-1 provides examples.
II. Application of the Reasonable and Proportional Requirement
A. General Rule. Penalty Fees must either come within the safe harbor provision or be supported by a compliant cost-based analysis, and in either case must not exceed the dollar amount associated with the violation. §§52(b)(1)(i), (ii); §52(b)(2).
Additional Related Comments. A new comment provides that an issuer may impose a fee for one type of violation pursuant to §52(b)(1)(i) (i.e., cost) and a fee for a different type of violation pursuant to §52(b)(1)(ii) (i.e., safe harbor). Additionally, an issuer is permitted to shift from charging fees based on a cost analysis to charging fees consistent with the safe harbor. Comment 52(b)(1)-1. The comment also prohibits an issuer from charging the higher safe harbor amount (i.e., after multiple violations) without having first charged the lower amount.
The Proposal would have allowed imposition of a fee if the issuer determines that the dollar amount of the fee is reasonably necessary to deter a specific type of violation using an empirically derived, demonstrably and statistically sound model. Industry commenters argued that such testing was impractical. The Board agreed, and the “deterrence” provision was eliminated from the Rule. (As discussed below, the safe harbor in §52(b)(1)(ii) would allow issuers to impose a higher fee for a second violation. The Board views this as incorporating a deterrence element into the Rule.) On the other hand, the Board declined to implement industry comments asking that issuers be permitted to consider each of the considerations set forth in TILA Section 149 (i.e., cost, deterrence, cardholder conduct and others determined by the Board). The Board states that TILA Section 149(c) requires the Board merely to consider the listed factors, not implement them.
B. Safe Harbor. The following rules apply to the safe harbors established pursuant to §52(b)(1)(ii).
- An issuer may impose an initial Penalty Fee of $25, to be adjusted annually by the Board to reflect changes in the Consumer Price Index (“CPI”). §52(b)(1)(ii)(A).
- In the event of a second violation of the same type as the first during the six billing cycles following the billing cycle in which a violation occurred, an issuer may impose a Penalty Fee of $35, to be adjusted annually by the Board to reflect changes in the CPI. §52(b)(1)(ii)(B).
- With respect to charge card accounts (i.e., accounts where payment in full is due each billing cycle), if a required payment has not been received within two (2) or more consecutive billing cycles, an issuer may impose a late fee of three percent of the delinquent balance. §52(b)(1)(ii)(C).
- Issuers that use the safe harbor do not have to determine that the Penalty Fees they charge bear a reasonable proportion to their total costs. Comment 52(b)(1)-1.i.A. Issuers may impose one type of Penalty Fee based on the safe harbor rules while basing other types of Penalty Fees on their cost-based analysis. Comment 52(b)(1)-1.i.B.
Additional Related Comments. Obviously, §52(b)(1)(ii)(B) (i.e., higher safe harbor fee for multiple violations) puts a premium on determining the billing cycle during which a violation occurs.
- For late payments, a violation occurs during the billing cycle in which the payment may first be treated as late consistent with the requirements of Regulation Z and the terms or other requirements of the account.
- For returned payments, the violation occurs during the billing cycle in which the payment is returned to the issuer.
- For transactions that exceed the credit limit, the violation occurs during the billing cycle in which the transaction occurs or is authorized by the issuer.
- For a declined access check, the violation occurs during the billing cycle in which the issuer declines payment on the check. Comment 52(b)(1)(ii)-1.i.
The Board cited a number of sources in finalizing these safe harbor amounts, including industry standards, penalty fees for other types of accounts, state and local laws regulating penalty fees, analogous rules in the United Kingdom and the results of a study conducted by large issuers.
C. Fees Based on Costs. If an issuer will determine the Penalty Fees it will charge based upon cost factors, the dollar amount of the fee must represent “a reasonable proportion of the total costs incurred by the card issuer as a result of that type of violation.” §52(b)(1)(i). Issuers have the option to round Penalty Fees to the nearest whole dollar. Comment 52(b)-2. Relevant factors include:
- The number of violations of a particular type experienced by the issuer during a period of reasonable length. The Board revised the proposed Rule to indicate 12 months as a reasonable period. Comment 52(b)(1)(i)-1.A.
- The costs incurred by the issuer during the period as a result of the violations. Comment 52(b)(1)(i)-1.B.
