[Federal Register: May 19, 2008 (Volume 73, Number 97)] [Proposed Rules] [Page 28965-29021] From the Federal Register Online via GPO Access [wais.access.gpo.gov] [DOCID:fr19my08-22] [[Page 28965]] ----------------------------------------------------------------------- Part IV Federal Reserve System ----------------------------------------------------------------------- 12 CFR Part 222 Federal Trade Commission ----------------------------------------------------------------------- 16 CFR Parts 640 and 698 Fair Credit Reporting Risk-Based Pricing Regulations; Proposed Rule [[Page 28966]] ----------------------------------------------------------------------- FEDERAL RESERVE SYSTEM 12 CFR Part 222 [Regulation V; Docket No. R-1316] FEDERAL TRADE COMMISSION 16 CFR Parts 640 and 698 RIN 3084-AA94 Fair Credit Reporting Risk-Based Pricing Regulations AGENCIES: Board of Governors of the Federal Reserve System (Board) and Federal Trade Commission (Commission). ACTION: Notice of proposed rulemaking. ----------------------------------------------------------------------- SUMMARY: The Board and the Commission are publishing for comment proposed rules to implement the risk-based pricing provisions in section 311 of the Fair and Accurate Credit Transactions Act of 2003 (FACT Act), which amends the Fair Credit Reporting Act (FCRA). The proposed rules generally require a creditor to provide a risk-based pricing notice to a consumer when the creditor uses a consumer report to grant or extend credit to the consumer on material terms that are materially less favorable than the most favorable terms available to a substantial proportion of consumers from or through that creditor. The proposed rules also provide for two alternative means by which creditors can determine when they are offering credit on material terms that are materially less favorable. The proposed rules also include certain exceptions to the general rule, including exceptions for creditors that provide a consumer with a disclosure of the consumer's credit score in conjunction with additional information that provides context for the credit score disclosure. DATES: Comments must be received on or before August 18, 2008. ADDRESSES: The Board and the Commission will jointly review all of the comments submitted. Therefore, you may comment to either the Board or the Commission and you need not send comments (or copies) to both agencies. Because paper mail in the Washington area and at the Board and the Commission is subject to delay, please submit your comments by electronic means whenever possible. Commenters are encouraged to use the title ``FACT Act Risk-Based Pricing Rule'' in addition to the docket or RIN number in their submission. Interested parties are invited to submit comments in accordance with the following instructions: Board: You may submit comments, identified by Docket No. R-1316, by any of the following methods: Agency Web Site: http://www.federalreserve.gov. Follow the instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm. Federal eRulemaking Portal: http://www.regulations.gov. Follow the instructions for submitting comments. E-mail: regs.comments@federalreserve.gov. Include docket number in the subject line of the message. Fax: (202) 452-3819 or (202) 452-3102. Mail: Jennifer J. Johnson, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue, NW., Washington, DC 20551. All public comments are available from the Board's Web site at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as submitted, unless modified for technical reasons. Accordingly, your comments will not be edited to remove any identifying or contact information. Public comments may also be viewed electronically or in paper in Room MP-500 of the Board's Martin Building (20th and C Streets, NW.) between 9 a.m. and 5 p.m. on weekdays. Commission: Comments should refer to ``FACT Act Risk-Based Pricing Rule, Project No. R411009,'' and may be submitted by any of the following methods. If, however, the comment contains any material for which confidential treatment is requested, it must be filed in paper form, and the first page of the document must be clearly labeled ``Confidential.'' \1\ --------------------------------------------------------------------------- \1\ Commission Rule 4.2(d), 16 CFR 4.2(d). The comment must be accompanied by an explicit request for confidential treatment, including the factual and legal basis for the request, and must identify the specific portions of the comment to be withheld from the public record. The request will be granted or denied by the Commission's General Counsel, consistent with applicable law and the public interest. See Commission Rule 4.9(c), 16 CFR 4.9(c). --------------------------------------------------------------------------- Web Site: Comments filed in electronic form should be submitted by clicking on the following Web link: https:// secure.commentworks.com/ftc-RiskBasedPricing and following the instructions on the Web-based form. To ensure that the Commission considers an electronic comment, you must file it on the Web-based form at https://secure.commentworks.com/ftc-RiskBasedPricing. Federal eRulemaking Portal: If this notice appears at http://www.regulations.gov, you may also file an electronic comment through that Web site. The Agencies will consider all comments that regulations.gov forwards to the Commission. Mail or Hand Delivery: A comment filed in paper form should include ``FACT Act Risk-Based Pricing Rule, Project No. R411009,'' both in the text and on the envelope and should be mailed or delivered, with two complete copies, to the following address: Federal Trade Commission/Office of the Secretary, Room H-135 (Annex M), 600 Pennsylvania Avenue, NW., Washington, DC 20580. The Commission is requesting that any comment filed in paper form be sent by courier or overnight service, if possible. Comments on any proposed filing, recordkeeping, or disclosure requirements that are subject to paperwork burden review under the Paperwork Reduction Act should additionally be submitted to: Office of Management and Budget, Attention: Desk Officer for the Federal Trade Commission. Comments should be submitted via facsimile to (202) 395- 6974 because U.S. Postal Mail is subject to lengthy delays due to heightened security precautions. The FTC Act and other laws the Commission administers permit the collection of public comments to consider and use in this proceeding as appropriate. All timely and responsive public comments, whether filed in paper or electronic form, will be considered by the Commission, and will be available to the public on the Commission's Web site, to the extent practicable, at http://www.ftc.gov/os/publiccomments.htm. As a matter of discretion, the Commission makes every effort to remove home contact information for individuals from the public comments it receives before placing those comments on the Commission's Web site. More information, including routine uses permitted by the Privacy Act, may be found in the Commission's privacy policy, at http://www.ftc.gov/ ftc/privacy.htm. FOR FURTHER INFORMATION CONTACT: Board: David A. Stein, Managing Counsel, or Amy E. Burke, Senior Attorney, Division of Consumer and Community Affairs, (202) 452-3667 or (202) 452-2412; or Andrea K. Mitchell, Senior Attorney, Legal Division, (202) 452-2458, Board of Governors of the Federal Reserve System, 20th and C Streets, NW., Washington, DC 20551. For users of a Telecommunications Device for the Deaf (TDD) only, contact (202) 263- 4869. Commission: Kellie Cosgrove Riley, Senior Attorney, or Stacey Brandenburg, [[Page 28967]] Attorney, Division of Privacy and Identity Protection, Bureau of Consumer Protection, (202) 326-2252, Federal Trade Commission, 600 Pennsylvania Avenue, NW., Washington DC 20580. SUPPLEMENTARY INFORMATION: I. Background The Fair and Accurate Credit Transactions Act of 2003 (FACT Act) was signed into law on December 4, 2003. Public