|Oregon State Bar Bulletin JUNE 2010|
Unless you are sitting around your office with time on your hands, you have dodged a bullet.
The Federal Trade Commission’s intent to apply its new anti-identity theft rules to law firms has been thwarted, for now, thanks to a lawsuit filed by the American Bar Association.
This means that lawyers, unlike the “financial institutions” and “creditors” still deemed to be covered by the FTC’s so-called “Red Flags Rules,” did not have to come up with identity theft-prevention programs by June 1.
But dodging a bullet is not winning the war. And despite ABA President Carolyn Lamm’s statement that “the FTC’s decision to apply [those rules] to lawyers is contrary to an unbroken history of state regulation of lawyers…,” the reality is that Big Brother has been watching lawyers for some time.
“In recent decades, the law governing lawyers has begun to fragment,” John Leubsdorf, professor of law at Rutgers Law School-Newark, writes in a meticulously researched article on the subject in the December 2008 Buffalo Law Review. “Nowadays, a lawyer’s duties often cannot be found in a single body of rules, such as the ABA Model Rules of Professional Conduct… The sources of those duties may well include not just the traditional duo of courts and bar associations, but also state and federal legislators, administrators and others.”
On the federal side, some of this regulation has been aimed at lawyers deliberately, such as lawyers who provide legal aid services. (See sidebar story.)
But others, like the FTC Red Flags Rules and the federal Consumer Financial Protection Agency (CFPA) that was proposed in the wake of the mortgage crisis, are part of what Leubsdorf describes as a group of “…new requirements [that] have often included nonlawyers as well as lawyers within their scope.”
“The regulators may not even mention lawyers specifically,” says Leubsdorf, “and may not have considered how lawyers might differ from others doing the same sort of thing.”
Or, unfortunately, may not differ from others doing the same sort of thing. Look at California, where the bar last year investigated and sanctioned more than a dozen attorneys for offering phony mortgage loan modifications.
“The CFPA is the biggest issue that’s coming up right now,” says the Oregon State Bar’s executive director, Teresa Schmid, who is so intrigued by the subject of federal regulation of lawyers that she once wrote a research paper on it. “It’s probably going to pass. The primary targets are banking and consumer credit agencies. Lawyers are a completely secondary target. But because of California, lawmakers are not convinced that lawyers are only tangentially involved in the mortgage lending practices that led to the CFPA.”
The Red Flags Rules Raise Red Flags for Lawyers
But before the CFPA, there were the Red Flags Rules: regulations issued by the FTC and other federal agencies in November 2007 to require “financial institutions” and “creditors” to have identity theft prevention programs.
The regulations are part of the Fair and Accurate Credit Transactions Act of 2003, variously referred to “FACT” or “FACTA.” They are known as the Red Flags Rules because the programs must address “red flags” that could indicate identity theft, such as unusual account activity, fraud alerts on consumer reports or suspicious documents.
The FTC originally required these programs to be in place by November 2008. However, it delayed the compliance date multiple times as a result of stiff opposition from the American Medical Association — whose health-care provider members are considered to be “creditors” under the rules — and others.
The ABA joined the fight after it learned, in April 2009, that the FTC also considered lawyers to be “creditors.”
Numerous state and local bar associations, including the OSB, also opposed the rules’ application to lawyers.
“The Oregon State Bar would like to express its strenuous objection,” then-OSB President Gerry Gaydos wrote to the FTC’s chair in June 2009. “Attorneys do not ‘extend credit’ in the normal sense of the term. While it is true that a normal attorney-client relationship contemplates payment for services only after those services are completed, this is not the result of some deferral of the payment obligation. It is because most state bar organizations explicitly require that, as an ethical matter, attorneys may not be paid for any services not yet provided. …[FTC] staff have acknowledged that they are unaware of even a single case of identity theft arising from such a law practice context.”
But the FTC responded that it could not exempt any profession from its regulatory oversight without the specific authority to do so.
