On September 15, 2020, the CFPB published a detailed outline of proposed options it is considering to implement a rule under Section 1071 of the Dodd Frank Act. Ten years ago, Section 1071 amended the Equal Credit Opportunity Act (ECOA) to require that financial institutions collect and report information concerning credit applications made by women- or minority-owned businesses and by small businesses. Although the CFPB was tasked with drafting rules to implement Section 1071, it did not take significant steps to meet that obligation until 2017, when it reported on some preliminary research, and then later in November 2019, when it held an information-gathering symposium.
As we previously noted, once Section 1071 is implemented, certain financial institutions will be required to collect information regarding the race, sex, and ethnicity of the principal owners of small businesses and women- and minority-owned businesses and submit this information to the CFPB, similar to what is currently required by the Home Mortgage Disclosure Act for mortgage loans. The CFPB’s outline released this week proposes several potential options for developing the small business lending data collection rule and is a precursor to any future proposed rulemaking. At this stage, the CFPB is seeking feedback on the direction of the rule. Feedback and comments on the scope of the rule can be sent to 2020-SBREFAfirstname.lastname@example.org until December 14, 2020. The CFPB is also seeking feedback on the potential impacts on small business entities and has requested submission of such feedback by November 9, 2020.
Below, we summarize the key aspects of the Bureau’s outline and its proposals regarding the scope of the rule.
Who would be required to collect information under the rule?
The Bureau is proposing to apply the data collection and reporting requirements to all entities that meet the statutory definition of “financial institution” under Section 1071: “any partnership, company, corporation, association (incorporated or unincorporated), trust, estate, cooperative organization, or other entity that engages in any financial activity.” Under this proposed definition, the requirements would apply to a variety of entities that engage in small business lending, including depository institutions, online lenders/platform lenders, community development financial institutions, lenders involved in equipment and vehicle financing, commercial finance companies, governmental lending entities, and non-profit, non-depository lenders.
Who would be exempt from the collection and reporting requirements?
The Bureau is considering proposals, in light of Section 1071’s statutory purposes, to exempt certain entities from the collection and reporting requirements based on size-based and/or activity-based thresholds. The Bureau is concerned that the smallest financial institutions, or those with the lowest volume of small business lending, might reduce or cease their small business lending activity because of the fixed costs of compliance with an eventual 1071 rule, which could be contrary to the community development purpose of Section 1071 and could also be contrary to one of the general purposes of the Bureau, to facilitate access to credit.
Specifically, the Bureau is considering whether depository institutions with assets under a given threshold should be exempt from collecting and reporting. The Bureau is considering setting this threshold at either $100 million or $200 million in assets. In addition, the Bureau is considering whether to require financial institutions to collect and report data only if they exceed either a specified number or dollar value of small business loans originated in a specified period. The Bureau is considering setting these thresholds at: (1) at least 25 loans or $2.5 million; (2) at least 50 loans or $5 million; or (3) at least 100 loans or $10 million. The Bureau is also considering whether to use these two tests together to determine coverage under its future 1071 rule.
Whose information would a financial institution be required to collect?
Although the language in Section 1071 suggests that the Bureau could require financial institutions to collect information from all small businesses and women- and minority-owned businesses, the Bureau is considering requiring data collection only for applicants that meet the Bureau’s definition of a small business. Under the proposed approach, financial institutions would not be required to collect and report data for women-owned and minority-owned businesses that are not “small,” but would be required to identify women-owned and minority-owned businesses within the pool of small business applicants. The Bureau is considering this simplified standard because it is concerned that a requirement to collect and report 1071 data on applications for women-owned and minority-owned businesses that are not small businesses could affect all aspects of financial institutions’ commercial lending operations while resulting in limited information beyond what would already be collected and reported about women-owned and minority-owned small businesses. In addition, the Bureau acknowledges that financing for large businesses can be much more varied and complex than the products used for small business lending.
As for the definition of a “small business” under the rule, Section 1071 requires the CFPB to either use the Small Business Administration’s (“SBA’s”) size standards or to request SBA approval for a size standard specific to the rule. Generally, the SBA classifies business size using North American Industry Classification System (“NAICS”) codes, which take into consideration each business’s specific industry, annual receipts, and number of employees. For purposes of its 1071 rule, the Bureau is considering adopting a simplified size standard in order to assist both financial institutions and applicants seeking to quickly understand whether a business is “small.” By adopting a simplified standard, the CFPB would not require financial institutions to determine the appropriate six-digit NAICS code, and then the relevant size standard based on that NAICS code, for each applicant. Rather, the Bureau is considering three alternative approaches for a simpler size standard: (1) defining a small business as one that earns either $1 million or less or $5 million or less in gross annual revenue in the prior year; (2) defining a small business as one that employees 500 people or less for the manufacturing and wholesale industries, or as one that makes $8 million or less in gross annual revenue for all other industries; or (3) using an applicant’s gross annual revenue or number of employees based on a modified version of the size standards in NAICS code categories.
