Risk-based pricing is a practice in which a business charges consumers who are a greater credit risk more money for the same goods or services provided to other consumers who are less risky.(( 12 CFR § 1022.70 et seq. See Section 5 of the Federal Trade Commission Act, 15 U.S.C. § 45, Section 615 of the Fair Credit Reporting Act, 15 U.S.C. § 1681m. )) Risk-based pricing is used in many industries, including insurance and banking, but the focus of this article is its use in consumer goods and services purchases. If a company offers Consumer A, who has a credit score of 650, a 24-month payment plan for a cellphone purchase of $59 per month but then offers Consumer B, who has a credit score of 710, the monthly payment of $49 per month for the same cellphone purchase, the business is engaging in risk-based pricing. Over the life of the contract, Consumer A will pay $240 more for the exact same cellphone. This practice is governed by the Consumer Financial Protection Act of 2010 (CFPA), 12 U.S.C. §§ 5564, 5565, the Fair Credit Reporting Act (FCRA), 15 U.S.C. § 1681(m), and Regulation V.
If a business uses a consumer credit reporting agency’s information to set risk-based pricing, it must provide the consumer with notice of the adverse action and an opportunity to cancel the contract. The Fair Credit Reporting Act (FCRA) allows state attorneys general to bring claims against businesses for failure to comply with the risk-based pricing disclosures required under the Act. The opportunity to cancel the contract can provide consumers with much-needed relief from oppressive risk-based pricing schemes. The Federal Trade Commission (FTC) and the Consumer Financial Protection Bureau (CBPB) have joint enforcement authority that is shared with state attorneys general to bring a federal claim.
Under the FCRA, the FTC and CFPB promulgated the Duties of Users Regarding Risk-Based Pricing Rule requiring businesses to provide a credit score disclosure notice to all consumers when the consumer report is used in conjunction with an application for credit and credit is granted on “materially less favorable terms,” which generally means a higher annual percentage rate (APR). If there is no APR, then the “material term” is one that has the most significant impact and varies based upon the consumer report information. Annual membership fees, service fees, or monthly service charges are examples of material terms. Businesses must send risk-based pricing notices if the business does not give the best terms offered to a substantial number of other consumers. Examples of “substantial number” comparisons are set out in the Rule.
Risk-based pricing may not necessarily come to the attention of consumers because they are unaware of the practice or the protections offered by FCRA. For a closed-end credit plan, the notice must be provided before the consumer is contractually obligated. 12 CFR § 226.2(a)(13). For open-ended credit plans, notice must be provided within 30 days. The notice must be clear and conspicuous, it must tell the consumer the credit score used, the source, and the possible credit score range, and other important information. FCRA provides for maximum penalties of $4,111 per violation in the case of lawsuits brought by the FTC. FCRA §§ 616, 617, 621.
Other than in cases of emergency actions to protect the public interest or prevent irreparable harm, there is a ten-day notice requirement to the FTC and CFPB before an attorney general can file an adjudicative proceeding before a court or an administrative or regulatory body for violations of the Dodd-Frank Act.(( 15 U.S.C. § 45 Sec. 61512 CFR § 1082.01, State Official Notification Rule 77 FR 39112-01 ))
In 2020, the Arkansas Attorney General’s Office and the Consumer Financial Protection Bureau filed a complaint against Alder Holdings, LLC, the parent company of a residential alarm company, for risk-based pricing violations. CFPB v. Alder Holdings, LLC (No. 4:20CV1445 E.D. Ark.) Arkansas’s discovery of Alder’s risk-based pricing practice arose during its broader investigation of other violations of Arkansas’s Deceptive Trade Practices Act (DTPA) and Home Solicitation Sales Act (HSSA). Arkansas v. Alder Holdings, LLC (No. 60-CV-18-2188 Pulaski County Circuit Court). The risk-based pricing practice set tiered “activation fees”(( The “activation fee” is a period fee under 12 C.F.R. § 1022.71(n)(3). )) and monthly monitoring rates that were tied to consumers’ credit scores. It also tied its salespersons’ incentives and bonuses to setting consumers’ fees and rates at higher rates for consumers with lower credit scores. The contract granted a consumer the right to defer payment of the total contract price for its goods and services over the life of the five-year contract which made Alder a “closed-end creditor” subject to the disclosure requirements of the Risk-Based Pricing Rule 15 U.S.C. § 1681-1681(y) (FCRA), 12 C.F.R. § 1022.71(c), (d), and (i).
In addition to Arkansas’s collaboration with the CFPB in Alder, the FTC filed a suit against Sprint on this issue in 2015, U.S. v. Sprint Corp., No. 2:15-cv-9340 (N. Kansas) and settled for $2.95 million. Under the terms of settlement in both cases, the defendants were required to comply with the rule going forward, provide current consumers with the required notice, and pay civil fines.
Arkansas was pleased to be able to partner with our federal colleagues on the Alder matter. We would be happy to share with other attorney general offices the lessons learned from its risk-based pricing related investigation and contact information for our CFPB colleagues.
