California’s vague new financial regulation law

Assembly Bill 1864 didn’t get much media or public attention as it zipped through both houses of the Legislature on the last day of the 2020 session.

Superficially, it appeared merely to reconfigure the state’s financial regulatory agencies into a new entity called the Department of Financial Protection and Innovation.

However, those in California’s vast financial industry were paying lots of attention because the bill creates an entirely new regulatory regime with broad powers, including fines of up to $1 million a day, to police financial players that hitherto have had little oversight.

The official rationale for the legislation is that President Donald Trump’s administration neutered the federal Dodd-Frank Wall Street Consumer Financial Protection Act of 2010, so the state must step in with an equivalent to guard against predatory financial practices that harm consumers.

The new California Consumer Financial Protection Law gives the reconstituted agency authority to go after “abusive practices” whose definition in the law is fairly vague. Thus, the agency itself will define the term as it also decides which businesses will face its scrutiny.

It appears that the new law will affect firms involved in debt settlement, credit repair, check cashing, rent-to-own contracts, payday lending, student loan servicing and financing for retail sales. However, its primary target seems to be financial services offered by non-banks, particularly what are called “fintech companies” that offer bank-like services via the Internet without maintaining physical offices.

Fintechs, many of them based in the San Francisco Bay Area, have blossomed in recent years as part of the digital economy, competing with traditional brick-and-mortar banks. Their disruptive nature is not unlike the challenge that technology-based ride services such as Uber and Lyft pose to taxicabs and buses.

Late-blooming changes in AB 1864 exempted traditional financial firms that are already regulated, such as banks and credit unions, from the new consumer protection law, leading some analysts to conclude that its unstated aim is to help them stave off competition from new kids on the financial block.

The vagueness of the new law was encapsulated in what Gov. Gavin Newsom said during a signing ceremony. The new law and the new department, he said, will “create conditions for innovation to flourish in a way where we can steward that and we can just work against its excesses. So we support risk-taking, not recklessness.”

Newsom also signed two other financial protection measures, one that requires debt collectors to be licensed beginning in 2022 and the other creating a Student Loan Borrower Bill of Rights.

Although the new state law is said to mirror the Dodd-Frank law, it contains at least one significant difference. When federal regulators levy fines for what they consider to be bad conduct, the money goes into the federal treasury. When state regulators impose their fines of up to $1 million a day, the money will be retained by the new agency to finance more activity.

Will that give the new agency a financial incentive to skip over minor consumer issues and go after big companies? It’s a question that only time will answer.

Significantly too, the new investigative and regulatory mechanism contained in AB 1864 specifically does not usurp the authority of the attorney general to also target companies under the state’s equally vague “unfair competition” law.

From its inception a decade ago, Dodd-Frank has attracted criticism from business executives for regulatory overkill. Will California’s new version be less controversial? We won’t know until the new agency puts some definitional meat on its bones.