So, in August 2009, the ABA sued the FTC, alleging that the application of the Red Flags Rules to lawyers was “arbitrary, capricious and contrary to law,” and that the FTC had failed “to articulate… a rational connection between the practice of law and identity theft; an explanation of how the manner in which lawyers bill their clients can be considered an extension of credit under the FACTA; or any legally supportable basis for application of the Red Flags Rules to lawyers…”
The ABA was represented by New York lawyer Steven Krane, who, in his previous incarnation as president of the New York State Bar Association, had helped to sue the FTC when it tried to bring lawyers under the provisions of another federal law, the Gramm-Leach-Bliley Act.
Krane told the Bulletin that he persuaded his firm to represent the ABA pro bono on the red flags litigation because “It’s important to lawyers: large firms and small firms.”
Krane mentioned law firm size because on Oct. 20, 2009 — just 10 days before the U.S. District Court for the District of Columbia ruled in the Red Flags Rules suit — the House of Representatives had hurriedly and unanimously passed a bill that exempted law firms and health care and accounting practices with 20 or fewer employees from the Red Flags Rules.
The vote was held under a suspension of House rules, which usually occurs for noncontroversial legislation on which limited debate is required.
But maybe the feds were just nervous about the pending court decision, which came down, in the ABA’s favor, on Oct. 30.
“We won on our summary judgment briefs, without their [the FTC] ever filing an answer,” Krane reported to the Bulletin in March. “There were no factual issues; it was strictly questions of law.”
Unlike the House-passed legislation, the court’s ruling made no distinction between large and small law firms.
The day after the ruling, the FTC announced that it was again delaying the Red Flags Rules compliance date so it could draft new rules.
“We don’t know how they will craft them,” Krane said in March, “but they have to be consistent with the judge’s opinion.”
As of mid-May — just two weeks before the June 1 compliance date — the FTC had not posted any draft new rules on its web site.
Although the FTC has appealed the district court’s ruling. Krane said that he expects to prevail, just as New York and the ABA did when the D.C. Circuit Court of Appeals “resoundingly” — as the ABA put it — upheld the district court’s decision exempting lawyers from the requirements of the Gramm-Leach-Bliley Act.
Judicial adoption of the legislative fix that the House enacted, Krane stressed, is not an acceptable middle ground.
“We don’t want an interpretation that the [Red Flags Rules] do apply to law firms with more than 20 employees,” he said.
Lawyers Seek Protection From the Protection Agency
In October, at the same time that the House and the court were debating the Red Flags Rules, President Barack Obama was promoting his proposed legislation to overhaul how the federal government regulates “financial products,” including the subprime mortgages that led to a worldwide financial meltdown.
“The new Consumer Financial Protection Agency that I have asked Congress to create will have just one mission: to look out for the financial interests of ordinary Americans,” Obama said. “The agency will have the power to make certain that consumers get information that is clear and concise — in plain language — so they can compare products and know exactly what they’re getting into. It will ensure that banks and other firms cannot hide behind those ridiculously confusing contracts — pages of fine print that no one can figure out.”
But Obama the lawyer should have anticipated that the drafters of “those ridiculously confusing contracts” wouldn’t be on board with having this new agency, dubbed the CFPA, regulate their own profession’s “financial activities.”
In November, the ABA wrote to the chair of a House committee:
[B]ecause “financial activity” is broadly defined… it would allow the CFPA to regulate the legal advice and other core legal services that bankruptcy lawyers, consumer debtor lawyers, and many general practitioners routinely provide to their clients. The expansive definition of “financial activity” also would cover many other activities in which lawyers routinely engage that are merely incidental to providing legal services…
For example, the ABA letter — which begins with a less-than-subtle reference to its 400,000 members — said that the proposed CFPA legislation would regulate lawyers when they:
n Transmit money, pursuant to their clients’ instructions, to complete transactions, make down payments or for other purposes;
n Act as the custodians of money, e.g., by holding money for one side or the other until certain conditions are met, or by holding client funds as retainers or in other trust accounts for payment of legal fees;
n Provide real estate-settlement services by making sure that the terms of sales contracts and mortgages have been met and disbursing money, pursuant to their clients’ instructions, as part of closing; and
n Act as financial advisers. “In every divorce where the parties have property to divide or where alimony or child support is at issue,” the ABA wrote, “and in many bankruptcy cases as well, the lawyer has an obligation to provide a certain amount of financial advice, usually including at least tax if not financial planning advice…”
But Oregon lawyers say that they do not typically provide some of these services, and when they do, they haven’t caused the problems that lawyers are alleged to have caused in California.
