Amid concerns about Section 1071’s potential impact on the secured lending and equipment finance industries, Brett Garver answers key questions about the new requirements and their implementation timeline. He is a partner with the Firm and has been heavily involved in this issue as an attorney for the Firm’s clients and as an advocate for their industries.
Brett believes that many finance executives are unaware of how broadly the new rules will apply. He says compliance will be burdensome, especially for smaller lenders; some customers will consider the required questions on gender and race to be intrusive; and the ultimate purpose of all this effort remains unclear.
Q – A recent column by Andy Fishburn of the ELFA implored companies to start preparing now for Section 1071. Do you think most finance executives have a basic understanding of Section 1071 and its implications, or are we still on a learning curve?
Section 1071 of the Dodd-Frank Act amended the Equal Credit Opportunity Act to require financial institutions to compile, maintain and submit to the Consumer Financial Protection Bureau (CFPB) certain data on applications for credit for women-owned, minority-owned, and small businesses. Congress enacted Section 1071 for the stated purpose of: 1) facilitating enforcement of fair lending laws; and 2) enabling communities, governmental entities and creditors to identify business and community development needs and opportunities for women-owned, minority-owned and small businesses.
My impression is that there is a wide range of understanding of Section 1071, as organizations like ELFA and the Secured Finance Network have been actively advising their member organizations to be prepared to comply with Section 1071. However, I suspect that many executives may be surprised at how broadly Section 1071 applies and believe there will be a steep learning curve within the industry, especially among smaller financial institutions.
Q-Which types of finance companies need to prepare for this change, and which segments of the industry will be most affected ─ only banks, or other lenders? Is there a lending ceiling or any other requirements that need to be met?
As drafted, Section 1071 applies to all financial institutions. “Financial Institution” is defined broadly under Section 1071(h)(1) as “any partnership, company, corporation, association (incorporated or unincorporated), trust, estate, cooperative organization, or other entity that engages in any financial activity.” Read broadly, this would appear to encompass every entity engaged in the extension of credit, without regard to the nature or size of the credit provider. Any financial institution that originates at least 25 covered credit transactions to small businesses in the two previous calendar years will have to comply. “Covered transactions” include, but are not limited to, small business loans, lines of credit, credit cards and merchant cash advances.
Q-What is the current status of Section 1071, your best guess regarding how requirements may (or may not) change, and the proposed implementation timeline?
Much of the rulemaking around 1071 developed following a lawsuit brought seeking to compel the CFPB to adopt rules to enforce 1071. Recently, the Court presiding over the action entered an Order, providing that “[b]arring an extension of the deadline between the parties (to the litigation) or further order of the Court, Defendants shall issue a Final Rule for the Section 1071 Implementing Regulations by March 31, 2023.” If that timeline plays out, lenders will have 18 months from that date to understand and comply with the new rule, and will be expected to begin reporting at the end of 2024. They will likely have to update their systems to collect the required information, implement new technology and train their employees.
Q-What changes will lenders need to make to their internal origination procedures and other areas of their business in order to comply?
Lenders will need to be prepared to have a segregated data collection process to collect and maintain the information required by Rule 1071. The party collecting the information must be independent from the parties taking the application and underwriting the transaction. The information will also have to be segregated electronically, such that it cannot be accessed by the underwriting team.
Q-We know finance executives are concerned about Section 1071 and its impact on their businesses. What concerns are you hearing, and what issues are you not hearing about that should also be considered?
Obviously, many lenders are especially concerned about compliance costs and increased overhead. Many smaller lenders, especially brokers and independent finance companies, simply are not staffed deeply enough to collect and report data independent from underwriting and sales. An area of concern to many, but perhaps less focused on, is the intrusive nature of the data collection and the natural suspicion many people have to race and gender-based questions. There is a possibility that the extra data collection will affect the taking and/or processing of certain credit applications. A major area of concern is also how publicly available the data will be and how much identifying information will be shared.
Q-Any recommendations for how companies should approach the new requirements at this stage? Later this year?
Since the final rule has not been adopted and may not be before March 2023, companies should be actively monitoring the rulemaking process directly and via organizations like ELFA, the Secured Finance Network and, of course, their counsel.
Q-Section 1071 and its implications have been discussed for years. How have you been involved in this issue as an attorney and industry advocate?
I have been a member of the Advocacy Committee of the Secured Finance Network and drafted both the comment letter submitted to the CFPB on behalf of the Secured Finance Network, as well as an advocacy alert for its members. I have also counseled the Firm’s financial clients regarding any inquiries they have as they prepare their businesses to comply with the upcoming 1071 requirements.
Q-Is there any confusion over the new requirements that we should try to clear up for readers?
One of the most confusing aspects of the new rule is that it is merely a data collection project at this point. It is not clear what the rule itself will be used to accomplish or even what the data will necessarily reflect. Having the new 1071 requirements implemented for some time should provide better clarity as to whether the regulation is achieving the original objective of understanding access to commercial credit for historically underserved populations.