What types of credit and applications for credit would be covered?
The Bureau is considering proposing that covered products under its 1071 rule include term loans, lines of credit, and business credit cards. In contrast, the Bureau is considering proposing that the following products be excluded from coverage under any 1071 rule: consumer-designated credit, most leases, factoring, trade credit, and merchant cash advances. Notably, the Bureau is considering proposing that factoring arrangements (i.e., purchases of accounts receivable) not be a covered product under Section 1071 because they are generally not considered subject to ECOA or Regulation B. The Bureau is also considering proposing that merchant cash advances, which usually involve a cash advance to a merchant in exchange for a promise to repay a percentage of future revenues, not be a covered product because including them may add additional complexity or reporting burdens given the unique structure of the transactions.
The Bureau is also considering clarifying circumstances that would not be reportable under Section 1071, even if certain of these circumstances are considered an “application” under Regulation B, including: (1) inquiries/prequalifications; (2) reevaluation, extension, and renewal requests, except requests for additional credit amounts; and (3) solicitations and firm offers of credit.
What data points will financial institutions have to collect?
Section 1071 directs the Bureau to require financial institutions to collection certain mandatory data points. Specifically, each financial institution must compile, maintain a record of, and report to the Bureau the following information provided by any credit applicant: (1) whether the applicant is a women-owned, minority-owned, and/or small business, (2) the application/loan number, (3) the application date, (4) the loan/credit type, (5) the loan/credit purpose, (6) the credit amount/limit applied for, (7) the credit amount/limit approved, (8) the type of action taken, (9) the action taken date, (10) the census tract of the applicant’s principal place of business, (11) the applicant’s gross annual revenue, and (12) the race, sex, and ethnicity of the applicant’s principal owners.
In addition, Section 1071 gives the Bureau the authority to require financial institutions to collect and report “any additional data that the Bureau determines would aid in fulfilling the purposes of [Section 1071].” The Bureau is considering requiring the reporting of the following “discretionary data points”: (1) pricing of both originated credit and credit that is approved but not accepted; (2) the applicant’s time in business; (3) the applicant’s NAICS code, and (4) the applicant’s number of employees.
More specific information on each proposed data point, including a description and data elements to be collected, can be found at Appendix D to the outline.
At what point in the application process will the data be collected?
The Bureau is considering not specifying a particular time period during the application process when financial institutions must collect 1071 data from applicants. The Bureau indicates that it is disinclined to specify a time period for collecting 1071 data from applicants, as it is concerned that doing so could be disruptive to financial institutions’ existing processes.
When would financial institutions be required to report the data?
The Bureau is considering proposing that financial institutions collect data under the 1071 rule on a calendar-year basis, and submit the information to the Bureau by a specified time after the end of each calendar year. In addition, the Bureau is considering proposing that financial institutions retain the data for at least three years after submission to the Bureau.
How long will financial institutions have to comply with the new rule?
The Bureau is considering proposing that financial institutions have two calendar years for implementation following the Bureau’s issuance of its eventual 1071 rule. Further, the Bureau intends to provide guidance in the form of plain language compliance guides and aids; technical specifications and documentation; and by conducting meetings with stakeholders to discuss the rule and implementation issues in order to assist financial institutions with efficient and effective implementation.
What will the CFPB do with the data?
Congress enacted Section 1071 for the purpose of facilitating enforcement of fair lending laws and enabling communities, governmental entities, and creditors to identify business and community development needs and opportunities for women-owned, minority-owned, and small businesses. In particular, the data will help the Bureau enforce ECOA’s prohibition on discriminating against an applicant, including business applicants, on the basis of race, sex, ethnicity, and other prohibited bases in any aspect of a credit transaction. The Bureau believes that data collected under the 1071 rule will also be helpful in fulfilling Congress’s purposes in enacting section 1071 by identifying potential fair lending concerns regarding small businesses, including women-owned and minority-owned small businesses, as well as the needs and opportunities for both business and community development.
The Bureau’s recent progress on the 1071 rule is part of a larger trend of increased momentum to regulate small business lending. For example, earlier this year the SBA promulgated regulations implementing the Small Business 7(a) Lending Oversight Reform Act of 2018. With regard to the 1071 rule, the CFPB was forced to move forward with implementation in order to comply with a settlement agreement the Bureau reached in a lawsuit alleging that the Bureau violated the Administrative Procedure Act by failing to timely promulgate the 1071 rule. Under the terms of the agreement, the Bureau was required to publish the outline of proposals for the 1071 rule by September 15, 2020. The agreement also requires the Bureau to establish a Small Business Advocacy Review Panel by October 15, 2020, and submit status reports on its progress on the rule every 90 days.