On September 1, 2021, the Consumer Financial Protection Bureau (CFPB) issued a proposed rule (1071 Rule) that, when finalized, would require financial institutions to collect and report to the CFPB certain data regarding small business credit applications. The release of the final rules on small business lending data collection implementing Section 1071 of the Dodd-Frank Act is expected to be issued no later than March 31, 2023.
 
These new regulations will significantly impact equipment finance providers of all sizes – with a potentially much more significant impact on smaller finance companies with limited resources. To learn more about what the equipment finance industry can expect from these new regulations, and how equipment finance companies of all sizes should prepare for the changes, Equipment Finance Advisor met with Paul Bent, Senior Managing Director with The Alta Group.

Equipment Finance Advisor: Paul, please provide a brief explanation of the Dodd-Frank Act Section 1071 and how it pertains to the equipment finance industry.

Paul Bent: After the major downturn in 2008 – 2009, Congress enacted sweeping changes in financial law and regulations with the Dodd-Frank Act, which created the Consumer Financial Protection Bureau, CFPB. One of the issues addressed in the law was built into Section 1071 of the Act. Section 1071 requires that certain types of personal and demographic information be obtained by the funder from anyone who applies for credit at the application level of the process. This is essentially to make sure there is no discrimination in the marketplace based on gender, race, ethnicity or size of business. Initially, most of us who analyzed the bill thought that small business would be a category alongside gender, race and ethnicity. However, as it turns out the regulators have put the focus on small businesses, meaning you are required to collect this data from small business applicants.

Equipment Finance Advisor: What are some of the operational and compliance regulations that finance companies are going to face in their efforts to collect this information? Will this be burdensome for them?

Bent: I think a lot of it is going to be quite burdensome. First, let's start with who's required to collect this information. The way the law is written, it is financial institutions, and those are defined to be businesses engaged in financing, regardless of the form of their business. The proposed regs even list them all in the law – corporations, partnerships, LLCs, and unincorporated associations. So basically, the regs will cover any entity that is engaged in providing financing, which is very broad obviously, but I believe they are likely to will apply to virtually everyone in the equipment finance industry. There are a few carve outs for specific types of business and specific types of applicants and so forth, but in terms of who it applies to there are few exceptions, and no exception specifically for banks and depository institutions. Virtually anyone in the finance business will need to comply – meaning all finance businesses, including very small businesses, will need to collect the data.
 
That's where I think the real pain point is going to be because the proposed regulations and statute identify at least 20 – and I think it’s closer to 25 – data points that must be collected from applicants. As an example, the purpose of the credit must be collected. Additionally, the method of application – whether it is online or on paper – must be collected and reported as well as the gender, race and ethnicity of the applicant, or of the controlling principal of a small business, if the applicant is a business. The approval amount if the application was approved, the reason for denial if it was denied, all the pricing details, the gross annual revenue of the applicant, how long they have been in business, and all minority ownership information if applicable and much more must be collected.

But then you really get into the weeds in the new and proposed regulations. For example, the term ethnicity is not used as we may traditionally understand it. So, for instance, if a borrower is identified as Asian, the lender needs to determine if the applicant is Chinese, Vietnamese, Korean, or any one of a list of possibilities (or a combination of them).  If an applicant does not wish to disclose his or her ethnicity, then the applicant may decline to do so under the law, but if they do decline then the burden is on the funder to make a guess. The regulation includes language stating the funder must “surmise” as to what ethnic group the applicant may appear to belong to. Frankly, this leaves me wondering how accurate a lot of these data are going to be.

Another wrinkle that I think is going to be difficult for many companies to deal with is that the collection of data must be conducted by a person not involved in the credit approval process. You can certainly see the logic of this, but on the other hand, if you think of small companies in our business that have a total staff of five or ten, it is unclear how they're going to be able to meet this requirement. I think there is going to be a lot of anxiety and concern about how this will work in practice.

The statute also requires that the data collected must be retained by the finance company for three years and requires the funder to submit an annual report of data collected. No one has yet seen what the annual reports will look like, but all these complications will likely be a challenge, especially for smaller companies that don't have separate staff just to comply with all the rules.

So, there are several issues, and this is why I suggest to our clients and to anyone who investigates this, that the time to start is now. The ELFA has submitted responses to the proposed regulations and many others have as well. People are talking about the end of March 2023 as a target for the issuance of the final regulations, but the effective date will probably be 18 months or so after that. Therefore, people have a little time, but with this level of complexity and importance, I think the time to start thinking about it is now.

Equipment Finance Advisor: Are there any exemptions to this regulation?

Bent: Yes, true leases are exempt. But there are plenty of cases that show us that clever defense lawyers will come into court and argue that a transaction in not a true lease because there's not enough residual, for example, or on some other technicality—and some judges will agree. The fact that true leases are exempt gives us some comfort, but nobody should rely on this 100 percent in my opinion. Also, the definition of “small business” (for determining whose data must be collected) refers to the definition used in SBA regulations, which would limit the requirement to businesses (applicants) with less than $5 million in gross annual revenue.

Equipment Finance Advisor: What steps should equipment finance players be taking now to prepare themselves?

Bent: As we all know, some of these data are already collected by companies, so there is no need to get panicky about the fact that there are 25 data points to collect, although that still seems excessive to me.  I think the priority may be to begin finding a way to organize those data points so they can be quickly and efficient reported to the federal government once a year.

Equipment Finance Advisor:  The ELFA is taking an active role in trying to ensure these rules will be less burdensome for equipment finance companies. What should equipment finance leaders do to impact the direction of these rules prior to finalization?

Bent: Andy Fishburn from the ELFA is doing a terrific job of keeping his eye on this issue. He probably knows more about it than anyone. I think it's important that practitioners in our industry pay attention to what the ELFA is doing. Andy is, in my experience, very forthcoming and willing to help. I certainly am happy to answer questions, but the important thing is to stay on top of it.  I’m sure as the effective date of the regs gets closer there will be increasing discussion and ideas in the marketplace as to how to deal with this issue.

I think the important thing now is don't panic, start early and get ahead of it. Make sure you understand how it will affect your business. If you are one of the major bank leasing companies, you can probably take it in stride. If you are a small finance company that is primarily working as a third-party originator with smaller borrowers, keep in mind that this requirement takes place at the application level. I think it will be much more burdensome for companies that don't have a great depth of resources. For them it's particularly important to get ahead of it and ask themselves: When is it going to happen? What do I need to do before that? How do I need to organize my resources to be able to scoop up this information effectively and make these reports and store the information? I think now is the time to start thinking about it and making plans … it’s not too early to start thinking about and planning for Section 1071.