Law 108-159, 117 Stat. 1952. In general, the FACT Act amended the Fair Credit Reporting Act (FCRA) to enhance the ability of consumers to combat identity theft, increase the accuracy of consumer reports, and allow consumers to exercise greater control regarding the type and amount of solicitations they receive. Section 311 of the FACT Act added a new section 615(h) to the FCRA to address risk-based pricing. Risk-based pricing refers to the practice of setting or adjusting the price and other terms of credit offered or extended to a particular consumer to reflect the risk of nonpayment by that consumer. Information from a consumer report is often used in evaluating the risk posed by the consumer. Creditors that engage in risk-based pricing generally offer more favorable terms to consumers with good credit histories and less favorable terms to consumers with poor credit histories. Under the new section 615(h) of the FCRA, a risk-based pricing notice must be provided to consumers in certain circumstances. Generally, a person must provide a risk-based pricing notice to a consumer when the person uses a consumer report in connection with an application, grant, extension, or other provision of credit and, based in whole or in part on the consumer report, grants, extends, or provides credit to the consumer on material terms that are materially less favorable than the most favorable terms available to a substantial proportion of consumers from or through that person. Section 311 is part of Title III of the FACT Act, which is entitled ``Enhancing the Accuracy of Consumer Report Information.'' The risk- based pricing notice requirement is designed primarily to improve the accuracy of consumer reports by alerting consumers to the existence of negative information on their consumer reports so that consumers can, if they choose, check their consumer reports for accuracy and correct any inaccurate information. \2\ --------------------------------------------------------------------------- \2\ See S. Rep. No. 108-166, at 20 (Oct. 17, 2003). --------------------------------------------------------------------------- Section 615(h) requires the Board and the Commission (Agencies) jointly to issue rules implementing the risk-based pricing provisions. The statute requires the Agencies to address in the implementing rules the form, content, timing, and manner of delivery of any notices pursuant to section 615(h). The rules also must clarify the meaning of certain terms used in this section, including what are ``material'' credit terms and when credit terms are ``materially less favorable.'' Section 615(h) gives the Agencies the authority to provide exceptions to the notice requirement for classes of persons or transactions for which the Agencies determine that risk-based pricing notices would not significantly benefit consumers. Finally, the Agencies must provide a model notice that can be used to comply with section 615(h). II. Developing the Proposed Rules In developing these proposed risk-based pricing rules, the Agencies sought to implement the statutory provisions in a manner that would be operationally feasible for the wide variety of entities that will be subject to the rules. At the outset of developing the proposed rules, the Agencies conducted outreach to various interested parties, including consumer groups, financial institutions, mortgage bankers, and consumer reporting agencies. The goals of this initial outreach were to get a broad sense of how risk-based pricing is used in practice, how information from consumer reports factors into risk-based pricing, and how interested parties believe the Agencies should implement these provisions. Based on this initial outreach, the Agencies determined that it may not be operationally feasible in many cases for creditors to compare the terms offered to each consumer with the terms offered to other consumers to whom the creditor has extended credit. After considering several approaches, the Agencies concluded that the most effective way to implement the statute was to develop certain tests that could serve as proxies for comparing the terms offered to different consumers. These tests could be used by creditors for which making direct comparisons among consumers would be difficult or infeasible. The Agencies then conducted additional, more in-depth outreach meetings with interested parties, including consumer groups, consumer reporting agencies, and a variety of different types of creditors, including large banks, small community banks, credit card issuers, mortgage bankers, auto finance companies, automobile dealers, private student loan creditors, manufactured housing lenders, and industry trade associations. This outreach provided the Agencies with valuable information about how risk-based pricing is conducted in various sectors of the consumer credit market. In addition, the Agencies sought feedback from outreach participants on a number of possible tests that could be used to implement the requirements of the statute. The Agencies' goal was to determine which tests would both identify those consumers who likely received materially less favorable terms than the terms obtained by other consumers and be operationally feasible for creditors to implement. The proposed rules reflect the Agencies' judgments as to the best approaches identified through these outreach efforts. As discussed more fully below, the Agencies recognize that no single test or approach is likely to be feasible for all of the various types of creditors to which the rules apply or for the many different credit products for which risk-based pricing is used. Therefore, the proposed rules provide a menu of approaches that creditors may use to comply with the statute's legal requirements. The next section provides a brief explanation of the proposed rules. III. Summary of the Proposed Rules Risk-Based Pricing Notice The proposed rules implement the risk-based pricing notice requirement of section 615(h). The proposed rules apply to any person that both: (i) Uses a consumer report in connection with an application for, or a grant, extension, or other provision of, credit to a consumer; and (ii) based in whole or in part on the consumer report, grants, extends, or otherwise provides credit to that consumer on material terms that are materially less favorable than the most favorable terms available to a substantial proportion of consumers from or through that person. The proposed rules clarify that the risk-based pricing notice requirements apply only in connection with credit that is primarily for personal, household, or family purposes, but not in connection with business credit. For more information about the scope of the proposed rules, see the discussion of Sec. ----.70 in the Section-by-Section Analysis. Definitions The proposed rules define certain key terms. Specifically, the proposed rules define ``material terms'' as the annual percentage rate for credit that has an annual percentage rate,\3\ or, in the case [[Page 28968]] of credit that does not have an annual percentage rate, as any monetary terms, such as the down payment amount or deposit, that the person varies based on the consumer report. For credit cards, which may have multiple annual percentage rates applicable to different features, ``material terms'' is defined as the annual percentage rate applicable to purchases. In addition, the proposed rules define ``materially less favorable,'' as it applies to material terms, to mean that the terms granted or extended to a consumer differ from the terms granted or extended to another consumer from or through the same person such that the cost of credit to the first consumer would be significantly greater than the cost of credit to the other consumer. For more information about the definitions of these and other terms used in the proposed rules, see the discussion of Sec. ----.71 in the Section-by-Section