Buyer Beware: CFPB and AGs Settle Claims Against Loan Purchaser
On August 17, 2017, the Consumer Financial Protection Bureau (CFPB) and 12 state attorneys general (the Government) filed proposed settlements with Aequitas Capital Management, a now-defunct private equity firm, in connection with loans that Aequitas funded for students of another bankrupt entity, Corinthian Colleges, Inc. The settlements follow the Government’s allegations that Aequitas engaged in “unfair, deceptive, or abusive acts or practices” (UDAAP) under Dodd-Frank and under similar state statutes targeting “unfair and deceptive acts and practices” (UDAP). Corinthian, formerly one of the largest for-profit colleges in the country, suffered a total collapse in 2015 following enforcement actions by both the US Department of Education (ED), for alleged violations of its rules, and the US Securities and Exchange Commission (SEC), for alleged securities fraud. Aequitas itself is currently in receivership following SEC allegations of securities fraud and of Aequitas operating in a “Ponzi-like fashion.”
In brief, the Government alleged that Aequitas joined Corinthian in a form of funding conspiracy through which Corinthian evaded ED’s “skin-in-the-game” rules. Those rules require that, in order to receive federal student loan dollars, a for-profit college must obtain at least 10% of its revenues from nonfederal sources. Allegedly, after Corinthian increased its tuition above federal aid limits in order to ensure that students (and not federal aid) were providing at least 10% of its revenues, Aequitas loaned funds to those students to cover the increase. Importantly, Aequitas provided those loans on a recourse basis in that Corinthian guaranteed the loans, and Aequitas and Corinthian allegedly entered into sham transactions in order to conceal those guarantees. The Government asserted that Aequitas engaged in misconduct by funding loans to Corinthian’s students, whom Aequitas knew or should have known were being charged “inflated tuition” and were also being misled by Corinthian as to likely job prospects upon graduation.
This action against Aequitas is somewhat unusual, both because the alleged conduct here (including a conspiracy to evade ED rules), if true, is particularly egregious, and because of the action’s complex procedural structure, which includes an SEC action and a bankruptcy receiver. Also notable and unusual is that the large dollar amount of penalties here ($183.3 million) consists solely of student loan principal reductions and cancellations, the true market value of which is almost certainly only a small fraction of the headline amount, meaning that the monetary value of the penalties is actually much lower. In addition, a bankruptcy receiver, and neither Aequitas nor its principals themselves, agreed to this settlement, a fact that undoubtedly reduced the defendant’s willingness to fight. The receiver, in a motion to the court in support of approving the proposed settlement, noted that his agreement was heavily influenced by the facts that
- the onerous costs of the investigation were wasting away receivership assets,
- the now-defunct Aequitas could not itself be damaged by the settlement, and
- settling was consistent with his duty to maximize funds available to Aequitas’s creditors.
Despite the unusual nature of this action, the case nonetheless implicates several important issues that warrant close attention.
- This is the first time that the CFPB has flexed its muscles over “abusive” acts and practices in this context, by alleging liability on the part of a third-party entity that purchases loans from another alleged wrongdoer. Because the state settlements are for unfair and deceptive practices only, however, it is unclear whether the CFPB’s use of its exclusive “abusive” authority is meaningful. Few limiting principles, however, other than the CFPB’s own prosecutorial discretion, appear to underlie this extension of authority: for example, it is a modest jump from here to the CFPB’s pursuit of an investor in a similar loan portfolio.
- The ultimate charge that the CFPB levied against Aequitas was not aiding and abetting an unfair or deceptive practice, but rather a direct, standalone assertion that the company committed an “abusive” act or practice. While the complaint’s tone strongly suggests that the agency’s concerns over Aequitas’s conduct were rooted in principles of secondary liability—i.e., culpability for another’s bad acts—the CFPB’s complaint treats the conduct as primary violative conduct and as squarely “abusive,” a theory of liability for which the contours have yet to be developed. Specifically, the CFPB complaint alleges that Aequitas violated the Dodd-Frank Act’s abusiveness prohibition when it took “unreasonable advantage” of student borrowers by “funding, supporting, and maintaining its purchase of Corinthian student loan portfolios and by participating in the Genesis Loan Program through the ‘forward flow’ agreements with Corinthian.” Stated differently, although the complaint discusses at length the alleged conspiracy to violate ED rules, the only charged violation is that Aequitas funded a loan program that the CFPB saw as abusive.
- The CFPB brushed aside the entire legal and title structure of the financing transactions for the loan purchases and alleged that the several legal entities Aequitas set up for the transactions were a single “common enterprise,” in that all entities operated as one and were therefore jointly and severally liable. The CFPB’s evidence for this conclusion appears to have been very limited, consisting of the following points noted in the complaint: after purchasing loans from Corinthian, Aequitas (i) sold those loans to related entities, (ii) “conducted the [bad] business practices . . . through [its] interrelated network of companies . . . that have common business functions, employees, and office locations,” and (iii) “shared operations and proceeds” flowing from the allegedly bad conduct.
- For the remainder of his tenure and perhaps beyond, the CFPB director and the agency may continue to pursue adding tools, as the director appears to have done in this action, to the CFPB’s enforcement toolbox through the use of the CFPB’s authority over “abusive” acts and practices. To state the matter plainly, the CFPB continues to be an aggressive and creative law enforcement agency, notwithstanding the change in administration.
- Even after the director departs, however, these issues and concerns will remain, given that state attorneys general may (and do now with some vigor) pursue actions independently. Notably, 12 state attorneys general (including the Republican attorneys general of Texas and Colorado) joined this action against Aequitas.
- When purchasing a portfolio of loans for products that are the object of heightened enforcement and regulatory scrutiny (e.g., payday loans, private student loans), in addition to reputational risk, there is a real risk that regulators may reduce or eliminate the asset, e.g., the loan principal, or seek other monetary relief directly affecting the purchaser.
- Those providing credit facilities or purchasing loan portfolios should conduct due diligence into potential underlying regulatory issues. Beyond simply ensuring overall regulatory compliance and creditworthiness, there should be some inquiry into the nature of these programs to evaluate whether the Government might view them as violating UDAP/UDAAP, and/or might view the purchase as an aiding and abetting (or even primary) violation.
- There also may be implications here for persons who invest in loan portfolio issuers, particularly if their investments are substantial or give an investor some level of influence or control over the issuer. Although the conduct alleged in this action, if true, was egregious, the Aequitas matter serves as a notice that persons doing business in the realm of consumer loans (particularly consumer loans that may attract regulatory scrutiny, e.g., small dollar loans, student loans) should be cautious about with whom they are doing business, or in which businesses they are investing. To avoid being caught up in, and potentially held liable for, activities that could lead to a CFPB action (or worse), buyers (loan purchasers and investors alike) should take a suitably diligent “buyer beware” approach to companies engaged in these types of activities in other areas that the regulators have indicated might present UDAP/UDAAP issues, or that have otherwise drawn regulatory scrutiny.