Privacy Rights Remain an Issue in California

A recent court decision in California has left mortgage servicers scrambling to understand the state's financial information privacy act, according to attorneys who spoke at the Western States Loan Servicing Conference here.

On July 30, the United States District Court for the Eastern District of California ruled that the national Fair Credit Reporting Act and the FACT Act do not pre-empt California's own privacy act, known as SB-1, which became effective on July 1.

Joseph Lynyak, an attorney with ReedSmith in Los Angeles, said the plaintiffs have said they will appeal the decision, but they have elected not to request an injunction against enforcement of the requirements of the California law while the appeal is in motion.

In a report about the court case, Mr. Lynyak and his colleagues at ReedSmith said the court decision caught financial intermediaries off guard, many of whom believed that SB-1 was "clearly pre-empted by the FCRA."

That leaves companies in a quandary, since the California law is more restrictive regarding the transfer of data than the federal law. The court ruled that SB-1 is not a credit reporting statute, but rather a privacy statute, and therefore not pre-empted, Mr. Lynyak said at the conference.

When working with third parties, lenders will have to ensure that contractual arrangements protect data, and they will probably face a higher due diligence burden with regard to data management, he said.

"What you also have to do as a loan servicer is think about, 'Do I really own this data?'" he said during the servicing conference, which was hosted by the California Mortgage Bankers Association.

Under the California law, consumers must "opt in" to any program that shares "nonpublic personal information" with unaffiliated third-party companies.

Among affiliated companies, the California law provides that a disclosure must first be provided to the consumer and the consumer must be allowed to "opt out" from sharing of personal data among affiliates.

However, the law does allow exceptions if the information is needed to administer or enforce a transaction requested or authorized by the consumer, or in connection with servicing or processing a financial product. Exceptions also cover secondary market sales and the sale of servicing rights.

Joint marketing efforts are also covered by a partial exception. And lenders can market materials on behalf of another company to their clients, as long as the lender controls the customer data throughout the process.

Mr. Lynyak said this "do it yourself" arrangement may become the rule of thumb for marketing programs.

The issue of federal pre-emption of state laws has created a tension in Washington, Mr. Lynyak said, in reference to efforts to pre-empt a myriad of state and local predatory lending laws. Tradit-ionally, Republicans have backed states rights, but now they are in the uncomfortable position of having their business allies lobbying for laws that would pre-empt local lending regulations. Democrats, traditionally more supportive of federal pre-emption, don't want to weaken state consumer protections.

"Right now, it's difficult to get anybody to give us a fair audience," Mr. Lynyak said.

As Congress debates the possibility of a national lending statute that pre-empts state and local rules, the lending industry should understand that any such statute will cover loan-servicing activities, he added.

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