Analysis. --------------------------------------------------------------------------- \3\ Under Regulation Z, which implements the Truth in Lending Act, 15 U.S.C. 1601, et seq., the annual percentage rate is a measure of the cost of credit, expressed as a yearly or annualized rate. See 12 CFR 226.14, 226.22. Regulation Z requires creditors to disclose accurately the cost of credit, including the annual percentage rate. See 12 CFR 226.5a(b)(1), 226.5b(d)(6) and (12), and 226.18(e). --------------------------------------------------------------------------- General Rule and Methods for Identifying Consumers Who Must Receive Notice The proposed rules generally restate the statutory requirement that a person must provide the consumer with a notice if that person both: (i) Uses a consumer report in connection with an application for, or a grant, extension, or other provision of, credit to that consumer; and (ii) based in whole or in part on the consumer report, grants, extends, or otherwise provides credit to that consumer on material terms that are materially less favorable than the most favorable terms available to a substantial proportion of consumers from or through that person. The proposed rules apply to a person to whom the obligation is initially payable (also referred to as ``the original creditor''). A person subject to the rule may determine, on a case-by-case basis, whether a consumer has received material terms that are materially less favorable terms than other consumers have received from or through that person by comparing the material terms offered to the consumer to the material terms offered to other consumers in similar transactions. It may not be operationally feasible for many persons subject to the rule to make such direct comparisons between consumers, however. For those persons who prefer not to compare directly the material terms offered to their consumers, the proposed rules provide two alternative methods for determining which consumers must receive risk- based pricing notices. Using either method, a person may determine when credit offered from or through that person is on material terms that are materially less favorable than the most favorable terms available to a substantial proportion of consumers from or through that person. The first method is the credit score proxy method. A credit score is a numerical representation of a consumer's credit risk based on information in the consumer's credit file. The proposed rules permit a creditor that uses credit scores to set the material terms of credit to determine a cutoff score, representing the point at which approximately 60 percent of its consumers have lower credit scores, and provide a risk-based pricing notice to each consumer who has a credit score lower than the cutoff score. The proposed rules require periodic updating of the cutoff score. The second method is the tiered pricing method. The proposed rules permit a creditor that sets the material terms of credit by assigning each consumer to one of a discrete number of pricing tiers, based in whole or in part on a consumer report, to use this method to provide a risk-based pricing notice to each consumer who is not assigned to the top pricing tier or tiers. The number of tiers of consumers to whom the notice is required to be given depends upon the total number of tiers. For more information about the general rule and the methods for determining which consumers must receive notices, see the discussion of Sec. ----.72 in the Section-by-Section Analysis. Application of Rule to Credit Card Issuers The proposed rules set forth a special test to identify circumstances in which a credit card issuer must provide a notice to consumers. A credit card issuer is required to provide a risk-based pricing notice to a consumer if the consumer applies for a credit card in connection with a multiple-rate offer and, based in whole or in part on a consumer report, is granted credit at a purchase annual percentage rate that is higher than the lowest purchase annual percentage rate available under that offer. The proposed rules assume that a consumer who applies for credit in response to a multiple-rate offer is applying for the best rate available. For more information about the application of the rule to credit card issuers, see the discussion of Sec. ----.72 in the Section-by-Section Analysis. Account Review Some creditors conduct periodic reviews of a consumer report in connection with credit that has been extended to a consumer. If the consumer's credit history has deteriorated, the creditor may, pursuant to applicable account terms, increase the annual percentage rate applicable to that consumer's account. The proposed rules require the creditor to provide a risk-based pricing notice to the consumer if the creditor increases the consumer's annual percentage rate in an account review based in whole or in part on a consumer report. For more information about the application of the general rule to account reviews, see the discussion of Sec. ----.72 in the Section-by-Section Analysis. Content of the Notice In addition to the minimum content prescribed by section 615(h)(5) of the FCRA, the proposed rules require the risk-based pricing notice to include a statement that the terms offered may be less favorable than the terms offered to consumers with better credit histories. The Agencies believe that including such a statement in the notice could encourage consumers to check their consumer reports for inaccuracies. The proposed rules also include special content requirements for the notice in the context of account reviews. For more information about the content of the risk-based pricing notices, see the discussion of Sec. ----.73 in the Section-by-Section Analysis. Timing of the Notice Section 615(h)(2) of the FCRA states that the risk-based pricing notice may be provided at the time of an application for, or a grant, extension, or other provision of, credit or at the time of communication of an approval of an application for, or grant, extension, or other provision of, credit. Section 615(h)(6)(B)(v) of the FCRA, however, gives the Agencies broad discretion to set the timing requirements for the notice by rule. The proposed rules generally require a risk-based pricing notice to be provided to the consumer after the terms of credit have been set, but before the consumer becomes contractually obligated on the credit transaction. In the case of closed-end credit, the notice must be provided to the consumer before consummation of the transaction, but not earlier than the time the approval decision is communicated to the consumer. In the case of open-end credit, the notice must be provided to the consumer before the first transaction [[Page 28969]] is made under the plan, but not earlier than the time the approval decision is communicated to the consumer. For account reviews, the notice must be provided at the time that the decision to increase the annual percentage rate is communicated to the consumer or, if no notice of the increase in the annual percentage rate is provided to the consumer prior to the effective date of the change in the annual percentage rate, no later than five days after the effective date of the change in the annual percentage rate. For more information about the timing requirements, see the discussion of Sec. ----.73 in the Section-by-Section Analysis. Exceptions to the Risk-Based Pricing Notice Requirement The proposed rules contain a number of exceptions to the risk-based pricing notice requirement. First, the proposed rules implement the statutory exceptions that apply: (i) When a consumer applies for, and receives, specific material terms; and (ii) when a consumer is receiving an adverse action notice under section 615(a) of the FCRA in connection with the transaction. The Agencies also have used the exception authority set forth in section 615(h)(6)(iii) of the FCRA to propose additional exceptions for classes of persons or transactions regarding which the Agencies believe that the notice would not significantly benefit consumers. The Agencies are proposing exceptions for creditors that provide consumer applicants with certain information, including their credit score, in lieu of the risk-based pricing notice.