In that state, the bar created a 10-person task force in March 2009 after it received thousands of complaints from homeowners that they had paid fees to lawyers to help them avoid foreclosure but had received no services in return.
Until October, California attorneys legally could accept such advance fees from borrowers for home-loan forbearance services, assuming that such services actually were provided. Consequently, “Lawyers’ services were in demand by foreclosure-relief companies and operators that could not otherwise receive payment until contracted or promised loan-modification work was completed,” according to The California Bar Journal.
That practice ended when Gov. Arnold Schwarzenegger signed a bill prohibiting lawyers, or anyone else, from collecting advance fees to modify or obtain forbearance of home loans.
“One of the things driving the CFPA is the huge problem in California with lawyers acting with regard to foreclosures and mortgage-debt problems,” says the OSB’s Schmid. “None of these acts [like the CFPA Act] are directly about lawyers, but with things the way they are in California, it’s harder and harder to argue that lawyers are only tangentially involved.”
But in Oregon, lawyers never could do anything with fees paid before they were earned except deposit them in their trust accounts.
“I am not aware that attorneys in Oregon are collecting any advance fees for loan modifications, other than their normal advances for legal work that are held in trust accounts until earned,” says Portland lawyer Greg Nelson, chair of the OSB’s Real Estate & Land Use Section. “From time to time Oregon attorneys have had complaints filed against them with the bar regarding the use of fees before they were earned, and in every case that I know of the bar has chastised and in some cases suspended them. The (Oregon) bar will not tolerate that kind of abuse.”
Even the practice of lawyers providing real estate-settlement services described by the ABA in its letter to the House is not done here.
“When I started out in the title business over 42 years ago, there were a number of attorneys who did real estate closings in Oregon, but that has not been the case for many years,” says Nelson, who is legal counsel for a title company. “There’s too much risk involved, primarily in handling the funds. I’m not aware of any Oregon attorneys who close real estate escrows anymore, although the practice is very prevalent on the East Coast.”
And Bend lawyer Richard Funk, chair of the OSB’s Family Law Section, says that Oregon family law attorneys don’t provide much of the financial advice described in the ABA’s letter, either.
“We divide property and litigate child custody, parenting time, spousal support and child-support issues,” says Funk. “We don’t act as financial advisers. We send clients to financial advisers, tax attorneys and bankruptcy attorneys if that is not an area we specialize in.”
“Do we give financial advice in the broad sense of the word?” Funk asks rhetorically. “I suppose. For example, we might say that spousal support is taxed, while child support is not taxed. Do we give specific financial advice? If a client said, ‘How much tax?’ we’d send him to a tax attorney. I don’t think any family law attorney who has been practicing for any amount of time would give specific financial advice. Are there some who do? Probably, but the wise ones don’t.”
Watching Big Brother
Beaverton lawyer Miles Monson, chair of the OSB’s Debtor-Creditor Section, which includes bankruptcy attorneys, says that he’s “generally” aware of the CFPA legislation but “hasn’t been tracking it particularly,” nor has the section as a whole been discussing it.
“That’s not uncommon,” says Monson. “On the state level, we have a committee that tracks legislation, but on the federal level, we wait and see what they do before we respond as a group.”
“If we spent our time on what might become federal law, it would be too overwhelming,” says Monson, pointing out that the bankruptcy “reform” act, the Bank Abuse Prevention and Consumer Protection Act of 2005, was “a good 12 years in the making.”