- Amounts charged to the issuer by a third party as a result of the applicable violation. Affiliates and subsidiaries of the issuer may be deemed third parties provided the issuer has determined the costs to be a reasonable proportion of the costs incurred by the affiliate or subsidiary as a result of the type of violation. Comment 52(b)(1)(i)-3.
- At its option, the issuer may consider the number of Penalty Fees it imposed as a result of those violations during the period that it reasonably estimates it will be unable to collect. Comment 52(b)(1)(i)-1.C.
- At its option, the issuer may consider reasonable estimates for an upcoming period of changes in the number of violation of that type, the resulting costs, and the number of fees the issuer will be unable to collect. Comment 52(b)(1)(i)-1.D.
- The number of Penalty Fees the issuer was unable to collect. While this calculation may include fees that were uncollectible due to bankruptcy, charge-off or other legal requirement, it may not include fees that the issuer decided to waive or otherwise not collect. Comment 52(b)(1)(i)-5.
Additional Related Comments. In response to industry comments, the Board added a provision allowing an issuer to make a single cost determination for all its card portfolios or make a separate determination for each portfolio. Comment 52(b)(1)(i)-1. Also in response to industry comments, the Rule expands the list of costs associated with returned payment fees to include investigating potential fraud with respect to returned payments. Comment 52(b)(1)(i)-7.i.B. It is also notable that the Board added a new comment stating that the costs incurred by an issuer as a result of a declined access check include costs associated with determining whether to decline access checks, costs associated with processing declined access checks and reconciling the issuer’s systems and accounts to reflect declined access checks, costs associated with investigating potential fraud with respect to declined access checks, and costs associated with notifying the consumer and the merchant that accepted the access check that the check has been declined. Comment 52(b)(1)(i)-9.
D. Costs Excluded as Factors. The Board has determined that the following costs may not be taken into consideration when determining the dollar amount of a Penalty Fee.
- Losses and associated costs, including the cost of holding reserves and funding delinquent accounts. Comment 52(b)(1)(i)-2.i.
- Costs associated with evaluating whether non-breaching consumers will do so in the future. (However, once a violation of the account terms or other requirements has occurred, the costs associated with preventing additional violations for a reasonable period of time may be included in the cost analysis.) Comment 52(b)(1)(i)-2.ii.
Additional Related Comments. The Rule, like the Proposal, excludes losses from the cost analysis. Industry commenters strongly objected to this, citing the high costs associated with losses and evidence that Congress intended the cost analysis to take account of losses. The Board did not agree, arguing that most violations do not result in losses and that issuers can still price for risk through initial interest rates. The Board also argued that the Act is silent on losses and gives the Board discretion to determine how TILA Section 149 is to be implemented.
E. Fee Reevaluations. The issuer must reevaluate the cost determination every 12 months. If the result of the determination is that costs have been reduced and, therefore, a lower fee would be reasonable, the issuer must begin imposing the lower fee within 45 days of the determination. If the issuer determines that costs have increased, and the issuer then determines to increase the applicable fee, the issuer must provide the usual change in terms notification as provided in §9 of the Rule (though, as explained below, the cardholder may not opt out). §52(b)(1)(i).
F. Amount Associated with Violation. As noted above, whether the amount of the Penalty Fee is determined using the safe harbor or a compliant cost-based analysis, it must not exceed the dollar amount associated with the violation. §52(b)(2)(i)(A). For example, a late payment fee cannot exceed the dollar amount of the minimum payment required immediately prior to the late payment fee being assessed (e.g., even though the standard late payment fee may be $20, if the immediately prior required minimum payment was $15, the late payment fee could not exceed $15). With respect to particular examples:
- Partial payments – when a payment that is less than the required minimum periodic payment is received on or prior to the payment due date, the dollar amount associated with the late payment is the full amount of the required minimum periodic payment, not the unpaid portion. Comment 52(b)(2)(i)-1.
- Late payments – in circumstances where a late payment fee is not imposed until after a new billing cycle has begun, the late payment fee must be based on the required minimum periodic payment due immediately prior to assessment of the late payment fee. Comment 52(b)(2)(i)-1.
- Returned payments – the dollar amount associated with a returned payment is the amount of the required minimum periodic payment due immediately prior to the date on which the payment is returned to the issuer. Comment 52(b)(2)(i)-2.
- Over-the-limit fees – the dollar amount associated with an over-the-limit fee with respect to a billing cycle is the total amount by which the account balance exceeds the credit limit during that billing cycle. Comment 52(b)(2)(i)-3.