\4\ For credit secured by one to four units of residential real property, an exception applies when a creditor provides the consumer with a notice containing the credit score disclosure required by section 609(g) of the FCRA along with certain additional information that provides context for the credit score disclosure, describes the creditor's use of credit scores to set the terms of credit, and explains how a consumer can obtain his or her free annual consumer reports. Another proposed exception applies to credit that is not secured by one to four units of residential real property, and is thus not subject to the credit score disclosure requirements of section 609(g). This exception is similar to the credit score disclosure exception for residential real property secured credit. --------------------------------------------------------------------------- \4\ These exceptions are distinct from the credit score proxy method discussed above. The credit score proxy method is one way in which creditors can comply with the proposed rules' requirement to identify those consumers who should receive a risk-based pricing notice. The credit score disclosure exceptions, on the other hand, provide consumers with a credit score and related information in lieu of a risk-based pricing notice. A creditor, therefore, can comply with the proposed rules either by using the credit score proxy method (or one of the other enumerated methods) to determine for a given class of products which consumers should receive a risk- based pricing notice, or by providing the credit score disclosure to its consumers for that class of products. --------------------------------------------------------------------------- In some cases, a consumer's credit file may not contain sufficient information to permit a consumer reporting agency or other person to calculate a score for that individual. A creditor using either of the credit score disclosure exceptions described above is permitted to comply with the regulation by providing an alternate narrative notice that does not include a credit score to those consumers for whom a score is not available. Finally, the Agencies have proposed an exception for prescreened solicitations. Under this exception, a creditor will not be required to provide a risk-based pricing notice if that creditor obtains a consumer report that is a prescreened list and uses that consumer report to make a firm offer of credit to the consumers, regardless of how the material terms of that offer compare to the terms that the creditor includes in other firm offers of credit. For more information about the exceptions, see the discussion of Sec. ----.74 in the Section-by-Section Analysis. Free Consumer Report Section 615(h)(5)(C) of the FCRA states that the risk-based pricing notice must contain a statement informing the consumer that he or she may obtain a copy of a consumer report, without charge, from the consumer reporting agency identified in the notice. Some industry representatives have interpreted this section as a reference to the free annual consumer report described in section 612(a) of the FCRA.\5\ These industry representatives do not believe that section 615(h) of the FCRA gives rise to a right to a separate free consumer report. Consumer groups, on the other hand, interpret this section as giving a consumer a right to a separate free consumer report.\6\ The proposed rule is based on the Agencies' reading of section 615(h) as giving consumers a right to a separate free consumer report upon receipt of a risk-based pricing notice. --------------------------------------------------------------------------- \5\ See letter from Mortgage Bankers Association to the Federal Trade Commission (Aug. 16, 2004), available at http://www.ftc.gov/ os/comments/FACTA-summaries/511461-0007.pdf and letter from American Bankers Association & America's Community Bankers et al., to Alan Greenspan and Deborah Platt Majoras (Sept. 9, 2004), available at http://www.mortgagebankers.org/files/ResourceCenter/FACTA/FACTARisk- BasedPricingComments9-9-04.pdf. \6\ See letter from National Consumer Law Center and Consumers Union et al., to Alan Greenspan and Deborah Platt Majoras (Feb. 2, 2005), available at http://www.consumerlaw.org/issues/credit_ reporting/ content/facta_riskbased.pdf. --------------------------------------------------------------------------- Section 612(b) of the FCRA provides for free consumer reports to consumers who have received a notification pursuant to ``section 615'' of the FCRA. Section 615 of the FCRA includes both the adverse action notice requirement (section 615(a)), the risk-based pricing notice provision (section 615(h)), and certain other requirements. Accordingly, the Agencies read the reference to the free consumer report in section 612(b) to apply equally when notices are given under section 615(a) and section 615(h)(5)(C), i.e., to require in both those cases a free report that is separate from the free annual report. The notices provided under the credit score disclosure exceptions are not risk-based pricing notices, and therefore do not give rise to the right to a free consumer report. Instead, a consumer who receives a credit score disclosure notice that identifies a consumer reporting agency or other third party as the source of the credit score could request the free annual consumer report that is available from each of the three nationwide consumer reporting agencies. For more information about the credit score disclosure exceptions, see the discussion of Sec. ----.74 in the Section-by-Section Analysis. One Notice Per Credit Extension The proposed rules contain a rule of construction to clarify that, in general, only one risk-based pricing notice will need to be provided per credit extension, except in the case of a notice provided in connection with an account review. The person to whom the obligation is initially payable must provide the risk-based pricing notice, or satisfy one of the exceptions, even if the loan is assigned to a third party or if that person is not the funding source for the loan. Although legal responsibility for providing the notice rests with the person to whom the obligation is initially payable, the various parties involved in a credit extension could determine by contract which party will send the notice. Purchasers or assignees of credit contracts will not be subject to the risk-based pricing notice requirements. For more information about the rules of construction, see the discussion of Sec. ----.75 in the Section-by-Section Analysis. [[Page 28970]] Model Forms Section 615(h)(6)(B)(iv) requires the Agencies to provide a model notice that may be used to comply with the risk-based pricing rules. For each of the risk-based pricing notices and alternative credit score disclosures, the Agencies have proposed model forms that are appended to the proposed rules as Appendices H-1 through H-5 of the Board's rule and Appendices B-1 through B-5 of the Commission's rule. For more information, see the discussion of the model forms in the Section-by- Section Analysis. IV. Section-by-Section Analysis Section ----.70 Scope Proposed Sec. ----.70 sets forth the scope of the Agencies' rules. Proposed paragraph (a)(1) generally tracks the statutory language from section 615(h)(1) of the FCRA, except that it limits coverage of the proposed rules to credit to a consumer that is primarily for a consumer's personal, family, or household purposes. Proposed paragraph (a)(2) provides that the risk-based pricing rules do not apply to persons who use consumer reports in connection with an application for, grant, extension, or