State attorneys general and the Federal Trade Commission have regularly skirmished with the collection industry over what they regard as the use of aggressive legal tactics supported by scanty records. Now the banks that originally created the debts are at risk of being drawn into the fray.
Many of the authorities' concerns about collection practices bear a resemblance to the mortgage market's so-called robo-signing scandal, which ultimately cost banks $25 billion to settle. Alleged problems in both markets include the use of mass-produced affidavits, piecemeal or nonexistent account records and haphazard quality controls.
Among the government officials probing banks' consumer debt collection practices is Iowa Attorney General Tom Miller, according to people who were contacted by his office. Miller, a Democrat and former president of the National Association of Attorneys General, played a lead role in the national mortgage settlement brokered jointly by the federal government and state attorneys general.
Iowa's review is still in its early stages, sources say, but Miller and a group of like-minded AGs are approaching debt collection as a potential follow-on to the mortgage servicing agreement. The concern is that sloppy business practices may mislead judges and produce erroneous claims against consumers.
"There are egregious examples of abuse of the judicial system," says a source familiar with the activities of the government officials. The states are "looking at the banks themselves, not just third party debt buyers," the source adds.
The scrutiny involves delinquent consumer debt. Typically, when such obligations become more than 180 days past due, banks write down the balance and try to recoup whatever they can, either by themselves bringing collections suits against debtors or by selling rights to do so to outside collection agencies. Individual debts amount to only a few thousand dollars per consumer on average, but the total sums at issue amount to billions of dollars a year for each of the country's largest banks.
Chargeoffs and delinquencies have fallen sharply since the end of the recession, but collection efforts involving the millions of accounts already written off will continue for years and new ones are constantly cropping up.
In addition to Iowa's AG, a slew of other government authorities are taking a similar look at banks' sale of defaulted accounts into the secondary market. Mississippi Attorney General Jim Hood and a separate group of AGs have been investigating JPMorgan Chase's handling of credit card debt since last spring, and the Consumer Financial Protection Bureau, a federal agency created under the Dodd-Frank Act with authority over banks and nonbanks alike, launched systematic examinations of major debt collectors at the beginning of 2013.
The FTC, which has jurisdiction over debt collectors but not banks, has been gathering data on the industry for several years. It is now on the verge of releasing a report that will detail the records debt collectors possess when making repayment demands and their relationships with banks.
"The main purpose of the FTC's study is to provide insights to assist federal and state policymakers and law enforcers in their decision-making," says Thomas Pahl, assistant director of the commission's financial practices division.
Key regulators appear to have a strong sense already that current industry practices are insufficiently rigorous. The clearest sign came last October when American Express signed a consent order with the Federal Deposit Insurance Corp. and the CFPB. The agreement requires Amex to provide credit card borrowers with "documentation evidencing the debt and each transaction" on all contested debts.
Although the records required by regulators significantly exceed what it has previously filed in state court collection cases, Amex says it will not have problems complying with the mandate. Lack of documentation has not been an issue for American Express," says spokeswoman Marina Norville. "We do our own record keeping, and look through our records to ensure we have what we need."
Other banks and debt collectors may prove unable to produce such materials consistently, or do so at a reasonable cost, both collections industry participants and consumer advocates say.
"For millions of Americans, you'd wipe clean what they owe because there might not be 10 points of documentation. Maybe there're only four of 10," says Mark Schiffman, vice president of ACA International, a trade association for collections agents. Banks have not typically furnished full account records to debt collectors, and abruptly requiring exhaustive documentation "would be game over" for many in the industry, he adds.
For banks, consumer credit defaults are the downside of a cyclical business. Peaking at $83 billion in 2009, credit card chargeoffs have since fallen by more than half, dropping to $34 billion in the four quarters through last September. In both good times and bad, however, collections are an important source of revenue for banks.
In the event that internal collections efforts fail, banks pursue legal judgments against borrowers, sell accounts to debt buyers or both. Banks often package accounts into portfolios with face values of hundreds of millions of dollars and sell them at steep discounts. Relatively fresh debts sell for a dime on the dollar in the secondary market, while heavily worked-over accounts or those for which the statute of limitations has expired fetch less than a penny on the dollar.
Much of the regulatory controversy surrounds how banks and debt buyers extract residual value from these accounts. When banks sell accounts to outsiders, they often provide limited supporting documentation. It typically includes only a spreadsheet identifying individual debtors and a general outline of their debts. Account statements, cardholder agreements and other contractual details are often lacking, raising questions about whether collections agencies are basing their claims on shaky legal and factual grounds.
Some bank contracts warn that records no longer exist. Even when they are available and debt buyers request them, banks often require additional payments to supply them. Such demands can prove prohibitively expensive or encourage debt collectors to gather detailed evidence only in sporadic cases.
"We have to pay for the supporting documentation," said Christie Costen, a document custodian for the debt buyer SquareTwo Financial, in a September 2012 deposition in a Florida state case involving a Bank of America credit card debt sold to CACH, a subsidiary of SquareTwo Financial. "So we try to do it in the most cost-effective manner."
Denver-based SquareTwo is among the largest consumer debt buyers in the nation. It maintains an inventory of $9 billion in consumer debt and buys around $4 billion worth annually from banks and other creditors, according to company financial statements filed with the Securities and Exchange Commission.
In some instances, banks themselves may be responsible for introducing errors into delinquent account files. American Banker last March reported that the Office of the Comptroller of the Currency had ordered JPMorgan to halt credit card litigation following revelations that account records contained errors, internal computer systems generated inconsistent debt balances and the work of outside attorneys involved numerous quality control failures. Some accounts the bank sold to debt collectors were so unreliable that JPMorgan Chase employees referred to them internally as "toxic waste," current and former employees said.
JPMorgan Chase declined comment through a spokesman.
Alleged debt documentation problems appear to extend beyond JPMorgan Chase. Debt sale agreements signed in 2009 and 2010 by Bank of America and CACH state that the bank could not vouch for "the accuracy of the sums shown as the current balance" and warned that some of the accounts being sold might have been repaid. Despite these hearty disavowals, CACH bought the debts for 1.8 cents on the dollar and farmed them out to affiliated attorneys around the country to litigate.
Attorneys representing CACH almost never file contracts containing such disavowals in court and sometimes seek to block their production during legal discovery. When the September 2012 deposition was taken in the Florida state case, for example, CACH attorney Jorge Palma cited "contractual privilege" in instructing CACH's document custodian not to answer "anything having to do with the contract specifics."
Palma did not return several calls seeking comment. Officials at CACH parent SquareTwo did not respond to phone calls or emailed questions about the accuracy of debt claims that Bank of America sold CACH with extensive disclaimers. Bank of America declined to discuss its debt sales.
Questions surrounding misconduct in the consumer debt collection industry remain controversial, but even industry participants acknowledge that the quality of the debt records provided by banks needs to improve.
"Our information is only as good as the information provided to us," says Mark Schiffman, the vice president and spokesman of ACA International, a nonprofit collections trade group also known as the Association of Credit and Collection Professionals.
The FTC's staff, which supervises debt buyers, has likewise raised questions about banks' practices for documenting claims they sell to collectors.
"The sticking point over the last few years has been the [original] creditors," says the FTC's Pahl. "When we've reached out to them, they haven't been very interested in engaging with us."
Because the FTC only supervises debt collectors — not banks — that meant original creditors generally stayed out of the discussion. With the CFPB now empowered to regulate banks and major debt collectors, the dynamic between regulators and the collections industry may be on the verge of dramatic change.