A “Key” Tactic to Undermine Consumer Protections

Yesterday at Higher Ed Watch, we wrote about how KeyBank has partnered with dozens of unlicensed and unaccredited trade schools to provide expensive private loans to the high-risk students these institutions tend to attract. Many of these schools then shut down before delivering on the education that was promised.

Ordinarily, students who attended these fly-by-night institutions would be held harmless, due to an existing federal consumer protection that gives students the right to discharge their loans if a school closes. However, KeyBank’s intentional disregard for this protection has left these students in a precarious position — heavily indebted with expensive private loans and no practical training.

At issue is a federal law Congress enacted in the late 1970s that was designed, in part, to protect students from sham trade schools. Lawmakers created the Federal Trade Commission Preservation of Claims and Defenses Rule, otherwise known as the FTC Holder Rule, to regulate private, nongovernment loans. The rule essentially requires schools and lenders that have “a referring relationship” to notify students that they have the right to have their private loans canceled if a school closes down without warning, or engages in fraud.

Congress enacted the law to discourage lenders from entering into business arrangements with disreputable schools and companies that are out to scam consumers. In the preamble to regulations carrying out the law, the FTC said that by holding loan providers accountable for the actions of their business partners, consumers would be safeguarded against “predatory practices and schemes.”

“We can imagine no reasonable measure of value which could justify requiring consumers to assume all risk of seller misconduct, particularly where creditors who profit from consumer sales have access to superior information combined with the means and capacity to deal with seller misconduct expeditiously and economically,” the FTC stated.

So how does KeyBank get around this seemingly straightforward law? By ignoring it altogether. The bank has refused to include the required notice in the private loan promissory notes it provides students.

Lawyers for KeyBank argue that the lender is not subject to the FTC Holder Rule because it is not regulated by the FTC, but by the U.S. Treasury Department’s Office of the Comptroller of the Currency (OCC), which oversees national banks and does not have a similar requirement in place. Contrary to the spirit of the FTC rule, KeyBank officials maintain that it is entirely the student’s responsibility to ensure that the schools they enroll in, with financing from the bank, are legitimate operations.

In defying the FTC Holder Rule, KeyBank is not alone. In March, the National Consumer Law Center’s Student Loan Borrower Assistance Project reviewed 28 private loan promissory notes it had collected and reported that it found that 40 percent of them did not include the holder notice in them at all. In addition, 90 percent of the notes that did include the notice also contained “contradictory clauses” that “undermined it in some way” — stating for example that even “if the student is dissatisfied with the school or fails to complete the course, the student must repay the note in full,” the project’s report stated.

According to Consumer lawyer Tom Domonoske, who has challenged KeyBank’s practices, the deliberate efforts by lenders to defy the FTC Holder Rule has been extremely harmful to students who have been victimized by unscrupulous schools. “Some of the students have been forced into bankruptcy, while others have been forced to refinance their debts to pay the high interest loan for which they received no benefit,” Domonoske wrote in a 2003 article in the trade journal The Consumer Advocate. “If the victims simply assert the FTC Holder Rule and refuse to pay the loan, negative information is reported to their credit that ruins their credit score.”

Despite pleas for consumer advocates, federal officials have neglected to intervene to force KeyBank and other private student loan providers to comply with the Holder rule. Until they do so, the low-income and working class students these trade schools tend to attract will remain at risk of being exploited.

Next week, we will take a look at other tactics that KeyBank and other private lenders have used to try and erode key consumer protections for borrowers. Stay tuned.