other provision of, credit for business purposes. Section 615(h) of the FCRA does not explicitly state that it applies only to a person using a consumer report in connection with consumer purpose credit. Section 615(h) does, however, require a person using a consumer report to compare the terms of credit offered in a particular transaction to the most favorable terms available to a substantial proportion of ``consumers'' and to provide a notice to the ``consumer'' if the person offers or extends credit on materially less favorable terms. In addition, several of the statutory exceptions reference the ``consumer'' or ``consumers,'' including those in section 615(h)(3)(A) (``the consumer applied for specific material terms * * *'') and section 615(h)(6)(B)(iii) (``* * * regarding which the agencies determine that notice would not significantly benefit consumers''). The statute's repeated use of the term ``consumer,'' which section 603(c) of the FCRA defines to mean ``an individual,'' suggests that Congress intended for the risk-based pricing provisions to apply only to credit that is primarily for personal, family, or household purposes. Business-purpose loans generally are made to partnerships or corporations, as well as to individual consumers in the case of sole proprietorships. The Agencies understand that business borrowers generally are more sophisticated than individual consumers. For business loans made to partnerships or corporations, a creditor may obtain consumer reports on the principals of the business who may serve as guarantors for the loan.\7\ The credit is granted or extended to the business entity, however, based primarily on that entity's creditworthiness, and that entity is primarily responsible for the loan. Also, when a consumer report is used in connection with a small business loan, the report may factor into the underwriting process quite differently than a consumer report utilized in connection with a consumer purpose loan. It may not be operationally feasible to compare the terms of credit granted for different business purposes because some types of business ventures pose a greater degree of risk than other types of business ventures. In addition, the Agencies believe that a comparison of the terms of business purpose credit to the terms of consumer purpose credit would not be meaningful. For example, the underwriting process used to set the terms for a business loan made to purchase a fleet of vehicles may differ substantially from the underwriting process used to set the terms of a single auto loan made to an individual consumer. The Agencies solicit comment regarding whether there are any circumstances under which creditors should be required to provide risk-based pricing notices in connection with credit primarily for business purposes. --------------------------------------------------------------------------- \7\ See FTC Staff Opinion Letter from Joel Winston to Julie L. Williams, J. Virgil Mattingly, William F. Kroener, III, and Carolyn Buck (June 22, 2001) (available at http://www.ftc.gov/os/statutes/ fcra/tatelbaumw.shtm). --------------------------------------------------------------------------- Proposed paragraph (b) provides that compliance with either the Board's or the Commission's substantively identical risk-based pricing rules would be deemed to satisfy the requirements of the statute. Both the Board's and the Commission's rules would apply to the persons covered by paragraph (a). The Board proposes to codify its risk-based pricing rules at 12 CFR 222.70 et seq., and the Commission proposes to codify its risk-based pricing rules at 16 CFR 640. There is, however, no substantive difference between the two sets of rules. Proposed paragraph (c), consistent with the statutory language in section 615(h)(8), provides that the risk-based pricing rules will be enforced in accordance with sections 621(a) and (b) by the relevant federal agencies and officials identified in those sections, including state officials. The risk-based pricing provisions do not provide for a private right of action. Section ----.71 Definitions Proposed Sec. ----.71 contains definitions for the following terms: ``annual percentage rate'' (and the related terms ``closed-end credit'' and ``open-end credit plan''), ``credit,'' ``creditor,'' ``credit card,'' ``credit card issuer,'' ``credit score,'' ``material terms'' (and the related term ``consummation''), and ``materially less favorable.'' Annual Percentage Rate Proposed paragraph (a) defines ``annual percentage rate'' by incorporating the definitions of ``annual percentage rate'' for open- end credit plans and closed-end credit set forth in sections 226.14(b) and 226.22 of Regulation Z, respectively. (12 CFR 226.14(b), 12 CFR 226.22). The concept of an annual percentage rate, as discussed later in this Section-by-Section analysis, is relevant to the Agencies' proposed definition of ``material terms.'' The Agencies believe that use of the Regulation Z definitions of annual percentage rate promotes consistency among the rules pertaining to consumer credit, including the rules that implement the FCRA and the Truth-in-Lending Act. Regulation Z prescribes two separate methods for calculating the annual percentage rate for credit, depending on whether that credit is open- end or closed-end. To ensure that the correct calculation methods for the annual percentage rate are applied to the appropriate products, the proposal also incorporates the Truth-in-Lending Act's definition of ``open-end credit plan,'' as interpreted by the Board,\8\ and the Regulation Z definition of ``closed-end credit.'' Paragraph (b) of the proposal defines ``closed-end credit'' to have the same meaning as in Regulation Z (12 CFR 226.2(a)(10)). Paragraph (k) of the proposal defines ``open-end credit plan'' to have the same meaning as set forth in the Truth-in-Lending Act, as implemented by the Board in Regulation Z and the Official Staff Commentary to Regulation Z (15 U.S.C. 1602(i), 12 CFR 226.2(a)(20)). --------------------------------------------------------------------------- \8\ The Board defines the term ``open-end credit'' in Regulation Z, rather than ``open-end credit plan.'' 12 CFR 226.2(a)(20). --------------------------------------------------------------------------- Credit, Creditor, Credit Card, Credit Card Issuer, and Credit Score Proposed paragraphs (d), (e), (f), (g), and (h) incorporate the FCRA's statutory definitions of ``credit,'' ``creditor,'' ``credit card,'' ``credit card issuer,'' and [[Page 28971]] ``credit score.'' Each of these terms is used in the proposed rules. Material Terms Proposed paragraph (i) contains three separate definitions of ``material terms,'' depending on whether the credit is extended under an open-end credit plan for which there is an annual percentage rate, is closed-end credit for which there is an annual percentage rate, or is credit for which there is no annual percentage rate. Proposed paragraph (i)(1) defines ``material terms'' for credit extended under an open-end credit plan as the annual percentage rate required to be disclosed in the account-opening disclosures required by Regulation Z (12 CFR 226.6(a)(2)). The definition excludes both any temporary initial rate that is lower than the rate that would apply after the temporary rate expires and any penalty rate that would apply upon the occurrence of one or more specific events, such as a late payment or extension of credit that exceeds the credit limit. The annual percentage rate has historically been one of the most significant pricing terms for open-end credit, and it is probably the term that creditors most often adjust as a result of risk-based pricing. Credit cards, unlike other open-end credit products, have multiple annual percentage rates, including annual percentage rates for cash advances, balance transfers, and purchases. The Agencies believe that purchases are the most common type