- Declined access checks – the dollar amount associated with a declined access check is the amount of the check. Comment 52(b)(2)(i)-4.
Additional Related Comments. In retaining the provision limiting the Penalty Fees to no more than the amount of the associated transaction, the Board disregarded industry comments objecting to the provision. These included arguments that, when the dollar amount associated with a violation is small, it could limit the penalty fee to an amount that is sufficient neither to cover the issuer’s costs nor to deter future violations. The Board responded that this limitation will encourage issuers either to reduce the costs incurred as a result of violations that involve small dollar amounts or to build those costs into upfront rates. Commenters also argued that charging individualized penalty fees would be operationally impractical.
III. Reevaluation of Rate Increases
A. General Rule. Issuers that increase rates on accounts (other than accounts that have been charged off or are subject to the Servicemembers Civil Relief Act (§59(h))) based on factors such as credit risk, market conditions (e.g., funding costs) or other factors, where such increase occurred on or after January 1, 2009, must reevaluate those factors to determine if the increased rates should be rolled back. §59(a). Such reevaluation must be conducted not less frequently than once every six months after the rate increase. §59(c). Issuers have the option to base their reevaluations on either (x) the same factors used to determine the rate increase in the first instance or (y) the factors currently used by the issuers for determining rates on similar new credit card accounts. §59(d)(1). Rates need not be reduced to the rate in effect immediately prior to the rate increase. Instead, the amount of the decrease must be determined based on the issuer’s policies and procedures under §59(b) for consideration of factors described in §§59(a) and (d). Comment 59(a)(1)-4.
Additional Related Comments. If a rate has been increased, but there is no balance to which it is applied (e.g., increase in penalty rate applicable to an account in good standing), there is no obligation to review the account to determine if the rate should be reduced. Once a balance is incurred at the higher rate, the six (6) month reevaluation cycle begins. Comment 59(a)(1)-2.
In addition, the Board adopted §59(d)(1) (i.e., permissible factors) substantially as proposed. The Board retained this requirement in spite of industry comments requesting that issuers be permitted to review the current factors that apply to similarly situated existing cardholders, not just new consumers. Additionally, the Rule, like the Proposal, does not name any specific factors that issuers must consider.
B. Policies. Issuers must have reasonable written policies and procedures in place to conduct these reviews. §59(b).
C. Transition Rule. When considering rate increases made between January 1, 2009 and February 21, 2010, during the first two such reviews, issuers must consider the same factors considered when determining rates on similar new credit card accounts unless the previous rate increases were based solely on factors specific to the consumer. §59(d)(2).
Additional Related Comments. The Board implements this new rule to account for rate increases implemented in anticipation of the Act.
D. Relation to §55(b)(4). In the event a cardholder’s rate has been increased due to non-payment of the minimum payment for 60 or more days, issuers need not reevaluate the account for a rate decrease until such time as the cardholder has made six (6) consecutive timely minimum monthly payments. The review must be conducted within six (6) months of when the sixth consecutive timely minimum payment has been made. §59(e).
E. Notice. If, as a result of a reevaluation, an issuer increases a rate, the change in terms notice sent pursuant to §9(c)(2) must disclose no more than four principal reasons for the rate increase, listed in the order of importance. §9(c)(2)(iv)(A)(8). However, the issuer may disclose any number of reasons so long as they relate to and accurately describe the principal factors actually considered. Comment 9(c)(2)(iv)-11.
Additional Related Comments. Stating that “a consumer may be better able to take action to mitigate [a] change [specific to the consumer] than for market-based rate increases,” the Board amended Comment 9(c)(2)(iv)-11 to require that a notice specifically disclose any violation of the terms of the account on which the rate is being increased, such as a late payment, if such violation is one of the four principal reasons for the increase. Additionally, Section 9(c)(2)(iv)(A)(8) requires such notice to inform consumers of any specific on-account behavior that gave rise to the rate increase and if the increase resulted from a decline in their creditworthiness.
F. Termination of Reevaluation Obligation. The obligation to review accounts for rate decreases terminates when: the issuer reduces the rate to (a) the rate applicable immediately before the increase (if the rate was based on a variable rate, then to a variable rate based on the same index and margin used to determine the rate immediately prior to the rate increase); or (b) a rate lower than the rate applicable immediately before the increase. §59(f).
