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(Reuters) - The genius of the litigation funding business was always that it fell between regulatory cracks. In broad terms, pre-settlement funders advanced cash to plaintiffs waiting for a litigation payout in exchange for the right to collect when the settlement money comes through. They could demand payback rates that would be considered usurious if the cash advances were loans – but funders carefully structure their contracts with plaintiffs so the advances are technically not loans. That way, litigation funders could avoid state banking and credit regulations.
That’s changing, according to litigation funding expert Victoria Shannon Sahani, a law professor at Washington and Lee. As the industry has boomed, tempting investors with double digit returns and low risk, at least 11 states have adopted laws regulating some aspects of the business of extending cash advances to plaintiffs awaiting settlement payouts.
Now it looks like the Consumer Financial Protection Bureau also wants a say. In the past several months, the federal agency has claimed authority over three litigation funders, sending a signal that it is investigating the industry and intends to rein in excesses.
The bureau’s latest case is a joint complaint against the funder RD Legal, filed Tuesday in Manhattan federal court by the CFPB and the New York attorney general. The suit won headlines because of who RD Legal allegedly scammed - 9/11 first responders and NFL retirees awaiting payouts from settlement funds. For the litigation funding industry, though, the RD Legal case is shaping up as a test of the CFPB’s power over businesses that have previously operated out of the reach of federal regulators.
In anticipation of the CFPB’s suit, RD’s lawyers at Caldwell Leslie & Proctor brought a declaratory judgment case against the bureau in Manhattan federal court. (RD brought a parallel suit against New York AG Eric Schneiderman, but I’m focusing on RD’s dispute with the CFPB.) RD argued that the CFPB does not have jurisdiction over its cash advances because it is not extending loans or credit to its customers. Its advances are structured as assignment and sale transactions in which plaintiffs awaiting settlement sell an interest in the proceeds they expect to collect. Those transactions, RD said, are not consumer financial products or services under the Consumer Protection Act, the Truth in Lending Act or any other federal law.
The litigation financier J.G. Wentworth has also challenged the CFPB’s regulatory power. In June, after Wentworth balked at a CFPB demand for documents, the bureau filed a petition in Philadelphia federal court to compel compliance from the funder, which offers lump-sum payments to customers who agree to repay through their income stream from structured personal injury settlements. Wentworth argued that the bureau does not have the authority to investigate because the funder’s transactions are not in the CFPB’s bailiwick. According to the docket, the case is pending before U.S. District Judge Darnell Jones.
In November, the CFPB sued the litigation financier Access Funding in federal court in Baltimore. Access, which was featured in a 2015 Washington Post story titled, “How companies make millions off lead-poisoned poor blacks,” was accused of violating the Consumer Financial Protection Act of 2010 by providing cash advances to plaintiffs owed settlement money from lead paint defendants. The Maryland AG has also sued Access, which moved in January to dismiss the CFPB case because the two suits are based on the same allegations and request relief on behalf of the same supposed victims.
It’s not clear exactly how deeply and broadly the CFPB wants to exert its power over the litigation funding industry. The CFPB disclosed in the Wentworth case that it is engaged in “an investigation of persons involved in advancing funds in exchange for the rights to future payments from structured settlements or annuities.” In its request for documents from RD Legal, the bureau said was looking at “litigation-settlement-advance firms.” RD described the bureau’s suit as “an overzealous effort to regulate the legal financing industry.”
But law prof Sahani and Jack Kelly of the American Legal Finance Association said it’s important to distinguish between pre-settlement funders, who extend advances to plaintiffs whose personal injury cases have not yet been resolved, and the post-settlement and structured settlement funders the CFPB has gone up against. Kelly said his organization, which is comprised of pre-settlement funders, has told CFPB investigators that they are not engaged in lending and should not be subject to the bureau’s oversight.
“It’s an open discussion,” Kelly said, adding that his group promotes “know what you owe” transparency in consumer transactions. “I’m not aware of any enforcement actions in the area of pre-settlement funding.”
Sahani told me she “absolutely” believes the CFPB has jurisdiction over RD Legal and other post-settlement and structured settlement funders. The state laws governing consumer litigation finance, she said, don’t address those advances, in which there’s extremely low risk to the funder. “It’s good the CFPB is looking at something not contemplated in the statute I’ve seen,” she said.
Brian Wise, president of the U.S. Consumer Coalition and an opponent of broad CFPB authority said he is working with industry groups to rein in the bureau. “They are trying to tell these companies who and how they should fund,” he said. “The CFPB should stick to its original mission.”
RL Legal, in addition to its argument that the CFPB exceeded its mandate, said it did not deceive 9/11 responders or NFL retirees. All the company did, according to its lawyers, was “provide immediate liquidity – in the form of an arm’s length transaction – to people who voluntarily sought the benefits of early funding.” RD is also facing an enforcement action by the Securities and Exchange Commission. That case is scheduled for a trial in March.