of open-end credit card transaction, and thus the annual percentage rate for purchases is the most commonly applied rate in credit card transactions. Moreover, it is one of the most common terms that consumers compare when shopping for credit cards. Therefore, for credit cards (other than those used to access a home equity line of credit), the proposal defines ``material terms'' as the annual percentage rate applicable to purchases (``purchase annual percentage rate''), and no other annual percentage rate. Similarly, proposed paragraph (i)(2) defines ``material terms'' for closed-end credit as the annual percentage rate required to be disclosed prior to consummation under the provisions of Regulation Z regarding closed-end credit (12 CFR 226.17(c) and 226.18(e)). This definition does not address temporary initial rates or penalty rates, because any such rates are not annual percentage rates for the purposes of the closed-end provisions of Regulation Z. The related term ``consummation'' is defined in proposed paragraph (c) to mean the time that a consumer becomes contractually obligated on a credit transaction. The proposed definition is identical to the definition of ``consummation'' in Regulation Z. 12 CFR 226.2(a)(13). Consummation is defined in the proposed rules for clarity and completeness. Most consumer credit products have an annual percentage rate, and it has historically been a significant factor, and often the most significant factor, in the pricing of credit. As discussed below, the Agencies have proposed a definition of ``material terms'' that generally focuses on a single term in order to ensure that there is a feasible way for creditors to identify those consumers who must receive risk-based pricing notices. The Agencies believe that focusing on the annual percentage rate is appropriate because the Agencies understand that when risk-based pricing occurs, it typically affects the annual percentage rate. The Agencies acknowledge that the pricing of credit products is complex and that the annual percentage rate is only one of the costs of consumer credit. In addition to the annual percentage rate(s) applicable to a given credit product, there may be other terms that affect the cost of credit, such as the amount of any down payment, prepayment penalties, or late fees. In addition, a single credit product may have a number of different rate structures, such as a credit card that has different annual percentage rates for purchases, cash advances, and balance transfers. The Agencies understand that the annual percentage rate is the primary term that varies as a result of risk-based pricing and that, for credit cards, the purchase annual percentage rate is the primary term that varies as a result of risk- based pricing. Thus, the Agencies believe that, in most cases, defining ``material terms'' with reference to the annual percentage rate will effectively target those consumers who are likely to have received credit on terms that are materially less favorable than the terms offered to other consumers. If creditor practices were to change in the future such that other terms of credit begin to vary as a result of risk-based pricing, the Agencies could revise the meaning of ``material terms.'' To satisfy the risk-based pricing notice requirements, creditors must have some feasible means of comparing different credit granted to different consumers. The Agencies believe that it would not be operationally feasible for creditors to compare credit terms on the basis of multiple variables. For example, it is unclear how a creditor would compare one mortgage loan with a certain combination of annual percentage rate, down payment, and points and fees to another such loan where all three variables differ, even for the same product, such as a 30-year fixed-rate loan. The Agencies welcome comment on whether there are other monetary or non-monetary terms that should be included in the definition of ``material terms,'' and how the comparison between terms granted to consumers could be conducted if multiple variables were taken into account. The Agencies solicit comment as to whether creditors vary temporary initial rates, penalty rates, balance transfer rates, or cash advance rates, on either closed-end or open-end credit, as a result of risk- based pricing. If those rates do vary as a result of risk-based pricing, the Agencies request comment on whether those rates also should be treated as ``material terms,'' and whether it would be possible to apply to those rates the existing tests described in proposed Sec. ----.72(b). If new tests would be required under such a broader definition of ``material terms,'' the Agencies solicit comment on what those tests might be. The Agencies understand that some home-secured closed-end and home- secured open-end credit plans may charge prepayment penalties. The Agencies invite comment on whether creditors vary prepayment penalties based on information in consumer reports, and whether prepayment penalties should be treated as ``material terms.'' The Agencies also request comment on how the tests in proposed Sec. ----.72(b) could be modified to account for risk-based pricing of prepayment penalties or whether entirely new tests would be required and, if so, what those new tests might be. Proposed paragraph (i)(3) defines ``material terms'' for credit with no annual percentage rate as any monetary terms that the person varies based on information in a consumer report, such as the down payment or deposit. This provision applies to creditors such as telephone companies or utilities that use consumer reports in extending credit (for example, in determining the amount of a deposit or prepayment requirement) but do not extend credit subject to annual percentage rates. This provision also applies to charge cards for which the annual membership fee varies based on information from a consumer report. The Agencies solicit comment as to whether the definition's reference to ``any monetary terms'' that the person varies based on information from a consumer report is sufficiently specific or too broad. [[Page 28972]] Materially Less Favorable Material Terms Proposed paragraph (j) defines ``materially less favorable,'' as it applies to material terms, to mean that the terms granted or extended to a consumer differ from the terms granted or extended to another consumer from or through the same person such that the cost of credit to the first consumer would be significantly greater than the cost of credit granted or extended to the other consumer. This definition clarifies that a comparison between one set of material terms and another set of material terms is generally required to satisfy the general rule and to identify which consumers must receive the notice. The statute focuses on whether the material terms granted or extended to a consumer are ``materially less favorable than the most favorable terms available to a substantial proportion of consumers'' from or through a particular person. Therefore, for purposes of making this comparison, creditors must: (1) Select the ``most favorable terms'' available to a group of consumers that represents a substantial proportion of consumers to whom the creditor extends credit; and (2) compare the material terms granted or extended to the individual consumer to the most favorable material terms granted or extended to the comparison group. It would not be acceptable, for example, to compare a consumer's material terms to an arbitrarily selected benchmark, such as the creditor's median or average material terms or to the material terms generally available to the creditor's less creditworthy consumers. On the other hand, a creditor should not use in its comparison material terms that are available to only a tiny percentage of its most exceptionally creditworthy consumers, such as very high net worth individuals. The proposed rules do not define what constitutes ``a substantial