Additional Related Comments. Rate reductions that lower the APR, but not to the rate in effect immediately prior to the rate increase, do not alleviate the need to continue the rate reevaluation process indefinitely until one of the conditions set forth above is met. The Board adopted §59(f) substantially as proposed. The Board disregarded comments arguing that requiring periodic reviews for an indefinite period would increase the cost and complexity associated with compliance and compliance examinations. Industry commenters also argued that consumers would not benefit from requiring reviews to continue indefinitely, especially since costs associated with ongoing reviews would be passed on to consumers in the form of higher fees and rates and more closed accounts. However, because TILA Section 148 does not expressly enact a limit, and because the Board believes that rate reviews may eventually benefit all consumers, the Board has declined to implement a limit.
G. Acquired Accounts. Generally, with respect to credit card accounts acquired (i.e., purchased or otherwise transferred) on or after January 1, 2009, which accounts have had rate increases on or after January 1, 2009 and were then subsequently acquired, the new issuer must review the factors used by the prior issuer to cause the rate increase on or after January 1, 2009. §59(g)(1). Alternatively, the new issuer may opt to review all the acquired accounts in accordance with the factors it currently uses in evaluating similar credit card accounts, provided the new accounts are reviewed within 6 months of acquisition. §59(g)(2).
IV. Compliance Dates
A. Compliance by August 22, 2010. The Supplementary Information accompanying the Rule provides special rules for compliance with the Rule by August 22, 2010. A card issuer must comply with the applicable substantive provisions set forth in §52(b) and §59 on August 22, even if the terms of the account have not been amended consistent with §9(c)(2). Therefore, if §9(c)(2) requires an issuer to provide notice of a change that is “necessary to comply with” the Rule, the issuer is not required to provide that notice 45 days before the effective date of the change. In addition, the Board states that it would not be appropriate to permit consumers to reject a change that is “necessary to comply with” the Rule. Issuers are therefore not required to provide consumers with the right to reject pursuant to §9(h) in such circumstances.
B. Waiver of Opt-Out. The Rule expressly permits issuers to make certain changes to the terms of an account without providing the right to opt out that would otherwise be required pursuant to §9(h). Specifically:
- The right to opt out does not apply when a fee is increased because of a reevaluation pursuant to §52(b)(1)(i). §9(c)(2)(iv)(B).
- The right to opt out does not apply when a fee is increased because of an adjustment to the safe harbors in §52(b)(1)(ii) to reflect changes in the CPI. §9(c)(2)(iv)(B).
C. Penalty Fee Disclosures. The mandatory compliance date for amendments to the penalty fee disclosures in §§5a, 6, 7 and 56 and Model Forms G-10(B), G-10(C), G-10(E), G-17(B), G-17(C), G-18(B), G-18(D), G-18(F), G-18(G), G-21, G-25(A) and G-25(B) is December 1, 2010. These revisions are described in DWT’s advisory, dated March 11, 2010, entitled “Federal Reserve Releases Proposed Revisions To Regulation Z Relating To Reasonable Fees And Reevaluation Of Rate Increases” (“March 11 Advisory”). Until December 1, 2010, an issuer complies with §§5a, 6, 7 and 56 if it discloses an amount for a late payment fee, returned payment fee, over-the-limit fee, or other penalty fee that exceeds the amount permitted by §52(b). For example, an issuer that imposed a late payment fee of $39 prior to August 22, 2010 may continue to disclose the amount of its late payment fee as $39 until December 1, 2010, even if the card issuer does not actually impose a fee that exceeds $35.
D. Other Disclosures. The mandatory compliance date for amendments to applications, solicitations, account-opening disclosures and periodic statements described in the Rule is December 1, 2010. These revisions are described in the March 11 Advisory.
The Rule, like the Proposal, is generally balanced, although, on the whole, it still favors the consumer. We remain of the opinion that the inclusion of losses and the costs associated with holding loss reserves should have been found to be appropriate (and reasonable) factors in determining certain Penalty Fees.
The good news is that both the provisions regarding reasonable fees and reevaluation of rate increases are subject only to administrative enforcement. While this may not stop class action lawyers from litigating based on UDAP claims, it will pose a significant obstacle to success in any such litigation.
If you have any comments or would like more information, please contact Robert Birnbaum, James H. Mann, Andrew Owens or Sona Balachandran.