Discover Financial Services agreed to pay at least $18.5 million for allegedly cheating more than 100,000 borrowers with private student loans, the federal Consumer Financial Protection Bureau said Wednesday.
The regulator alleged that the company, one of the nation's largest banks with more than $84 billion in assets, broke the law when it overcharged borrowers, likely denied them important tax benefits, hounded them with early-morning and late-night collection calls to their cell phones, and engaged in illegal debt-collection tactics.
Discover "failed at providing the most basic functions of adequate student loan servicing," the CFPB said. Discover, which is mostly known for its credit cards, neither admitted to nor denied the allegations. Jon Drummond, a bank spokesman, declined to comment.
With more than 41 million Americans collectively owing nearly $1.4 trillion on their student loans, making it the second-largest source of household debt after home mortgages, the federal government has taken a keen interest in improving how student loan specialists interact with borrowers. About one in five borrowers is in default on their student loans, a figure policymakers fear will rise if companies such as Discover don't improve their loan servicing activities.
The federal government either insures or owns nearly 90 percent of all outstanding student debt, Education Department and Federal Reserve data show. The CFPB said borrowers with private student loans generally already have federal student loans and carry high levels of debt.
Since private student loans don't offer the same generous repayment plans and strict consumer protections as federal loans, consumer advocates and federal regulators reckon that private loan borrowers are among the nation's most vulnerable debtors. The student loan industry disagrees with that assessment.
The Discover settlement is the consumer regulator's first public enforcement action against a company accused of mistreating student loan borrowers. It comes as the CFPB considers new rules to govern student loan servicing, or the business of processing borrowers' monthly payments and counseling them on their repayment options.
The consumer regulator accused Discover of deceiving some 7,000 borrowers by overstating the minimum monthly amounts they owed nearly 30,000 times, causing some to fall behind and pay unnecessary late fees and penalties. Discover also allegedly misled more than 156,000 borrowers by falsely telling them they hadn't paid any interest on their loans, likely causing them to pay more in federal taxes because they didn't think they qualified for important tax deductions.
In addition, the CFPB accused Discover of placing more than 150,000 calls demanding payment to borrowers' cell phones at inconvenient times, such as before 8 a.m. or after 9 p.m, with many of the calls occurring before 7 a.m. More than 1,000 borrowers received dozens of such calls. Discover found out about these practices in October 2012, but didn't address it until February 2013.
The student loan industry for years has been trying to convince the Federal Communications Commission to ease restrictions on calling borrowers' cell phones, federal records show. The Education Department, backed by the White House, has repeatedly asked Congress to change the law and make it easier for student loan contractors to call borrowers' cell phones, according to federal budget documents.
Discover also failed to provide 252 borrowers in default on their debts with basic information, such as details about the amount owed, the source of the debt, and the borrower's right to contest its validity. The CFPB accused Discover of violating the Fair Debt Collection Practices Act.
"Discover created student debt stress for borrowers by inflating their bills and misleading them about important benefits,” said Richard Cordray, the consumer bureau's director. “Illegal servicing and debt collection practices add insult to injury for borrowers struggling to pay back their loans."
Many of Discover's allegedly illegal practices concerned loans it acquired beginning in 2010 from Citigroup, the nation's third-largest bank with more than $1.8 trillion in assets. Discover "maintained many of Citibank's procedures and policies for servicing the acquired loans," the CFPB alleged, referencing Citi's banking unit. The allegation raises questions over whether Citi also will face future enforcement actions.
Mark Rodgers, a Citi spokesman, and Moira Vahey, a CFPB spokeswoman, declined to comment.
Concerns are mounting among federal policymakers that inadequate student loan servicing is causing unnecessary defaults. President Barack Obama in March ordered federal agencies to recommend new measures to improve how companies service student loans and treat borrowers.
"If a servicer like Discover can't even correctly disclose basic information, it raises serious concerns about the industry overall being able to perform the complex hands-on work of helping distressed borrowers," said Maura Dundon, a former regulator at the Federal Trade Commission who now serves as senior policy counsel at the Center for Responsible Lending.
The CFPB ordered Discover to pay a $2.5 million fine. The company also agreed to pay borrowers at least $16 million in restitution.
About 5,200 borrowers will have their student loan accounts credited up to $500. Roughly 130,000 borrowers will either receive up to $300 reimbursement for tax preparation costs, or have free tax services provided, as a result of filing amended tax returns due to Discover's faulty practices. Some 5,000 borrowers will have their accounts credited up to $142 for inconvenient collection calls.
The company is one of the nation's largest lenders of private student loans, with nearly $9 billion in non-government backed student debt balances on its books, according to its latest quarterly report filed with the Securities and Exchange Commission. The company values a portion of that debt, which it acquired from other lenders, at about 92 cents on the dollar.
Discover warned its investors in April that it expected the CFPB's enforcement action, and first disclosed the investigation in February 2014. The CFPB said last October its examiners had found many of the unfair practices the agency on Wednesday accused Discover of engaging in.
CFPB enforcement actions against banks, like in Discover's case, typically include parallel proceedings by the lender's banking regulators, such as the Office of the Comptroller of the Currency, Federal Reserve or Federal Deposit Insurance Corp. It's unclear why other regulators didn't join the CFPB's settlement with Discover.
The regulator's settlement with Discover didn't require the company to admit wrongdoing. Sen. Elizabeth Warren (D-Mass.), who conceived of and helped create the consumer bureau, has criticized other federal financial regulators for not requiring companies to admit misconduct when settling accusations they cheated households. In response, the CFPB said its settlement will result in improvements in Discover's practices.