proportion'' of consumers, even though that concept is integrally linked to the concept of ``materially less favorable'' terms under the statute. The Agencies have not identified a definition of ``a substantial proportion'' that could reflect the widely varying pricing practices of creditors generally. For example, one creditor may offer its most favorable material terms to ninety percent of its consumers and materially less favorable material terms to ten percent of its consumers. Another creditor may offer its most favorable material terms to ten percent of its consumers and materially less favorable material terms to ninety percent of its consumers. A third creditor may offer its most favorable material terms to one percent of its consumers, slightly less favorable material terms to twenty percent of its consumers, and materially less favorable material terms to its remaining consumers. For these reasons, the Agencies do not believe it is appropriate to define ``a substantial proportion.'' Nonetheless, the Agencies expect that creditors would consider ``a substantial proportion'' as constituting more than a de minimis percentage, but that may or may not represent a majority. Within these limitations, however, the proposed definition provides guidance regarding how to determine whether a particular set of terms is materially less favorable. Under the proposed definition, factors relevant to determining the significance of a difference in the cost of credit include the type of credit product, the term of the credit extension, if any, and the extent of the difference between the material terms granted or extended to the individual consumer and the material terms granted or extended to the comparison group. Consideration of these factors by different creditors may result in two creditors reaching opposite conclusions about the materiality of the same difference in annual percentage rates. For example, a credit card issuer considering these factors may conclude that a one-quarter percentage point difference in the annual percentage rate is not material, whereas a mortgage lender may conclude that a one-quarter percentage point difference in the annual percentage rate is material. In assessing the extent of the difference between two sets of material terms, a creditor should consider how much the consumer's cost of credit would increase as a result of receiving the less favorable material terms and whether that difference is likely to be important to a reasonable consumer. The Agencies solicit comment on the proposed definition of ``materially less favorable.'' In particular, the Agencies seek comment on whether the proposed definition is helpful, and whether the interrelated terms ``most favorable terms'' and ``a substantial proportion of consumers'' also should be defined and, if so, how they should be defined. Section ----.72 General Requirements for Risk-Based Pricing Notices General Rule Proposed Sec. ----.72 establishes the basic rules implementing the risk-based pricing notice requirement of section 615(h). Paragraph (a) states the general requirement that a person must provide the consumer with a notice if that person both: (i) Uses a consumer report in connection with an application for, or a grant, extension, or other provision of, credit to that consumer that is primarily for personal, family, or household purposes; and (ii) based in whole or in part on the consumer report, grants, extends, or otherwise provides credit to that consumer on material terms that are materially less favorable than the most favorable terms available to a substantial proportion of consumers from or through that person. This paragraph mirrors the language in proposed Sec. ----.70(a) and generally tracks the statutory language. Although the statute would permit various interpretations of ``from or through that person,'' the Agencies interpret the phrase to refer to the person to whom the obligation is initially payable, i.e., the original creditor. Under this interpretation, the original creditor is responsible for determining whether consumers received materially less favorable material terms and providing risk-based pricing notices to consumers, whether or not that person is the source of funding for the loan. When the original creditor is the source of funding for the loan, the consumer obtains credit from the original creditor. This occurs, for example, where the consumer obtains credit directly from a bank or finance company. When the original creditor is not the source of funding for the loan, however, the consumer obtains credit through the original creditor. This occurs, for example, where the consumer enters into a credit contract with an auto dealer, but the dealer does not fund the loan. Instead, the dealer has an agreement with a bank or finance company to purchase the contract. The bank or finance company provides the funding for the loan. The dealer immediately assigns the credit contract to a bank or finance company upon consummation of the transaction. In that case, the consumer has obtained credit through the auto dealer, rather than from the auto dealer. The Agencies recognize that this interpretation excludes from the scope of the proposed rules brokers and other intermediaries who do not themselves grant, extend, or provide credit, but who, based in whole or in part on a consumer report, shop credit applications to creditors that offer less favorable rates than other creditors. Instead the proposed rules require an intermediary, such as a broker, to provide risk-based pricing notices to consumers only when the intermediary is the person to whom the obligation is initially payable. The Agencies believe this is the most appropriate [[Page 28973]] interpretation of the statute, given its language and purpose. With respect to the statutory language, section 615(h) applies to the ``material terms'' granted, extended, or provided to the consumer based on a consumer report. An intermediary's decision regarding where to shop a consumer's credit application generally occurs before the material terms are set. Thus, at the time the application is shopped to various creditors, it is too early in the process to perform the direct comparison of material terms required by the statute, even if a consumer report influenced the intermediary's decision regarding where to shop the consumer's credit application. The Agencies also believe that their interpretation of the statute with respect to intermediaries is consistent with its purposes. For the reasons described below, requiring intermediaries to provide notices based on the creditors to which they shop a consumer's credit application would not provide a significant benefit to consumers; would likely be confusing to consumers; and would be operationally difficult, burdensome, and costly. First, a rule requiring intermediaries to provide notices when they shop applications to certain creditors would frequently result in the consumer receiving multiple risk-based pricing notices in connection with a single extension of credit. Under such a rule, consumers who work through intermediaries would in many cases receive two notices: The first from the intermediary when it shops the application, and the second from the creditor itself if the creditor grants credit to the consumer on materially less favorable material terms than it grants to a substantial proportion of its other consumers. In some cases, the intermediary is also the original creditor and could be required to provide two notices to the consumer. This scenario could arise, for example, in the context of an automobile loan. Under a rule requiring a shopping-triggered notice, if a dealer shops the consumer's application to finance companies that offer materially less favorable material terms than do other sources of financing, the dealer would be required to provide a notice to the consumer. In addition, an auto dealer that is the original