To which the ABA’s response might be that bankruptcy attorneys must now pay attention to that long-awaited act, since the U.S. Supreme Court, in March, determined that its regulatory provisions apply to them. (Milavetz et al v. United States.) And, moreover, Milavetz was only one of at least 10 cases relating to the role of attorneys and the practice of law that the U.S. Supreme Court was expected to hear this term.
That’s why the ABA, after getting the House to pass a version of the act that contained an exception for lawyers and those acting under them when engaged in the practice of law, immediately went to work on the Senate committee to which the legislative ball had been tossed.
On March 22, the ABA wrote the chair of that committee to urge him “…to amend the Senate bill to include the same ‘practice of law’ exclusion that was included in the House-passed financial reform bill.”
At that time, the Senate version of the bill contained what ABA President Lamm told the Bulletin was an “extremely weak” exemption for lawyers.
“Although one key provision in the bill initially exempts attorneys engaged in the practice of law from the new bureau’s authority to conduct examinations — but not from the bureau’s many other expansive regulatory powers — another provision in the bill essentially eliminates the exemption,” Lamm said in late March. (Examinations refers to the agency’s authority to examine the regulated entity’s records and to require it to provide supplemental information or to answer questions.) The second provision basically says the practice of law exemption doesn’t apply if the lawyer is providing any ‘consumer financial product or service.’ But providing such a product or service is what subjects a person to the coverage of the bill in the first place. Therefore, the current attorney exclusion in the bill would be totally ineffective and would allow the new bureau to fully regulate many bankruptcy lawyers, consumer lawyers, real estate lawyers, general practitioners and litigators as if they were mortgage lenders or nonbank financial institutions.”
Despite the ABA’s efforts, the Senate bill passed on May 20, without including a broad practice-of-law exemption consistent with that contained in the House-passed bill. The next step is for House and Senate conferees to reconcile their respective bills.
Regardless of what happens to the CFPA as it applies — or doesn’t apply — to lawyers, the debate over who should regulate lawyers will continue.
In Leubsdorf’s view, the fragmentation of such regulation “…complicates the lives of lawyers, and increases the need for them to obtain advice about their own obligations, as well as the need for law firms to provide internal mechanisms to promote compliance.”
“It means,” he says in his 2008 bar review article, “that, more than in the past, changes in the law governing lawyers will result from a political process involving tradeoffs among various interested groups inside and outside the profession, worked out in a variety of judicial, administrative, and legislative bodies, and often including competition among those bodies.”
From his point of view, that’s not necessarily a bad thing.
“In emphasizing how regulators changed the previous rules,” he writes, “I do not mean to suggest that the changes were for the worse. On the contrary, I think that a number of them were improvements, and that the resistance of the bar and bench to making desirable changes often helps explain the intervention of new regulators.”
But Schmid says that the bar’s history of regulating itself is “more than tradition.”
“It’s a central core value that the profession be self-regulated,” she says.
At the same time, she says, “The question being raised is, ‘To what extent are legal services impacting interstate commerce and the economy as a whole?’ If lawyers are as important to the economy as we think we are, we should expect that the federal government will step in and attempt to regulate us.”
Not if the ABA can help it, says Lamm.
“The FTC overreached in attempting to cover lawyers under its Red Flags Rules,” she told the Bulletin bluntly. “Lawyers are not engaged in the type of commercial activity that Congress tried to regulate in the underlying statute, and the FTC has not provided a single instance of the type of identity theft addressed by the rule occurring in a legal-practice setting. The U.S. District Court for the District of Columbia, ruling for the ABA, held that the Red Flags Rules cannot be properly applied to attorneys in the overly broad manner in which the [FTC] seeks to enforce them.”
“The ABA,” she pledged, “will continue to work to ensure that regulation of lawyers remains vested in state courts.”
Red flag program guidelines are available at www.ftc.gov/opa/2007/10/redflag.shtm/.
ABOUT THE AUTHOR
Janine Robben is the director of the Oregon Crime Victims Law Center. She is a frequent contributor to the Bulletin.
© 2010Janine Robben