creditor on the loan must provide a notice to a consumer who receives materially less favorable material terms than those received by a substantial proportion of the dealer's other consumers. The Agencies generally do not believe that a consumer would benefit from receiving more than one risk-based pricing notice in connection with a single extension of credit. The purpose of the statute is to notify consumers that information in their consumer reports caused them to receive materially less favorable material terms, and to encourage those consumers to check their consumer reports for possible errors. The Agencies do not believe that providing a consumer with a second notice in connection with the same extension of credit is necessary or beneficial to educate or motivate the consumer to obtain a copy of his or her credit report. For that reason, the rules of construction in proposed Sec. ----.75, discussed below, codify the principle that generally one notice for each extension of credit is sufficient. Second, requiring multiple notices in connection with a single extension of credit would introduce significant compliance burdens and costs. As an operational matter, it would be difficult to establish by regulation appropriate criteria for determining when shopping a consumer's credit application to certain lenders would trigger the requirement to provide a risk-based pricing notice. There is no single, uniform method for distinguishing a prime lender from a subprime lender, for example, and some lenders may make both prime and subprime loans. In addition, requiring multiple notices in connection with a single extension of credit could impose significant costs on the credit reporting system (which costs would be passed on to consumers) in view of the Agencies' reading of the statute as providing consumers with a right to request a free consumer report upon receipt of each risk-based pricing notice. The Agencies recognize that, under the proposed rules, some consumers who use an intermediary will not receive a risk-based pricing notice, even though their consumer reports, in whole or in part, influenced the intermediary's decision to shop their credit applications only to creditors that generally offer less favorable material terms than other creditors. This would occur if the creditor to whom the application was shopped granted its most favorable material terms to the consumer. Under the statute, however, the same issue exists when a consumer applies directly to subprime lenders because the statute does not require a creditor to compare the material terms it offers to consumers to the material terms offered by other creditors. The Agencies solicit comment on whether intermediaries who are not original creditors, such as brokers, should be required to provide risk-based pricing notices to consumers based upon the intermediaries' decisions regarding the shopping of consumer credit applications to certain creditors and, if so, how such a requirement could be structured. Direct Comparisons and Materially Less Favorable Material Terms Creditors may follow the general rule in determining, on a case-by- case basis, whether a consumer has received materially less favorable terms than the terms a substantial proportion of consumers have received from or through that creditor. The general rule is flexible and permits the creditor to determine, consistent with its particular circumstances, when material terms are ``materially less favorable than the most favorable terms available to a substantial proportion'' of its consumers. When a creditor undertakes direct, consumer-to-consumer comparisons, such comparisons necessarily must account for the unique aspects of that creditor's business. For example, many creditors make pricing decisions based on a number of variables that are not based on information in a consumer report (e.g., debt-to-income ratio or type of collateral) in addition to variables that are based on information in a consumer report. The role each of these variables plays in the pricing decision may vary from creditor to creditor and product to product. Similarly, creditors must compare the transaction at issue with past transactions of a similar type, and must control for changes in interest rates and other market conditions over time. A particular method of comparison that is sensible and feasible for one creditor may not be sensible and feasible for another creditor. No precise regulatory benchmark could account for such creditor-specific and product-specific variations. Although the proposed rules do not impose a quantitative standard or specific methodology for determining whether a consumer is receiving materially less favorable terms, the determination should be made in a reasonable manner. The Agencies expect that creditors would provide risk-based pricing notices to some, but fewer than all, of the consumers to whom they extend credit. Under the general rule, the creditor would first need to identify the appropriate subset of its current or past consumers to compare to any given consumer. Each consumer would need to be compared to an adequate sample of consumers who have engaged in similar transactions, such as those who have applied for or received the particular credit product for which the consumer has applied. The terms offered to a [[Page 28974]] consumer in a 30-year fixed-rate purchase money mortgage, for example, cannot be compared to the terms offered to consumers who obtain auto loans, credit cards, student loans, or adjustable-rate mortgages. The creditor also would need to tailor its comparison to disregard any underwriting criteria that do not depend upon consumer report information. Such a comparison also would have to account for changes in the creditor's customer base, product offerings, or underwriting criteria over time. Similarly, adjustments would have to be made if the terms offered to consumers in the past are not presently offered to consumers. The Agencies recognize that, even with the flexibility provided in the proposed rules, it may not be feasible or practical for many creditors to make the direct comparisons required by the general rule. Many creditors are likely to encounter operational difficulties in determining whether a consumer report played a role in a particular pricing decision that was based on multiple variables, and in identifying an appropriate benchmark with which to compare a given consumer's material terms. Small creditors in particular may have difficulty identifying a sufficient number of comparable benchmark credit transactions, since those creditors may make relatively few loans of any given type. For these reasons, proposed paragraph (b) sets forth two other methods, the ``credit score proxy method'' and the ``tiered pricing method,'' that creditors can use to identify which consumers must receive notices for a given class of products. These two methods provide alternatives to the direct consumer-to-consumer comparison described in section 615(h) of the FCRA. Consumers identified by either of these two methods will be deemed to have been granted, extended, or otherwise provided credit on materially less favorable material terms. The Agencies have crafted these two methods in order to enable a creditor to provide the risk-based pricing notice to fewer than all consumers without having to make a direct comparison between the material terms granted to each consumer and the material terms granted to its other consumers. The Agencies recognize that these methods may not result in a precise differentiation in every case between consumers who received the most favorable terms and those who received materially less favorable terms. The Agencies believe, however, that each of these methods is a reasonable proxy or substitute for identifying those consumers who received materially less favorable terms. Permitting the use of proxy methods also recognizes that, at least in some